MATSI MODISE: Closing the SME funding gap can attract foreign investment and boost the NDP

The National Development Plan (NDP) has an admirable vision for SA, seeking economic growth and a fall in unemployment in 10-year cycles, broken into shorter interim cycles. This vision for the country is great, but unfortunately the NDP has thus far missed all its targets. Growth in 2023 was less than 4%, while unemployment — supposed to drop to 6% by 2030 in terms of the NDP — instead shot up to 32% officially in 2023.

One area the NDP gets right is that the SME sector must grow, a lot, to make even a dent in the plan’s targets. SA has a gold mine of untapped small business acumen. The reason this remains largely untapped is the lack of SME funding compared to the funding opportunities in the country. This is known as the “funding gap”. The good news is that this gap can be closed quite quickly by changing a few things.

If SMEs are the engine of the SA economy, funding is the lifeblood of the SME sector. SMEs can be loosely grouped into three categories: start-ups that need funding to get going; existing businesses that need finance for operations; and those that need funding to grow to the next level.

Start-ups are risky to invest in. Many start-ups will fail, but some will grow and build the economy and create jobs. The initial funding of start-ups is mostly done by venture capitalists (VCs), who will fund a new venture in return for a share of the future business. VCs are always looking for opportunities, but they need space to move.

If it becomes too onerous to invest in SA start-ups, Nigeria or Kenya also have great investment opportunities, perhaps with fewer obstacles. Kenya is now finalising a bill to make the country more attractive for investment in start-ups, while Nigeria recently introduced similar legislation.

After the start-up phase the number of VCs will increase as the investment risk decreases. They will take the SME through its risky first steps to market stability, further development, growth, and even to go public. VCs make the creation of businesses possible, but are also a vital component in helping those businesses survive and grow. Because they trade finance for equity, VCs will often bring business or technical expertise to the SMEs they invest in.

Starkly, VC investment in Africa fell by almost 50% in 2023, as it did in emerging markets as a whole. This global drop in VC activity is a hangover of the supply chain and high inflation/interest rate landscape after Covid-19. Though the US economy is now resilient and conditions for VCs are improving, emerging markets tend to lag by about two quarters. More work can be done on the African continent to enhance the policy environment and direct public sector resources towards bridging the VC investment gap on the continent.

To illustrate this point, one of our key strategic partners, Milisa Mabinza, director of the UK-SA Tech Hub, believes development support within the start-up ecosystem can serve as a mechanism to derisk start-up investments in SA, which will in turn attract investment, facilitate relational capital and bridge the gap between investors and founders locally. This is illustrated by the work the UK government has done through the UK-SA Tech Hub in facilitating R44m in equity and grant funding for SA start-ups through development support initiatives designed to address the funding gap.

Increased development support and collaboration with the SA government can create a more enabling fundraising environment for local founders. It is for this reason that policy reform initiatives such as the Startup Act Movement, which aid in engaging local policymakers and development institutions, can facilitate start-up support in this area. This would drive VCs to hunt for undervalued opportunities. SA must get its share of the incoming VC boom to even remotely meet the high-bar NDP targets — and it could, if we can remove the obstacles.

Exchange controls are onerous and should be amended. SA has a highly developed set of exchange control regulations, but these are often difficult to navigate and time consuming to overcome. Cross-border exchange approval takes time, and money can often not move without prior approval. This is meant to protect the currency, but instead impedes business and investment. If a VC has to choose between two similar investment opportunities, it will always choose the one in which doing business is more efficient.

Exchange controls make it difficult to declare dividends, pay foreign loans or interest on loans, pay royalties or service fees. Trade debtors are also left in the lurch. Business is increasingly global, yet our exchange controls are still very parochial. It would be possible to amend exchange controls specifically to smooth the road for VCs.

Work permits are another obstacle. Businesses, not only start-ups, find it difficult to bring in skills not available here. The reasons are myriad, and many are well meaning, but if the lack of skills hinders economic growth and job creation these policies need be urgently reconsidered. It is encouraging that the president addressed this issue of visa reforms in the April 2023 Investment Conference, and we await next steps on this policy update.

The department of home affairs is a particular speed bump on the investment highway. There is huge backlog in 90-day visas. This affects the important tourism sector in general, but particularly the investment landscape. Investors will more often invest in places they know. SA has a huge contingent of swallows — wealthy northern hemisphere visitors who come here for our summer to escape their winter.

These tourists often spot great local investment opportunities and are important investors here, but home affairs stipulated that given the backlog in issuing visas, swallows on 90-day visas will have to leave the country by February 29 unless they were able to renew their visas by January 23.

Of course, VC is not the only way to fund SMEs in SA. Alternative funding, which does not place a debt burden on SMEs, offers great funding opportunities to start-ups and SMEs that are not quite yet in the formal sector.

Modise is vice-chair of SiMODiSA. This article was co-written by the StartUp Act steering committee.