TR0039

Written evidence submitted by the Venture Capital Trust Association

Introduction

The Venture Capital Trust Association (VCTA) represents thirteen of the largest Venture Capital Trust (VCT) funds across the UK, which together represent more than 90% of the VCT industry by value. As such, our answers below apply to the VCT scheme specifically.

The businesses we support range across sectors as diverse as digital technology, medicine development, specialist manufacturing and online retailing.

The thirteen funds we represent are Octopus, Gresham House, Albion Capital, Foresight Group, Downing, Beringea, Mercia, Maven Capital Partners, YFM Private Equity, Canaccord Genuity, Molten Ventures, Pembroke VCT and Puma Investments.

Investments in VCTs carry tax relief to encourage retail investors to support smaller, higher risk companies who would otherwise not invest in such companies. VCTs are investment companies which pool investments with those of others, allowing investors to spread their risk over a number of small companies.

VCTs invest throughout the UK, helping to balance the nation’s economy, and as VCTs support businesses that are growing rapidly through the development of their management teams and operational functions, VCTs help create employment at all levels  within a business.

1. Does the current suite of tax reliefs represent good value for money? The Committee would welcome answers in relation to:

• Economic growth
• Employment
• Investment
• Research and development
• Non-economic benefits and desirable behaviours
• Any other appropriate measure

The UK is a great place to start and grow a business and is helped by tax-incentivised

investment through schemes such as the Seed Enterprise Investment Scheme SEIS, the Enterprise Investment Scheme (EIS) and VCTs. These have helped to develop a thriving start-up community recognised around the world, providing financial support at the earliest stages of starting a business by encouraging investment in small, unquoted trading companies.

As highlighted in the VCTA’s response to the committee’s recent inquiry into Venture Capital, a 2019 report collating data on general economic factors from the World Bank, World Economic Forum, UNESCO, OECD, and tax consultancies ranked the UK as the second-best country in Europe for start-up businesses – a strong indicator that the VCT scheme, EIS and SEIS are delivering good value for money.

These high growth small businesses are the engine of the economy, growing rapidly to

punch well above their weight in terms of their economic contribution, productivity, and

job creation. They are not without risk, however, which is why the government provides

tax incentives to encourage investment by private individuals.

Many early-stage, high-growth small businesses struggle to access funding because they are high risk investments. VCTs are demonstrably good value for money in that they address that market failure and help to close this gap in the funding landscape through attracting private investors by means of the tax benefits, which help to offset the risk.

Patient capital is locked in by the need to hold the investment for 5 years to retain the upfront tax relief – and as noted above, more than nine in ten investors hold their investment for longer than this.

VCTA members also co-invest in places with the British Business Bank. The British Business Bank’s role in the deployment of capital into the regions, e.g., through the Northern Powerhouse Investment Fund (NPIF) and Midlands Engine Investment Fund (MEIF) is important. This combined with schemes like EIS and VCTs attracts capital into the regions, which helps to develop self-sustaining environments for business growth and job creation. As the MEIF and NPIF are typically limited to £250k-£2m investments, VCTs have an important role to play as growing start-ups look for investment in the £2m-£5m range.

VCTs have an excellent track record of stimulating well-paid jobs in innovative, fast-growing industries across the UK. Of the 72,404 jobs at VCTA-backed businesses across the country, 37,319 are based outside of Greater London. This includes: 

•       More than 1.3 thousand jobs in Scotland;  
•       More than 1.7 thousand jobs in the West Midlands;  
•       More than 8.7 thousand jobs in the South West;  
•       More than 4.8 thousand jobs in the North West;  
•       More than 4.4 thousand jobs in the East Midlands;  

•       More than 5.7 thousand jobs in the North East;  

In addition, across every UK region and nation, the average salary for an employee at a VCTA-backed business is higher than the average salary for all full time employees in that region/nation. As average salary is used as a proxy for productivity by the British Business Bank, among others, this also reflects a boost to productivity across the UK’s regions and nations. 

Moreover, as highlighted in the VCTA’s earlier response to the Committee’s inquiry into venture capital markets, VCT companies invest significantly in R&D – especially important for innovative companies in the science and tech sectors. Between 2019 and 2021, the total VCTA R&D spend increased from £420m to £548m, despite the pandemic. 76% of the VCTA’s cohort of post-2015 investee companies spend on R&D.

It is the complementary nature of the VCT scheme, the EIS, and SEIS together that makes the UK such a successful place to start and scale a business. VCTs often invest when larger sums of capital are required and where entrepreneurs are seeking the certainty provided by the patient capital that VCTs offer.

