There is tension between the Government’s desire to encourage scale-up funding and concerns about mis-use of tax incentives, says Kuber chief executive Dermot Campbell
Consultation has just closed on the Treasury’s Financing growth in innovative firms review, which aims to improve the flow of long term finance to innovative and high growth firms in the UK. Given the risks associated with Brexit and the potential loss of more than £1bn of SME funding from the European Investment Fund, this could be one of the most important Reviews of this century, with the potential to dramatically change the economic fortunes of the UK, for better or worse.
The issue of Patient Capital has become an increasingly prominent political issue in recent years, culminating in the 2017 Conservative manifesto officially promising: “We will help innovators and start-ups, by encouraging early-stage investment and considering further incentives under our world-leading Enterprise Investment Scheme and Seed Enterprise Investment Scheme”. In the shake out following the election, it is still unclear how this aspiration can be achieved in practice.
There is a tension at the heart of the “Patient Capital Review”, between the desire to improve the environment for smaller firms wishing to “scale up” and the determination to prevent fiscal incentives from being, as the Treasury sees it, mis-used to shield capital rather than to spur risk taking.
Nowhere is this more evident than in official attitudes to the Enterprise Investment Scheme (EIS), whose potential to fill the gap in support for scale-up businesses has been severely curtailed by legislation. In the words of the Treasury the objective of the review is to: “focus on whether a gap in the supply and use of patient capital is holding back more firms from growing to scale in the UK.”
Ministers are right to be concerned. In terms of encouraging start-up businesses, British policy is a world leader. Tax breaks have encouraged high net worth individuals (HNWIs) and private investors generally to bankroll start-ups, with the result that the UK has one of the most favourable climates for new businesses.
It is a different story when such businesses are ready to take the next step and scale up. Tax-efficient investment seems skewed towards supporting businesses that rarely progress much beyond the start-up stage.
Scale-up businesses are critical to economic success, being the engine of job creation and wealth creation, and – as the Treasury has acknowledged – Britain has too few of them.
The EIS had a role to play in bridging this support gap between start-ups and corporate giants, who can access capital markets, but a change in the law in 2015 severely constrained its ability to do so. The effect was to restrict tax-efficient EIS investment to firms aged seven years or less.
At a stroke, scale-up businesses faced the loss of fiscal support once they turned seven. This change has, without doubt, seriously impacted the ability of start-ups to become “scale-ups”.
Of course, as the review points out, the EIS, along with the Seed Enterprise Investment Scheme (SEIS) and Venture Capital Trusts (VCTs) have not always been well targeted. There is evidence of tax breaks for investments that would have happened anyway – and of the use of such schemes for the preservation of capital rather than the creation of new businesses.
However, this evidence should not be pushed too far. There is talk of denying tax-efficient status to asset-backed schemes, on the basis that they are “risk free”. This is wrong. There is still operational risk in asset-backed investments and the low risk that the PCR refer to is out of date, as renewables were removed from the scheme in 2015.
We have made two suggestions to help address the objections to supposed mis-use of EIS and other such schemes. One would be to target each scheme at a different market segment: SEIS for start-ups, EIS for early-stage firms and VCTs for scale-up. By clarifying the type of business they are intended to support, we believe much of the official concern about such schemes can be allayed.
The second would be to seek to enrol pension funds as suppliers of patient capital. With many schemes currently over-funded, it is tax inefficient to simply put more money into them. Tax relief against Lifetime allowance excess tax charge for patient capital investment would therefore be a powerful incentive for them.
Whilst the instincts at the heart of the patient capital review are sound, opportunities are being missed. With industry consultation ongoing, only time will tell if the promise of Patient Capital can be realised.
Dermot Campbell is chief executive of Kuber Ventures