Venture capital (VC) presents an attractive value proposition for funding the development of green economy projects and, coupled with entrepreneurship at grassroot economic level, has unlimited potential to create financial inclusivity, National Empowerment Fund (NEF) senior investment associate Mduduzi Dlamini said on Wednesday.
Speaking at Sustainability Week’s Sustainable Energy seminar, in Pretoria, he noted that, depending on a project’s degree of development, VC was often a more favourable funding source than debt, as venture capitalists offered “patient capital”, were less risk-averse than other funders and were more likely to adopt a longer-term exit strategy.
VC funding was largely provided by individual or institutional equity investors that managed start-up or early-stage equity investments and provided seed capital for business concept research, evaluation and development.
“Early-stage projects take longer to generate cash flows and, therefore, typically require ‘patient capital’ for execution. [VC] is thus a very important source of funding for start-ups that do not have access to capital markets. It typically entails high risk for the VC investor, but has the potential for above-average returns,” commented Dlamini.
Elaborating on the advantages of this form of development finance to the borrower, he said VC provided more “cash in hand” for growth, as it often provided a flexible and extended repayment period.
In addition, investors only realised their investment if the business performed well and, if it failed, there was “usually” no obligation by the borrower to repay the investment.
“VC also seldom requires the provision of [collateral] or security of investment, while active involvement from an equity partner could increase growth and returns for all stakeholders, as the investor has a vested interest in the business’ success,” Dlamini explained.
No single fund manager type currently dominated the VC asset class, as the South African VC market was at an early growth stage and comprised a “very small” part of the broader private equity (PE) industry.
However, while the local VC market was relatively underdeveloped compared with those in the US and Europe, it was fast becoming the preferred form of investment for new market entrants with projected future escalation.
Attracted by “exceptional” growth opportunities that required substantial funding, he added that VC and PE investors were currently shifting their focus from traditional VC and PE-favoured destination countries towards emerging States.
He cautioned, however, that this form of finance was not without challenges, adding that existing exchange control regulations were the greatest impediment to growing the VC asset class.
“Because exchange controls obstruct the mobility of money and intellectual property (IP), it hampers the internationalisation of locally developed IP, making it virtually impossible to take local innovations to new high–growth markets – the crux of the VC fund manager's role,” Lamina said.
He added that the lack of public-funded IP was also a drawback for the development of the VC industry.
Nongovernmental VC investors accounted for more than 65% of all transactions recorded, but these private fund managers made little mention of local science councils – such as Mintek and the Council for Scientific and Industrial Research – and universities as a base for transactions.
“The VC industry desperately needs a closer relationship with science councils and universities – that receive public funding to develop IP – and the agencies' funders, which, in South Africa, is predominantly government,” stated Lamina.
“The perceived lack of mechanisms for public–private engagement and the number of innovations available for investment from publicly funded research institutions may be to blame. Further, the absence of transactions by private VC fund managers involving public funded institutions, is a great concern,” he remarked.