Policy Innovation Blog

Increasing the supply of finance to early stage companies

Yannis Pierrakis - 23.03.2011

Today's budget announcement on the changes of EIS tax incentives is promising to facilitate more early stage investments to UK based companies currently struggling to secure external finance from other means.

Tax incentives play an important role in the provision of finance to high growth early stage companies and several governments around the world allow tax deduction for individuals, and companies invested in high technology start ups or qualified Venture Capital funds. Consecutive governments in the UK have been very active in providing tax incentives to investors (Enterprise Investment Scheme (EIS), the Venture Capital Trust (VCT) and the Corporate Investments Scheme (CVS)).

Today's budget announcement on the changes of EIS tax incentives is promising to facilitate more early stage investments to UK based companies currently struggling to secure external finance from other means. Here are some stats on the importance of the tax schemes:

• Since their inception, the 3 schemes together provided £10bn of finance to businesses which is equal to 57 per cent of the amounts provided by the VC market.
• EIS provided 48 per cent more finance to early stage businesses than the VC industry and for the years 2002-04 EIS provided more than twice the amounts the VC provided. 
• EIS provided more funds than VC for amounts less than £2m. In 2006-7, for amounts up to £2m, EIS provided 63 per cent more funding than the VC industry
• Only half of the companies that receive EIS receive it for the first time
• The average size of EIS subscription is going down while the average size of the total amount that the company receives is increasing which indicates that now companies receive more but smaller individual investments

There is evidence that EIS provides significant additionality to the supply of finance to the market. In a survey conducted by NESTA, 80 per cent of business angels surveyed had used the EIS at least once and 57 per cent of the businesses invested in also made use of it. Notably 53 per cent of the investors would have made fewer investments without tax incentives.

Number of companies raising funds and amounts raised

When previous changes in the maximum limit of individual investors took place, considerably more money was invested through the EIS. The distribution of investors and amount invested in the lower investment levels remained steady and only significantly changed at the top limit of investments indicating that the change did not cause a shift of investments from lower to higher amounts (Reference). This suggests that the change in the rules only affected a small proportion of investors (2 per cent - 4 per cent) that are responsible for approximately one quarter of all investments and allowed more investments to be made through EIS from wealthy individuals. The amount an individual can invest through the EIS - which currently stands at £500k - will be doubled to £1m from next month. This change together with the increase in the income tax relief from 20 to 30 per cent and the relaxation of the rules regarding the size of eligible companies will have a positive effect in the supply of finance to early stage companies and we anticipate a large increase in investments from a relatively small proportion of investors that are willing to invest more through the tax schemes.

In addition, as increasingly more companies receive follow on investments through the EIS, the announced changes in the roles will also serve the financial needs of these particular companies.