Patient Capital Review: Are Tech Startups Under Threat?

Enterprise Investment Scheme (EIS)

There is no doubt some EIS money is used in ways that do not adhere to the spirit in which the EIS scheme was created. Perhaps this has gone too far and a wake-up call is needed. The wording in the consultation seems to suggest that the government thinks so and may be considering taking action to “reprioritise” how the current tax reliefs are targeted.

What's the issue?

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.

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

Gone are the days of fund managers raising £60m and carpeting areas with solar panels (energy is now a disqualifying trade), with the investors enjoying their 30% income tax relief and also benefitting from the investee companies receiving the government's renewable tariffs. That strategy was extremely scalable for fund managers and delivered for investors, but did not do much for growth businesses - although one could argue it kickstarted the UK's green revolution.

Now the growth and development condition and other qualifying rule changes mean more EIS and VCT funds than ever are being invested into jobs, new products and the economy at large. This, of course, is a positive development.

Are tech startups affected by the changes?

The good news is that tech startups and scale-ups are not a target here. Companies to be affected by the changes are those that are asset-backed - i.e. employing SEIS and EIS funds to purchase assets such as their office building or machinery and equipment.

The sector that may be most affected is film and television companies, as their structures are seen as providing a "capital preservation" strategy - with pre-sales and film tax credits/rebates also offered, the capital invested in these companies is not seen as "risky" enough to require further tax incentivisation

What could happen?

This is totally hypothetical at this stage, but potentially EIS investors might need to be more patient EIS and VCTs were designed to invest in growth companies. By definition this is a longer term holding period. The various ‘capital preservation schemes’ over the last few years have resulted in investors thinking short term (getting cash back as soon as possible after the 3 year holding periods for EIS). This will mean a lot of tax efficient investors they might have to change their approach if they want to keep the tax breaks.

The government will need to be convinced that the EIS tax schemes are ‘effective, well targeted, and provide value for money’ and for that funds and investors will have to demonstrate the capital is benefitting the company for growth and development purposes.

When will we know?

The results of the review are likely to form part of the Autumn 2017 budget on Wednesday 22 November so watch this space!

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