Small Talk: Rowing back on tax relief cuts for VCTs will lift SMEs

Small businesses' difficulty in accessing bank finance is routinely cited as one of the major obstacles holding back growing companies. No doubt that's true, but the focus on bank debt has overshadowed other funding pressures on small and medium-sized enterprises (SMEs), notably the huge problems encountered by many small companies which are looking for growth capital.

There was a time when the banks were prepared to take equity stakes in growing businesses, providing a valuable source of capital to SMEs investing for long-term development. But the advent of the private-equity industry forced banks out of the game, even before the financial crisis struck. Now that private equity has retrenched, SMEs find growth capital tough to come by.

The Business Growth Fund, set up three years ago by the Government with finance from the major banking groups, has begun to plug the gap. However, there is another source of growth capital providing SMEs with even more generous support and it is a powerful example of how governments can use tax policy to good effect, as long as they take a long-term perspective.

Venture capital trusts (VCTs) are collective funds that offer individual investors generous tax reliefs in return for risking their money on small businesses. VCTs build portfolios of stakes in small companies (the limit on annual turnover for a qualifying VCT investment is now £15m) and are a hugely valuable source of growth capital.

That value is documented in a new report from the Association of Investment Companies (AIC), based on survey responses from 40 per cent of the VCTs active in the marketplace. Those funds invested in 78 different companies for the first time during 2012, supplying them with £145m of capital. In addition, they put £211m worth of follow-on investment into 160 companies they had previously backed. This level of investment suggests VCTs, which cost the Treasury roughly £160m a year according to estimates from HM Revenue & Customs, offer good value to the taxpayer. The average company created 52 jobs following a VCT investment, the AIC says, and boosted turnover by £10.8m.

Two-fifths of the companies backed by VCTs are exporting their products and services while a third of them have invested in research and development. VCTs provide more than just finance. Four-fifths of companies that have taken VCT money have a representative of the fund on their boards, providing valuable business experience and contacts. The Business Growth Fund operates in similar fashion, placing its people on the boards of companies in which it invests.

This additional contribution from the investor is one reason why growth capital is often a better source of funding for SMEs than bank finance. It also tends to be less restrictive and longer term. Bank loans routinely require borrowers to stay within demanding covenants or the owners risk losing the business, and are rarely available over terms of more than five years.

Investors' enthusiasm for VCTs is growing. They put £403m into VCTs in the 2012-13, the best year of fundraising for the sector since 2005-06, when the total was £779m. That was the final year in which upfront income tax relief on VCTs was at 40 per cent; the cut in April 2006 to 30 per cent precipitated a plunge in interest in the funds from which the recovery has been painfully slow.

It's a good example of the unforeseen consequences of even small changes in tax policy. In 2006-07, VCT fundraising was £267m.

Given the sensitivity of investors to changes in VCT tax reliefs and the value offered by the sector, there is now a good argument for further support. A return to 40 per cent upfront tax relief would be an excellent start.

Following the code voluntarily could pay

While the UK Corporate Governance Code does not apply to most small listed companies (and none at all on Aim, the Alternative Investment Market), many would benefit from signing up to its provisions on a voluntary basis.

There is evidence that voluntary compliance with some of the code's provisions can boost shareholder value.

Research from Edward Drummond, the executive search firm, says Aim-listed companies with a majority of non-executive directors on their boards have seen their shares rise by an average of 22.3 per cent a year in the past three years. Those where executives are in the majority, in contravention of the code, have registered only 17 per cent gains.

One source of corporate governance best practice might be the Quoted Companies Alliance's Corporate Governance Code for Small and Mid-Size Quoted Companies. It is less rigid than the rulebook by which Britain's largest companies must abide, but could be a useful compromise option.

Number-crunchers can give firms a helping hand

If you're a small business owner or manager who might benefit from professional advice on your commercial or financial strategy, check out the Institute of Chartered Accountants in England and Wales (ICAEW).

Its Business Advice Service is running a string of free events around the country during June (as well as some paid-for sessions) aimed at start-up businesses and other SMEs.

"As the ICAEW/Grant Thornton UK Business Confidence Monitor shows, the economic recovery is starting to strengthen," says Michael Izza, the group's chief executive, pictured.

"However, we still have a long way to go. Crucial to sustaining this are the entrepreneurs and small-to-medium businesses that create jobs and wealth across the country."

The ICAEW is offering all small businesses one free advice session with a qualified chartered accountant (see for details).

Small Business Man of the Week: Tarek Nseir, Founder TH_NK

We set up the business when I graduated from Newcastle University in 2004 but it had been going before that. At the end of my first year a friend needed a website designing, so I advertised for designers at the local college and we pitched for the account. We got that one and did something similar in my second year with a menswear shop. When I left university, we decided to do it properly.

"TH_NK is a strategic digital agency. We provide design and build digital services as well as provide consultancy on companies' digital strategy. Our first big client was Northern Rock. We had four great years with it and it accounted for most of our business. Then, in 2008, it was gone in a fortnight. It was terrifying. We decided we couldn't remain in the North-east, so we relocated to London. We picked up new clients almost straight away.

"Our clients these days are people like Warner Bros, Nando's and Bupa. We also worked on Pottermore, JK Rowling's online venture after the Harry Potter series. She came to us with a high-level vision and we turned that into reality. We've got 130 people and we're scaling up to the next level. We're the biggest independent digital agency in the UK.

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