Is small still beautiful?

Venture Capital Trusts (VCTs) were intended to plug this gap when the Government launched the scheme in 1995. VCTs are pooled funds listed on the Stock Exchange that have become mainstream providers of funding for smaller private companies or those listed on AIM, with around a dozen launched each year since the scheme was initiated. The Government has been keen to promote them in a bid to make Britain more entrepreneurial and subscriptions for new shares in VCTs offer lucrative tax benefits to tempt investors; capital gains tax (CGT) exemption on disposal of shares and no tax to pay on income or gains from the trust.

A total of £718 million was raised by new VCTs in the 2005/06 tax-year. However, since April this year, income tax relief investors receive on money invested in new VCT shares has been reduced from 40 to 30 per cent. Moreover, the law was changed so that VCTs only invest in companies with gross assets of £7 million or less (as opposed to £15 million). The rules also stated that £1 million is the maximum a trust can invest in any one deal to qualify for tax relief. The Government no doubt adjusted the ‘gross asset’ test in a bid to force VCTs to focus on their original remit of backing young, growing companies. But this may have backfired. Simon Rogerson, CEO of Octopus Asset Management, expects the reduction in tax relief to investors will in the future reduce the amount raised by new VCTs, which will result in ‘too little capital chasing too many companies.’

Government intervention
Some reports suggest it’s not just early-stage ventures that find it hard to source small equity hits. The Government began a public consultation process on the subject in 2003 with the publication of its paper entitled Bridging the finance gap, which found that, ‘while the risks associated with investment in early-stage businesses are often particularly high, established businesses (including those in ‘traditional’ sectors) can also be affected by a shortage of risk capital – for example, when seeking investment to modernise or diversify their activities.’

The situation was deemed such a serious threat to the health of the nation’s enterprise sector that the Government intervened again. In July 2005, it made up to £200 million available to match private funding from VCs or angels into Enterprise Capital Funds (ECFs). These are designed to be commercial funds to which SMEs can apply for up to £2 million of equity finance. ECFs are broadly based on the Small Business Investment Company (SBIC) programme that’s operated in the US for the past 45 years, backing the early growth of companies such as FedEx, Intel, Apple and AOL.

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