Lawyer questions UK government's Future Fund

By Michael Buckworth, CEO, Buckworths

15 July 2020

The pandemic, though primarily a human tragedy, is wreaking havoc on jobs and economies globally. In the UK, SMEs make up 98 percent of private sector businesses, and employ more than 16 million people. Evidently, small businesses and startups will be a vital part of the UK’s economic recovery as we emerge from the pandemic, usually contributing £1.9trn per year to the economy. As such, the Government has provided several financial schemes and funds during this ongoing crisis with a view to protecting British business.

However, to date, around one in four UK small business owners said the government’s support schemes are not adequate to ensure that they survive. The government’s Future Fund, which was launched in May, looks to match private sector investment with public money to aid start-ups affected by the pandemic. Individual investors providing matched funding under the scheme, however, cannot claim Enterprise Investment Scheme (EIS) - a tax relief to motivate investment in early-stage businesses - on their investment as the Future Fund round is structured as a convertible loan. As well as this, angel investors seeking to invest equity in startups under EIS may well not be able to claim EIS wherever the investment is used to pay off existing debt (including debt accrued during coronavirus such as the Coronavirus Business Interruption Loans Scheme (CBILS) and Bounce Back loans) and for working capital needs. EIS funds are used for growth and not for working capital, which means many startups will be lacking adequate financial support.

Undoubtedly, the Future Fund does not meet the needs of many start-ups. Indeed the chancellor has acknowledged that the government’s support schemes have by necessity not been tailored to the specific sectors that need help. Now, more than ever, tailored support is needed for startups as we move to reopen the economy and get Britain back on its feet.

The lie of the land for start-ups and SMEs
At present, high street and challenger banks can loan money to businesses via government-backed loan schemes. Where businesses want to borrow larger sums of money, banks tend to want personal guarantees from directors meaning that directors are personally liable for the loan if the borrower defaults, and banks can restrict the ability of businesses to borrow by applying inflexible qualification criteria. CBILS, for example, could not be used by ‘businesses in difficulty’ (which include high-growth start-ups with accumulated losses exceeding half of their paid-up share capital) and, though that restriction has now been lifted, one wonders to what extent banks will now change their approach to allow such start-ups to qualify for the scheme. Government-backed schemes are therefore evidently not suitable for all businesses, and even where businesses may qualify, borrowers will have to repay the debt that the business is taking on.

To date, UK companies have borrowed £38.4bn via government credit programmes since the coronavirus crisis hit, pointing to businesses’ desperation for finance to fund cashflow. As the government begins to reopen the economy and we tentatively emerge from the pandemic, the next year will be a pivotal period for business survival. The employer contribution to the furlough scheme is growing, while re-launch costs will combine with arrears for suppliers.

Numerous businesses will aim to raise investment to facilitate their working capital requirements and enable them to pay back CBILS and bounce back loans looking further down the line. However, as outlined above, the existing schemes, including EIS, do not allow tax relief on investments which are used to repay historic debt and to fund working capital, since EIS monies must be used for growth. As a result, many young businesses will find it difficult to raise the investment they need.

The Future Fund has a very limited scope
The government’s most recent funding scheme seeks to provide £250m to innovative start-ups via a ‘Future Fund’ controlled by the British Business Bank. It looks to motivate private sector investors to shoulder some of the risk required to bolster the UK economy. Yet, since the scheme uses convertible debt (which does not qualify for EIS relief), angel investors have no incentive to provide matched funding, limiting the scope and effectiveness of the Future Fund scheme.

Many UK angel investors rely on EIS to minimise their risk and reward them for high-risk investments in early-stage startups. Investments under EIS can enjoy a 30 percent upfront income tax relief and 100 percent capital gains tax relief on sale. With only equity investments able to qualify for EIS, many SMEs have not been able to access the scheme, while many have also been unable to access CBILS and bounce back Loans because of the (now lifted) state aid restrictions applicable to those schemes.
Companies looking to take advantage of the Future Fund need to have raised a minimum of £250,000 from investors during the last five years, which disqualifies many early-stage startups and SMEs boot-strapping or growing organically.

Alternatives needed
It is clear that SMEs need an alternative to the Future Fund and other coronavirus loan schemes which can help to moves the risk from the government onto private investors. A temporary tax relief scheme similar to EIS would work to do this, by encouraging angel investors to invest in startups.

Funds raised via such a scheme would provide working capital to SMEs and could be utilised for the repayment of debts incurred as a result of the pandemic, including loans such as CBILS and bounce back. Since investors usually seek to invest for growth and not working capital purposes, a higher upfront rate of income tax would be needed to compensate for the higher risks of providing working capital to a start-up. Age restrictions applicable to EIS must be removed for any such temporary scheme to be effective. By introducing such an alternative, we can ensure investors are motivated to invest in smaller companies, and support businesses as they move to recover from the crisis.

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