Why investing in venture capital is crucial for the future of UK SMEs
In the UK, SMEs account for around 99.9% of the business population, three fifths of employment and around half of the total turnover of the private sector. A constant source of innovation and competition, SMEs are the jewel in the crown of the British business landscape, and continued venture capital investments into them have never been more crucial.
Venture capital investments have played an incredibly important role in supporting the SME sector over the years, offering private investment for the next generation of innovative, early stage companies to create jobs, transform industries, and make real changes to those operating in and around their sectors, all whilst generating investors an average internal rate of return in the UK in excess of 14% every year from 2008-2019.
And whilst some sectors have continued to outperform in terms of investment throughout 2020/21 (the UK tech sector in particular noticing record levels of venture capital investment in in excess of £11.2bn in 2020), pressures routing from the Covid-19 pandemic have put many early stage SMEs in particular in a challenging position for further growth.
Consequently, this has pushed investors across Britain to seek out more high-growth venture capital investment opportunities to add to their portfolio that allow them to contribute to the continued growth of the UK’s diverse SME ecosystem all whilst benefiting from potentially considerable returns - a direction many have prioritised over recent months especially.
The key role of investors
The UK’s dynamic SME landscape has already proven itself as a flexible, adaptive and vital tool in reacting to impacts of the pandemic over the last 18 months, often by innovating in ways that larger, less mobile firms have often not been able to.
Whether it be Intelligence Fusion’s enhanced threat intelligence platform that has kept hundreds of businesses safe throughout the pandemic through globally personalised insights, or QikServe’s touchless digital ordering systems, which have allowed SMEs operating throughout the hospitality industry the ability to continue trading within Covid guidelines, a host of examples of SMEs that have provided innovative solutions in otherwise challenging times across the UK - with numerous examples included within our own portfolio.
For many venture capital investors, this abundance of success stories that have appeared across the UK has made investing in SMEs even more so of an attractive option throughout the pandemic, not just due to their investment’s potential to make a real, considerable change in an industry but also due to it’s considerable opportunity for growth.
A recent AIC report found that 81% of venture capital trust (VCT) investors felt the pandemic made supporting small businesses more important, with 88% claiming it was important to them that VCTs help support the UK economy and 74% admitting that a key reason for their venture capital investments was due to the growth potential of backing young companies early.
Whilst stats like these reaffirm the mutual understanding between early stage companies and venture capital investors in their role to contribute to the growth of the SME sector and the inherent understanding of benefits of doing so, many investors aren’t always aware of the range of individual benefits that venture capital investments can offer to investors, as well as how they in themselves can differ from type to type.
How can investors benefit?
Beside contributing to the resilience of the UK SME sector and helping to bolster the growth of small businesses throughout the UK, there are a host of other investor incentives associated with many types of venture capital investments.
From venture capital trusts that offer high levels of diversification and liquidity, to private equity deals involving highly experienced firm managers, venture capital investments can offer investors a host of portfolio-enhancing benefits, with potential tax advantages being some of the most popular.
Yet whilst venture capital investment methods such as VCTs do offer some forms of tax benefits, the wide range of generous tax incentives available via the Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS) have proven to be especially popular with venture capital investors keen to support the next generation of British businesses.
Introduced in 1994, the EIS was formed to help inject innovation into the SME sector and kickstart the growth of promising early stage SMEs that may have otherwise lacked the funding to grow. Similarly, the EIS’s younger relative, the SEIS, was introduced 19 years later with the same mission, but focusing on startups and very early stage companies exclusively (reflected in its differing eligibility and available tax reliefs).
The main premise of both the EIS and SEIS is to offer private investors the opportunity to invest in a potentially high growth business in exchange for an equity stake in that business and a host of generous tax advantages that range from income tax relief to capital gains tax exemption and loss relief.
Since their introduction, the EIS and SEIS together have raised over £25bn for more than 46,000 early stage SMEs and startups - figures that have undoubtedly contributed significantly to the growth of the UK SME sector and the jobs it has created over the past 26 years.
But whilst these figures reflect the positive work both the EIS and SEIS has stimulated for growing SMEs, it’s also important to note the tax efficient impacts the schemes have had on investors - 45,615 investors claimed either EIS or SEIS income tax relief on their tax returns in 2019/20 alone, whilst also benefitting from a host of varying tax advantages that reflect the differing risk level of the pair.
These tax reliefs can be especially beneficial to investors) that are looking to help shield their hard-earned capital or maximise their retirement savings - a recent study showing as much as 56% of VCT investors stated their main goal for investing was to help save for retirement.
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Offering capital protection from increasing market taxes and allowing maximum annual deposit limits of as high as £2m in the EIS’s case (compared with the UK’s maximum annual pension contribution of just £40,000) it comes as no surprise that investors are increasingly turning to venture capital investments as a means of saving for retirement, and in turn, the awareness of the tax, diversification and growth benefits they can offer is growing year on year.
This increased awareness of all forms of venture capital investments is a trend that could not only be crucial for a new wave of investors seeking high growth, tax efficient returns, but could be one of the key factors in fuelling the further growth of the UK's exciting SME economy for years to come.