Over at Conservative Home, Charlie Elphicke MP has written a piece looking at how the government could help small businesses motoring and driving the economic recovery. While I agree entirely with the sentiment, I despair at his solution.
A growth fund could provide that capital. This is different from simple small business debt finance where security is so often required. The purpose of the fund would be to assess the quality of the business rather than the quality of the security (i.e. look at the business plan rather than the director’s family home). It would be to provide intermediate and equity finance. Indeed, Labour dipped a toe in the water with a small scale £75m fund called the Capital for Enterprise Fund.
The growth fund would be invested by fund managers from the City, not by Government. SMEs would apply to the Growth Fund for capital and have to make their case on solid business principles, dragon’s den style.
No, no, and thrice no.
Charlie correctly identifies there is an equity gap at the bottom end – typically the entrepreneurial end – of the market. It is a British disease that Venture Capital contains no venture but lots of capital. If you are an established company seeking growth finance then, relatively speaking, money falls from the sky. But if you are a start up or young company seeking seed or 1st round equity funding, then you are in trouble.
The problem with Charlie’s proposal is that it is centralised. A central fund doling out cash to the SME/entrepreneurial end of the market, with people in the city VC/finance sector evaluating the plans.
In the UK there are around 4,000-6,000 Angel investors, investing an average of £42,000 per investment. Angels are a small army of usually successful businesspeople with knowledge, experience and contacts, which can really help young companies succeed. However the number of Angels is small, being limited to individuals with disposable or readily accessible cash to invest and, for any given investment opportunity, limited further by the fact Angels tend to invest in sectors they understand and can add value.
The solution is not therefore a centralised fund managed by city boys, but a market based solution which embraces distributed knowledge, experience and diversity.
Tax relief available to Angel investors tends to be through the Enterprise Investment Scheme, offering 20% income tax relief, capital gains tax relief and loss relief. However this is too little. It provides a small amount of risk reduction, and improves investor incentives slightly, but not significantly, but it does not address directly the total availability of capital.
So, what would my solution be?
Tax Relief: Increase tax relief on investment at the bottom end of the market. 40p and 50p Income Tax relief, not just 20p. Also give full CGT relief on realised investments, and extend loss relief so loss risk is reduced substantially, perhaps allowing £1 of losses to be offset against more than £1 of taxable income. Also give tax relief on dividends paid to investors, removing the discrepancy between dividends and capital gains, and giving investors another route to obtain a return rather than sale or flotation of the company/shares – this also has the value of potentially shortening the ROI period and reducing the risk that returns are reliant on a strategic buyer or costly flotations.
Co-Invest: Angels are great at evaluating investment opportunities, and generally like to invest individually or with a small number of other Angels. A scheme to co-invest, for example providing up to 33% of total investment value, would increase the total capital available by 50%, and benefit from the Angel’s risk evaluation (Angels are more cautious than fund managers because it is their own money). Also companies seeking larger sums who would previously require a larger consortium of Angels would now need fewer Angels, making the likelihood of securing the investment larger.
In other words what is required is substantial sculpting of tax reliefs in several areas, complimentary to each other, designed to minimise risk, maximise potential returns, and perhaps direct government funding injected into the system to increase total capital available. But the system must be distributed, use market mechanisms, and be widely available, in order to work. It must send both a signal that it pays to take some risk, and materially help that to be the case.
However a centralised government led fund, run by fund managers, is not the way to go about it. It is not distributed and relies on a small number of people evaluating the opportunities, whom will unlikely have experience, knowledge, or contacts in the sectors to meaningfully add value to the business.
Growing new and small business was the topic on the Politics Show in the West Midlands on Sunday and it was the same stuff from the Labour and Con MPs on the show that we must help the new and small business to start up and grow and get people into work again.
Yes it would help if the tax levels were brought down or removed for businesses to start up. For people to be able to get job and for the government to leave and stay away from the private sector and let it do it’s job as it’s trying to do!.