By virtue of the fact that a VCT operates as a fund, investors receive a share of all the investments held by the VCT when they invest. This provides a diversified investment (albeit focused on early-stage companies) from which a less volatile return might be expected. EIS requires investors to invest directly into the shares of one or more early-stage companies which investors will then hold until there is an exit event. EIS tax reliefs are more generous overall due to the availability of loss relief for non-performing investments, which recognises the fact that losses and growth will be offset within a VCT itself.

Both investments tend to be held over a long period by investors, but with EIS there is typically no option to remain invested after an exit event has occurred. VCTs typically appeal to less experienced early stage investors because diversification can be achieved from lower investment values, and they have more straightforward administration. Crucially, at the stage of a small business’s development where they are seeking investment to grow, VCT fund managers also provide integrated business support and advice that is bespoke for each business to help the entrepreneurs scale their companies faster, by developing new products, entering new markets, and creating new jobs.

Experienced VCT managers have a network of specialists who can help investee companies scale and grow, for example advising how to hire and build effective management teams, supporting overseas expansion, or to develop effective sales and marketing strategies.

VCTA member firms are represented as board members or board observers on over 70% of all VCTA backed companies, providing professional, intensive support and guidance over the long term. The VCT scheme was established at the same time as the EIS, and both, alongside SEIS, are essential rungs on the funding ladder for start-ups looking to scale. Since their establishment , the schemes have had cross-party support and the demand for, and success of, the SEIS, EIS and VCT schemes has been consistently noted by a series of independent reports over the last five years.

As the Patient Capital Review found in 2017, the “popularity of these schemes has contributed significantly to the development of a vibrant UK start-up scene.”  That review led to the tax incentive schemes prioritising knowledge intensive companies undertaking research and development, thus strengthening the ability of these innovative high growth small businesses to access the incremental capital they need to develop their businesses. 

The Future of Growth Capital Report, published by the Scale Up Institute in 2020, found that “approximately 80% of total investment in angels’ investment portfolios were made through these [EIS and VCT] schemes in 20153, and the British Business Bank’s Angel Market research report of 2018 revealed that 86% of total investment in angel investment portfolios were made through these schemes in 2017”4. 

The Kalifa Review of UK Fintech, commissioned by the current government and published last year, found that this popularity has not waned, with a survey showing that “97% of founders have used tax-incentivised investment schemes including EIS, SEIS and VCT.” Separately, the Number 10 Taskforce on Innovation, Growth and Regulatory Reform5 published a series of recommendations calling for the VCT scheme to be expanded in order to unlock investment outside of London and the South East as part of the government's levelling-up agenda.  

The 2022 COADEC Tech Start Up Manifesto noted the success of the VCT scheme and raised their concerns that “EIS and VCTs are due to expire in 2025... The periodical sunset for EIS and VCTs gives investors and start-ups undesirable uncertainty, limiting both financial and business planning. If the UK is to maintain its momentum and pride of place as an attractive destination for venture capital and entrepreneurs, it should extend its world-leading incentive schemes in perpetuity.”

In addition, independent parties including the UK BioIndustry Association, Innovate Finance, Coalition for a Digital Economy (COADEC), the UK Business Angels Association (UKBAA), the ScaleUp Institute and the Institute of Chartered Accountants in England and Wales (ICAEW) voiced support for the VCT scheme and EIS in their submissions to the recent Treasury Select Committee inquiry into the venture capital market.

2. The Committee would also welcome any views on how the various reliefs rank relative to each other in terms of cost effectiveness. 

Not answered.

3. Do “cliff edges” in the structure of tax reliefs lead to problems for taxpayers, businesses or for the wider economy?

Built into the 2015 Finance (No.2) Act is a sunset clause, which states that eligibility for VCT and EIS tax relief will only apply to shares that are issued before 6 April 2025. Unless the sunset clause is amended or removed, this ‘cliff edge’ means that the last time new shares can be issued to subscribers who will still be eligible to claim VCT income tax relief is 5 April 2025. 

This means that unless the government acts to extend the sunset clause or remove it to place the VCT scheme and EIS on a permanent footing, no new capital would be raised after this point, because the tax break is essential in raising further money for the VCT scheme and EIS.  The industry needs certainty that the schemes have a future beyond April 2025; without this, raising money into a VCT may rapidly become challenging from a governance perspective, due to the risk of bringing investors into an illiquid fund without the means to create liquidity or continue to invest and grow.

The sunset clause was inserted as it was a requirement under EU state aid rules; now that the UK has left the EU, removing the clause represents an opportunity to make the best of the UK’s post-Brexit regulatory environment and support our start-up ecosystem. 

