Section 12J: Questions you should be asking the fund manager

*Content provided by 12Cape

The final opportunity to invest in a Section 12J Venture Capital Company (“VCC”) and claim the attractive tax deduction is ending on 30 June 2021. This has led to a flurry of marketing activity by the industry to secure investments for the last time. This can be highly confusing for investors, especially those investing in a VCC for the first time.

As part of your pre-investment due diligence, we suggest that you ask a VCC fund manager the following questions before investing in any fund. 12Cape provides its answers for context.

  1. What institutional fund management experience do you have? In other words, do you have a history of managing other people’s money before Section 12J?

12Cape’s executive directors have over 30 years of fund management experience and its board over 60 years. Our core team, unchanged since inception, also has a track record of building great businesses.

Many VCC managers are entrepreneurs that see Section 12J as an opportunity to raise funding but have never been custodians of, nor managed investor capital.

  1. Has your investment mandate or strategy changed since inception?

In longer term businesses, consistency in process and strategy is critical. 12Cape’s investment strategy has not changed since its inception 4 years ago despite recent changes to Section 12J rules and the Covid-19 pandemic. A review of our quarterly investor letters confirms this. If anything, we are more convinced of our strategy today than ever before and our Aparthotel’s occupancy statistics during the 2020-year bears testimony to this.

Some VCC’s promote a strategy that might attract investors in one year, only to pitch something completely different the next. You cannot build long-term durable businesses in that way.

  1. Do you own any operating assets and how did these assets perform in 2020?

Yes, 12Cape has deployed 100% of its capital into operating assets. Its flagship asset, the Latitude Aparthotel in Sea Point, has been operational since November 2019. Despite Covid-19 and the lockdown it had an average occupancy of 72% from January to December 2020 confirming our belief in our strategy and the quality of the asset.

  1. Are the assets / businesses you are investing in being acquired from non-related bona fide sellers?

Yes, 12Cape purchases its assets on an arm’s-length basis and no 12Cape director has any personal interest in the transactions.

In instances where VCC’s apply investor capital to purchase assets from sellers with a personal financial interest in the VCC, ensure that the transfer price is not inflated. In instances where sellers or VCC managers have a personal interest in a service provider providing services to those assets, like the hotel operator, understand how they manage these obvious conflicts of interest.

  1. Does the VCC comply with Section 12J rules, and how can you confirm this?

As of today, 12Cape is already compliant with Section 12J rules (note that costly penalties are imposed should a VCC not comply). A well-known legal firm recently confirmed this in a 32-page due diligence report conducted on behalf of one of South Africa’s top wealth managers. We have scheduled another review later this year to ensure continued compliance.

  1. Does your VCC already have sufficient capital to be sustainable, or are you relying on this final capital raise to reach that sustainability threshold?

12Cape has enough capital to be sustainable. It owns the successful Latitude Aparthotel in Sea Point, is unlevered, and has cash on hand. We are now raising growth capital to acquire a highly attractive pipeline of assets currently available in our area.

Sustainability is critical given the 30 June sunset clause and ties in with (5) above. Many VCC’s will be facing this predicament after 30 June and investors will carry the cost of non-compliance.

  1. Do you guarantee investors an exit after 5 years, and if so, who is providing this guarantee?

12Cape doesn’t guarantee investors an exit, but we have adopted a liquidity policy that provides a mechanism to facilitate an exit for investors that do wish to sell their shares after 5 years. All the assets in the 12Cape portfolio have an open market value in an actively trading market.

It is important to note that Section 12J rules require an investor to own an equity share in a VCC and, by definition, an instrument that guarantees the holder the option to sell that instrument in future at a predetermined price does not qualify as an equity share. Many VCC’s include the words “guaranteed exit” in their marketing material, but the investor must fully understand who is providing that guarantee, how it can be enforced, and if the shares they are purchasing qualify as equity shares.

  1. Are there any hidden fees that are not being disclosed?

12Cape’s fees are transparent and in line with private equity fees the world over. There are no undisclosed fees and 12Cape does not share in the tax benefit created for investors.

Look out for VCC’s charging additional directors fees or management fees to each of the qualifying companies; these undisclosed fees can easily add an additional 1% to the quoted fees.

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