12J investment vehicle pursues ‘conscious capitalism’

Secha Capital VCC offers SMEs growth, impact capital. Vote in the poll.

Secha Capital believes impact investing can help grow and support small- and medium-sized enterprises (SMEs), which harbour the most potential for job creation… and in so doing, generate investor returns.

The ‘patient capital impact investment holding company’ received a boost in April, when international wealth and asset management firm Caleo Capital, and “other high net worth South Africans” invested in and partnered with it, to form a 12J investment vehicle called Secha Capital VCC.

“Secha Capital VCC enables the allocation of growth, impact capital into established local SMEs in the fast-moving consumer goods and agribusiness space,” says MD Brendan Mullen. In the future, Secha Capital may raise additional 12J vehicles that focus on other job-creating sectors.

Why 12J?

The company has been structured as a 12J holding company and not as a general partnership because the 12J dovetails with Secha’s investment horizon line and focus: patient capital for established South African SMEs in sectors that create jobs. 

“In short, [12J] is a great vehicle for a patient capital impact investing,” says Mullen.

The South African Revenue Service (Sars) introduced Section 12J – a tax incentive regime – to cater for deductions in costs incurred in exchange for venture capital companies’ (VCC) shares. Sars now has 56 approved VCCs.

Section 12J increases funding to small- and medium-sized businesses.

SarsMedia tells Moneyweb that, after an initial slow uptake, interest in the VCC incentive has increased significantly.

“This is ascribed to a number of legislative amendments over the years, but in particular due to amendments as per the Taxation Laws Amendment Act (No. 43 of 2014). One of these amendments is that no recoupment take place in the hands of the investor on the sale of acquired VCC shares, if held for more than five years (effective January 1 2015).

“Various other amendments have made the tax incentive more attractive for investors, and also allows the VCCs more time to find the necessary investors. Sars believes the outcome of the incentive is positive….”

At the time of investment, investors receive an immediate tax break, which can be re-invested. As long as investment in Secha is held for at least five years, there will be no recoupment of the tax break when the investment is realised.

According to this Moneyweb article, Section 12J companies require minimum investments, generally ranging from R500 000 to R1 million (some less).

How Secha works

Caleo Capital founder and CEO Nicholas Liebmann said: “The design of our 12J is both returns- and impact-focused. Caleo and Secha will allocate investment capital into South Africa’s most promising SMEs and then the team will work with the companies to help them grow.”

Secha Capital fellow MD Rushil K Vallabh, said the platform can serve SMEs previously ignored by business, which he calls the ‘missing middle’. SME funding is most concentrated for start-ups or late-stage strategic acquisitions, hence the term ‘missing middle’. “We provide capital, management expertise and market access – solving the top three pain points of most small businesses.”

After investing growth capital into the SME, Secha employees, or external professionals, are seconded into the SME’s management team to transfer skills and knowledge.

A repeatable nine-monthaccelerator toolkit’ and ‘skills transfer playbook’ is implemented in the SME’s teams, helping it understand what they need to do and why, says Vallabh.

Secha helps the SME pick strategic initiatives they can work on, and develops a nine-month acceleration plan. After nine months (or longer), Secha steps back, taking more traditional board seats, but still helping to get the product to market.

Investment returns, incentives

Potential investors will use a standard share subscription agreement to invest. “The 12J investment process is standardised and codified. It enables a diversity of capital – from institutions, strategic investors, as well as individual retail investors. This process ensures that the average investor has access to the impact investing private equity asset class,” explains Mullen.

Secha Capital VCC won’t collect the traditional (usually 2%) management- or raising fee. “This way, the founders are not incentivised to raise more money and can instead write small, impactful cheques that ensure the long-term interests of the vehicle and the entrepreneurs are aligned.”

The entrepreneur needs to see value for Secha employees to earn their (nominal) salaries, as opposed to their automatically earning the 2%. Secha believes this decreases investor risk, while returns are boosted by ‘sweat equity’.

Traditional private equity or venture capital funds have five- to seven-year investment mandates. Secha Capital VCC offers SMEs ‘patient capital’.

“With normal private equity, for example, you’d raise R100 million or R1 billion and you’d draw down your 2% management fee, thus investors push you to show value in your business. So typically you’d look to exit between five to seven years, [or] sooner, because then your investors get their return,” Vallabh explains. 

Patient capital implies a longer-term play. SMEs “have this growth inflection point and the value’s going to come a lot later. For the investors, because we’re investing at this inflection point later on, we’re getting better valuations,” he says. When the operational companies reach full potential, growth capital is recycled. Ten years or so later, an exit with a more strategic acquisition partnership could be considered. 

Vallabh says returns upwards of 20% are expected.

Caleo invested millions of rands of its own capital and, together with its clients, will own roughly half of the 12J, says Mullen. 

 

Read: ‘Should you be looking at a tax-deductable Section 12J investment?’

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Wishing them the best of luck! South Africa needs more venture capitalists to kick-start new businesses.

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