Exchange control reduces FDI, job creation and GDP growth
Why reforms are urgently needed to reduce SMEs setting up shop offshore to secure venture capital
Over the past 15 years SA has lost its attractiveness for foreign direct investment (FDI) from international venture capital (VC) funders largely due to onerous exchange control legislation that is urgently in need of an overhaul.
Without foreign funding flowing into our local start-up community to help them grow their operations, we are stunting job creation — especially in the ICT sector — and reducing our SMEs’ ability to positively affect the tax base and, as a sector, meaningfully contribute to GDP.
This is nothing but an own goal. Relying on local VC to bolster high-growth businesses’ scalability only goes so far (the local venture capital market was 0.5% of the $643bn global VC market in 2021). We need the deep pockets of international investors to stimulate the SA start-up community. Yet we’re caught in a challenging Catch-22: without financial input from VCs around the world, high-growth entrepreneurs that could otherwise significantly scale are stunted, their economic impact wasted. Rather, these innovative enterprises with unicorn-status prospects set up shop offshore to escape the time-consuming, expensive and legal processes of scaling into global markets.
With all this considered, why is government holding on so tightly to existing exchange control legislation? As it stands, current regulation prevents SMEs from attracting FDI as they are unable to restructure their businesses by swapping shares in a new, offshore holding company. Instead they must secure approval from the SA Reserve Bank before undertaking a corporate restructure (via a share exchange). Adding to this challenge, the Bank does not stipulate the criteria for evaluating these requests, which makes the process extremely difficult to navigate. This further creates regulatory and timing uncertainty for investors and start-ups, resulting in many international investors walking away from potential opportunities.
Lobbying for exchange control legislation reforms is the SA StartUp Act Movement. Launched in 2014 SiMODiSA, as the StartUp Act Movement’s secretariat, has over the past nine years sought to identify legislative hurdles that hamstring SMEs’ ability to grow by engaging with the National Treasury and government, as well as other key stakeholders, on red tape issues.
Tunisia was the first on the African continent to enact a start-up act. This was followed by Nigeria and Congo, which signed theirs into law in 2022. Many African countries are in the process of doing the same and are increasingly securing international VC as a result, bolstering their SME sectors. We need to follow suit. By stunting the enactment of the law in SA we will continue losing out on FDI. The result? Many high-growth businesses will and are leaving our shores to secure the VC investment they need to take their businesses to the next level. This does no-one any favours and is why the local Startup Act Movement steering committee is tirelessly working to engage government to affect legislative change.
Since the StartUp Act Movement’s inception there have been a number of successes. For instance, in April the president announced key changes to our visa regimes that have long been a stumbling block for growing businesses. Before the reform, businesses reported time delays, cost implications and an inability to employ the required skilled workers needed to grow their operations. It also meant moving operations abroad because of difficulties with work visas, affecting much needed foreign investment into SA as well as jobs and tax revenue. This was a big win for the country and for our burgeoning start-up community.
In 2021 it also brokered a partnership with the UK-SA Tech Hub, an initiative of the UK government, which is supporting economic development through interventions that support the SA tech entrepreneur ecosystem. Policy reform is a key area in creating a thriving ecosystem and the initiative is focused on core transition areas, be it exchange control legislation, intellectual property (IP) transfers or capital gains tax legislation. UK-SA Tech Hub director Milisa Mabinza says it has been working with the StartUp Act to help address, or ultimately abolish, these legal issues with a view to putting SA high-growth entrepreneurs on the international radar.
Buoyed by that success, the StartUp Act Movement is now focused on driving the reform of exchange controls. To this end, members of the StartUp Act Movement steering committee recently met the director-general of the National Treasury, the department of small business development and the department of science & technology to motivate for the liberalisation of exchange controls to make it easier for SA start-ups to create offshore holding company structures and transfer their IP. It was a positive engagement we eagerly hope to see fruits of these efforts announced in the upcoming mini-budget and/or the 2024 state of the nation address and budget speech. Ignoring it means we will continue to see how SA law prohibits SMEs from meaningfully adding to the local economy, boosting job creation, reducing poverty and driving inclusive growth. That would be a travesty for us all.
• Modise chairs the SA Startup Act Movement, Lotz is head of regulatory affairs at the Southern African Venture Capital & Private Equity Association, and Mabinza is director of the UK-SA Tech Hub.
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