Pension funds, venture capital and seizing the moment
There is a glaring chasm between SA’s pension fund industry and our nascent venture capital sector. We were reminded that there is much work to be done to create a healthy financial ecosystem that supports start-ups and small businesses at the recent SA Venture Capital & Private Equity Association (Savca) annual conference in Stellenbosch.
Last year was the fifth year running when more than R1bn was invested into start-up companies by early-stage fund managers in the Southern African venture capital (VC) asset class. However, the value of deals done in 2022 contracted by 14.5% (to R1.12bn from R1.31bn in 2021) and is down 19.4% from the 2020 record of R1.39bn invested.
We believe SA’s retirement industry, with assets estimated to be worth at least R5-trillion, is critical to building a supporting framework for the inflow of funds into the venture capital sector. But instead of an enabling ecosystem where symbiotic relationships produce benefits for all parties, the disconnect between our venture capital industry and pension fund industry means start-ups are missing out on the opportunity of their lifetime.
Let the funds flow
Our pension fund industry has historically shied away from allocating funds to start-ups, largely because they are regarded as inherently risky business ventures. However, in developed markets, venture capital funding forms an important part in pension fund allocations.
The success of some of the biggest and well-known global firms today, such as Apple, Facebook, Tesla, and Spotify, can be ascribed to venture capital investments with the backing by the US retirement industry. Estimates suggest that public pension funds contribute at least 65% of the capital in the US venture capital market, 18% in Europe and 12% in the UK.
To tap pension fund allocations as venture capital in SA you need to work through the SA SME Fund, which invests in funds that support entrepreneurs. Though our pension funds have been allowed to invest up to 15% of their assets in “alternative investments” for the last few years, the uptake has been painfully slow. Allocations to alternative investments, including venture capital, are now below 2%.
It’s noticeable that we have not seen an initial public offering on the JSE in a long time. With delistings taking place at an alarming rate, major financial institutions are starting to look more at venture capital as an investment class, but we need an enabling ecosystem, stronger commitment to collaborate among industry players, and an environment that supports the inflow of funds into the venture capital sector.
The venture capital industry should be a stepping stone for small, micro, and medium enterprises (SMMEs) that could eventually become listed entities. And while the Cape Town Stock Exchange is supporting SMMEs with market caps of R25m to R2bn, we believe there is a much greater role for other financial services sector players.
Missing a beat
At the past three Savca annual conferences we’ve seen a repeat of the same narrative: if venture capital firms showed good track records and exits, then the pension fund industry would be more willing to invest funds in venture capital. But there are venture capital firms that have done — and are doing — just that.
In 2020, with our corporate partners, we invested almost R200m into 14 investee companies. These start-ups provided their corporate investors with strong transformation prowess, a promising model for attractive returns while prioritising transformation beyond BEE scorecard requirements.
To date we have six exits, namely Zulzi, LBB Foods, Red Baron Tomatoes, Quench, Lipa and Cycad. Our average holding was 18 months and the average returns on our exits were about 2.8 times what we invested. And we know we are not the only venture capital firm that is securing these stellar returns.
Underweight and under-loved
Though the industry is worth trillions of rand of capital, the way pension funds invest does not contribute to economic growth. An Econstor study showed that accumulated pension funds have no significant effect on the overall investment level and economic growth in the SA economy. The study recommends that policymakers and the pension funds regulators come up with workable means by which pension funds can be invested to significantly benefit the economy.
Essentially, venture capital as an asset class for investors here is underweight by portfolio composition, while pension funds are either investing internationally or ignoring the gains in the local venture capital sector. Fund mandates need to catch up with allocations, and pension funds and managers need to review their fund mandates as well.
If venture capital and pension fund players moved closer together to collaborate for the growth of start-ups while ensuring sound governance, then we believe they could unlock the opportunity of this moment.
We aren’t calling for the irresponsible raiding of the hard-earned money of citizens, but that we take our lessons from the Springboks and be more strategic in working together to ensure that the generation that is going to retire in 20 or 30 years will have enough to set up future generations for success.
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