By Sarah Barber, CEO of Jenson Funding Partners
Government typically receives even less praise from businesses for well-made decisions than from the electorate. But both EIS and the later-formed SEIS tax relief schemes for high-growth businesses have been success stories and should be celebrated as such.
Today, though, both schemes are beginning to show their age. While fundamentally they still meet their purpose – funnelling investor cash to high-growth companies – there are several areas in which they can be improved and made to work better for investors and companies alike.
EIS radically changed the UK startup ecosystem – for the better
Being an entrepreneur has never been easy – that’s a statement of the obvious. But it remains true that before the EIS scheme was introduced in 2002, the fundraising environment for many entrepreneurs was a lot more hostile.
To those without existing connections to the ‘old boys’ network’ of existing VCs, it was a wilderness both difficult to penetrate and to navigate if you were lucky enough to break through. At the time some might’ve argued this lack of openness served a purpose – to keep out bad ideas.
But the past two decades have proven this wrong. In reality, this gatekeeping just reinforced an elitist status quo and was a major obstacle to people from more diverse backgrounds starting a business. While EIS and SEIS haven’t completely broken down these barriers, they have played a big part in making them easier to overcome.
Why EIS and SEIS need to be brought up to date
So far, so good – but as any entrepreneur will tell you, providing a good idea can work in practice is just the start. Over the past twenty years, we’ve learnt a lot about how to devise tax-efficient schemes to benefit investors, companies and wider society, and yet innovation in this area has been minimal.
The primary issue with our existing system is that it creates a ‘lumpy’ environment for fundraising. The gulf between caps for raising cash via SEIS and EIS is broad – for SEIS, companies can raise to £150,000, while EIS is limited to £5m.
Today, £150,000 does not get you very far – and in the context of rising inflation and wage expectations, that’s going to become even more of a problem. At the SEIS level, companies are forced to spend a huge amount of their time going to investors to top up their bank accounts because they are unable to raise it all in one go. This detracts from their ability to build a business, which isn’t good for anyone.
How to change our tax relief system for the better
There are a few steps the Government can take to solve these issues. The first is to raise the funding cap limits of SEIS from its current level of £150,000 and shorten the gap between it and the EIS limits.
While some may raise legitimate fears around handing very early-stage companies even more cash to play around with. But there are ways around this. Of course, the basic principle of companies should learn to walk they run remains true.
Investor cash could be delivered to companies in tranches – over periods of 3-5 years – encouraging companies to act with caution but also reassuring them of runway so they can focus their attention on business matters.
Secondly, more should be done to support companies through the very earliest stages. The British Business Bank does great work, but it can take an even more active role. This could be through closer collaboration with VCs on things like deal flow, or by providing more funding.
Thirdly, we should ask frank questions about whether the tax incentives for each scheme truly marry up to the risks inherent in them. In theory, tax incentives should reflect the risk profiles of each stage of investment.
If you follow that logic, SEIS should be the most generous, followed by EIS, followed by VCTs. But in practice, SEIS only offers marginally better tax relief than EIS. And VCTs are a very different proposition to EIS when arguably they should be a marginally improved version of EIS (as they offer access to more mature companies).
Fiddling with tax incentives is a sensitive issue and should be done with care, but a more balanced set of schemes would also help smooth fundraising by preventing stockpiles of cash at the VCT end and spreading cash more evenly across the high-growth ecosystem.
Making the UK the world’s best place to start a business
You might look at EIS/SEIS and ask, what’s not to like? Both remain appealing to investors who continue to see handsome returns. The taxpayer has seen a return on their investment through higher tax receipts on company earnings and salaries. And incredible companies have gotten access to funding that would otherwise have been inaccessible.
But this just demonstrates the potential that the model has. If we can iron out some of the wrinkles that have appeared over the years, we can create the most hospitable environment for growth companies in the world.