Small start-ups falling through the cracks
Start-ups are some of the most hardest hit businesses by the crisis. If you didn’t raise investment just before the crisis, you are up a certain creek without a paddle.
Funding in start-ups has dramatically withered as investors aren’t investing. The pandemic has recalibrated their world view, with investors instead focused on survival – keen to hold back cash to support their existing investments and protect assets for their families. While there may have been £663 m of investment between March 23 and April 27 (up 34% higher on last year), only 7.6% went to new investments. These would have been in special areas that are extremely well positioned for the crisis (think mini ‘Zoom’ style companies), with money flowing from funds where the strategy is to invest when competitors are not.
The agenda in government meetings was simple: Help start-ups, by introducing a governmental fund to encourage investment. The outcome, however, was ‘The Future Fund’ (backwards fund would be more appropriate) which offers matched funding of convertible debt for those promising companies.
The problem is that this is a convertible debt and completely incompatible with the tax relief that attracts investment from UK individuals and almost all venture capital funds, i.e. the Enterprise Investment Scheme, and Seed Enterprise Investment Scheme (EIS & SEIS) – that allow investors to claim tax relief of 30% or 50% of their investment respectively, amongst many other incentives. In other words, it was claimed that investors’ funding would be matched but on a conditional basis – applying only to the minority of investors and companies which are not reliant upon EIS/SEIS relief. Additionally, if it did not convert, amongst other unhelpful clauses, you would owe 200% of the money back.
The bright sparks of HMRC and Government got what they wanted – headlines and no tax relief, rather than create a tool which is actually useful for struggling start-ups.
What should have been done instead, was to allow funding to be EIS compatible. This would welcome a ‘boom’ in investing. Between the fund, EIS and R&D relief, someone could turn £100k investment into almost £266k of value in one move.
But no, somewhere along the line HMRC was already feeling the pinch, and the Government was keen on headlines that sounded right, but had no real substance. It is hard to believe that any of the UK’s great entrepreneurs were present at the discussion table.
What should have been done within the current law framework is to allow the use of Advance Subscription Agreements (ASA), initially coined in the US as Simple Agreement for Future Equity (SAFE). ASA is an investment for equity where the investor pays in advance for shares that will be allocated at a later date – it is not debt, just cash now, and a deal on when you do raise at a valuation in the future. There are several benefits to this – primarily that it is EIS/SEIS compatible. This means that you do not have to set the valuation now – something very hard to do for businesses in such a changed world – you get the money instantly, and the investor receives the important reliefs when the shares are issued.
Who will the Future Fund benefit? Older investments (EIS has a seven year time line), ineligible investments (property, energy, and other less risky highly profitable industries are ineligible for EIS), but certainly not the start-up community.
Thankfully one thing is always in start-ups favour. Innovation and persistence. If anyone can work out a way to move forward … it is certainly them.
Andrew Oury, Partner at Oury Clark Chartered Accountants