Developing a framework for the early exit of venture capital investment in South Africa

Abstract

This study sought to develop a framework that facilitates the early exit for Venture Capital (VC) investment in South Africa (SA), and to outline feasible strategies in the framework that would yield optimum results, drawing examples from the USA and the BRICS+ bloc founding members, where Venture Capital activities are yielding significant returns. Despite the increase of activities in the sector, exit performance in SA remains an issue stifling the industry's progress, due to an unfriendly regulatory environment hamstringing the flow of funds into the industry. To analyse this problem, an explanatory sequential mixed methods research was adopted with the aid of surveys completed by 203 VC industry participants. Survey responses were analysed using exploratory factor analysis and descriptive statistics to identify the factors impacting VC performance and exit in SA. This was followed by in-depth interviews with 11 industry experts, who provided valuable insights, and contextualised the quantitative results. The findings indicate that economic and financing environment, deal-sourcing, business performance, and regulatory environment are critical factors impacting VC performance and exit rate in SA, in addition to the acute lack of institutional funding vehicles, lack of incentives, unfriendly regulatory practices such as exchange control, IP controls, and labour regulations, which deter investment into the industry. Further findings revealed that VCs are positioning their investees outside SA so that they are not affected by the unfavourable SA economic and political environments. Funding is conservative and often allocated to expansion rather than early-stages, as VCs are risk-averse and hesitant to finance earlystages in dire need of funds. Nevertheless, the study observes an average exit duration of approximately 8 years, with an average exit return of 15.12% (IRR), despite the challenges. Superior innovative technology drives investment into SA. Exits are mostly opportunistic and predominantly mergers and acquisitions (M&As) and trade sales, as large corporates are acquiring technology that is disruptive to their operations. To facilitate early exits and improve VC performance, the study proposes a Public Private Partnership Arrangement (PPPA) between the VC practitioners, the government, and other industry facilitators (e.g. SAVCA, SiMODiSA and AVCA) to co-create an enabling regulatory environment that ensures policy reforms that attract investors; put in place institutional funding vehicles, a structured capital market, early-stage funding drives in innovative technology, and foster alliances with trade blocs such as SADC, AU, and BRICS+ to position SA as a competitive global player in the VC market. Recommendations for further study include an examination of the effectiveness of Startup Acts in building resilient VC ecosystems, and an assessment of the challenges of the private equity market in South Africa.