At the Institute of Directors, we believe that markets generally perform better when intervention from politicians is kept to a minimum. So it may surprise readers of CapX to hear that we’re calling for a dose of state support to help more of our fledgling start-ups get the investment they need.
Market failure is often given as reason for government intervention, but in this instance, the market isn’t failing. In fact, you could even say it is booming. By all available measures, the alternative finance and start-up equity markets are growing exponentially year-on-year, as investors look for returns in the age of low interest rates and business show an appetite to try new methods of obtaining finance.
But that’s not to say there isn’t room for improvement, and where Britain has the potential to lead the world, we should accept some gentle pushes from our politicians to help us get there. Britain lags many countries even in Europe on its approach to risk capital, meaning businesses find it hard to raise money for ambitious growth projects. Just 20% of all finance raised by small and medium-sized businesses in Europe is done so on the capital markets. That compares to around half by American firms. Such a reliance on bank finance means SMEs on this side of the Atlantic are too exposed to the health of high-street lenders, making them susceptible to the cycle of the financial industry. As we saw in the downturn, when banks hit trouble and are told to bolster their balance sheets, lending suffers.
Investment tax reliefs like the Enterprise Investment Scheme and Seed Enterprise Investment Scheme offer a partial solution to the liquidity problem. They decrease the amount of risk an investor will have to take on. It’s understandable that small investors are often risk-averse. Many may be worried about buying a few shares in a company because they think they’ll lose the lot. EIS and SEIS reduce the risk by ensuring that investors are guaranteed at least 30% (through EIS) or 50% (through SEIS) of their investment back in tax relief.
This is the framework – straightforward and simple. But the clearing system – the process through which this framework is administered – is laborious and complex. For anyone who has weighed up the risks, spotted a company they like and wants to take the plunge into company ownership, they instantly meet a raft of bureaucratic barriers.
In the Institute of Directors report, Opening the Equity Economy, launched this week, we call on the government to do what it can to streamline the process. EIS/SEIS investments should be alongside peer-to-peer lending and crowdfunding as the tools which will revolutionise 21st century finance.
All three should be included in the flagship ISA wrapper, not for any additional tax relief purposes, but to highlight how simple they are to make and encourage more providers to take an interest. ISAs have proved incredibly popular with the public, and could be used to direct savers to small businesses as well as listed company shares.
For any investments of less than £2,000, investors should be able to make their tax relief claim entirely online. Only around 10,000 people make EIS/SEIS investments of less than £10,000 in any given year. Along with a general lack of awareness, part of this must stem from the fact that making an investment of a few hundred pounds simply doesn’t seem worth navigating the tax bureaucracy.
These are the first steps we advocate to dramatically simplify the system for potential investors. But the system contains other quirks that could be ironed out. The rules currently prevent parents from using the tax relief schemes if they invest in a child’s business. There are understandable concerns about the need to prevent money laundering and fraud, but we are missing an opportunity here. Around two-thirds of first time house purchases are made possible by cash from the bank of mum and dad, how much better would it be if some of that money went into start-ups instead?
In Britain, there is clearly an appetite among businesses to raise more money from non-bank sources. And there could be plenty of potential investors. So while the pill may have the bitter tang of interventionism, it’s one worth swallowing.
