As a consulting company, with a special focus on economic research and the production of feasibility studies, we often engage and discuss the country’s policy landscape, the direction we should or are taking regarding small businesses and possible interventions that can be delivered by our government to assist small and emerging businesses. Recently, we have seen first-hand the negative impact of Covid-19 on small and emerging businesses, which prompted internal discussions including the importance of having a supportive ecosystem, and what the prominent ecosystems in South Africa (SA) should do to not only support small businesses, but also improve their international rating on being a start-up ecosystem.
Curious and excited, we set out to investigate this phenomenon and in this blog we share our key findings on the subject. Lessons learnt from leading ecosystems, including policy reforms (and other efforts) implemented in support of small businesses, are documented in this blog with a view to start a discussion amongst economists and policy makers on what needs to be done to make our ecosystems more supportive and globally competitive. We start this blog by defining an ecosystem.
What is a start-up ecosystem?
By definition, a start-up ecosystem is a clustering of interconnected individuals, organisations and bodies that facilitates and supports entrepreneurial activity (Mason & Hruskova, n.d.). It is defined as a cluster of start-ups and related entities that draw from a shared pool of resources and generally reside within a 100 kilometre radius of a central point in a particular region (Global Entrepreneurship Network, 2021). The main goal of an ecosystem is to launch and grow start-up companies.
What makes up a supportive start-up ecosystem?
In a quest to answer this question, we visited a number of academic and non-academic articles. In a non-academic article published by Hubbub Labs, there are a number of “key ingredients” listed that an ecosystem must possess in order to strive and be supportive to start-ups. These include the availability of funding, the willingness of funders to invest in start-ups, co-working space, mentorship, willingness of service providers to provide services such as bookkeeping to start-ups, and supportive government agencies. It is argued that the combination of these factors make it easier for start-ups to strive and ultimately scale. In another article entitled “How Startups Can Build Sustainable Ecosystems”, Yann Lechelle argues that it is not just the availability of mentorship, as suggested by Hubbub Labs, that makes up an ecosystem to be supportive and compel start-ups to strive, but also the experience of mentors and willingness of corporate leaders to be part of ecosystem.
He points out that in some ecosystems, entrepreneurs are mentored by inexperienced officials, and as a result, they do not scale. He then suggests that for any ecosystem to be sustainable or supportive, it is crucial to ensure there is profusion of knowledge, experience, capital, a bit of luck and strong business relations with other regions and international markets “access to markets outside your region”.
Don’t we have all these enablers in place as South Africa to be ranked #81 in the 100 emerging ecosystems?
As we investigated this phenomenon, we discovered that a number of strides have been made in SA to create an enabling environment for small and emerging businesses. We noted that the ease of doing business in SA has improved significantly over the years and that the prominent ecosystems such as the Silicon Cape in Cape Town have attracted millions worth of investments from both government and venture capitalists. Funds have been made available for skills development, enterprise development and supplier development. We have even seen investment to support small business from corporations through accelerators and incubators.
What is it that other ecosystems are doing better to be ranked in the top 30 globally and in the top 100 emerging ecosystems? Lesson from leading ecosystems
- They excel in providing funding. Governments of the leading ecosystems have continuously made radical policy reforms when it came to supporting start-ups. Because of these radical reforms, leading ecosystems are, and continue to attract large sums of investment. We learnt that governments in the leading ecosystems have stepped in to establish tax incentives for venture capitalists and angel investors, increasing access to finance for start-ups. In the Silicon Valley ecosystem, #1 globally, access to finance is not an impediment because there are about 1000 venture capitalists firms, thriving because of the incentives provided. The government provides tax rebates for venture capitalists or angel investors investing in start-ups with high potential for growth. In Seoul, an ecosystem in South Korea, they host a venture capitalist summit, a platform for start-ups to engage directly with funders (Global Entrepreneurship Network, 2021).
- Universities and colleges are not only providing talent but also leading the revolution. A second lesson we learnt was that institutions of higher learning, such as universities, located within the leading ecosystems, are not only providing talent but are an integral part of the ecosystems. We learnt that universities in these ecosystems, through their human resources and labs, are assisting small businesses conduct market research and test their innovative ideas. The university’s staff form part of the mentors in the leading ecosystems and entrepreneurship is embedded in the curriculum. As a consequence, it is interesting to note that in a number of cities, including Philadelphia, university alumni are the founders of the supported start-ups. Alumni from Philadelphia University launched more than 600 companies funded by venture capitalists in the past 10 years. Universities in these leading ecosystems are also pledging funds to support start-ups (Global Entrepreneurship Network, 2021). In February 2021, Drexel University and the Science Center announced the $500,000 to support local underrepresented founders (Global Entrepreneurship Network, 2021).
- There is profusion of knowledge. A third lesson, tying to what has been articulated by the serial entrepreneur Yann Lechelle, is that there is abundance of information in the leading ecosystems. The universities and the private sector are playing a leading role in providing knowledge. CEOs and directors of successful companies are mentoring small businesses. For example, in Tokyo, they run a 60 days start-up challenge and a 6 week start-up boot camp featuring intensive workshops and mentorships (Global Entrepreneurship Network, 2021).
