Wednesday, May 24, 2006

SINCE 1994, the South African government has invested significant political capital in the support of small and medium-sized enterprises (SMEs). This is because SMEs are recognised as key contributors to both growth and employment, contributing 30% of the country?s gross domestic product and almost 70% of private-sector employment. Government intervention in this sector has included the provision of wholesale finance and nonfinancial support services. The 2005 and 2006 budgets have also given support to SMEs through the tax system, streamlining VAT procedures and raising qualifying tax thresholds for small businesses.

But while there is government support at the company level for SMEs, there is practically no government support for private individuals wishing to invest in small businesses. In many developed economies, private investors are able to take advantage of a range of tax incentives, including an upfront income tax deduction, tax-free dividends, capital gains tax deferral, and so on.

Such individuals may be highly sophisticated professional investors ? so-called ?business angels? ? or less sophisticated investors who prefer to invest in pooled funds managed independently by professional fund managers, as part of a long-term savings strategy. However, both types of investor contribute to the supply of equity finance to small businesses, thus filling the ?equity gap? which afflicts SMEs in many economies ? namely, the absence of risk capital at a level that is higher than ?friends and family? can provide but that is too low to attract traditional venture capital. Further, private investors (directly or through a fund manager) tend to bring much-needed management support, governance, advice and mentoring to small businesses.

In SA it is estimated that there are 37000 individuals with more than R6m in investable assets. The private-equity industry, a vibrant part of the financial system with R43bn in assets under management at the end of 2004, has seen an increasing trend towards larger transactions, a typical feature of private equity across the world. Although a small number of firms, such as Business Partners, are actively investing in small businesses, there is an equity gap in SA (especially at investment size at R5m or less) as there is elsewhere in the world. The focus on increasing the supply of debt finance (for example, through the banks? commitments under the financial sector charter) merely accentuates the need for equity finance at the SME level.

The question is this: can tax incentives help connect the potential supply of equity finance from private investors with the opportunities that exist in the SME sector, to the advantage of investors, SMEs and the economy?

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Source: Business Day (link opens in a new window)