THE PATIENT CAPITAL REVIEW

THE PATIENT CAPITAL REVIEW

By Matthew Cushen…

 

The Government published their ‘Financing growth in innovative firms’ consultation paper last month, with submissions due this week (the deadline is Friday 22 September). Commonly known as the ‘Patient Capital Review‘ it was announced by the Prime Minister in Autumn 2016 and mentioned in Philip Hammond’s Spring 2017 budget. The results of the review are likely to form part of the Autumn 2017 budget on Wednesday 22 November.

The political premise of the review is about increasing UK productivity – by increasing the availability of long term investment that enable growing and innovative businesses to realise their potential.

My business partner, Paul, and I have been investing in start-ups for around 12 years. There was a decent tax break available through the Enterprise Investment Scheme (EIS) – at that time we were delighted to get 20% of our investments refunded from our tax bill. But during the course of our investing experience we’ve been fortunate that the EIS income tax relief has been increased to 30% and the Seed Enterprise Investment Scheme (SEIS), introduced in 2012, offers even more generous reliefs, including 50% income tax relief.

No doubt many investors are like us. They are delighted with the tax reliefs and those reliefs result in an increased level of investment, as the reliefs mitigate some of the risk of investing in a high risk asset class. Unfortunately some investors seem to be fixated on the reliefs and not the returns – and quite probably not making good investment choices as a result. Some investment products have been engineered to be about capital preservation rather than in the spirit of supporting the growth of seed and scale up businesses. These are the reasons why our submission to the consultation is not making any argument for an increase in reliefs or the investment limits for investors – they are generous enough as it is.

Our 5 point ‘wishlist’, based on our bias towards the earliest stage investing, and our response to the consultation is:

  1. An increase in the SEIS limit placed on the start-ups raising funding. Currently this is £150,000. The scheme has been well designed to encourage investment in the most early-stage businesses, often with little more than an idea (although we like to see a few proof points about market and potential demand when we invest). £150,000 was considered enough for a business to get up and running, get a product in the market and create some momentum and traction before a second raise. This can indeed be the case, but often the investment needed creates too short a runway for the entrepreneurs before they need to start the process of raising more cash (given that the lead time to give fund raising should be at least 4 months). This is particularly true for any capital intensive ideas – like opening a shop or setting up some manufacturing, and is even the case for some digital development. We would like to see the limit increased to £250,000. This will not increase the tax reliefs available to individual investors (limited to £100,000 in one year), but will mean there is more SEIS investment opportunity to be shared amongst investors and exponentially more opportunity for a new business to establish itself (and increase its valuation) before raising again.
  2. Removing the consideration of grants within the SEIS limit. Part of being in the EU has been to conform to state aid limits. For the funding of small businesses, the EU considers up to €200,000 to be ‘de-minimus’ and outside the legislation. However, SEIS funding comes within that limit, as do various grants that come from the public purse. This can mean that some of the best businesses, those that have received grants or prizes, have to forego the equivalent value of investment from the £150,000 of SEIS investment allowance. We find this is often the case for businesses from the regions (and particularly Scotland) where there is a high availability of grants. We are hoping that one silver lining from Brexit will be to remove the grant element from within the limit.
  3. Increasing the 2-year maximum for qualifying for SEIS investment. A business has to have been trading for less than 2 years at the point of an equity investment for the investor to qualify for reliefs. Whilst momentum is the friend of innovation, there are often good reasons why an entrepreneur might experiment for a while, for example whilst still being in a salaried job, before they properly get after their dream. We’d like to see this raised to 3 years.
  4. Protecting investors by making a portfolio mandatory. This will be more controversial, and more difficult. We see many unsophisticated investors – particularly those that are crowdfunding – that are blinded by the tax reliefs and are investing in just one or two companies. With such a high-risk investment category, where some failures are to be expected, it is essential to build a portfolio. We’d like to see investors nudged in this direction by a requirement of 4 or more qualifying SEIS or EIS investments in a tax year before being able to claim reliefs.
  5. Increasing the publicity given to SEIS and EIS. In the 2015/16 tax year, 2,225 companies raised £170 million under SEIS and 3,285 companies raised a total of £1,647 million of funds under the EIS scheme. Much, or maybe all of this funding, may not have been forthcoming without the schemes. But much more could be demanded and supplied. There are still entrepreneurs that are unaware of the schemes and the wide qualification criteria. Then much more can be done to educate investors, financials advisors, wealth managers and accountants as to the value of the schemes and the attractions of early stage investing. Ideally this would not just be the attractions of the tax reliefs, but also the potential returns and the softer benefits of seeing an investment grow and supporting the UK economy. Whilst I’ve never been to a dinner party where an investor is talking about their pension or ISAs, I know plenty that jump at any chance to share their stories of investing in growing businesses. Or being proud to show their grandchild a product that they have backed that has made it to the shelves.

We are the envy of the global investment community for the generosity and effectiveness of our SEIS and EIS legislation. With a few tweaks, they could kick-on to even greater impact.

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