Written evidence submitted by Octopus Group
Octopus Group welcomes the opportunity to contribute to the Committee’s consultation on the venture capital market. Founded in 2000, Octopus has become the market leading venture capital trust (VCT) manager in the UK.
As of December 2021, Octopus manages around £12.5bn of funds on behalf of more than 60,000 investors, including over £2.5bn of growth capital – both retail and institutional, including pension funds. As the UK’s market-leading manager of VCTs, we currently have approximately £1.9bn of VCT funds under management, which roughly equates to just over a quarter of the UK’s VCT market. Over the years we have invested in more than 500 SMEs including household names such as Depop, Cazoo and Zoopla . Our investment has helped businesses and created thousands of new jobs.
VCTs exist within an interconnected funding ecosystem that allows businesses to access capital throughout each stage of their growth journeys. It is this ecosystem taken in totality that makes the UK one of the most attractive places to start and grow a business. VCTs specifically are capital-raising vehicles that have been proven over the pandemic to be adaptable and responsive to economic shocks. They form a critical part of the wider puzzle that makes up the funding pipeline for British businesses, equipping a broad range of UK businesses with robust and resilient investment firepower as they grow.
This response will frame VCTs within that wider interconnected ecosystem and will outline Octopus’ perspective on the ways in which Government can protect and increase their success. The tax reliefs available to those who invest in VCTs are an excellent example of a vehicle that encourages private investors to take more risk with their money by investing into high-risk companies. These reliefs are widely recognised as having played an important role in the overall start up culture of the UK, including by the Treasury’s Patient Capital Review in 2017.
As the largest VCT manager in the UK, Octopus is well positioned through both our fund management experience and the frequent discussions we have with investors to know where concerns exist in the venture capital market and where there may be opportunities for policy interventions. This submission will therefore also make recommendations for shoring up investor confidence in the market and potentially opening up new channels of investment into UK businesses.
The most urgent intervention that the Government should make relates to the sunset clause on VCT tax relief. If the tax incentives on VCTs cease in 2025, as would be the case in current legislation, then the entire asset class would be destroyed, resulting in a genuine shortage of capital for early-stage companies. The sunset clause will cause investors to turn their backs on VCTs after 2025 and lead to one of the growing and most productive funding channels in the UK for early-stage businesses to dry up.
There are additional opportunities to help the UK venture capital market continue to grow and thrive, in particular looking at opening up access to growth capital for businesses that reach the stage in their growth trajectories where VCTs and EIS can no longer support them (the stage that the Government’s own Patient Capital Review identified as a barrier to business growth in 2017). With this in mind, we also explore in this submission the benefits of changing ISA investment rules to allow investment into unquoted companies and allowing investments made into VCTs by Self-invested Personal Pensions (SIPP) to qualify for income tax relief.
We welcome the Committee’s interest in the role of VCTs in encouraging investment, and look forward to engaging with you further as this inquiry progresses.
Octopus has been managing VCTs since 2001 and is now the UK’s largest manager of VCTs. In that time, we have backed hundreds of companies, including several businesses that have gone on to be worth more than £1bn. VCTs have been an extremely effective way for small, growing companies to access the expertise, support and capital that they need to succeed. VCT funding has proven especially useful to these businesses over the pandemic - unquoted VCTA companies actually increased sales by 36.2% from 2019 to 2020 and a further 9.1% from 2020 to 2021.
As discussed above, VCTs play an important role within the wider funding ecosystem in the UK, enabling small businesses to expand and innovate. They are the perfect vehicles for “patient capital,” because a VCT is a pooled investment vehicle, meaning the support it can provide to an investee company tends to be much longer term. VCTs make ongoing investments into businesses until they reach a certain size, supporting them through the early stage of their growth journey.
The UK’s well developed business ecosystem is not driven solely by unicorns but also by those businesses that grow more slowly, employ more people and struggle to access the growth funding they need through this more gradual development path. VCTs form a critical part of the wider puzzle that makes up the funding pipeline for British businesses, equipping a broad range of UK businesses with robust and resilient investment firepower as they grow.
