At today’s Budget, Chancellor Rishi Sunak’s focus will be on containing the economic impact of coronavirus. The top priority will be preventing otherwise profitable businesses from going bust and damaging long-run productivity. But it will be a missed opportunity if the short-term measures to keep SMEs afloat aren’t matched with policies to enable them to grow and scale once the dust has settled.
The Chancellor has a range of tools at his disposal to remove the barriers preventing startups from accessing the finance they need. In my new report for The Enterprise Trust and The Entrepreneurs Network, Unlocking Growth: how to expand access to capital, I explain how.
To unlock long-run economic growth, equity investment should be a key focus. Though most start-ups will stick to bank loans, venture capital-backed businesses have an outsized impact on the economy. In the US, while only 1 in 600 new businesses in the US are backed by venture capital, those businesses employ 10% of private sector workers and make up 50% of stock market listings.
The good news is we have seen a massive expansion in the use of venture capital over the past decade. Since 2011, the annual number of VC deals has tripled and the total amount invested has increased almost tenfold from £1.6bn to £12bn to 2019.
However, we still have got a way to go before we catch up with the US. According to PitchBook data, US VCs invested more than 10 times as much as UK VCs in 2017. To explain the shortfall, you need to look at our pension system. They provide 65% of venture capital in the US, but just 12% in the UK. If just 3% of the money invested defined-contribution schemes went to venture capital, it would amount to a £30bn increase in equity investment available for startups by 2029.
Two barriers block pension fund investment into venture capital. First, workplace pensions are subject to an annual 0.75% cap on fees. It’s meant to protect savers, but is poorly suited to the VC model, where investors take a much more active role. Second, pension regulations require regular valuations of assets under management. That’s easy enough for standard stocks and shares but VCs only book a valuation after an external event like a funding round. Tweaking these rules would help us close the gap on the use and help spread venture capital funding to more of the UK.
Sunak should also look at the Enterprise Investment Scheme and Seed Enterprise Investment Scheme. The generous tax reliefs are enormously popular with angel investors: 9 out 10 business angels have used them and three-quarters (74%) believed the reliefs were a key factor in their decision to invest. The reliefs have played an important role in getting more high-growth startups to scale, but there’s a problem. Investors will typically require startups receive Advanced Assurance from the taxman that the investment will qualify for the relief.
This wouldn’t be a problem if the process was quick, but delays of six to eight weeks are common. Needing to name your investor in your application to HMRC compounds the problem. This creates a chicken-egg situation, where investors are unlikely to commit time to meet SMEs if there is a risk the investment will not qualify for the relief, and you cannot get approval without meeting investors. Delays can be painful for start-ups who often have to put their business on hold while they wait for approval. Fixing this should be another priority for the Chancellor.
The last decade has shown the value of having regulators that are open to innovation and new business models. As traditional lenders put in place tougher lending criteria, a wave of alternative lenders have helped plug the gap. Over £2bn a year is now lent through peer-to-peer lenders and close to 400 equity crowdfunding deals (average size: £525,000) take place in the UK each year. The enabling approach from the Financial Conduct Authority (FCA), which prioritised informing investors, has allowed the sector to flourish. Moving forward, the Chancellor should look at how policies like the FCA’s fintech sandbox can be built upon to allow more innovation.
R&D Tax Credits can be a lifeline to early-stage innovative ventures, but it needs modernisation. The process to get the relief takes more than 28 days for around half of startups, according to Coadec polling. HMRC’s definition of research expenditure is also out of date. Many expenditures SMEs consider essential to their R&D work either do not qualify or it is not clear whether they qualify. For instance, the use of cloud services is essential to start-ups working with data, but accountants and advisers differ as to whether they partially qualify, if at all. There are hints that the Treasury understands this and is poised to act.
The UK’s recent start-up success story is to be celebrated. At the budget, the Chancellor should go further and turn it into a scale-up success story by removing barriers to finance. Fixing ill-suited regulations, streamlining tax reliefs, and unlocking additional investment into venture capital may take a backseat at the Budget, but they will be key to generating growth in the long run.
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