Is investor appetite for the Enterprise Investment Scheme (EIS) waning? It would appear so, from recent news that there has been a sharp drop in the funding small businesses raised through EIS last year.
Though the total figure is still high at £1.6bn, it is down by 12 per cent from £1.9bn the year before, largely due to a tightening of the rules in 2015. The environment has become more challenging for companies seeking vital investment funds and investors looking for decent returns on their capital - but the implications are wider-reaching.
Consider what EIS is actually for. Designed to help smaller businesses raise finance by offering generous tax reliefs to investors, the Government’s ultimate goal is to help boost economic growth, drive innovation and stimulate job creation (and tax revenues) for the greater good of UK plc. This fall suggests that the changes made to the scheme may be undermining this aim.
The new rules mean that companies which have been trading for more than seven years are no longer eligible except in very restricted circumstances. Investors can now only benefit if they invest in higher-risk start-ups and early stage companies rather than more established growing businesses, as before. The problem is, many do not have the desire or risk profile to do so, given the higher failure rate of such deals.
The changes were triggered by a need to clamp down on misuse of the scheme by “artificial structures” whose primary purpose is to obtain tax relief rather than to support genuine trading growth. Although there was a clear need to do so, there’s a real risk that the tightening of the scheme has gone too far and dampened demand from what is clearly a willing investor base.
Small businesses that have been trading successfully for some time need investment just as much as new companies if they are to capitalise on growth opportunities. They also tend to be more significant contributors to the economy via taxation and employment. Take the example of one of our portfolio companies – a major coffee chain franchisee company called 23.5 Degrees Ltd. Since our investment under two years ago (which was EIS qualifying), the number of staff it employs has quadrupled to over 500 as it rolls out its expansion plans. However, it’s unlikely the investment would qualify for EIS today.
That said, it’s also true that a lack of tax breaks should not deter investors if the investment proposition is sound in its own right, offering a good quality deal in a strong business with potential to deliver real returns. There can be a whole host of reasons why a deal is attractive, and tax breaks should never be the driver for investment.
Nevertheless, it’s a shame that fewer companies are now able to use EIS as a selling-point to get the funding they need to take their business to the next stage. If the downward trend continues, the UK economy will be the poorer for it.