How do Section 12J VCCs mitigate risk when investing?

To protect South African investors Section 12J Venture Capital Companies, (VCC’s) are highly regulated and require licenses from both the South African Revenue Service and Financial Services Board.

When assessing section 12J funds to invest in, conducting a high level due diligence on the VCC is a necessary step for potential investors. Investors looking to invest into a Section 12J company, should ensure they are investing in a reputable and experienced VCC, with the appropriate skills and experience to invest in and build companies into assets of value that can be sold in the future.

Early stage investments typically are seen as riskier than later stage, that being said, early stage investments have the ability to return higher than average returns and sometimes large multiples of the invested capital. In fact, the Section 12 J legislation was implemented as a result of its great success in the United Kingdom through their Venture Capital Trusts. Section 12J structures are similar to the structures implemented in the UK to stimulate the economy and propel economic growth through job creation and company growth.

In order to mitigate risk, the requirements for a Section 12J registered VCC are as follows:

The company must satisfy the following requirements by the end of each year of assessment after the expiry of 36 months from the first date of issue of Venture Capital Shares:

A minimum of 80% of the expenditure incurred by the VCC to acquire assets must be for qualifying shares, and each investee company must, immediately after the issuing of the qualifying shares, hold assets with a book value not exceeding:

1. R500 million in any junior mining company; or
2. R50 million in any other qualifying company

The expenditure incurred by the VCC to acquire qualifying shares in any one qualifying company must not exceed 20% of the total capital raised.

In addition, the VCCs qualifying shares must be acquired from companies operating in South Africa within the permitted industries and sectors.

The legislation also prescribes that no single investor can hold more than 20% of the issued share capital of any venture capital company, and that the entity itself may not hold more than 69.9% in any underlying company. These have been put in place to mitigate against some of the risks of investing in unlisted businesses in their early growth stages.

The minimum investment amount is to be decided on by the individual funds, e.g. The minimum amount to invest in Kalon Venture Partners digital technology fund is R100 000.
However, investors should be aware of looking for venture capital companies that have demonstrated a track record of returns.
As always, it is vital to understand what you are buying, as well as the risk-return profile that you can expect.