Entrepreneurs and VCT-backed businesses require certainty for long term investment, especially when the nature of patient capital means that businesses require support from VCT investors for an average of seven years (as shown by VCTA data). 

The ability of VCTs to raise additional capital has been an increasingly important part of supporting early-stage businesses to scale. The continued availability of capital resulting from this ongoing fund raising means that entrepreneurs can receive additional funding to support the continued growth of their businesses – something that is directly under threat from the ‘cliff edge’ represented by the 2025 sunset clause.

Since the Patient Capital Review (2017), the value of follow-on investment per annum across the whole industry increased from £88.3m in 2017 to £197.8m in 2021, as businesses sought increasing investment to support their ambitious plans. There is therefore a significant latent demand within existing portfolio businesses for further tax-incentivised capital, in addition to the need for new businesses to access VCT support for the first time (between £235-334m per annum between 2017 and 2021).  

4. Are tax reliefs being used in a way that Parliament or Government intended?

VCT funds are fulfilling their intended purpose in facilitating access to finance for smaller businesses with the potential to scale. In 2015, the government introduced specific changes to the administration of the VCT scheme, to ensure that the tax relief offered to VCT investors continues to be used appropriately.

Since the rule changes to the VCT scheme in 2015, VCTs have focused on seeking out high growth areas of the economy, including specialist manufacturing, data analytics, digital security, health tech, automation and FinTech. As the then Treasury Permanent Secretary Tom Scholar wrote on 16th August in response to correspondence from the Chair of the Treasury select committee on deadweight costs:

The Government has made changes to the schemes to ensure they continue to address the market failure. A recent example of this is the Risk to Capital conditions, introduced in 2018...These changes have moved investment towards higher-risk firms with genuine growth ambitions and capital intensive, highly innovative firms.

Our focus on growth sectors of the economy extends to growth regions – the Kalifa Review of UK FinTech recommended supporting regional specialisms and nurturing the growth potential of the UK’s top ten FinTech clusters to maintain the UK’s status as a FinTech hub, and by design the VCT scheme is ideally positioned to offer much needed patient capital to fast-growing start-ups in those regions. 

Therefore, in addition to fulfilling their core purpose from their inception in 1995, VCTs have won the support of successive governments through acting as an important tool to leverage private investment to achieve further government policy goals, including ‘levelling up’ and positioning the UK as a STEM ‘superpower’.

5. What problems do tax reliefs cause, whether in relation to the tax system including tax evasion or avoidance, or the wider economy? In answering this question, please identify particular reliefs and where possible, quantify the problems caused.

Not answered.

6. Please outline potential reforms to the system of tax reliefs, whether related to:

• Adding additional tax reliefs
• Removing or reforming current tax reliefs
• The administration of tax reliefs, including reforms to reduce complexity or cost of administration
• The Government’s analysis and transparency around tax reliefs. 
• Means testing and targeting

One of the most important things the UK can do to ensure that new and growing businesses can access patient capital is to support the VCT industry and the EIS, which together provide patient equity capital to thousands of SMEs every year. We have set out some further suggestions for reform elsewhere, including in our submission to the Committee’s venture capital inquiry; however, by a vast distance the most important and necessary reform to the VCT scheme and to EIS is to place them on a permanent footing.

The urgent and crucial action needed now is to remove the ‘sunset clause’ built into the 2015 Finance (No.2) Act, which as the situation stands, will leave SMEs hoping to receive patient capital funding from VCTs or EIS unable to do so after expiry date of the schemes in April 2025. As mentioned in our answer to question three, the industry needs certainty that the schemes have a future beyond 2025 to raise more capital to ensure the continuation and health of the schemes, as this ensures liquidity to enable investment into new companies.

VCTs can provide evergreen patient capital, which means they can remain invested in companies for many years. This is possible because the structure of VCTs means that individual investors are, after an initial lock-in period of five years, able to sell their investment without the whole fund having to be liquidated and a VCT is therefore able to raise further funds to support more young companies.

Because VCTs are evergreen funds, the initial 30% income tax relief not only leverages the additional 70% of private capital, but this sum can grow and be re-invested multiple times by the fund into new eligible businesses across the UK. Moreover, only around 7% of investors sell once the 5 year minimum hold is up - the average investment term is therefore significant.

This combination of an evergreen fund structure and recycling of capital has meant that VCTs have had capital to invest through cycles and – importantly in times of greatest economic need – when fundraising may be more challenging.  As the country looks set to face a period of economic turmoil, with small businesses particularly vulnerable to the impact of  ongoing ultra-high gas prices, it is more important than  ever to provide certainty that the VCT scheme and EIS, which many SMEs rely on for patient capital investment, will continue beyond 2025.

October 2022

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