Powering up the venture economy

In the 1960s Israel was known for kibbutzes and Jaffa oranges. By 2012 the country had more companies listed on the Nasdaq than any other country outside of the US and was known as the ‘Start-up Nation’ thanks to the 2009 book of the same name.

While there are many reasons behind Israel’s success in research, development and innovation, a government-sponsored fund known as Yozma is credited with kick-starting the country’s venture capital (VC) industry, which in turn funded hundreds of start-up companies.

The initiative, which ran between 1993 and 1998, saw participating VCs each raising $12 million in private capital and teaming up with a local Israeli partner. Yozma would then provide $8 million in matching investments to those who qualified. The initiative led to more than 30 foreign-based venture capital firms setting themselves up in Israel.

Multiplier effects

While assessing the success of the programme, Olav Sorenson, a professor of management at the Yale School of Management noted that, generally, each company funded by venture capital creates an additional two to six start-ups. This, he said, was thanks to venture capital’s ‘multiplier’ effects: start-ups need suppliers; the ideas and technologies they develop may enable follow-on innovations; their employees may learn how to become entrepreneurs themselves and strike out on their own. And, last but not least, seeing one start-up succeed can inspire others to try as well.

South Africa has a VC industry. And it has government agencies – lots of them – that in one form or another are responsible for catalysing and supporting small and medium-sized enterprise (SME) development. But the VC industry is small and capital-constrained, and the government agencies have failed spectacularly in their task of catalysing a vibrant start-up and SME culture in SA.

“When it comes to our VC industry, we are so far behind the curve in terms of what best-of-breed countries like Israel, Taiwan, South Korea [and areas like] Silicon Valley are doing that it is not even a case of replicating what they are doing,” says Ketso Gordhan, CEO of the SA SME Fund, “we needed to just start the process.”

Learning from the best

With R1.24 billion to invest – a drop in the ocean when compared to VC elsewhere – Gordhan and his team studied the methods adopted by the world’s best VC nations.  

In the case of the Yozma programme, there were three key success factors, according to Sorenson: First and foremost, it supported many small independent funds rather than one large government-administered fund. Second, it did not try to pick winners. Third, it fostered relationships between Israeli and international venture capitalists.

The SA SME Fund, which was established by members of the CEO Initiative as an avenue of support for the SME sector, is applying at least the first two of these principles. It has allocated funds across the board – to six venture capital funds that operate in different areas (KNF Ventures, Grindstone, Savant and 4Di Capital; more on the other two later), an established private equity player (Pape), as well as debt funding house Spartan, among others.

And it is definitely not trying to identify winners upfront. “This is not how you grow this sector,” says Gordhan. “We are backing young, innovative businesses that are trying to get ahead. Not every business will succeed, not even one in two will succeed. We have adopted a flexible approach to funding and we aim to prove that VC makes money while growing companies and creating jobs – if we lose money it will send the wrong message.”

Fast-tracking approvals

The capital that has been allocated is already greasing the wheels of the sector. “I have been raising capital for my fund for four years,” says Zuko Kubukeli, CEO of Pape Fund Managers. “We are in the top percentile in terms of performance of private equity players, returning an internal rate of return of 32% a year. Yet it can take up to two years for government finance institutions to approve funding. It took the SA SME Fund four months to do the necessary due diligence and approve an equivalent R100 million investment into our fund. It’s ridiculous.”

Pape is a private equity player. For VC investors it is even more difficult to fund-raise, according to Justin Stanford and Keet van Zyl, managing partners at 4Di Capital and Knife Capital. “Elsewhere there is a culture of institutions placing money into VC funds,” says Stanford. “In the US VCs raise from pension funds, or university endowment funds. Often these are the anchor investors, which helps the VC to raise further funds. That piece is very much missing in SA. That is now the SA SME Fund’s role – it’s a powerful step.”

Gordhan expects the R1.24 billion fund to be fully committed by August this year. Of this, about 25% will be drawn down by August. The balance will be invested over two or three years.

Varsity innovation

But it is the other two (of the six) VC funds that are making Gordhan particularly excited. The first to be launched – possibly in May – will be a university innovation fund. Initially, the participating universities will be UCT and Stellenbosch, but the fund will be open to any of SA’s varsities, he says.

It must be said that university innovation offices are not new, but what limited them was access to ready capital. 

“We were inspired by Oxford University which in 2015 created Oxford Sciences Innovation to develop and commercialise intellectual property [IP] from the university,” says Gordhan. The fund has spun out some 43 companies since inception and now attracts funding from tech companies like Tencent and sovereign wealth funds such as Singapore’s Temasek and Oman Investment Fund.

“In 2018 Stellenbosch was the leading university in the registration of patents, followed by UCT,” says Gordhan. “In the same year, UCT applied to the Technology Innovation Agency [TIA] for seed funding on eight ideas – none were successful. 

“This is the second largest producer of IP in the country. If and when the person generating the idea gets any money from TIA they have moved on and we have lost the ability to commercialise,” he adds.

The fund will be seeded with R125 million. Of this, R25 million will fund 25 ideas. “You need a million to determine whether an idea can become a business. We hope five to six ideas will be backable.”

Gordhan hopes to attract like-minded investors to the fund.

Biotech

The second new fund will be a biotechnology fund, to be launched by July.

This sector is ripe for development as no biotech-specific funds currently exist. SA’s first biotech fund, Bioventures, was launched in 2000. According to a research paper on the subject, the fund enjoyed modest success. Of its eight investments, two failed, two returned their initial investment, three returned between two and three times, and one returned between five and seven times. This represents a solid but not spectacular return – proof of concept that it is possible to do life sciences investments in South Africa and make money.

“There is no cookie-cutter approach to venture capital and SME development,” says Van Zyl. “What SA SME is doing is backing different funds and funding models, and getting out of the way. They are flexible and creative in their approach. That in itself is a first in South Africa.”