Well, the uncertainty is over, Philip Hammond has taken his shiny red box and delivered the Budget and the Patient Capital Review, and was even able to throw in a joke or two.
Overall, we think that the changes proposed to EIS and VCTs are balanced. They are certainly more positive than what the market was expecting after the initial publication of the Patient Capital Review but we will of course have to wait for the details of the new principles-based test on risk-taking to be able to assess the potential impacts to the market. How that test is interpreted will go a long way to determine which of today’s range of products fall foul of the new rules.
The Government will:
The government will target VCTs towards investment in higher risk areas of the market:
The Budget seems to have confirmed Treasury’s view that many asset-backed, lower-risk products did not fit in with a wider vision of capital being channeled towards higher-risk, scalable enterprises which fit more neatly into the Government’s broader vision of what the UK’s industrial strategy should be.
Rather than eliminate products simply based on the sector in which they are in, we welcome the principles-based test as a way of judging each product on its merits in terms of taking an appropriate amount of risk. This stops a few bad apples from spoiling the whole batch when it comes to any particular sector.
What Treasury’s measures show is that the Government will not allow taxpayers to subsidise investing in companies which exist in order to trade off the underlying assets, rather than the growth of the company itself. It does seem that the Treasury have recognised the crucial role EIS has played in funding UK Independent films. However, the future of EIS-funded films could well be changed radically based on the new rule, with the tax credits and pre-sales used as collateral coming under the microscope. Where the line is drawn in terms of their collateral will be a key test for the new rule.
The anticipated change for constitutes a knowledge-intensive company from a backward to a forward-looking test, is a nuanced but important change, allowing companies to pivot their strategy and encourage innovation whilst still qualifying for government help.
Guidance on the principle-based test will likely reduce the number of applications for Advanced Assurance from low-risk/asset-backed businesses clearing HMRC evaluators to provide quicker Advanced Assurance for those who meet the requirements.
The increased limits of investments into knowledge-intensive companies, will mean more capital coming into the tax-advantaged space, which can only support early-stage, growth businesses and should help companies scale more quickly. Paired with the increased annual EIS investment limits, this could lead to additional eligible capital, which could help these companies in their fundraising to achieve scale and commerciality. We see the increases in the investment limits as a positive to help offset some of the expected capital outflow.
The trick will be to see how many investors will now switch from more capital preservation investments to alternative high-growth products, and how many instead exit the tax-advantaged venture space altogether rather than take the additional risk.
MJ Hudson Allenbridge’s survey of top UK Venture Capital players showed a mixed reaction to the idea of a new fund aimed at growth companies, which indeed was announced in the Budget, although the industry has broadly welcomed the Northern Powerhouse and Midlands Engine. As ever with these things, the devil will be in the detail: the success of the Fund will depend on a clear mandate, proper governance, and selecting the right managers for the job.
Broadly we support the proposed action points and the concept that start-up companies that are genuinely trying to achieve profits for their owners, i.e. investors, will need to have the owners’ capital at risk, and excluding those which do not take risk will remove products in the market that are specifically designed to maximise the tax benefit and rather than investor returns. This is certainly a positive for the taxpayer, and better for some investors. However, the consequences to investors more broadly are not entirely positive, as the rule changes will certainly mean that there is less diversity of companies and risk profiles in the sector. This makes portfolio construction less efficient.
Venture capital fund managers will likely be happy with these changes while Media focused managers will breathe a sigh of relief and others will have to revise their strategies significantly post-Royal Assent. In the coming days we will be reaching out to the market to survey opinions and any anticipated changes in strategy resulting from the budget.
We are still processing information supplied already and waiting for clarification on the principles-based test and will look to revert back with our analysis.
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