Aid Budget – Would A Relaxation Of State Support Rules Mean More Funding For U.K. Startups?

As things stand, negotiations on a post-Brexit trade deal are at an impasse, with state aid being one of the main sticking points. 

In a nutshell, the European Union is seeking guarantees that the U.K. won’t undermine the single market by pumping huge amounts of cash into strategic industries. For its part, the British government is unwilling to give undertakings that would tie its hands.   

So here’s the question. Why is a Conservative government, choosing to pick a fight over state aid to industry and perhaps lose any chance of a trade deal in the process? Since the time of Market Thatcher, Conservatives have tended to argue that financial support for sectors and individual companies should be strictly limited because a) intervention runs counter to free-market principles and b) politicians and their civil servants are pretty poor when it comes to picking winners.

Well, the answer – according to some commentators – is that the government is keen to provide support for cutting-edge technologies, such as artificial intelligence, in a bid to ensure that the U.K. can either establish or maintain a leadership position. 

But that raises a question. If governments and civil servants have been bad at picking winners in the past will they be any better at spottings the technology champions of the future?  

Well, perhaps they won’t have to. State aid can be distributed in a number of ways, including grants, loans or bailouts. But it can also be channeled through the tax system by giving professional investors and high net worth individuals an incentive to commit cash to startups and early-stage businesses. 

Tax Relief 

Venture Capital Trusts provide an example of how this can work in practice. Essentially, private individuals who invest in VCTs can commit up to £200,000 per year and receive relief on income tax of up to 60 percent. This makes investing in small, fast-growth companies a much more attractive prospect as it spirits much of the risk away.  And the model has been successful in attracting investors. Currently, members of the Venture Capital Trust Association have £4.5 billion under management.

And as Stuart Veale, Chairman of the Venture Capital Trust Association (VCTA) explains: “VCTs are a special kind of Venture Capital Fund. They represent a type of public/private partnership.”  Or to put it another way, trusts invest like traditional VCs but they are underpinned by tax system support.   

But here’s the thing. Until January 1 at least, VCTs operate under the regulatory umbrella of European State Aid rules, and according to Veale that is limiting their ability to provide additional support for early-stage businesses in response to the pandemic. 

“Under the rules, the limit for VCT investment is £12 million over the lifetime of a company,” says Veale. “There is also an age limit. Businesses only have seven years after the first sale to raise money from VCTs.”   

As Veale sees it, these rules mean certain businesses that could benefit from VCT investment, fall outside the criteria. 

So are these limitations having a real impact on businesses that currently require funding?  Well, according to Veale, at the start of the pandemic, a relaxation of the rules governing VCTs could have freed up additional funding of up £0.5 billion. 

 You could argue, of course, that VCTs are not the only game in town. There is, after all a huge amount of capital available through conventional Venture Capital Funds. And in addition to the VCT routes the Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS) also offer tax breaks to investors.  

Patient Capital 

However, Veale stresses that Venture Capital Trusts can play a particularly important role in developing young businesses. “Most VC funds are structured as 10-year limited partnerships,” he says. “This can mean that businesses are encouraged to sell out before they are ready.”  VCTs don’t operate under that kind of time restriction, meaning that businesses can be supported over a longer timeframe.  

All of which seems to suggest that a no-deal Brexit wouldn’t be the end of the world in terms of new business funding. Certainly, the UK government – if it chose to do so – could relax current restrictions and, thus, encourage investors to channel more capital through not only but also VCTs, EIS and SEIS.    

But there is, of course, a bigger picture. A no-deal scenario would also mean more limited access to markets, tariffs where there were none before, non-tariff barriers and disruption to supply chains – at least in the short or medium term.     

What is certainly true, though,  is that VCTs currently comprise part of a funding ecosystem that will be vital in helping UK startups bounce back in the post-pandemic world.