Globally, 2022 has been a year of economic turmoil, with continued supply chain issues, energy supply issues and talk of recession; even big tech has seen company valuations plummeting with many jobs being shed.
Given all that negative economic sentiment, what has been happening in the South Africa venture capital (VC) and start-up sector? To get a picture of the highlights and key issues, ITWeb spoke to a panel of local venture capitalists.
“It hasn’t really been much of a highlights year with the market correction that’s been taking place,” says Justin Stanford, co-founding general partner at 4Di Capital.
“There's been quite a bit of doom and gloom going around the venture capital markets globally.”
Locally, however, he’s seen resilience in the African VC ecosystem. “Despite the global correction, we’re still seeing funding activity taking place. I think the fact we’re a smaller player in the global picture, there’s still room to grow, even in a market that's under pressure.”
Gideon Greaves, MD of CV VC Africa agrees. He says that while the VC market globally is experiencing a downturn, specifically in the developed markets, “Africa is up”.
“It's the only market where venture capital is still growing since the macroeconomic side of things started to look negative. Africa does have a lower base, but we've also seen that there's an influx of new funding coming into the market, with the likes of Sequoia Capital, Andreessen Horowitz, Tiger Global, all entering the market for the first time in the last 18 months,” says Greaves.
When it comes to our own local economy, which is seeing slow post-pandemic recovery and rising inflation, this doesn’t necessarily translate in the VC world, says Stephan J Lamprecht, the independent research partner for The Southern African Venture Capital and Private Equity Association. “If you look at the last three or four years, what we’re seeing in terms of investment activity in South Africa does not track what's happening in the economy.
“The VC sector in South Africa, to some extent, has been an outlier. It might all be depressing on the economic side, but in the VC side, people have found deals,” he says.
While there’s undoubted local positivity, Keet van Zyl, co-founder and partner, Knife Capital says the global economic outlook is influencing South African start-up valuations and deals being made.
“Valuations are more difficult to achieve, especially outsized valuations for start-ups, because multiples are down, the markets are down; however, it's just a system phase. It's debatable whether, in the start-up industry, it’s a market correction or if it was a little bit heated. Many start-ups have raised bridge (funding) rounds, with a view to do a (full) raise next year.”
Fabian Whate, head of Naspers Foundry, says 2022 has been a tough year, especially when compared to 2021.
“I think in South Africa last year (2021), funding was up three times versus the prior year. In contrast, this year, funding is likely to be half of last year’s, so there are fewer businesses being funded and investors have become a lot more selective.”
He says the lack of capital is raising the bar and is resulting in more strict pre-investment vetting.
“In 2021, a lot of fundraising rounds were happening kind of fast and loose. That wasn’t the case in 2022, investors are now doing deep due diligence on everything and fundraising is taking longer. If you could have done it in three months in 2021, in 2022 it’s closer to six months to close out a fundraise with an investor.”
Clive Butkow, CEO of Kalon Venture Partners, agrees that the days of quick pre-investment audits are gone. He also thinks there’s a need for start-ups to undertake some belt-tightening to weather the economic uncertainty ahead.
He says there are a couple of states for start-ups to be in during a downturn, the first is “default dead”, where entrepreneurs, who had been expecting repeat funding rounds in future will struggle to find new rounds and the start-up is too far from breakeven point for sustainability. The idea, he believes, is to get to breakeven status without focusing so significantly on growth.
“You need to get to a state that you can get free cash flow. If you need to turn your business, you might have to cut costs. But number one focus is to get to ‘default alive’, so if your business doesn't raise more capital, you can actually be free cash flow positive, and you can run the business.”
He says, he’s already seeing some companies “hit the wall” and expects this to be a continuing trend into 2023, especially those default dead which are burning through capital too quickly.
While the Section 12J income tax incentive that encouraged private investment from high net worth individuals into venture capital ended in 2021, it has still played a part in the VC space in 2022.
“There was a spurt of funding into 12J funds because it came to an end, and it then takes 24 months or so to deploy all that capital,” says Van Zyl.
“A lot of the people that benefited from 12J now have to mature those investments because they've got a five-year rolling window in which to work with that money before, in line with the incentives, they have to return it,” says Lamprecht.
Amendments to Regulation 28 of the Pension Fund Act were introduced this year, which regulates how pension funds are allowed to invest. While this relates more to private equity, it is expected to filter through to venture capital, although the impact won’t be immediate.
Asked whether it will rebalance the funding gap left by 12J, Van Zyl says: “It may, in time, perhaps a couple of years. It’s not going to immediately self-correct; nothing has filled the venture capital hole that 12J has left yet.”
Regulation 28 will hopefully encourage investment from the more traditional finance houses, and there are already signs that institutional investors are coming into the VC space, as Van Zyl’s Knife Capital has secured funding from Mineworkers Investment Company and Standard Bank, among others, in the past two years.
Van Zyl says: “Historically, it has been difficult for South African venture funds to raise institutional capital. Also, we sort of fit into a middle zone of a country where the development funding institutions are more interested in developing East and West Africa.”
This development finance has helped other African markets leapfrog South Africa. Whate says Kenyan and Nigerian start-ups are both expected to raise at least $1 billion this year, while South African funds and start-ups will raise about $500 million. He also attributes the growth of these markets to the encouragement of governments in these markets through frameworks and legislations, and even funding.
South Africa does have the SA SME fund, which is backed in part by the Public Investment Corporation, as well as listed local businesses. It has continued to raise funds, and, says Lamprecht, “is quite active in the industry, in terms of supporting fund managers. It has fund manager development programmes, in terms of transformation and bringing on new fund managers.”
Progress is being made in growing the industry. And while the global outlook isn’t overly positive, the local one, it seems, is, with international investors seeking returns from the growing African market.
Start-ups, especially in South Africa, are however going to have to work harder to convince investors to back them, as the money that is available will be seeking out only the best investments.