Ariadne Recommendations for UK Budget 2011 - How to Drive Funding for Start-ups

Ariadne Policy Recommendations

These recommendations were made by an informal group of leading Investors and Entrepreneurs [many of whom are Ariadne's own founding investors] put together by Ariadne Capital in the run up to the UK Budget in mid March. 

I.    EIS

Everyone agrees that the EIS tax compliance scheme is a good one and is critical to encourage more Angel investing due to it being an immediate incentive and possible future capital gains advantage, it also reduces investment risk because losses can be claimed back against income rather than capital gains (and so it is reasonably certain a portion of any loss can be recovered).   Why is EIS relief at 20% when the top tax rate is 50%

Several suggestions on how to improve a good thing were made:

• £2 million/year is a good level
• Why not extend it to private debt financing as well - much of that has had to take place due to the lack of bank lending.
• EIS must retain the write off against income tax;
• Remove restrictions around connected party and being a Director. This is counter productive as start-ups need expertise + cash and investors need to retain some control. You can make angels pass a bone fide test to prevent owner/single investor abuse
• Remove restrictions around only ordinary share structures and enable Angels to participate in more normal, preference or part equity/loan structures. Often these structures are essential for Angels to follow their money in subsequent rounds or to bring in funds alongside their cash. Nearly all £1m+ rounds will require these structures and EIS should 'reach ' this level if you want companies to grow.
• Reduce holding period from 3 yrs to 2 yrs to enable flexibility to sell and reinvest.
• Increase EIS relief on way in to match income tax (or at least new CGT rate)
• Increase the limit that investors can take to 49%  in EIS
• Extend EIS benefits to individuals connected with the company so that a person founding a company can put their own money into the company and get the EIS incentives.   One of the major improvements needed here is that people connected with the business in a management capacity should be able to benefit from EIS as well.  At the moment employees, directors etc generally don't benefit.  This  acts as a deterrent for investors to become actively involved in businesses and also penalises those people that actually set the business up themselves.  As always any increase in allowances would also obviously help encourage more investment.

II.      EMI Options

• EMI options - remove restrictions around Angel Directors not getting them ie more 25hrs week working in company
• EMI options make them tax free (up to say £500kpp) so that they are a real incentive for senior people and become a great tool for start ups to use to recruit talent

III.    Overall Tax Framework and Corporation Tax

• It is difficult to give time to a start up in return for shares.  When a start-up has raised some money already but doesn't have much if any spare cash, then it ought to be easy to give some time to the company in return for shares in the company rather than cash.
• However the problem is that if the company issues shares in return for his/her time then the investor/advisor has an immediate income tax charge (because the investment to date will fix a valuation for the company and its shares, so even though the shares he/she would receive cannot be sold and indeed may well end up being worth nothing because the company fails, he/she is immediately taxed as if the shares were liquid).
• There may be ways to get around this with share option schemes or restricted shares but it is certainly not obvious or well known how to do it (and the cost and effort of setting up approved share schemes is high and approved share schemes have many restrictions anyway).
• One fix would be to only have to pay the tax when the shares are actually tradable and actually have some value (and that the tax need never be paid if it turns out the shares were worthless).
• Work towards an overall simple model system that government generally tried to aim towards so that every change to taxation was a simplification rather than every change being yet another layer of complexity on top of an already overly complex system.
• Reduce tax on foreign-controlled corporations if they channel funds held in the UK into SME's and funds backing SME's

IV.     Capital Gains and Taper Relief

• Taper relief should be reintroduced.  Currently, an investor pays the same amount of CGT on a long term investment as on short term speculation.  Actually he/she is worse off if investing for the long term as he no longer benefit from indexation allowances when calculating my CGT.  There should be a  reduction for longer term investing.  The  old 40% headline tapering down to 10% worked well.   We need to give people a benefit when they invest for the long term to encourage them to do it.  Also, at the moment the vast majority of employees of businesses lose out completely.  They don't qualify for Entrepreneur's relief and taper relief no longer exists.
• Dramatically increase, or better remove, the limit on Entrepreneur's relief.   £5mm is a lot of money but equally anyone who thinks they are about to create the next Facebook won't see that as much use.  If EIS and taper relief are adjusted so as not to penalise the founders of businesses then this becomes less important, but without changes there this is an easy one to implement, I think.  It is important not to lose sight of the founders of business, not just their investors.  
• A  lot of the reticence of Govt to embrace a lot of these ideas is fear that they will be abused by a small minority of investors.  The  opposition to the reintroduction of taper relief is that people will simply move investments around and put them in wrappers etc to obtain the relevant tax reductions.   We should  stress to everyone that it is better to legislate for the majority of the population who will use these schemes in the right way and then act to close down the loopholes used by people who want to abuse them, rather than not to legislate in the first place because someone might find a way around the rules. 
• Entrepreneurs Relief - reduce requirement to have 5% to 1% shares but keep Director requirement - this again means key Execs in biz required to grow biz are incentivised.

V.      National Insurance and PAYE

• Eliminate National Insurance not just for companies in their first two years and under 10 employees but until they have £1 million in profits

VI.      VCT's and ECF's and new venture models

• VCTs are low risk, so not doing the job in the early stage.
• They are OK for development capital so have a place.
• The impact of ECFs is minimal.
• The question is therefore how to motivate the private money on risk investments. For this there need to be far more attractive tax breaks, as well as more easily accessible funding from government.
• When they announce new funds for enterprise, they are always directed at well established businesses, not early stage.

VII.     Other

• Remove planning requirements for green initiatives such as solar panels.
• Continue R&D Tax Credits - very useful