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02-10-2017 - - 0 comments

Patience is a virtue.. or is it?       

Everyone has been talking about the Patient Capital Review, possibly the most important Government consultation to engage the angel world in living memory.  The inferred threat that HM Government might severely limit the S/EIS and VCT schemes either by constraining what types of company can receive investment and or a reduction in the tax breaks on offer was enough to get everyone pretty excited.  My LinkedIn post to encourage people to respond to the consultation received over 11,000 views in two days!

There is an issue around how the Government should financially support enterprise (without breaching State Aid rules).  This does not only apply to the private investor schemes but also the issue of what will replace the European Investment Fund post Brexit.  The VCs and PE houses who have been recipients of £1-2bn a year from the EIF are clearly keen to know what the Government will offer as a replacement to this capital.  It was rather frightening that a Government which is at its party conference this week espousing capitalism, has mooted that the replacement could be a nationalised venture capital fund owned by the British Business Bank!  Why it does not just make the FANGs (Facebook et al.) fund a new UK Investment Fund and keep the cost off the taxpayer, I don’t understand.

From the conversations I have had, everyone across the equity crowdfunding, angel, VC and smaller PE markets has a relevant and valid view, including many who see that new schemes should be adopted to target perceived “thin markets” in various parts of the investment economy.  One can only hope that the variety and volume of responses will lead the Government to the conclusion that doing anything in the November budget will be horribly premature and dangerous. 

Many fund managers have adopted a policy of, what I would argue is close to appeasement.  There is a view, which is worthy of acknowledgment but not one I agree with, that if the rules are tightened to prevent investment in less risky “capital preservation” or “asset backed” investment strategies then the Government will leave off the rest.  Maybe, but I am not so sure.  If asset backed investment is forbidden at the point of investment where do the limits lie?  Can a tech company not buy its head office at some point in the future (clearly after the 3 year EIS holding period!)?  May a manufacturer not buy its factory?  Is a nursing home looking after council paid for clients not a pretty risky investment for its owners in today’s climate? My fear is that conceding in this area will just lead our next Government (led by Mr Corbyn?) to extend the interpretation of the rule further and further until a company cannot get tax advantaged investment if it does or intends to own valuable distinct and separately saleable assets, such as patents. 

The now populist phrase, Patient Capital, has also been imbued with some dangerous undertones. Of course, prima facie, we know what it means.  You cannot normally trade in and out of Venture Capital (incorporating angel and crowdfunding) investments in probably less than a 7-15 year timeframe.  Even in profitable PE, one would be looking at 3-5 years.  When your average market maker might see one week as a holding period that is too long, these time frames are unbelievable but in our world they are “normal”.  

It is extremely concerning that now somehow you are a better, or worse, more acceptable, investor in the eyes of the Government if you are a Patient investor.  Not at all. In the race to a Unicorn, investors need to be as impatient as possible.  And at the end of the day the measure for what is Patient or impatient, nay Rapid Capital, must remain in the eye of the investor.  Core to this argument in the context of tax advantaged investment is not how long any one investor holds their equity position, but whether the capital invested is being put to long term growth within the company and ideally to the benefit of the UK taxpayer. In the context of the latter, I mean building companies that employ staff who pay taxes, generate VAT and Corporation Tax to the Exchequer.

The government must stop caring who owns the company’s equity. If you want to make thin markets fat, the easiest way to do this would be to end holding periods and allow shareholders to sell and buy shares as often as they wish.   After all the capital is by then being put to work in the company.  Making the secondary market work would solve the recycling investment capital challenge and fatten up the market.  And we all know that making money move faster can be just as or more effective than any other way of growing an economy.

The concept of Restricted Activities is one that deserves deep thought.  Should a tech company which gets Advanced Assurance from HMRC but which ends up serving e.g. the agriculture market, also be restricted on the basis that its customer base will be strong and stable?  And what about all those FinTech companies that are blatantly tech (therefore qualifying) but in Financial Services (not qualifying)?

If the government cannot help itself but to create more restricted investments, it must also acknowledge that activities can become riskier over time because of market forces.  It must send a message that it is willing to withdraw types of investment from the Restricted provisions in the future if market conditions mean they have become a riskier proposition.

The Government has a perception that some are abusing the spirit of the S/EIS and VCT schemes even if they are obeying the rules.  The challenge here is one person’s abuse is another person’s market led investment strategy.  Let’s face it all, but especially vanilla retail investors, look for the minimum risk for the maximum return and their advisers will look to do what their investors want. 

It can be argued that the fund managers offering capital preservation are only offering what the market wants. For the government deliberately to interfere in the market to prevent investment is counter intuitive.  Would it not be better to force fund managers to create balanced venture capital portfolios, which by definition, will include some less risky investments?  A compromise might be to limit the element of asset backed, later stage or capital preservation investments within a portfolio to say 10% or 20% of NAV. In the case of individual companies, looking to intangible assets and fixed assets and placing some sort of limit on these as a proportion of net assets might be a solution.

I have discussed just some of the bigger issues that have arisen thanks to the Patient Capital review.  In itself,  the Review will have given HM Treasury lots of data and also things to think about.  I would be shocked if it now thinks it can come up with effective policy in just 8 weeks.  So I expect the Chancellor to conclude that more work needs to be done.  I hope he does, because there are some more far reaching and long term solutions that would solve the UK enterprise investment challenge out there far better than the way S/EIS and VCTs are structured at the moment.  If the Chancellor moves now he may kill these opportunities before they have the chance to see the light of day. 

And wouldn’t that be a tragedy for capitalism and the party that now differentiates itself on that philosophy. I beg that the Chancellor adopts a Patient approach himself before going any further in the desire to make investors do so.

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