Tom Hopkins fears the responses to the Patient Capital Review consultation may fall upon deaf ears and urges advisers to remember there is always a way forward
Judging by most of the media coverage of the Patient Capital Review, it is a worry that despite the wide-ranging consultation, the government has already made up its mind and could unleash a determined assault on the tax-efficient sector. Let’s begin with a reminder how we have all understandably arrived at this confusion. The government undertook the Patient Capital Review in an attempt to review how the UK is supporting growth businesses, especially in a post-Brexit world. The main reason is to see how it can replace inflows from the European Investment Fund (EIF), a European Union agency effectively funded by member states. The EIF has been an important backer of British venture capital and accounted for more than a third of investment in UK-based institutional venture capital funds between 2011 and 2015.
So far, so good – but the consultation is also reviewing the effectiveness of the UK venture capital schemes – venture capital trusts (VCTs), the Enterprise Investment Scheme (EIS), Seed EISs and and social investment tax relief. As we have written for Professional Adviser more than once, following the 2015 changes to the rules that cover the government’s venture capital schemes, more capital than ever is flowing from these schemes into growth businesses. Yet the government wants more changes and some of the feedback coming out of recent meetings suggest that is exactly what is coming – perhaps regardless of the feedback from the industry.
Changes on the way
At this point it seems asset-backed EISs have been thrown under the bus. The government is not keen on a company building or buying any asset – for example, freehold or long leases – using EIS and it seems the industry has accepted that argument. So, for instance, a pub company will no longer be EIS-qualifying. There are valid counterpoints, however, such as, even if there is an asset, there is operating risk that could mean the asset may be worth very little if the company in question fails. Recent EIS investments into anaerobic digestion plants are a good example with some investors nursing heavy losses despite the supposed asset-backing. But it would seem that battle has been lost – one fund manager recently withdrew a VCT offer that focused on asset-backed deals.
It is also interesting the Treasury has stated that job creation alone is not enough – it wants innovation and growth to be part of the venture capital schemes’ story. This has resulted in investments in television and film coming under scrutiny, with both the Association of Investment Companies (effectively the VCT association) and EIS Association prepared to discuss film and television as excluded activities for EIS and VCT investments.
Again, given the importance of the creative industry to the UK, good arguments exist for continuing with the status quo but these have seemingly been sacrificed for the greater good – in other words, a continuation of the EIS and VCT schemes…
It is unclear whether tax relief for VCTs may be part of the review although the greater than ever number of VCT offers out at this time of year suggests concerns leading up to the November budget.
So what can advisers do?
All this uncertainty comes at a time when some of the historical EIS renewable funds are exiting, so investors are asking their advisers where they should invest their proceeds from these funds, especially if there are capital gains tax deferral implications. Unfortunately, there will never be another solar type investment in EIS again. But that does not mean there cannot be good returns made for investing in higher-risk deals.
So what do advisers need to be aware of? For EIS, advanced assurance is as important as ever – especially for non-growth focus EIS funds – and, if you want to invest in an asset-backed EIS, then it is probably best to do so ahead of the 22 November Budget. Rather than trying to second-guess government policy, however, the safest route is just to look for funds that have always followed the spirit of the rules – in other words, growth EIS funds or VCTs that have never had to change their investment strategy. Yes, with investments such as the Parkwalk EIS funds, there is the greater risk that you would expect from growth EIS investments but – past performance caveat to the fore – such funds are generating real returns for taking this additional risk.
As for the VCT option, do be aware of changes to historical investment strategy and the high cash/quantum ratio in a number of VCTs, which suggests some are struggling to deploy the capital into deals as they adjust to the 2015 rule changes. Smaller VCT raises might therefore be worth considering – and diversification is important – with the likes of Pembroke VCT having always invested in growth businesses (rather than management buy-outs) and boasting a low cash ratio.
We will not know the final decision on the Patient Capital Review until the Budget. I hope the conclusion will be that the UK venture capital schemes play such an important role in supporting UK PLC that there will be some limited tweaks to build on the 2015 rule changes – in effect, continuing to direct capital to growth businesses and having limited impact on investor demand. Asset-backed EIS would seem to be the main target at the moment but I would not be surprised if we see changes to address competition and structural issues in VCTs. As we await the Budget then, one thing is for certain – the government has made up its mind it wants more of this capital to be invested in growth businesses if the UK venture capital schemes are to continue.
Tom Hopkins is a co-founder and partner of Kin Capital, which provides fund-raising and fund management services to funds operating in government tax-efficient schemes, for more information please see our About us page.