Taxing times for venture investors

Government tax incentives for venture capital investment are too low and compare unfavourably with similar incentives in the UK and other countries.

That’s the view held by many in the VC sector and it’s an opinion that has been endorsed in a recently published Forfás review, which supports calls for widening the tax reliefs currently available.

The Forfás report was undertaken as part of the Government’s Action Plan for Jobs in order to identify steps which can be taken to support equity investment in productive firms.

The report examined the Employment and Investment Incentive Scheme (EIIS) that replaced the Business Expansion Scheme (BES) last year. It provides income tax relief for investors in qualifying firms.

Eligibility criteria

It recommends that the EIIS is extended beyond the current deadline of the end of this year and that early application is made to the EU Commission to enable approval before the end of June.

The report also recommends that EIIS relief is excluded from high income earner restrictions to encourage further investment by high net worth individuals.

Regina Breheny, director general of the Irish Venture Capital Association, notes that while the scheme is an excellent example of the positive outcomes of government funding supports particularly at the seed and start-up funding stage, the uptake in the technology sector has been slow.

She says that the scheme’s eligibility criteria are too restrictive and recommends the removal of the EIIS from the list of tax reliefs subject to the High Income Earners Restriction.

“The tax benefit of 30 per cent for rewarding the investor to make a high risk investment is inadequate. The curtailment of tax reliefs for pension and other forms of investment will create a demand for tax efficient investment vehicles. The EIIS will not realise its full potential as long as the tax relief is curtailed by the High Income Earners Restriction,” she says.

“The EIIS should be expanded to include investments in venture capital funds. Tax incentivised risk capital, which is what the EIIS is designed to provide, should help to fill the funding gap that has been identified in our recent report to Government .

“By investing in a venture capital fund – in other words a ‘pool’ of such companies – investors can mitigate the risks associated with early stage investment,” she says.

Breheny also points to the Seed Capital Scheme that new business promoters could access. This scheme allows an entrepreneur to claim a PAYE refund on leaving employment which can then be used as seed funding for a new start -up.

“We think it should be more widely used by start-ups but many may not be aware of the opportunity.”

Michael Culligan, national director of the Halo Business Angel Network (HBAN), agrees that the EIIS is helpful but lacks profile. He also notes that the tax regime in the UK – where up to 50 per cent tax relief is available and where no capital gains tax is payable on investments – provides a greater degree of incentives to investors.

Most UK taxpaying angels will get to keep all of their gains without paying any tax. Even if the investment is unsuccessful, they are likely to have up to half of their investment returned in the form of tax relief. It is currently possible for Irish taxpayer to invest in a company based in the UK on these terms and vice versa, subject to the company having a presence in that jurisdiction.

“Investments of this type by their very nature are very high risk, so it is appropriate that there are commensurate rewards. International research has shown that 50-60 per cent of investors either don’t get their money back or get back only their initial investment,” Culligan explains.

High potential

Nonetheless, on a more positive note, the figures also point to an overall rate of return of around 22 per cent, given a holding period of four years, and some 9 per cent of investors generate a tenfold or more return on their investment, underlying the high potential reward nature of this type of investment for canny operators.

The factors associated with success include high levels of due diligence before the initial investment, the relevant experience of the investor and active involvement by that investor.

The angel investment sector is a growing area at the moment. The HBAN group was responsible for about €9 million out of total business investment of €25 million last year, with co-investors typically including Enterprise Ireland or seed funds such as Kernel, ACT or Delta Partners amongst others.

Many of the investments involve syndicates and HBAN is currently assembling two new syndicates, one focusing on food/neutraceuticals, the other on med-tech.

“Typical investors would be medium to high net worth individuals rather than the super high net worth person,” Culligan explains.

“Often they are people who have exited a business with cash and who are keen to get involve but don’t want to build a business directly themselves.”