- There are programmes designed to assist small businesses access international markets and customers outside their regions. One of the key challenges faced by small businesses is access to markets. In these leading ecosystems, small businesses are not only assisted to access local markets but also access international markets and customers outside their regions, hence the high rating on connectedness.
- Have opened up to international talent. As we were researching these ecosystems, we also discovered that what makes these leading ecosystems be where they are is the abundance of talent, especially international talent. It is an undeniable fact that, as individual countries, we sometimes lack certain skills or talent, crucial to the success of small businesses or needed to build new industries. In addressing those shortcomings, cities such as Seoul supported entrepreneurs’ move to Seoul and Tokyo, a city in Japan which previously had a policy stance of no foreign talent, also made interesting reforms. In Tokyo, a start-up visa was introduced in National Strategic Special Zones, granting successful applicants a 6-month or 1-year temporary residence permit (Global Entrepreneurship Network, 2021). In 2021, because of these reforms, coupled with others relating to access to finance and markets, Tokyo moved up the ladder and is now ranked as #8 globally with a score of 9 out 10 in talent.
What progress has been registered by the South African ecosystems in relation to the above discussed factors?
As we took a closer look at the prominent South African ecosystems, Silicon Cape in Cape Town, Johannesburg and Durban ecosystems, we noted that although these ecosystems are amongst the top in the African continent, not much progress has been made to address challenges pertaining to start-ups accessing foregin customers, the availability of experienced software engineers (talent), attracting immigrant founders (visa success rate) and the availability of funding.
In 2017, only 14% compared to the global average of 23% were able to access foreign customers in the Cape Town ecosystem, visa success rate sat at 36%, lower than the global average of 60%, and the ecosystem was valued at $172 million, lower than the global median of $4,1 billion (Global Entrepreneurship Network, 2017). In 2021, four years later, Cape Town’s ecosystem has not caught up to the global average of $10,5 billion and it’s only valued at $1,2 billion. Its ranking on access to funding is amongst the lowest in the world (2 out of 10), access to foreign customers has declined since 2017 (rated 1 out 10), and foreign talent rated 5 out 10 (Global Entrepreneurship Network, 2021).
What can be done differently to improve the conditions of the South African ecosystems?
As correctly pointed out by Yann Lechelle, building a healthy ecosystem takes time “Just as soil is enriched by the lifecycle of the many organisms that grow in it, a startup ecosystem is nurtured by the lifecycle of companies within it”. Although this might be true, there are few lessons we can draw from the above discussion that the national and local governments might consider to improve the existing ecosystems.
- Provide incentives for venture capitalists investing in small businesses with high growth potential. A section 12J venture capital company (VCC) tax incentive was introduced in South Africa with a sole purpose of incentivising investors. Evidence however, as tabled by the National Treasury during the 2021 budgetary statement, have suggested that the tax incentive was being abused by investors and the objectives were not being achieved. As a result, the National Treasury killed the Section 12J tax breaks for venture capital (Wasserman, 2021). Perhaps instead of abolishing the VCC tax incentive completely, the South African government should consider drawing lessons from the implementation of Section 12J and introduce a refined proposal to incentivise venture capitalists to invest in small businesses with potential. Evidence from leading ecosystems is suggesting that there is a crucial role that venture capitalists can play in this regard. Also, there are initiatives such as the Green Outcome Fund that lessons can be drawn from https://www.greencape.co.za/.
- Intensify international and regional market linkage efforts. It is common knowledge that accessing international markets is a process and a half. There is red tape and compliance issues to deal with before accessing international markets. In South Africa, obtaining compliance certificates (such as the SABS approval) is very costly, a cost that small businesses cannot easily bear. Perhaps there is a need for the South African government, through its development agencies, to intensify its efforts to increase access to international markets. Development agencies such as Trade and Investment KwaZulu-Natal (TIKZN) can become more accessible and visible to small businesses.
- Fast track and ease the approval of visa applications. For start-ups located in the South African ecosystem to access international talent they desperately need to grow their small businesses, the South African government needs to put some thought into how it can improve its visa application process. The suggestion is not for the complete ease of the process, but rather to identify areas for improvement. The issue of accessing international talent remains a challenge.
- Make institutions of higher learning an integral part of ecosystems. The lesson from leading ecosystems is that universities need to play a key role in local ecosystems. Instead of universities and colleges only supplying ecosystems with local talent, perhaps they need to be persuaded to become key players in the ecosystem.
- Capitalise on learning from leading ecosystems. One thing the leading ecosystem does well is capitalising on learnings from other ecosystems. They learn what the leading ecosystem does and improve on it.
- Global Entrepreneurship Network. (2017). Global Startup Ecosystem Report 2017.
- Global Entrepreneurship Network. (2021). The Global Startup Ecosystem Report GSER 2021. 2017(2017), 21.
- Hubbub Labs. (n.d.). What is a startup ecosystem and how can you build one? https://hubbublabs.com/the-insider/startup-ecosystem/.
- Wasserman, H. (2021, 02 24). In a shock move, govt just killed Section 12J tax breaks for venture capital. Retrieved 11 03, 2021, from https://www.businessinsider.co.za/budget-2021-govt-kills-section-12j-that-gave-tax-breaks-for-venture-capital-investments-2021-2
For indicators on measuring the startup ecosystem in SA and KZN, with particular emphasis on innovation, see our work with Innovate Durban here.
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