Opinion: South Africa’s Tech Startups Can Ride Out Junk Ratings Status

By Tom Jackson AFKI Original Published: April 28, 2017, 1:00 am
Seedstars South Africa winners 2016. Photo: Seedstars

So, the worst has happened. South Africa’s sovereign credit rating has been downgraded to junk by ratings agencies Standard and Poor’s (S&P) and Fitch. But what impact does it have on the country’s growing startup scene?

South African startups were the most popular in Africa for investment in 2016, with Cape Town and Johannesburg establishing themselves as hubs. Junk status could have a serious impact on this.

Obtaining credit for South African companies will become more expensive, with small businesses feeling the pain as a result of the increased difficulties faced by domestic banks.

“South African banks are directly impacted by South Africa’s sovereign credit rating and as a result of the downgrade to junk status, S&P also downgraded South African banks to junk status,” said Mark Paper, chief operating officer at Business Partners International.

“Thus an increase in borrowing costs by the domestic banks will, over time, put pressure on shareholder return. In order to bolster this return, banks will be forced to increase the cost of funds while reducing operating expenses – both impacting on the South African SME (small and medium-sized enterprises) ability to obtain and service loans.”

Michael Jordaan, former CEO of South Africa’s First National Bank (FNB) and now an investor in innovative tech startups, agrees the ratings downgrade is bad news for the economy as a whole. Higher rates will lead to lower economic growth and even slower job creation, he said.

Yet he believes startups will be less affected by the downgrade than larger firms.

“The impact will be hardest felt by large companies as their growth is highly dependent on the overall economy,” Jordaan said.

“The impact is very different for small startups as they have to sell their product or solution to a much more defined customer base. Startups need to dominate a niche at first and in this sense the macro economy is a very small factor.”

Some of the best startups are born in tough times, Jordaan said. He advised entrepreneurs to keep the focus on making their customers happy and not get distracted.

Startups seeking investment are likely to have a tougher time

Many institutional investors are mandated to invest in highly rated bonds.

“Overall, the risk premium will affect equity prices too,” Jordaan said. “At some stage higher rates and perceptions of relative valuation compared to other emerging markets will start attracting investors again.

“The real pity is that a ratings downgrade is a burden that the economy doesn’t need. We could be growing at 5 percent if we took the right, pro-growth decisions.”

Paper with Business Partners International sounds more positive, saying that though investing in South Africa is now deemed more risky, SMEs should continue to invest in their businesses.

“While faced with these uncertain times, it doesn’t mean that SMEs should suspend activity, or stop moving forward. Borrowing money, in good or bad times, can make a lot of business sense for well-managed companies,” he said.

“SMEs need to ensure that they understand the funding options that exist, as well as what type of funding is best suited to their needs, be it equity, long-term debt for fixed assets or shorter-term working capital. This will determine who to approach, the term and price to pay, and what impact this will have on the business cash flow.”

SMEs should take another look at their business plans, and look at ways of improving performance, Paper added. There also needs to be more emphasis on handling debtors promptly to ensure cash flow is not affected at a vital time.

South Africa should focus on backing its entrepreneurs, according to Paper. But Jordaan said this has never been a priority, and it’s unlikely to change, given the dire news of the “junk” downgrade.

“None of the 19 startups where I am involved have received any form of support by government,” Jordaan said.

More help is unlikely given the higher cost of debt for the government, but Jordaan remains optimistic.

“If the junk rating leads to certain pro-growth reforms like selling a loss-making airline or partnering with the private sector to create jobs, then it may be the medicine that the patient needs.

“Either way, startups should take comfort that they will survive and thrive if they keep their customers happy,” he said.

 

Tom Jackson is the co-founder of tech news and research platform Disrupt Africa and a journalist covering innovation on the continent from the Cape to Cairo.

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