Venture capital is a form of investment in early-stage companies, typically in return for an equity share of the business. This type of financing is risky: a high proportion of firms that receive venture capital will fail. But it is a crucial form of investment for innovative companies with high growth potential. A dynamic venture capital sector can be an engine of economic modernisation and growth.
The UK venture capital sector receives state support in the form of three tax reliefs (targeted reductions in tax liability). These are the Enterprise Investment Scheme (EIS), the Seed Enterprise Investment Scheme (SEIS) and Venture Capital Trusts (VCTs). The sector also receives support via British Business Bank (BBB) funding schemes.
We heard that the venture capital tax reliefs are globally competitive and a key draw for investors. The reliefs have made a positive contribution to the venture capital market and investment in small, high-potential businesses, but there are areas of concern.
The EIS and VCTs have statutory sunset clauses that will cause them to expire in April 2025. The Government has signalled an intention to extend the schemes but has not said when it will do so or for how long. This uncertainty is a risk to investment. We call on HM Treasury to detail and implement an extension urgently.
This renewal of the EIS and VCT schemes is an opportunity to improve them to address current shortcomings. These chiefly comprise diversity, regional inequality and scale-up capital.
Diversity in the sector is extremely poor, both in terms of the characteristics of business founders that receive venture capital funding and the people who make venture capital funding decisions. Women and people from ethnic minorities are highly underrepresented in both groups. This holds the sector back.
We recommend that the provision of statistics relating to diversity in staffing and funding decisions should be a condition of receiving tacit taxpayer support in the form of the EIS and VCT tax reliefs. We also recommend that venture capital firms be required to comply with the industry standard Investing in Women Code or explain why they are not. Finally, we recommend the Government and BBB consult on the creation of venture capital funds targeted at women and ethnic minority founders, in the same vein as the BBB’s regional fund programmes.
Venture capital investment is disproportionately allocated to London and the surrounding areas. High-potential firms in other UK regions and nations struggle for access to capital. We heard that firms outside London tend to take longer to get established, which means they are disproportionately penalised by the upper age limits of businesses that can benefit from investment supported by the EIS and VCT schemes. We recommend that HM Treasury consult on extended age limits from 2025 with the objective of alleviating regional inequality.
We heard that relatively mature high-potential businesses struggle to ‘scale-up’ to the next level. We find that limits to funding that may be provided through the EIS and VCT schemes inhibits this crucial process. We recommend that HM Treasury consult on revised limits from 2025 with the objective of supporting scale-up business growth.
More generally, the dearth in UK domestic capital leads to businesses seeking investment elsewhere: being acquired by foreign investors or choosing to list on overseas exchanges. UK pension funds offer a vast pool of potential funding, but such assets are not invested in innovative businesses to the extent seen in international competitors. We welcome the Government’s plans to bring forward proposals to facilitate defined contribution pension fund consolidation, which should promote higher risk, higher potential investment. We will scrutinise the details of those proposals closely. Any change must pay due regard to the balance between risk and reward for pension investors.