VCTs also provide valuable non-financial support to help companies scale and compete, by providing a range of expertise in areas such as IT, operations, management and financial guidance. As a large, professional investor, VCT managers often take a seat on the board of their portfolio companies, providing valuable advice and challenge gathered from years of smaller company investment experience. Providing patient capital and expert guidance, VCTs are therefore a major contributor to the culture of entrepreneurship that has been built over the last twenty years in the UK.
Our evidence shows that experienced investors (advised appropriately) do not need to have rapid access to their investments, and do not need to be able to sell the investments to pay their daily bills. The long holding period of VCT investments, and the willingness to retain investments during periods of extreme economic stress, such as the pandemic and the current cost-of-living crisis, make VCTs a critical source of capital for smaller companies during times of economic instability when other sources of funding may be scarce. This is particularly important because smaller businesses thrive during periods of change, so having access to the capital needed to leverage that opportunity is vital.
With these benefits in mind, it is unsurprising that VCT investment has helped many start-up companies across the UK go on to have an extremely high value, creating significantly broader economic value with the jobs and wider investment that this business growth leads to. Our own portfolio has included high growth, VCT-funded businesses in places like Chester, York, Cardiff and Leicestershire.
Deadhappy in Leicestershire is just one of many examples of a VCT success story. Founded in 2013, this company set out to revamp traditional life insurance companies after noticing most people cancelled their life insurance policy after 7 years of purchasing it. With the help of VCT funding and from Octopus Ventures and the patient capital it brings, DeadHappy have gone from strength to strength, more than doubling their workforce from 8 to 20 between 2020 to 2021 despite the challenges of the pandemic. In 2020, they received the Innovation Award from the Protection Review Organisation.
Antidote Technologies, a UK-based clinical trial matching platform with operations in the US, helps patients find medical trials online. By 2021, the startup had made 14,000 ‘matches', and plans to reach full coverage of US trials next year with added features, such as matching cancer patients to studies using mutation-level data. In 2021, Antidote raised £11m in a funding round in which Octopus Ventures provided further patient capital to enable Antidote to realise its growth ambitions. Antidote exemplifies the benefits of the patient capital unlocked by the VCT scheme. In the first half of 2021, as the global economy was still reeling from the impact of the pandemic, the funding provided by Octopus and others was available to give Antidote the financial injection it needed to grow its innovative platform dedicated to solving the clinical trial participant shortage.
Overall, VCTs are patient, stable funding vehicles built in large part on the investment of well-incentivised private individuals, which have underpinned the success stories of businesses across the UK.
VCTs are made attractive to investors by the tax incentives that they receive from absorbing risk and investing in illiquid companies. However, the 2015 Finance (No.2) Act contains a sunset clause, which states that eligibility for VCT and Enterprise Investment Scheme (EIS) tax relief will only apply to shares that are issued before 6 April 2025.
This sets a deadline beyond which VCTs and EIS will become unviable for investors and effectively cease to exist, creating a gap in the funding ecosystem for early-stage businesses looking to raise capital. This is something we see as completely incompatible with the culture of enterprise that Government and HMT have said they want to create in the UK. The funding ecosystem needs to be robust and diverse, catering for companies at every stage of their growth journeys, and currently VCTs and EIS play an important role at a particular point in businesses’ trajectories. To make them unviable asset classes would be to create a gap for businesses looking to access capital as they grow and to put those businesses at a disadvantage to their counterparts that have followed similar growth trajectories over the last 25 years and had access to VCT and EIS growth capital.
This sunset clause was introduced to comply with EU state aid regulations that no longer apply. It is also a notable feature of the UK's new subsidy regime that one of its stated aims is to provide certainty for business investment. In this context, it is our view that this is exactly the type of clause that can and should be removed from UK law following the country’s departure from the EU.
The UK’s world leading investment ecosystem is based on the success of a funding “conveyor belt,” which provides businesses with capital and support the whole way through their growth journey’s, from start up to listing.
VCTs play a central role within this picture, alongside the Enterprise Investment Schemes (EIS) and Seed Enterprise Investment Schemes (SEIS). In addition, Business Relief (BR) provides a separate incentive that harnesses wealth from older investors towards supporting the growth of typically slightly later stage growing companies. VCTs should be seen as a fundamental part of the ecosystem, playing their particular role in the overall success of UK’s vibrant entrepreneurial culture.
