VCM0009

Written evidence submitted by Station 12 Limited

I am the founder and Managing Partner of Station 12 (‘S12’), a specialist early stage investor in sports, entertainment, knowledge and the circular economy.

Prior to founding S12, I had an operational career in the entertainment industry, before switching to investment, where I have managed both limited partnerships, AIM listed funds and SEIS/EIS funds. I have over 25 years experience of venture investment.

S12 is regulated by the FCA and operates a SEIS/EIS fund, allocating investment to companies in the UK within our specialist sectors. Our investment sizes range from £150,000 (SEIS) to £500,000 (EIS).

S12 also acts as an investment manager to third party funds, both private and public (i.e. listed), with total assets represented by S12 and third parties of circa £100m.

Our investment philosophy is that risk is mitigated by specialist knowledge and as such we are not a bulk investor. We invest in a small number of companies and are actively involved in their development. We occasionally ‘venture build’ – that is create and build companies ourselves that meet market gaps we have identified.

Our investments include companies operating in live events, TV production and distribution, sustainability in fashion, theatre rights, sports education and artificial intelligence/digital humans

My comments to the Committee are from the stand point of a private investment firm in early stage investment utilising SEIS/EIS tax advantaged funding.

CURRENT STATE OF THE UK INDUSTRY

It is our view that the early stage venture sector is an example of market failure.

Access to early stage investment in the UK remains difficult with the primary burden falling on angel investors either investing directly or through angel networks, crowd platforms or funds operating SEIS/EIS.

Larger venture funds managing institutional money are less likely to invest unless certain revenue targets are already in place, i.e. over £1m p.a. and their allocation targets are met – i.e. larger funds wish to deploy significant capital per investee, but very early stage is excluded due to its lack of performance track record.

The UK ‘attitude to risk’ for early stage investment compares badly with the United States. Israel is also often cited as a better market for early stage businesses.

There is a bias in the UK towards ‘tech’ based investment when this sector is as – or more – risky than other sectors.

The ‘burden’ of early stage investment is on the shoulders of individual investors.

The market for early stage investment has been significantly prejudiced by:

-         The position prior to the patient capital review where structured ‘EIS products’ were sold to investors on a non risk basis;

-         Investors now believing early stage is ‘too risky’ despite significant tax mitigation benefits available through SEIS/EIS;

-         Independent Financial Advisors not being able to properly advise their clients on venture investment;

-         State intervention disrupting the market: significant funding to state organisations (such as the British Business Bank) who are failing to effectively disperse funding to support early stage investment funds.

CO-OPERATION BETWEEN START UPS AND ESTABLISHED INDUSTRY

Information as to the sources of capital and how to connect with venture investors remains opaque for entrepreneurs and founders. Those without family or social connections still find it challenging to contact and meet investors.

OPERATION AND EFFECTIVENESS OF SEIS/EIS/VCT

We do not operate a VCT fund, so our comments are restricted to SEIS/EIS

Without these schemes, it is unlikely early stage businesses could raise any investment.

However, there is an urgent need for reform.

• As a general observation, the SEIS/EIS regime is over complicated and have rules that are no longer fit for purpose
• The restriction on paying back loans should be removed other than founder, director loans – debt is the killer of early stage businesses;
• The restriction against utilising SEIS/EIS for share acquisitions needs to be removed – early stage businesses can scale through acquisition;
• The restriction on subsidiary ownership needs to be reviewed – a 51% holding should qualify;
• Preference shares and different classes of shares should qualify for SEIS/EIS;
• Founders should receive relief on their capital invested;
• Investors should be able to benefit from pre-arranged sales post the 3 year qualifying period, i.e. call or put options, as lack of liquidity is a dis-incentive to invest. The quid pro quo should be that investors opting for pre-arranged liquidity should have their income tax relief reduced, but benefit from gains tax relief. Buy back should be restricted to companies buying the their own shares back or if a third party financier provides the buy back option, on repurchase income tax relief is lost (via claw back) but any gain is allowed tax free;
• The definition of qualifying trade needs to be updated to allow agencies to benefit as well as companies acquiring pre-existing intellectual property;
• The rate of SEIS per company should be increased to £1,000,000 – this would be a major catalyst to giving companies access to significant start up capital at the same time mitigating investor risk.

In addition, the way in which investors can access SEIS/EIS needs reform:

Currently most investors enter the market as ‘advised retail clients’ on the recommendation of their Independent Financial Advisor (‘IFA’) or through non advised platforms who promote funds for commissions.

