Start-ups should not escape the chancellor’s beady eye

There has been one striking absence from the debate about tax and investment ahead of the budget. Amid all the arguments over capital gains tax, the non-dom regime and carried interest, there has been little mention of the schemes that provide generous tax breaks for investors in start-ups.
The Enterprise Investment Scheme (EIS) and other venture capital programmes cost the government almost £1 billion in lost tax last year. That may not be huge compared to the £22 billion “black hole” in the public finances but it is still a lot of money.
Perhaps the silence should be no surprise. The EIS has had strong cross-party support since it was introduced 30 years ago and other countries have copied it. Partly thanks to the scheme, Britain has a vibrant start-up culture that in some ways now rivals the US.
The figures are impressive. Over the last three decades the EIS alone has channelled more than £32 billion of investment into private companies with almost 400,000 employees last year, according to analysis commissioned by the Enterprise Investment Scheme Association. The scheme also supports a small army of advisers and provided big tax breaks for more than 40,000 investors last year.
No wonder it has so many fans. But is it the best use of taxpayers’ money? Here the evidence is less clear.
Dame Angela Eagle has said she was “very unhappy” with the evaluation of the scheme when she was a Treasury minister in Gordon Brown’s government. In a Treasury committee hearing last year, Eagle challenged Andy Griffith, then the City minister, about a continued lack of analysis.
“In theory it’s a good thing to finance start-ups, so everyone thinks, ‘oh fantastic’, but no one was evaluating properly whether it was value for money,” she said. Griffith replied that it was difficult to assess what would have happened without the tax breaks.
Even some entrepreneurs have their doubts. David Woolger, chief executive of the quantum brain imaging start-up Cerca Magnetics, says companies with little chance of success get EIS funding because the investment is driven by the tax breaks rather than real evaluation of their potential.
In the end many fail and in the meantime they have competed for resources with companies that have much better prospects. In Cerca’s case, competition from EIS-funded companies has driven up the price of scarce quantum scientists. “When you stand back and look, economically it is not a good use of resources,” he says.
Some critics also worry that the structure of the EIS pushes the owners of successful start-ups to sell out, triggering tax-free capital gains for their investors, rather than continue to expand their companies. “The tax system encourages British companies to be sold,” Steve Rigby, co-chief executive of Rigby Group, wrote in The Times earlier this year.
Thanks partly to the schemes, venture capital investment in start-ups in the UK has caught up with the US relative to GDP. Yet there is still a big gap in funding for later stage companies. This has prompted calls for taxpayer support to be shifted towards “scale-up” funding. But the previous government ruled out broadening the EIS to allow investment in more mature companies.
Last November, HM Revenue & Customs published studies of the schemes that suggested they had a big effect on the growth of the companies they funded. But the research did not examine the longer-term economic impact, the survival rate of the companies or value for the taxpayer. Despite the concerns raised by the likes of Eagle, now a Home Office minister, Labour appears to have made no further assessment of the schemes before last month’s announcement that they would be extended until 2035.
Few would deny that encouraging start-ups is a good thing. But given the intense pressure on the public finances, it is odd the new government hasn’t looked more carefully at whether the support is being provided in the best way.