On 4 September 2018 Statistics South Africa announced that the South African economy had slipped into recession. The country's GDP is reported to have dropped by 0,7% in the second quarter of 2018. In making the announcement,. Statistics South Africa mentioned that the finance, real estate and business services sectors increased by 1,9% and they contributed 0,4 of a percentage point to GDP while agriculture was one of the worst performing sectors during the same period.
It's often argued that, correctly so, to improve South Africa's economy and create jobs, startups and small businesses are the key. However, with each year that passes, the country's unemployment rate remains relatively unchanged as the country's economy yo-yo's in and out of recession. Part of the problems, especially for technology startups, is the inability to raise funding while incorporated in South Africa along with various legislation, which compared to other more startup friendly nations, seem to be stunting growth of startups.
Thus, what is slowly happening is that, many technology startups that go past the traction stage and start making revenue and experience accelerating growth, tend to end up incorporating their businesses in Delaware, USA especially at the request of their investors. There are many reasons why this is the case and below we take a quick look into 7 changes the South African government can consider to make it sensible to incorporate a technology company in the country and attract investment.
7 changes required for South Africa to attract tech startup VCs
1. Tax: The tax rate for companies, and especially new technology startups, would need to be dropped to 8%. This would make South Africa comparable to Delaware. Additionally, there should be no Intellectual Property (IP) exit tax because from an investor's perspective it is a huge deterrent as they incur extra taxes. There should also be a graduated personal tax rate of 6.6% or less.
2. Skills VISAs: Skills VISAs at this stage in South Africa are terrible, and the situation is not getting any better. If South Africa wants to compete globally then it is necessary to allow startups to hire global talent, without much of a hassle.
3. Labour laws: Our labour laws do not sit well with several investors and are seen globally as unfavourable to employers.
4. IP transfer: There shouldn't be a delay in transferring IP, it should be faster than it currently is and transfer of IP should be targeted to take a maximum of 2 weeks.
5. Limited liability: Laws need to be put in place to protect / shield entrepreneurs from personal liability.
6. Stock structure: The country should consider offering a flexible stock structure and make it easy to issue different classes of stock. Additionally, it should be made easier for investors to use different financial documents (like convertible notes, SAFES, warrants, subordinated debt).
7. Medical cover: Maximize medical coverage tax deductions. This will be difficult given the National Health Insurance strategy.
Some people might say the country needs to fund startups, this I consider silly. You need to keep in mind that 1% of of startups get funded and 1% of those see some form of success. The failure and risk rate is too high for government to spend money on anything but poorer citizens. It would be irresponsible South Africa's government to do so.
Having said that. matching funding of Direct Foreign Investment (DFI) into startups would be a good idea with a cap and also subject to strict due diligence, no double dipping , and ownership rules.
Cover image credit: Randy Rooibaatjie. Unsplash