With just 24 hours to go until Philip Hammond holds his red box aloft in front of 11 Downing Street, we thought it would be useful to remind ourselves what might be in store for venture capital schemes like SEIS, EIS and VCT, and how this might affect UK businesses seeking capital to scale.

Investment providers, financial intermediaries and the wider SME ecosystem are waiting with bated breath for tomorrow’s budget, and the outcome of the government’s Patient Capital Review (PCR).

As we know, the PCR’s key objective is to “strengthen the UK further as a place for growing innovative firms to obtain the long-term ‘patient’ finance that they need to scale up”, part of which was a far-reaching consultation by HM Treasury looking at ‘Financing growth in innovative firms’.

We support both of these notions, but despite these noble aims the PCR received zero mainstream press coverage. Instead, discussions have centred around what tinkering might be possible to the underlying trades and tax reliefs. This is unfortunate, and a missed opportunity.

We decided, therefore, to analyse the leading industry stakeholder consultation responses to help you understand what changes might be announced, and to see if government has listened and seized the real opportunity that the PCR presents for the UK.

Encouragingly, some positive signals emerged at our 2017 Growth Investor Awardstwo weeks ago. Chris Philp MP, entrepreneur and member of the Treasury Select Committee, gave the keynote and spoke optimistically about the outcome of the PCR.

“The government’s recent consultation on financing growth recognises that start-up and growth capital is still not as readily available as it should be. I believe there are opportunities to widen the scope of VCT, SEIS and EIS,” Philp revealed. “At the same time, we must ensure that very low-risk or mainly asset-based investments are not unfairly benefitting from what are supposed to be schemes to incentivise risk capital.”

We also heard Margot James, Parliamentary Under Secretary and Minister for Small Business, Consumers and Corporate Responsibility at the ScaleUp Institute’s Annual ScaleUp Review on 14 November, remind us that the UK ranks third in the world for start-ups but only 13th for scale-ups, according to OECD data. SEIS, EIS and VCT have been widely praised by successive governments for their role in supporting the early-stage growth ambitions of UK companies, but these statistics suggest more needs to be done for follow-on funding for scaling business.

Why SEIS, EIS and VCT are now potentially under fire

At our EIS & VCT Showcase held at the London Stock Exchange last week, financial advisers and providers alike were agnostic about the future. Irrespective of anticipated changes in the budget, advisers are continuing to recommend tax-advantaged investments on a case-by-case basis.

In our straw poll, 39% of attendees thought the government would be ‘supportive’ of the schemes in this week’s budget, 39% ‘neutral’ and just 22% ‘unsupportive’. They agreed that if changes were made, any changes would not be immediate (and, going by history, not retrospective). Many pointed out that the industry has responded to change many times, such as excluding investments into renewable energy in 2015. Investors can still invest in VCT funds that hold investments that were made before the rule changes, so investments made under old rules now form attractive ‘legacy’ investments in the portfolios of some providers.

So what did the leading industry stakeholders agree on?

• It’s widely thought that ‘asset-backing’ will be stopped or made very difficult, and if that ensures continued government support for EIS and VCT then it’s for the best.
• Technology companies are not the only businesses that need venture capital: most consultation respondents feel that changes must be sector-neutral.
• The UK scale-up ecosystem needs a strong pipeline of start-up companies: a heavy-handed approach could see the chancellor do lasting damage to the UK economy.
• If venture funding for film and television cannot be made more targeted, this sector could be added to the list of excluded activities.
• A replacement urgently needs to be found for the European Investment Fund (EIF), which accounted for more than a third of investment in UK-based institutional venture capital funds between 2011 and 2015.

What stakeholders differ on

• ICAEW differs from other respondents on the need for reform to be sector-neutral, openly arguing that most funding should be directed to ‘industries of the future’, such as robotics and virtual reality.
• Conversely, BVCA, AIC and EISA were all quite sceptical that the need for funding is greatest in newer and high-tech sectors. They encourage government to think about the patient capital gap as being related to size and ability to scale up, rather than any particular sector.
• ICAEW also gives a more guarded backing of a new National Investment Fund; the right staffing would be key and it must not crowd out private investment.
• The ScaleUp Institute argues that supply of patient capital isn’t the only issue to address; government should provide more sustained education to business on the options, benefits and accessibility of growth finance, including a digital platform.

A snapshot of the industry’s responses to the PCR consultation 

Enterprise Investment Scheme Association (EISA) – is open to change on asset-backing, but the case for EIS’ existence remains clear

• EISA recommends preventing EIS or SEIS funds from being used to buy or long-lease property, as well as “[improving] the cost effectiveness” of any EIS funds received by film and television production companies.
• EISA is unconvinced that patient capital is “as a matter of definition, capital provided to innovative, disruptive firms”. Firms engaged in all sectors “have difficulty raising larger later-stage funding rounds”.
• On the importance of EIS to realising the government’s ambitions for UK business, the message is clear: “It should… not be forgotten that the most acute market failure currently is in the area that EIS is not particularly active (later-stage growth funding). If EIS were removed or aggressively restricted then the early-stage funding gap would open up again and there would be no start-ups to then scale up.”

