As there are more than 180 Section 12J venture capital companies which have been registered with SARS, each offering at least five underlying investments, it’s become increasingly difficult for investors to determine which one should be selected.
A 12J investment is available to individuals, companies and trusts and is 100% tax deductible in the year of investment, thereby boosting investment returns and providing downside protection.
As a result of the attractiveness of this tax break, the 12J industry has raised more than R8 billion of investor capital to date and has started to make a meaningful impact to the growth of SMMEs and job creation across the country, which in turn results in an increase in the direct and indirect taxes received by the fiscus.
According to the 12J Association of South Africa, a high-level survey conducted by PwC in 2019 indicated that its member base (comprising approximately R5.7 billion of 12J capital raised) has the potential to create approximately 27,000 jobs (direct, indirect and inferred).
12J investments are increasingly being promoted as viable alternatives to other tax incentive driven investments such as retirement annuity (RA) contributions and tax-free savings accounts.
A 12J investment is no different to any private investment. Investing in, managing and exiting private investments requires certain key considerations. Westbrooke Alternative Asset Management recommends that you ask the following questions:
1. What is the underlying fund investment strategy and mandate? When considering a potential private investment, consider the tax benefit to be an added bonus and rather focus on the merits of the underlying investment strategy, the industry of investment, key trends and themes. This should be governed by the mandate of the fund.
2. Who is managing my investment and how much experience do they have in making, managing and exiting private investments? Prior to investing, perform a thorough analysis of your investment manager and the depth of the investment team; including their experience in finding, making, managing and exiting investments, how successful they have been in previous investments and what other investment products they offer. Also consider their reputation, stability and the degree to which they are trusted custodians of third-party capital.
3. Does my 12J manager have ‘skin in the game’? A great way to ensure that you and your investment manager are aligned is to assess whether and to what degree they have invested their own capital alongside yours.
4. How does my 12J manager plan to fund their business if 12J is not extended in June 2021? 12J is subject to a ‘sunset clause’ so no new investors can claim a 12J tax deduction after June 2021. Despite this, 12J funds created prior to this date still need to manage their funds for the minimum 5-year investment term and exit the investments thereafter. Consider the scale and depth of your fund manager’s business and shareholders, as well as how they plan to fund their operations should they not be able to raise further 12J capital. This is an especially important consideration when assessing those fund managers that have funded their businesses through up-front fees.
5. Is my manager able to reach scale in their underlying funds? Following amendments to 12J in 2019, the maximum annual 12J investment is R2.5 million for individuals and trusts and R5 million for corporates (previously uncapped). According to the South African Venture Capital and Private Equity Association (SAVCA), the minimum size for a viable, sustainable 12J fund is R200m which would need to be raised from a spread of a minimum of 80 investors. Ask your manager for information regarding its track record in raising scalable funds, as well as how they plan to continue to achieve scale in the context of the new investment cap. Another important consideration is whether your manager, having reached scale, has the depth of team and skills required to invest capital raised in opportunities that meet the risk / return requirements of the 12J fund mandate.
6. What is the fund exit strategy? To generate the cash required to exit your investment at the end of the minimum 5-year investment term, your manager will typically be required to find a suitable buyer for their investments. Ask your manager about their exit strategy and understand the likelihood of this successfully taking place.
7. What governance structures are in place to protect investors? Following a number of corporate failures in the past few years, the quality of corporate governance has become an increasingly important theme when making investments. 12J companies are required to be SARS and Financial Sector Conduct Authority (FSCA) accredited, but good fund managers should incorporate additional mechanisms to protect investors. These include a robust and tested investment process, an independent and suitably skilled and experienced board of directors, an annual independent audit, use of an independent administrator, the obtaining of relevant tax opinions where necessary and adequate periodic investor reporting.
8. Is my 12J manager’s fee structure aligned to performance? Another way to ensure alignment between you and your 12J manager is to assess whether their fee structure is aligned to performance. Generally, a fee structure that is weighted to the back-end and which will only be charged upon a successful exit for investors is aligned to investors’ requirements.
Wealth managers and independent financial advisors have become increasingly knowledgeable regarding tax incentive investing. Investors should make use of these tips in conjunction with the advice of an experienced wealth manager or advisor to make the most appropriate 12J investment decision for their specific circumstances prior to the end of the February 2020 tax year.
Dino Zuccollo is chair of the 12J Industry Association of South Africa and principal at Westbrooke Alternative Asset Management. Views expressed are his own.