Culture, Media and Sport CommitteeWritten evidence submitted by Edge Investment Management Ltd

About Edge

Edge Investment Management Limited (Edge) is a specialist fund manager focused on the entertainment and media sector with investments ranging from children’s character animation to live music, from literary licensing to mobile apps and from social networks to media technology. Edge is best-known for Edge Performance VCT, the UK’s largest venture capital trust, which has raised nearly £120 million to be invested in growing companies in the creative industries. Edge believes that in “people businesses” like entertainment and media, access to well-networked and experienced executives is a key indicator of success. Edge applies this philosophy to its own organisation with directors of Edge companies including the UK’s best-known impresario Harvey Goldsmith, former HMV and EMAP Chairman Sir Robin Miller, superstar DJ Pete Tong, Elton John’s manager Frank Presland, Eric Clapton’s manager Michael Eaton and Edge Group founder and renowned entertainment industry dealmaker David Glick.

Summary

Access to finance is a particular barrier to the growth of emerging companies in the creative industries;

Key factors in this include a gulf in understanding between the investment industry and the creative sector and a lack of information sources on available sources of finance;

We believe that Government could address these issues at relatively modest cost;

Tax reliefs have an important role to play in directing investment to growing companies and Government has provided a number of such mechanisms, some available to a broad range of sectors (for example Venture Capital Trusts and the Enterprise Investment Scheme) as well as some targeted specifically at the film, TV and games sectors;

We do not believe there is any need to create further specific tax reliefs aimed at the creative sector;

However, we suggest strongly that existing schemes be reviewed to ensure they do not contain in-built biases against the creative industries;

For example VCT and EIS funds are effectively prevented from investing in companies which generate more than 20% of turnover from licences, copyrights or other intellectual property which has been acquired rather than developed internally. We believe this limit is based on a misunderstanding of the realities of the creative industries, and that it should be raised;

In addition, we propose closer monitoring of the outputs of specific tax reliefs and the setting of specific targets by Government of the amount of investment such reliefs generate for specific sectors—such as the creative industries;

Such targets would require closer coordination between relevant Government departments (DCMS, BIS, HM Treasury), something which in any case is desirable to improve the effectiveness of Government policy towards the creative industries.

Specific Responses to the Inquiry

Question: Barriers to growth in the creative industries—such as difficulties in accessing private finance—and the ways in which Government policy should address them. Whether lack of co-ordination between government departments inhibits this sector

Access to finance is a significant barrier to the growth of small and medium sized enterprises (SMEs) in all sectors. This is not a problem restricted to the UK. A recent study by the European Central Bank discovered that 18% of 7,500 SMEs surveyed across the European Union said it was their biggest single obstacle to growth.1

The problem is particularly acute in the creative industries. In the music business, for instance, improving access to finance and lobbying Government on the issue has long been a priority for organisations ranging from the Association of Independent Music to the Music Managers Forum, the BPI and UK Music. Government has acknowledged the specific problem which exists in the creative industries by introducing tax reliefs for film and more latterly, computer games.

An important reason for the difficulties creative companies encounter in raising finance was identified by a ground-breaking Demos study—the perception within the financial community that somehow the creative industries are more risky than other sectors.2

The study established through the analysis of Companies House data that start-ups in the creative industries are no more risky than start-ups generally and are less risky than those in some sectors (such as hotels and restaurants). It concluded, “The lazy assumption that the creative industries are inherently risky is harming Britain’s path to growth.”

While the Demos study made a powerful case, the misperception of risk in the creative industries is difficult to budge. Edge encounters it among investors frequently.

We believe it is compounded by the often unrealistic expectations of entrepreneurs in the creative industries when considering external investment. Too often their passion for their business can blind them to the reasonable requirements of investors for information disclosure, board influence and return on investment.

In short there is a specific and substantial gap in understanding between the creative and investment sectors.

Because there is no sustained history of third party investment in the creative industries, the problem is exacerbated by a lack of aggregated information on, for example:

Sources of private sector finance for the creative industries.

Where the specific gaps in finance provision lie (by size or stage of company).

Historical return on investment data by sector (music versus film versus games etc).

The lack of such information means prospective investee companies do not necessarily know where to find investors. It means prospective investors encounter nothing to challenge the entrenched view that the creative industries are not for them.

Perhaps most importantly, the lack of such information means that policy-making in this area is under-informed by hard fact.

Edge proposes to the Select Committee that one relatively low cost intervention would be for Government to commission research which aggregated data on private sector sources of investment in the creative industries, which thereby identified current gaps in private sector provision and which highlighted examples of best practice and successful investment in Britain’s creative economy.