Association of Investment Companies (AIC) – recommends venture capital no longer be used inappropriately, but reform must be sector-neutral

• If it’s difficult to exclude poorly targeted investment in film and TV using a ‘principles-based’ approach, the AIC recommends that television and film production should be added to the excluded activities list, along with investment in property.
• The AIC emphasises that innovation is not limited to technology companies. It’s difficult to identify which investment propositions offer the best chances of success: “The government wants to support enterprises that might deploy digital, scientific or other forms of technology to create new markets or transform existing ones. It should also recognise that innovation can take many different forms.”
• “This process is unlikely to flourish where the opportunities for businesses to receive capital to support innovation are limited by legislation trying to actively direct investment into certain areas.”

British Private Equity and Venture Capital Association (BVCA) – venture capital schemes are well-known to retail investors, but government can play a greater role in attracting institutional investment

• BVCA encourages government to give full support to EIS, SEIS and VCT, describing them as “well-established programmes that resonate well with investors and investees”.
• BVCA cites compelling productivity statistics on venture capital: “Companies backed by venture capital and angel investment are more likely to be in high-productivity sectors such as digital, financial and health. As a result, average GDP per job in these firms is estimated to be £73,700 per annum compared to £47,500 per annum for the private sector in aggregate.”
• BVCA is supportive of a new National Investment Fund under British Business Bank’s remit: “This will improve the industry’s ability to support companies over the long term by taking meaningful stakes in businesses over multiple funding rounds, including the larger, later-stage funding rounds associated with scaling up a business.”

UK Business Angels Association (UKBAA) – is a major supporter of a new National Investment Fund, emphasising regional possibilities

• UKBAA states that business angels represent a key source of patient capital and know-how – “bringing both investment and access to experience and knowledge to support their investee businesses on their growth journey” – and that most angels make active use of SEIS and EIS.
• UKBAA supports a new National Investment Fund, stating its key aim should be: “to increase the number of larger venture and growth capital funds in the UK by attracting additional institutional investment. This will improve the industry’s ability to support companies over the long term by taking meaningful stakes in businesses over multiple funding rounds.”
• UKBAA states that too much – 70% – of angel investing is focused on the London-Cambridge-Oxford triangle, but that supporting the previous point the angel market in Scotland is well developed because it has been nurtured by the Scottish Investment Bank’s CoInvestment Fund.

ScaleUp Institute – backs better education for business on growth finance, and a shift in government resources

• The ScaleUp Institute champions allocating new funds to the British Business Bank to create a UK replacement for the EIF. Further, it encourages a National Investment Fund to ‘crowd in’ institutional and retail investors, “as exemplified in the Scottish Enterprise model, which works to great effect in joining up public and private sector initiatives”.
• The ScaleUp Institute calls for continued targeted tax reliefs for SEIS, EIS and VCT, but lifting the time and capital limits on VCT to allow them to provide much-needed follow-on funding for fast-growing firms.
• The institute calls for stimulating demand and improving knowledge of finance among high-growth firms as part of the development of comprehensive local ecosystems.

Institute for Family Business (IFB) – family firms exemplify a long-term approach to business, which removing Business Relief would undercut

• The IFB emphasises how economically vital family business are to the UK: “The family business sector in the UK now employs over 12m people, generating a quarter of GDP and paying £133bn in tax annually.” 85,000 family-run SMEs transfer ownership of their businesses each year and around 64% of family SMEs are estimated to be first-generation businesses.
• The IFB argues that Business Relief plays a key role in ensuring that these SMEs can focus on scaling up their businesses, without worrying that all the proceeds of their hard-earned growth will be lost to the taxman.

Institute of Chartered Accountants in England and Wales (ICAEW) – stresses the risks of unintended consequences of changes and crowding out private investors

• The ICAEW states that SMEs in many industries do not require significant external investment. The pressure on funding is greatest in ‘industries of the future’ such as robotics, AI, data analytics, 3D printing, virtual/augmented reality, new biotech and new materials science.
• “The government has an opportunity to direct financing into strategic sectors, to innovative business with the potential to create the biggest long-term benefit.” ICAEW recommends the replacement of lost funding from the EIF should be addressed on this basis.
• Any newly created National Investment Fund should “provide genuinely new capital, so as not to displace private capital,” and staff should be equipped with deep knowledge of both finance and the sectors mentioned above, where potential for innovation is greatest.

Creating a roadmap for SME success

The economic value of EIS and VCT: some 480,000 jobs were created by VC-backed companies between 2010 and 2015, equivalent to the UK’s entire retail sector. In the VCT sector alone, every £1m of investment is accompanied by an average increase of £2.2m in turnover.

Channeling venture capital funding into technology and innovation is important but as Symvan Capital’s Kealan Doyle said at Intelligent Partnership’s London EIS & VCT Showcase last week: “Almost all businesses these days are tech businesses to a certain extent.”

It’s clear that going forward the UK must position itself as not just a world-leading place to start a business, but a world-leading place to grow and scale a business. The second part of that equation, identified as a key deficit in the PCR, may be beyond the scope of EIS or VCT funding (although the latter could be extended), but clearly these schemes offer irreplaceable support for companies embarking on their growth journeys, which will be vital for the UK’s economy in the short-to-medium term.

Join the debate: please share this post and let us know what you think. And look out for our Budget special in 48 hours. Sign up to receive that briefing here.