Stepping back and examining the conveyor belt as a whole, EIS typically appeals to investors who are happy to invest into one or more individual early stage companies in the hope of achieving significant capital growth on exit. As this is an investment into the shares of individual companies rather than a fund, the opportunities for exit are very limited and investors will expect to hold each qualifying investment for a long period, typically 5-10 years or more. This is a crucial mechanism for individual angel investors to provide funding in the form of initial injections of capital into companies, often at the very early stages of growth.
Many early-stage companies benefit from EIS/SEIS funding, but will benefit from incremental VCT investment which is better suited to making follow on investments, and gives greater visibility of long term support (financial and management) as they grow and progress to the next stage. The UK’s internationally leading investment landscape is successful in drawing support schemes together in a way that fosters a culture of entrepreneurial ambition.
Initiatives like R&D tax credits, which HM Treasury is currently reviewing, play an important role in the UK’s investment ecosystem, and will often support large, established companies invest in innovation, but they do not provide the kind of support that VCT funding does. This difference obviously does not preclude VCT-backed companies from being significant investors in R&D; in 2021, the median VCTA R&D spend was £0.6m, an increase of 50% compared to 2018 despite the pandemic. VCTs play a different and crucial early-stage role in supporting entrepreneurs to fulfil their potential once they have established their businesses. Too many entrepreneurs sell up too soon, often because they have not been able to access the capital they need to scale up and take their business to the next level.
Octopus is also the largest provider of investments that qualify for Business Relief, an incentive that is vital in supporting unlisted companies at the next stage of their growth journey. Business Relief plays a key role in encouraging investment into both unlisted and AIM listed companies when they reach a slightly larger size and are no longer able to be supported by EIS or VCT. These various mechanisms each support businesses in different ways and at different stages of their growth journeys, a point raised as crucial by the Patient Capital Review.
As the Government reviews the complex system of tax reliefs that exists in the UK, it is critical that it does so in a way that pays due consideration to the capital raising ecosystem that businesses operate within.
While the existing system of investment incentives outlined above has been successful in funding and supporting UK businesses at crucial stages, there is more that can be done to drive forward business growth across the country.
In order to expand the reach of VCTs, we also recommend that investments made into VCTs by Self-invested Personal Pensions (SIPP) are permitted to qualify for income tax relief. For many people, their SIPP represents their largest pool of capital, and it feels an anomaly that this money is not at present used by investors to invest into VCTs. Since this money is by nature not expected to be liquid, it is a long term pot, and the cost to HMT should be less than non-SIPP funds as growth and dividends are already tax free for SIPPs. it has been a goal of the Government for some time to find ways to direct pension money into smaller companies; enabling people to make this choice themselves is likely the most straightforward way to achieve this goal.
Beyond this, we believe that changes to ISA Regulations could deliver a meaningful impact in unlocking capital for business growth across the UK. This could be done by allowing more established unquoted companies with a permanent establishment in the UK to be qualifying investments for stocks and shares ISAs.
While the scale-up funding environment may feel robust from the standpoint of the small number of high profile, rapidly growing tech companies on the path to being unicorns, this isn’t the case for those that have become too large and mature to be eligible for VCT and EIS funding, particularly those outside London and the South East.
There is an estimated £315 billion in stocks and shares ISAs, held by millions of people across the UK. If only 2% of this capital were to flow into unquoted companies in the coming years this would make a tremendous difference to the availability of funding for high growth companies.
In 2013, HMT expanded the range of ISA qualifying investments to include company shares admitted to trading on recognised stock exchanges, which brought shares traded on the Alternative Investment Market (AIM) within eligibility. This opened up a new route to capital for those companies and has helped make AIM one of the world’s most successful markets for high growth companies.
Extending this to well establish unquoted companies would help a greater range of businesses to access growth capital. This would support a greater proportion of businesses outside London and the South East, who traditionally have poorer access to funding, and reduce the risk that entrepreneurs sell exciting businesses too early.
Recommendation: Further changes in ISA Regulations to extend qualifying investments for stocks and shares ISAs to unquoted companies with a permanent establishment in the UK, with accompanying protections to prevent investment without financial advice.
Recommendation: Allowing investments made into VCTs by Self-invested Personal Pensions (SIPP) to qualify for income tax relief.