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David Prosser: Europe’s most generous tax incentives are on offer for a seed investment scheme - but will the Treasury spoil it?

Small Talk
  • @davidprosserind

Which company will be the first to make a substantial return to investors under the seed enterprise investment scheme? The SEIS offers Europe’s most generous range of tax incentives for investors prepared to put up to £150,000 into start-up businesses, and having been launched in April 2012, it is now reaching an age where some companies will have performed sufficiently well to attract the attentions of buyers. That would trigger tax-free windfalls for those first brave investors.

It would be unfortunate, however, if these big-name winners began to emerge just as the SEIS lost favour with investors. There is always a risk of this sort of fall from grace when governments decide to change the rules of these schemes, so the publication a few days ago of a consultation paper on whether the Treasury should do exactly that ought to worry people.

Naturally, the paper is not positioned in these terms – rather, David Gauke, the Exchequer Secretary to the Treasury, says he wants to ensure that tax efficient “schemes continue to support small and growing businesses”. He is looking into whether the SEIS, as well as the better-known enterprise investment scheme and venture capital trusts, needs to be overhauled.

Fair enough – but governments have a bad habit of fiddling with policy simply for the sake of doing so, often with disastrous consequences. And even apparently small changes can make a significant difference to this sort of scheme, particularly in a marketplace where the competition for investors’ capital is fierce.

In the 2005-6 tax year, for example, the venture capital trust sector raised just over £790m from investors. Then, in April 2006, the Government cut the upfront tax relief on VCTs from 40 to 30 per cent and told investors they would henceforth be required to hold their shares for five rather than three years in order to retain their tax breaks. In the 2006-7 tax year, VCT fund raisings slumped by almost two-thirds to only £269m.

Given that we have already begun to hear success stories that probably wouldn’t have been possible without the scheme, we must cross our fingers that history is not about to repeat itself.

Take the foodstuffs producer Scarlett & Mustard, one of the first companies to raise money under the SEIS – the Suffolk-based firm needed the cash to turn what was a kitchen table business with sales of bottles of salad dressing averaging around £75 a day into a fully fledged company. Two years on, it has just announced that annual sales have now broken through £400,000, thanks to distribution deals with the likes of Waitrose and Harvey Nichols. The figures are “testimony to the support we have received [from the SEIS],” says co-founder Sandy Ruddock.

There will be many more such stories as the scheme matures – but only if the Treasury resists the temptation to fiddle.

It’s not always easy to anticipate the impact of such interventions. After all, on its launch, many in the venture capital and corporate finance sectors did not expect the SEIS to be a success. They worried the scheme would be shunned as too risky by investors – and that in any case, the £150,000 funding cap would prevent start-ups raising the finance needed to really make a go of their businesses.

That negativity has proved misplaced. So far, investors have put up £175m of funding for more than 2,000 small companies in need of finance. It has helped, of course, that the tax breaks on offer through the SEIS are so generous that investors’ downside is pretty small – indeed, in the first year the scheme was so generous that it was possible for investors to make a profit even if the companies they backed went bust.

Another major plus-point for the scheme has been its compatibility with crowdfunding sites that raise equity finance for small businesses. It is now commonplace for companies pitching to investors on platforms such as Crowdcube and Seedrs to set up their offers so that they are qualifying SEIS investments.

The scheme, in other words, has had a fair wind. Nevertheless, having proved the critics wrong, it would be a shame if the Treasury undid all its good work by mucking up the SEIS with unnecessary reforms. If it ain’t broke, don’t fix it.

Mystery over Arc transaction

Curious goings on at Arc Capital, the Chinese private equity fund listed on the Alternative Investment Market, which announced 10 days ago that trading in its stock had been suspended.

The company said the suspension followed the failure of its investment manager to provide up-to-date financial statements and to resolve a key transaction – shareholders were told that PAG, owner of the fund’s investment manager, Arc Capital Partners, had unexpectedly not completed on the sale of its holding in Fortress Group, which represents 60.5 per cent of the fund’s portfolio.

On Friday, Arc Capital issued a statement admitting the board had been unable to find out yet when the sale “was purportedly completed and what has happened to the sale proceeds”.

The company added that it is now weighing the implications of “considering a material adjustment to the fair value” of its holding, while it has also instructed legal advisers to consider “all its options” in respect of the sale.

Meanwhile the shares are still suspended.

Trust battles to avoid tax problems

Investors in Oxford Technology Venture Capital Trust and its sister fund Oxford Technology 3 have endured anxious times since HM Revenue & Customs announced it would withdraw the fund’s VCT status – and thus its tax advantages – amid allegations it has breached the rules of the tax-incentive scheme. Now new independent directors have joined the funds to improve their governance.

The appointments include Robin Goodfellow, a member of the shareholder action group set up by the private investor group ShareSoc to campaign for change at the trusts. ShareSoc said it hoped the appointment of new directors would help to convince HMRC to rein back on the tough stance it has taken with the VCTs until now. The funds are appealing against their loss of VCT status and HMRC has suspended its withdrawal while it considers this appeal.

“These changes should demonstrate that these companies will continue to strengthen their internal processes to avoid the kinds of mistake that led to the loss of VCT status,” says ShareSoc’s deputy chairman, Roger Lawson.

Small business person of the week

James Livingstone-Wallace; Founder, Quinola

“I founded the business in 2011. I’d worked in the City but I took redundancy following the financial crisis and my family and I went travelling for a year. Part of the plan was to find a Fairtrade business I could launch on my return; I wanted to do something that wasn’t just making rich people richer.

“We came across quinoa in Peru and the children loved it. When I started doing some research, I discovered its ‘superfood’ qualities; it’s a complete vegetable protein that is so good Nasa uses it in its space missions.

“We set up a deal with a collective in Peru and helped them to get Fairtrade certification before we began importing the quinoa they produce back to Europe. It comes into France, where we have a packaging operation employing people with learning difficulties, and it is then distributed in the UK – we have deals with lots of independent shops, Ocado began stocking our products at the beginning of the year, and we’re now rolling out across Asda’s stores, which stocks us in its gluten-free ranges.

“The business is already profitable but the challenge is cashflow, because we’re growing so fast, so we’ve worked hard with our bank to set up a revolving credit facility.

“This is definitely more fulfilling than my old job in fund management, but it’s not without its frustrations. When I worked in the City I was free to concentrate on the cerebral part of my job but when you run your own business you have to take care of everything.”