Financing growth in innovative firms
ICAS responds to HM Treasury consultation on financing growth through introducing an EIS knowledge-intensive fund.
HM Treasury’s Patient Capital Review concluded that many knowledge-intensive companies struggle to receive capital to grow and scale up. The government has announced a ten-year plan to unlock investment in innovative firms. This includes extensions and reforms of the venture capital schemes (Enterprise Investment Scheme, Seed Enterprise Investment Scheme, Venture Capital Trusts).
The government is also consulting on the introduction of a new approved fund structure within the Enterprise Investment Scheme (EIS), with the possibility of additional incentives to attract investment. This fund structure would focus mainly on investing in knowledge-intensive companies.
We do not believe that the tax framework is the main barrier to accessing additional funding. Investment should be driven by the quality of the company and not be further driven by additional tax breaks. We believe that other non-tax barriers are a more significant issue preventing wider investment in EIS.
In our experience, the proportion of investor-ready businesses which lead to a successful equity investment deal is very low across each stage – approximately 1%. One of the main obstacles is that the vast majority of companies who pitch for investment are not yet investor-ready. We believe that more support to educate, incubate and mentor early-stage companies would enable them to better prepare and present their business potential, therefore increasing their chances of successful private investment.
Our suggestions for further improving the flow of patient capital to knowledge-intensive companies are:
1. Extending 3-year limits after 5 years
Typically it takes £5m to £10m and 10 years to get a knowledge-intensive business to a cash flow positive situation. Investor fatigue is common, making later funding rounds difficult to complete. Sometimes, the old company may be perceived to be near to success via a potential exit within the 3-year limits so investors at that stage may lose EIS reliefs on investment and capital gains. This can make an investment in new EIS companies more attractive.
We would recommend that where an investor has invested for over 5 years in a particular company the three-year rule for a minimum investment period without losing tax reliefs in that company should be suspended.
2. Spreading investments over a longer period
Many rounds of investment are needed before a company reaches a cash flow positive position, so investors may need to maintain the capacity to spread their investment over several years rather than front load it too heavily.
3. Permitting mergers between small companies without loss of EIS relief
Acquisitions, mergers and other capital events may make commercial sense particularly between small companies eligible for EIS reliefs. They can help the business scale-up and make a more viable entity.
We recommend that mergers between EIS eligible entities should not trigger the loss of EIS tax relief. Tax avoidance risks can be managed through a pre-clearance procedure with HMRC.
4. Sidecar funds
Sidecar funds could be introduced. This could open up a fund for passive angels who entrust a syndicate to perform the due diligence and make investments on their behalf. All investors in the sidecar fund would have to be high net worth individuals or sophisticated investors to enable an individual to self-certify.
Does this topic interest you and would you like to engage in future consultations?