We believe such research in itself would act as a spur to further investment in the sector.

It would also ensure that the debate about the access-to-finance gap in the creative industries, much of the evidence for which is at this point anecdotal, is properly informed by market data.

Question: The extent to which taxation supports the growth of the creative economy, including whether it would be desirable to extend the tax reliefs targeted at certain sectors in the 2012 Budget

Edge believes that tax reliefs have an important part to play in directing investment which would not otherwise be provided to small and medium-sized enterprises. Edge Performance VCT is itself a successful example of the use of such tax reliefs with nearly £120 million raised for the creative sector since 2006.

Tax reliefs are an important tool by which Government can direct investment to where it is most needed, but it is also a vital element in ensuring the competitiveness of “UK plc” versus other countries, many of which have more beneficial tax regimes or specific tax breaks.

In general we agree with HM Treasury’s historic position that non-sector specific tax reliefs (such as VCTs) are more effective and less prone to abuse than sector specific reliefs.

We accept that there are good reasons for specific reliefs for challenged sectors such as film, videogames and high-end animation. However we do not see any pressing need to extend specific reliefs to sectors such as music, where we believe the recently-introduced Seed Enterprise Investment Scheme (SEIS) could do much to assist with project financing.

Such a generalist approach to reliefs, however, needs to be informed by an understanding of the specific characteristics of the creative sector.

VCT and EIS funds are effectively prevented from investing in companies which generate more than 20% of turnover from licences, copyrights or other intellectual property which has been acquired rather than developed internally.

This means, for example, that an investment in a small music publishing, book publishing, television or record company which has bought an existing catalogue is problematic, even if the investment would be used for developing new IPR and therefore is unquestionably legitimate risk capital.

While historically HM Treasury has been prepared to use some discretion on the admissibility of particular investments, the benchmark remains 20%.

The problem is exacerbated by the fact that there are no phasing provisions on the 20% limit. This means, for example, that if a new music publishing company were, on day one, to acquire an existing publishing catalogue and separately sign up a new songwriter, then the company would be earning immediately from the catalogue whereas the process of writing the song, then recording, then releasing and finally receiving royalties could take at least a year or two.

Even if, once that process is over, the vast majority of the company’s revenue were to be derived from internally-developed intellectual property, the fact that 100% of its revenue in the interim were derived from the acquired catalogue would mean the company would not qualify as a valid investment under VCT and EIS rules.

Edge believes this 20% limit on acquired IP is an indication of how general tax reliefs can contain an in-built bias against the creative industries;

Edge suggests to the Select Committee that all existing generalist tax reliefs for SMEs (such as VCT, EIS and SEIS) should be reviewed with input from industry and the three relevant Government departments (BIS, DCMS, HM Treasury) to ensure they properly meet the needs of the creative industries.

A further focus of attention, we believe, should be clarifying the success criteria for the tax reliefs which are available. Too often tax breaks seem to be created in a vacuum with no clear sense of desired outputs. Once they are in operation, there seems to be little ongoing monitoring to ensure their continuing effectiveness.

In the case of VCTs, for instance, the total amount of new money raised by the sector to invest in SMEs in the year to April 2012 declined by more than a quarter to just £270 million compared with the previous year. Given that the relief was created in order to increase the flow of new money to SMEs, this should be regarded as a cause for concern. It is understandable given the current state of public finances that the Treasury should seek to minimise tax reliefs, but this must be done with an awareness of the upside they were created to generate, both in terms of economic activity and of overall tax receipts.

Research by the Association of Investment Companies (AIC)3 suggests that for every £1 of upfront income tax relief received on VCT investment, £7 of new turnover is recorded.. Further, the AIC estimates that overall tax payments from VCT investee companies over the minimum five year life of a VCT investment are 3.5 times the value of up-front income tax relief received.

As well as setting success criteria for tax reliefs generally, we believe there should be specific success criteria to ensure that the creative industries receive their “fair share” of the tax-advantaged investment capital. The precise measure requires further investigation, but if the creative industries account for 6% of GDP, there should at least be monitoring to discover what percentage of tax-advantaged venture capital they account for.

It is important that any such criteria are set with expert input from the creative industries and all relevant Government departments.

Edge suggests to the Select Committee that more granular success criteria for existing generalist tax reliefs for SMEs (such as VCT, EIS and SEIS) are established with input from industry and the three relevant Government departments (BIS, DCMS, HM Treasury.

November 2012