Benjamin Disraeli once famously said that “There are three kinds of lies: lies, damned lies, and statistics.” and the latest HMRC EIS/SEIS statistics released in May tell bear this out.
Those statistics tell us that in 2016-17, 3,470 companies raised a total of £1.797 billion of funds under the EIS scheme. On a trending basis, this is down on the previous year but as always we expect to see these numbers revised upwardly at the next data release point. EIS and SEIS continue to be popular schemes both with investors and small businesses seeking funding. In short, they work. They help provide small businesses with access to finance they might otherwise have not been able to get access to.
But that’s not the whole story.
It’s clear the investment landscape in EIS has changed dramatically due to the November 2017 Budget. Those schemes that targeted capital preservation investment strategies have been forced to change their investing philosophy and adapt to the new growth world order. We wont see what effect that will have on investor sentiment until the release of figures from HMRC in May 2019 but the likelihood is that they will be well under £1.797 billion. Why? Largely because most investors have been fed capital preservation deals for a number of years so they will either need some time to adjust to the new investment philosophy or will see the attaching perceived rise in risk profile as being too rich for their blood and turn to alternative investments.
This then presents a challenge to our industry. How do we keep those investors who have previously invested in capital preservation EIS deals investing in EIS’s which now have a very different look, feel and more importantly risk profile? Or a bigger question still, how do we make EIS accessible to an even wider group of investors? After all, there are estimated to be approx. 500,000 HNW individuals in the UK and currently only 29,860 invest in EIS on an annual basis. If our industry is to continue to grow we need to find new and deeper pools of potential investors to help provide the finance for the new, exciting, entrepreneurs our fund managers hope to fund.
Below then I have outlined some thoughts (musings in some cases) as to how we could make our industry bigger and better. Some of them are sensible, some wishful thinking, some I support, some I dont and some are possibly even controversial! I outline them merely to spark debate.
• The Patient Capital Industry Panel observed that institutional investors currently allocate most of their capital to listed (and therefore liquid) assets, with a lower exposure to equity compared to a decade ago. Only a small percentage of their assets are allocated to ‘alternatives’, of which a smaller proportion still is allocated to venture capital. Exploring some tax advantage schemes that encourage institutional investment could be very valuable and broaden out the investor universe to support start-ups through their entire life cycle. As the Office of Tax Simplification notes in its report “Simplifying the taxation of key events in the life of a business” published in April 2018 “The absence of an entry relief for companies making venture capital investment is inconsistent with the other forms of venture capital investment…. It might be worth exploring what effect this inconsistency might be having in distorting and reducing the availability of venture capital from the corporate sector.” In summary, consideration should be given to a well-targeted entry relief, which would encourage utilisation of the existing cash reserves of the corporate sector which would be a valuable additional source of venture capital.
• The key to unlocking more funding for growth stage businesses is to bring different pools of capital together so that they can act in tandem rather than as silos. EIS can provide a major contribution to addressing the market failure at the growth stage as part of the funding solution, alongside other sources of capital. Work is required to bridge the gap between early and later stage funding and the British Business Bank initiatives need to have far closer relationships with EIS/SEIS fund managers to assess prospective dealflows in order to both coinvest alongside those funds as well as provide follow on funding. The problem is most acute at the scale up stage (circa £10M) particularly where the current lifetime limits for EIS are reached very quickly and further rounds of funding are not ready to commit. Increased limits would help alleviate this problem as would the ability for EIS funds to make follow on investments even if gross assets exceed £15M.
• Additional support is also required at the very earliest stages of seed funding where it is increasingly difficult for start-up knowledge intensive companies to find funding given the long journey to revenue and profitability. There is therefore a case for the BBB seeding funds at the start-up/seed stage targeted at very high risk ‘knowledge intensive companies (e.g. technology, battery energy and energy storage and early stage life sciences) where it is unclear what the product, business model or even market is at that stage. These are likely to struggle for support even from tax-advantaged sources of fund as they are very high risk and the investment model requires a large portfolio approach to risk management given the very high failure rate. Of the additional £2.5BN of funding provided by the Government, a proportion of this should be allocated to seed funding and to helping develop angel syndicates
• Consideration should also be given to relaxing the rules preventing the parents and family members of small business owners from investing in their businesses. This would open a new avenue of retail capital. As the OTS note “The absence of any immediate tax relief for the capital contributed by the start-up owner contrasts sharply with the plethora of tax reliefs that are available to subsequent investors”.
• The FCA remains a barrier to investment for investors due to marketing regulations and this would need to be addressed to broaden the appeal of EIS funds and the investment they can attract from private individuals
• Give EIS funds upfront tax relief – in a similar way that VCT investors receive one certificate for their entire investment. Enhancing the Approved EIS fund concept has been discussed several times over the years and the concept of an Approved fund vehicle has high potential. However the current Approved fund structure isn’t favoured, by fund managers in particular, because of the required speed of deployment of funds and the possibility that if one investment becomes disqualifying the whole EIS could fail creating a “cliff edge” scenario. 12 months is also not a long enough time period to make investments, particularly given current HMRC delays in dealing with advance assurance applications and compliance statements.
There we have it. A blueprint for our future or a load of garbage? You decide.
Either way, the year ahead promises to be an exciting one for EIS and SEIS. We have the promise of a new Knowledge and Intensive EIS fund structure and should see more exciting investment opportunities than ever.