Following the (well needed) reforms in the Patient Capital Review, SEIS/EIS companies need to demonstrate, inter alia, that there is a genuine risk to capital in the investee company in order to qualify.

Accordingly the emphasis on marketing by IFA’s to their clients is that this type of investment is very high risk. IFA’s generally are not well placed to advise on real venture risk, as the tax benefit for the investor coming in is irrelevant to whether a venture fund (such as Station12) invests or not. It is the quality of the company’s business plan that venture investors look to, not the availability of tax breaks to underlying retail investors.

However, what has happened is that there is a disconnect between those assessing, evaluating and managing venture investment and their potential investors, as IFA’s opt for large generalist brands and direct investment there, with smaller, specialist firms faced with this as a barrier to raising significant direct funding.

For IFA’s/investment platforms, their business is driven by advisory fees/commissions not the investment performance of the underlying companies. These recommendations are made by organisations with no experience of venture investing and who themselves take no risk of capital.

We therefore propose that retail clients may only access tax reliefs through SEIS/EIS if they go direct to a qualifying SEIS/EIS operator (‘Authorised Venture Fund or AVF’).

To be an AVF, an operator will need:

1. To be directly authorised as an AIF by the FCA;
2. To have as its main objective the long term investment in venture capital companies;
3. To have staff qualified to make venture capital investments.

AVF will be restricted to funds raising £20m or less in each tax year.

An AVF will be enabled to:

1. certificate to a retail investor that their investment is being made into a SEIS/EIS qualifying venture company
2. IFA’s/investor platforms will purely provide advice on the individual’s tax position but will not enabled to recommend which AVF to invest in.

OPENING NEW POOLS OF INVESTMENT

As the economy faces significant challenges, the need to support enterprise and innovation becomes more important.

We think that pension funds and large corporates should be provided with an incentive to invest in venture fund primarily through an allowance/write off that can be set against pre tax profits. The funds generated would be pooled to disperse into early stage venture funds. In return, those venture funds would return a profit participation to the funding corporates, pension funds on exit of those portfolios receiving this aid.

IMPACT OF STATE INTERVENTION

The state should not directly undertake investment in the venture market but ensure it encourages or disburses investment to private venture funds that are operated at risk to their partners i.e.where there is direct accountability for investment performance.

The British Business Bank is well funded with a direction to encourage new venture funds to be established.

The primary structure for this is the ‘Enterprise Capital Fund’, a match fund  where the profit share of the BBB can be shared with incoming match investors to enable the fund to close.

Our experience of the BBB has been disappointing, driven by an opaque application process and a circular methodology whereby the BBB will not set down what profit transfer it will accept at the outset.

This makes discussions with potential match funders frustrating and expensive.

Our proposals are:

-         The ECF be reformed so that the BBB becomes a cornerstone investor, giving a firm commitment from the outset to invest subject to match funding being established;

-         The ECF to be prohibited from follow on second funding – it should only support first time funds

-         Its timetable to be re-focused on 6 months;

-         Its deployment targets to be substantially increased

As a general observation, state backed or created funds disrupt the market as investment should be through private authorised funds where the partners and founders are directly invested as opposed to individuals employed by state backed organisations.

In this respect it is noted that BGF is not seen to be active in the early stage sector.  It should also allocate some of its funding to AVF to deploy into the sector.

FINAL OBSERVATIONS ON THE UK MARKET

UK entrepreneurs are as good as or better than their international competitors but they are faced with a number of structural disadvantages:

-         The UK market is small and it is difficult to scale a large global business based only on the UK, our companies always need to look to scale through international sales or expansion – by comparison US start ups have a domestic market of 350m people to scale in;

-         Over regulation is a significant cost to early stage businesses – new regulations require the cost of advisors for small businesses to comply with, in addition devolution and duplication of structures adds an additional burden and complexity;

-         The shortage of very significant start up capital makes our companies vulnerable to early acquisition, primarily to the US;

-         The US is becoming the investor of choice to our best companies due to the easier availability of risk capital there.

-         We need to ensure that the flow of funds to early stage venture is substantially increased and acknowledge that many companies will fail – failure should not be seen as evidence that our companies are not any good, but as a necessary part of the process in stimulating the right volume of start ups;

-         Founders need to be incentivised and rewarded for starting companies up -  starting, building and running companies at early stage is stressful, very often financially challenging and we need more people to take the step forward as these companies employ significant numbers of people and start or invent new products or services. The new restrictions on entrepreneur relief and the fact founders cannot access SEIS/EIS for their own invested capital discourages founders, who often feel they are the last in the queue to be rewarded.

June 2022