By Dillen Iyavoo on Thursday 3 September 2015
It’s no secret that around 50% of start-ups fail in the first five years; the Government knows that, businesses know that, and investors know that.
On the face of it, the risk seems high: a toss of a coin, if you will. Start-ups are therefore at an immediate disadvantage when approaching the funding gauntlet – they’ve got a bad rep because so many before them have failed, but on the bright side, the same number have succeeded. Regardless, the failure side to this particular coin is always the one that is most scrutinised because, when it comes to investing in these high-risk businesses, it’s people’s hard earned money we’re talking about – and a 50% chance of losing your entire investment seems high to even the most hardened of investors.
The length of time it takes before an investor even begins to get a sniff of profit share is another factor putting start-ups at an immediate disadvantage when looking for funding. Given that it could be three or more years before a start-up is in a position to start delivering returns to investors, investors need a little extra encouragement to invest in these types of businesses – and that’s why tax breaks are so effective.
SEIS/EIS tax relief schemes are the cornerstones to early-stage business investment. Between 2013-2014, the schemes raised a combined £1.6bn in equity investment for start-ups in the UK.
Tax incentives not only mitigate the risk of investing in unlisted UK businesses, but also provide investors with an incentive upfront in return for their confidence in the business; tax breaks enable investors to possibly receive up to 50% of their investment back just months down the line.
Despite the incredible things SEIS/EIS schemes have done for equity crowdfunding, there is still a significant imbalance between equity crowdfunding and peer-to-peer lending. The former raising £48m for businesses last year – the latter around the £1.5bn mark.
The balance will almost certainly tip further towards that of p2p lending when the new Innovative Finance ISA wrapper is launched. There’s no denying that the ISA will do fantastic things for this side of the industry, and will certainly push the lending/investing method further into the mainstream. However, a refocus on the equity side of the industry needs to take precedence now. After all, it’s the early-stage businesses that go on to become the SMEs that typically raise money through peer-to-peer business lending at a later date. So if we start neglecting the foundations of the industry/economy by not better supporting them with things like improved tax relief schemes, while firming up the structure further up, we start to compromise the stability of the entire funding pathway.
What we don’t want to see is people beginning to shy away from equity investing because the peer-to-peer propositions are better supported by the Government, making the overall p2p package more attractive and casting shade over the equity side of the industry. An investor is an investor at the end of the day: they’re continuously weighing up risks versus returns – and it’s hard to deny that, for the retail investor, the new ISA deal will be an attractive proposition come April of next year. For obvious reasons, this may lead a large chunk of retail equity investors to begin looking to the other side of the sector in search of returns. This will no doubt reduce the funding capabilities of equity crowdfunding platforms.
As good as the current SEIS/EIS schemes are for attracting all types of investor into equity campaigns – offering what could be seen as a more immediate reward for investing in high-risk unlisted UK companies that won’t be returning anything for a number of years – the process can become onerous and elongated. It can take months before an investor recoups a percentage of their original investment back in tax breaks. This can be the deal breaker for those investors who are interested in the schemes, but are turned off by the length of time it could take to get some of their investment back. What’s more, there’s a definite lack of awareness of the schemes, meaning there could potentially be thousands of investors out there that would be more willing to take on the risk of investing in a start-up but lack any knowledge of these key incentisiving schemes.
A concern that has been drawn from the recent announcement of the new Innovative Finance ISA, coupled with the news that the Government will look into changing the equity tax benefits – remember SEIS/EIS was only supposed to be a short term solution to jumpstart investment – is that the all-encompassing name ‘Innovative Finance’ suggests it will one day be an umbrella term for other types of non-traditional investments.
Maybe we’re jumping the gun here, but say we were to see the current SEIS/EIS offering displaced by an equity ISA package – this would only spell bad news for the industry.
Lining investors up for tax breaks months down the line is one thing, lining them up for tax breaks on earnings that might never arrive, or at the very least take three years to land, is another. It would be totally thoughtless to bring in such a scheme and expect investors to be incentivised in much the same way they are with SEIS/EIS schemes; the very schemes that have contributed billions of pounds to the industry over the years.
The nature of the current SEIS/EIS system – although slow – works because it isn’t based on the outcome of the business invested in. It is based directly upon what stage the business is at at the time the investment is made, which makes complete sense given that these businesses are very much taking every day as it comes with a future that is not promised – so why make the tax breaks dependent on the success of the business when in up to 50% of cases that will result in no returns whatsoever?
The industry is growing remarkably well. But to become overconfident and pull the supports away from the structure too soon could end up destroying the progress that has already been made.
There needs to be some serious thought given to the equity investing tax breaks to bring them up to speed with the peer-to-peer lending side, and we need to be wary of making any rash decisions that could seriously damage the great work that’s already been done.