Ian Ritchie / The Herald Business HQ / October 2024
WHEN I WAS struggling to raise investment to fund our start-up software company back in 1984 there were few sources of risk capital available, and even fewer wealthy individuals willing to consider a personal investment in early-stage start-ups.
There was a good reason for this, for an early-stage start-up is at the point of maximum risk.
Even if the technology or service is hugely innovative and world-beating there is no guarantee that it can turn into a successful business. Well-funded competitors might emerge with better solutions or simply better marketing.
The new company might hire an ineffective management team, and they might not be able to raise the follow-on investment funds that they require for their growth, or a massive multi-national corporation might put a product on the market that makes their offering redundant overnight.
The wealthy individuals who invest in early stage companies are called “business angels”, a play on “theatrical angels”, the traditional term for well-heeled theatre-goers who make high-risk investments in theatrical productions.
Business angel investors were thin on the ground back then but suddenly, 30 years ago this autumn, there was a development that accelerated the angel community – in the finance statement in 1994, Chancellor Ken Clarke announced the Enterprise Investment Scheme (EIS).
The EIS was aimed at angel investors who might be willing to invest in early-stage companies and rewarded them with several valuable tax breaks that would help to mitigate the risks involved.
It allows that 30% of the amount of the new investment can be deducted from your current tax liability; if you have any capital gains tax (CGT) then the equivalent amount of the investment can be deferred and will reappear years later on the eventual exit; there is no CGT chargeable on any financial gain on the eventual sale of the business; and all these investments are exempt from inheritance tax liability on your own personal, final, exit.
These are very attractive tax breaks; in particular the ability to reduce your current tax bill and defer any CGT that are due, and if the company succeeds and eventually exits for a good return the lack of any CGT liability is a huge win.
(When we successfully sold our business in 1989, CGT was charged at 40% of the gain, and there was no such thing as entrepreneurs relief – Today it would all be free of tax.)
We can basically date the growth of the UK’s business angel community to that EIS announcement. It has since been followed by an enhanced scheme, the Seed Enterprise Investment Scheme (SEIS) for very early-stage companies and by the establishment of Venture Capital Trusts (VCT) a new type of venture capital company which give similar tax breaks to individuals who invest in funds which are restricted to making investments in early-stage companies.
In the last 30 years, over 54,000 start-ups have used EIS and SEIS schemes to raise over £28 billions of investment, creating a vibrant community of dynamic young businesses. And, of course, these companies generate substantial tax revenues via their employees PAYE and NI, corporation tax and VAT.
Once they have made their initial investment, the business angels are permitted to serve as non-executive directors of the company and, as many of these individuals are successful experienced business people, they can often add huge value to the new emerging company.
Over the years, the venture capital and private equity community have moved away from providing early-stage seed capital – it’s just too risky for them. They prefer to invest at later stages, when there is an established business generating revenue and the early jeopardy has been minimised. As a result, almost all seed investment today is made by business angels.
Initially, business angels acted individually, but over time they began to see the advantage of grouping together.
It is always more reassuring if there are other people sharing the risks and opportunities of a potential investment, and your fellow angels will often have special experience, in areas like technology or finance which are particularly relevant.
When I was a board member of Scottish Enterprise in 2003, we established a “Co-Investment Fund” which would invest alongside approved investment partners. This had the advantage that an investment of, say £400,000 from an investment group could double-up to an £800,000 investment by calling on the matching co-investment funds.
This has had a dramatic effect on the formation of angel syndicates. At that time there were three angel syndicates in Scotland, but today there are more than 20. And these angel syndicates have largely professionalised their operations, with specialist legal, financial and technology expertise in house. They have become the go-to providers of early-stage risk capital.
So, happy 30th birthday to the EIS, which created today’s UK early-stage investment climate, and has made the UK a dynamic, innovative economy.
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