Economic Growth, Entrepreneurship and Venture Capital in South Africa

 

Private Equity and Venture Capital

 Various authors, politicians and analysts as well as bureaucrats have widely proposed the
importance of venture capital as a stimulant for growth, not only in particular regions, such as Silicon Valley in the United States, but as a country as a whole (Botazzi and Da Rin, 2002). Rapidly growing entrepreneurial enterprises are viewed as important sources of innovation, employment and productivity growth, and they are thus more likely to benefit from access to finance in the form of investment. Several governments, including those of Canada, Chile, Israel and Germany, have promoted increases in their supply of venture capital in order to stimulate economic growth (Cumming and MacIntosh, 2007).
 

Venture capital is a subsector of the larger private equity investment sphere. Private equity can be loosely defined as investing in non-listed companies or business ventures. Private equity investments can occur during various stages of a business’s life cycle as indicated in Figure 1 below. The business life cycle is often referred to as the ‘J’ curve (Meyer, 2008). The name refers to the shape of the net cumulative cash position of a business throughout its ideal life cycle.

Private equity and venture capital firms have evolved towards a common organisational structure (Samila and Sorenson, 2011). Each firm has a number of investors, called limited partners, which include wealthy individuals or family offices, college endowment funds, institutional investors, pension funds and insurance companies. The venture firm is known as the general partner, and it actively manages the funds of the limited partners, looking for attractive investments to maximise returns. In exchange for their services, the firm charges a management fee as a percentage of the funds under management, as well as a share in the profits above a certain threshold return. The general partner therefore has strong incentives to invest wisely and grow the business.
 

The impact of the private equity industry on business and economic growth has been the subject of extensive debate and academic studies over the past decade. Studies have revealed some interesting facts regarding the socio-economic impacts of private equity investments and the industry as a whole. The most complete review of the global industry has come in the form of a series of working papers sponsored by the World Economic Forum since 2007 (WEF, 2010). These papers have reviewed scholarly articles and examined the impact of private equity investments across 20 industries in 26 major nations between 1991 and 2007. 

These studies have revealed the following on a global scale:

  • Industries with private equity influence have higher growth rates of production and value add, with an average annual growth rate that is 0.906% higher than non-private-equity industries (WEF, 2010).
  •  Private equity industries are less sensitive to industry shocks. Hence, a swing from +5% to –5% (10% total difference) in aggregate growth rates translates into a swing from 5.6% to –2.4% (8% total difference) in the growth rates for private equity industries (WEF, 2010).
  •  An increase in private equity investments of 0.1% of GDP is associated with an increase in real economic growth of 0.2% for buy-outs, 0.3% for venture capital and more-so 0.96% for early - stage investments (Meyer, 2010).
  •  Private equity aids industry entry in otherwise stubborn high R&D industries, accelerating growth and development (Popov, 2009). 

Consistent with these findings is the fact that companies backed by venture capital enjoy a higher level of employment and sales growth than the average start-up (Jain and Kini, 2005; Engel & Keilbach, 2007), and consequently an expansion in the availability of venture capital stimulates macro-economic growth (Greenwood and Jovanovic, 1990; Keuschnigg, 2004).

However, even with the evidence supporting an increase in venture capital, some propose that companies who receive venture capital would receive funding from other sources in its absence.
 

Evans and Jovanovic (1989) and Blanchflower and Oswald (1998) argue that start-ups receiving venture capital do not have collateral to obtain other forms of backing or formal financing, with the odds of becoming an entrepreneur rising with household wealth. 

Therefore, a lack in early stage business financing may prevent many from starting their own businesses, which in turn hinders growth, as good ideas do not receive the necessary financial support (Keuschnigg, 2004).
 

Secondary to the support of new businesses, venture capital can create valuable spin-offs in at least two ways (Samila and Sorenson, 2011). The first is the demonstration effect: entrepreneurs confessed in interviews that they were encouraged to start their own venture upon seeing someone else do it (Sorenson and Audia, 2000). The second is that, due to the experience gained from being an employee within a venture capital backed firm, future entrepreneurs absorb the knowledge on how to design and manage their own firms.

Samila and Sorenson (2011) found empirical evidence of these effects, as they concluded that an increase in the supply of venture capital stimulates the development of new firms. Samila and Sorenson (2011) proposed that would-be entrepreneurs incorporate the availability of funds in their calculations, when they contemplate starting their own business. Samila and Sorenson (2011) also found that an increase in venture capital in a region raised the employment level as well as aggregate income.
 

The empirical findings of Samila and Sorenson (2011) were synonymous with theoretical discussions to the effect that an increase in financial intermediation improves the efficiency with which capital is allocated, and hence stimulates growth (Greenwood and Jovanovic, 1990). An important outcome of Samila and Sorenson’s (2011) empirical study was that venture capital fills a definite ‘niche’ need, in that it allocates capital to uncertain ideas and innovations, which might not be funded from formal sources, such as banks. Moreover, Samila and Sorenson (2011) concluded that venture firms provide added benefits in the form of training and expertise during the ‘incubation period’, which cannot be
sourced from informal funding sources, such as ‘angel’ investors.

Source:

University of Cape Town

By Hendrik Snyman

2012

Submitted in partial fulfilment of the requirements for the degree
Master of Commerce (Financial Management)


Supervisor: Darron West

Mozambique Doing Business - South Africa

2025

Link :  https://open.uct.ac.za/server/api/core/bitstreams/1731cfa1-9d56-4adf-8c06-0c22aecb18aa/content

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