A critical analysis of the misuse of the venture capital company regime

Abstract

In the economy of South Africa there is room for the promotion of entrepreneurship, mechanisms that will decrease unemployment and inequality, and to increase access to finance. One mechanism that can be used to promote entrepreneurship, decrease unemployment, and increase the access to finance is to promote the growth of SMMEs. However, SMMEs often have a high risk attached to the investment due to the failure of new start-ups. The VCC incentive was enacted to address the above-mentioned risks and promote the growth of SMMEs. The three objectives of the VCC regime were first, to increase access to equity financing and supportive managerial services; second, to create a pooling mechanism for investors to reduce the risk of investing in SMMEs; and third, to develop growth in SMMEs and use that as a mechanism to decrease unemployment and inequality. Thus, it should be considered why the incentive did not meet its objectives. The primary objective of this research was to identify aspects in the design of the legislation of the VCC incentive which made it susceptible to misuse. First, an analysis was performed of the historical development of the VCC incentive to determine what the objectives of the VCC regime were. In the second place, a critical analysis was performed to identify which aspects of the design of the VCC incentive made it susceptible to misuse. The VCC incentive was measured against the following three criteria: instrument choice, qualifying criteria of the tax incentive, and administration and monitoring requirements. According to the findings in this study it could be concluded that it was not clear what the outcomes of the investments were and therefore it fell short in its expected deliverables of creating employment and promoting growth of SMMEs. The qualifying criteria for the qualifying investee company could have been better targeted. The form, instrument choice, and targeting structure of the incentive drew the investments to capital intensive industries that would not have decreased unemployment. In the last place, the policy uncertainty and complex requirements and regulations were difficult to monitor and administer which made the incentive susceptible to misuse. In this research there are several principles that could be considered when an incentive is designed by the National Treasury that will increase the access to finance for SMMEs and which can be used as a mechanism to decrease unemployment and inequality. The principles that must

be considered when designing an incentive could also be used to mitigate the risk of the incentive being misused and to bring the incentive closer to its intended deliverables.