Economy

Lord Flight Excerpts

Thursday 10th September 2015 Lords Chamber

[Lord Flight (Con)]

My Lords, I regret that I do not have time to make my intended comments on the wider economy as I wish to focus on the importance of entrepreneurship and the problems now presented by the new EU state aid rules for the provision of risk equity finance for SMEs. It is vital to maintain and encourage the growth of entrepreneurship and new businesses, much of which is based on new technology. That is what provides for a dynamic economy. I declare my interest as chairman of the Enterprise Investment Scheme Association.

By way of background, Britain has been easily the best country in which to start new businesses. It is much easier here than in many other EU countries, and there has been great success, with 1.5 million new companies over the last two and a half years. Universities are collaborating with business to exploit inventions and developments. But SMEs need risk capital as well as bank finance, and the EIS scheme here has been a great success. It has raised £13 billion since it started and the amounts raised over the last three years have virtually trebled. This has been largely the result of the reforms which the Government brought in in 2011, widening the parameters for companies to qualify for both EIS and VCT finance. The crucial thing here was that it meant that small businesses which were starting to expand and cut their teeth could thus get the necessary equity finance.

I was therefore horrified by the changes to the state aid rules that the EU Commission is forcing on the UK. These changes will reduce and, in some cases, cut off the flow of risk equity funding. So far the Government are seeking to make the best of things and argue that the changes have gone beyond the state aid rules. However, I do not think that the Commission is listening to the widespread complaints and concerns of the venture capital industry. The changes discriminate against UK private sector incentives for providing risk equity under state aid. Many continental European companies are substantially financed by state aid—for example, biotech in Germany. However, that happens in the form of grants, which have no restrictions on companies acquiring other companies or being acquired. Such restrictions are now being imposed on the UK. The brief of the noble Lord, Lord Hill, to increase capital market funding for SMEs will be made much more difficult. Indeed, I had urged him to promote the EIS scheme across the EU, as France has done extremely successfully in the last two years.

A major objection is that there is no apparent economic or commercial logic to the new rules. There are several problems. The rules will disqualify companies that have existed for more than seven years, cutting out for no reason the ability to redevelop and drive forward such businesses with necessary equity funding. We have had a limit of £10 million per annum for combined EIS and VCT investment, and it has worked satisfactorily. The limit is now to be reduced to £12 million over the life of the company, and on a retrospective basis, which will cut off funding particularly for SMEs that are expanding. It will also not always be easy to check all the historic state aid funding that has been received, which brings with it the danger of disqualification. The new rules relating to subsidiaries and the seven-year rule are unclear. When a qualifying company has a subsidiary that is over seven years old but is not old itself, and when the EIS funding it has raised is not for its subsidiary, will the seven-year rule disqualify it because its subsidiary is over seven years old?

The new rules maintain the requirement for major monitoring and record-keeping, especially in relation to any subsidiary. The requirements to monitor staff composition in knowledge-based companies is unrealistic, if not impossible. The bias against investment in intangibles is wrong in today’s world, where much capital investment is in the form of intangible knowledge-based assets rather than old-fashioned physical capital. The rules banning the use of EIS and VCT finance for buying companies or acquiring a business by way of purchasing their plant, machinery and good will have no economic logic and stop the valuable economic benefits of such businesses being rescued, keeping their skills and keeping the jobs. The rules are not clear, as they permit purchases of assets such as plant and machinery as required. Where is the line drawn between buying a trade and buying its plant and machinery?

The Commission has also made it clear that it will monitor the UK closely and if it believes that UK law for VCT and EIS investment is outside its interpretation of the new state aid rules, it will override UK law and demand recovery of the tax incentives. Should that happen, it will be a major turn-off. The Commission is overstepping its reach here and is unfairly discriminating against the UK. The new rules will slow the flow of this funding to equity businesses, and there is considerable resentment in the industry.