Venture Capital Trust Association (VCTA) submission to the Business, Energy and Industrial Strategy (BEIS) Committee’s small businesses and productivity inquiry
About the VCT Association
1. The Venture Capital Trust Association (VCTA) represents ten of the largest venture capital trust managers in the UK, which make up 75% of the VCT industry which is equivalent to £3 billion. These VCT funds support a range of high growth, small businesses across the UK, operating in sectors as diverse as digital technology, software, medicine development, specialist manufacturing and online retailing. The ten funds we represent are: Octopus Investments, Livingbridge, Albion Capital, Foresight Group, Downing, Beringea, NVM Private Equity, Mobeus Equity Partners, Maven Capital Partners and YFM Private Equity.
2. VCTs invest throughout the UK, helping to balance the nation’s economy, and as VCTs support businesses that are growing rapidly through the development of their management teams and operational functions, VCTs help create employment at all levels within a business. Research by the Association of Investment Companies (AIC) shows that where investment has been present for over five years, the average increase in jobs is over 100 per company. Companies currently backed by the VCT scheme have created 27,000 jobs since the date of the first investment by a VCT.
Executive summary
3. Businesses supported by VCTs are typically highly productive and drivers of local growth. The potential economic benefit of VCT funding is currently not being fully exploited due to restrictions surrounding time limits, funding levels and bureaucratic delays during HMRC’s advance assurance process.
4. An increase in the age of businesses that VCTs can provide finance to, alongside an increase in the size of investment permitted, would do much to encourage higher rates of productivity and more scale ups across the UK. There is currently a funding shortage in rounds between £5 million to £50 million and for companies with a market capitalisation of between £15 million and £100 million. These companies are typically 10 or more years old and are not eligible for VCT investment.
5. The bureaucratic delays at HMRC are severely undermining the ability of high growth small businesses to access the finance they need to scale up. The current target for HMRC to process advance assurance applications, as announced in the 2017 Budget is 15 days, yet the average length of time for clearance currently stands at 64 days. Due to the draconian penalties regime in place for investments found to be non-qualifying, businesses cannot receive the funding until the investment has been formally approved by HMRC.
Scale Up
6. As the government has correctly identified, the biggest challenge facing high growth British firms is access to scale up investment. Crucially, the funding gap for high growth / high risk companies seeking to raise more than £5 million needs to be filled and there is a valuable role that government can play in bringing together significant institutional funds.
7. The UK’s start-up finance ecosystem works well, but we believe the ‘finance gap’ has only been partially addressed to date and that a material number of firms in the UK still lack the long-term finance they need to scale up and reach their full potential, and this is where VCTs play a vital role.
8. However, there is a funding shortage in rounds between £5 million to £50 million and for companies with a market capitalisation of between £15 million and £100 million. These companies are typically 10 or more years old and, under the current rules, can no longer access VCT and EIS funding in the UK. The VCTA believes that investors need to be able to support companies for longer. As a consequence, these companies – which have significant potential to scale up – are often forced to attempt to bring in overseas funders, predominately from the US, if they are to finance their growth plans.
9. Barclays’ Scale-up UK: Growing Business, Growing our Economy report published in 2016 found that the median UK fund size was $78m compared to $100m in the US, illustrating the size and frequency of follow-on funding rounds in the UK are typically smaller and shorter. Only 15% of UK companies’ investors invested for three rounds or more compared with 25% of US companies’ investors. The funds under management of the 10 members of the VCTA collectively amount to £3 billion, so VCTs are well placed to provide larger rounds and more follow-on investments. There remain unnecessary obstacles for a material number of firms looking to access finance and scale up.
10. A report by the British Business Bank, Small Business Finance Markets, published in February 2017, corroborates the challenge that firms face securing scale up funding in Britain by comparison to the US. 62% of UK series A seed deals received a follow on round of finance compared to 68% in the US. The lack of follow on rounds is likely to be holding back the rate of growth of UK companies. This is in addition to UK follow on rounds being smaller in size to the US.
11. VCTs provide a well-established support ecosystem alongside each investment. The significant skill base of VCT fund investment professionals, make available expert advice and place people with specific experience in the businesses in which they invest. VCTs provide a broad range of support in areas such as IT, operations, management and financial guidance. VCTs are therefore a major contributor to the culture of entrepreneurship.
Advance assurance
12. There are aspects of HMRC’s advance assurance process that are creating significant barriers to the deployment of capital to high growth SMEs which would allow them to scale up. Delays and a disproportionately harsh penalties regime for even just minor breaches are curtailing growth at a critical stage in businesses’ development, thus affecting productivity. Currently any kind of breach, however minor, could result in the disqualification of an entire fund.
13. The government understandably has to ensure that VCT funds go to businesses that are within the VCT mandate and the rules of the scheme are being applied consistently. Therefore, before any investment can be made by a VCT into a business, they must apply for advance assurance from HMRC. If any VCT fund makes a non-qualifying investment, the current penalty in legislation can result in a complete loss of status for the fund in question.
14. HMRC aims to respond to all straightforward advance assurance applications received within 15 working days and the target for more complex cases is 40 working days. Yet the average length of time for clearance currently stands at 64 days, with some applications from September 2017 only being processed in March. As part of our evidence, we have also submitted an anonymised spreadsheet from March 2018 showing the investments awaiting advance assurance clearance from HMRC.
15. Such severe delays in funding can have serious and catastrophic effects on businesses, who may have no other recourse for financial support and are relying on clearance from HMRC.
16. The VCTA know of one business while awaiting advance assurance using a senior executive’s personal credit cards to cover costs, whilst also being notified by a debt collector within HMRC that they were coming into the business to ‘lock the assets of the company’, because of unpaid PAYE which was a direct result of the delays in the advance assurance process within HMRC.
17. A fast growing e-commerce platform based in the north west of England is another business which has suffered as a result of the delays within HMRC. In September 2017, the business was successful in attracting external investment through a VCT to support their ambitious growth plans and an application for advance assurance was lodged with HMRC accordingly. The application was only approved in March which has prevented the company from creating 50+ new jobs. The company depends on a regular supply of products for delivery, but due to cash falling to an unsustainable level supply has been disrupted with the resulting service levels to customers suffering. This temporarily impaired the viability of the business.
18. A small business in a deprived area of East London has been waiting on a £1 million VCT investment since October. Despite it being a straightforward application, and advance assurance being applied for some 5 months ago, it is still yet to be approved. The investment would transform the business allowing them to increase their headcount by 33% and take advantage of significant growth opportunities in their market. Instead of growing, the business is at risk of being permanently damaged by bureaucratic delays at HMRC.
19. As demonstrated above, the issues with the advanced assurance process are hugely detrimental to the UK’s SMEs and productivity levels, with some companies looking to scale up being unable to because of the lack of funding that would otherwise be available to them.