Could changes to EIS tax breaks would see more fledgling businesses cut off from business angel funding.

The Office of Tax Simplification will be reviewing all tax reliefs and allowances ahead of this year’s budget. The Enterprise Investment Scheme will be one of those tax reliefs under the microscope – but as investment through the scheme has slumped, the real question is, will it be missed?

The UK government may be going against public opinion by going easy on bankers bonuses but it still has to find the money from somewhere. The latest issue concerning entrepreneurs and business angel investors alike will be some potential changes to tax relief on schemes such as the EIS.

The EIS and perhaps even Venture Capital Trusts could be abolished if it is decided the government is being a bit too generous with investors.

Last year’s changes to capital gains tax was supposed to have pushed more of those who could afford it towards angel investing and the EIS. They would consider it worth the risk putting some of their money into these schemes whilst helping entrepreneurs get their fledgling businesses off the ground at the same time.

Private Investor Syndicate Hotbed has stepped out and called on the coalition to increase rather than limit (as it does at present) the tax relief for investors in SMEs and certainly not scrap it as part of their review. They feel this would encourage more investment from business angels and other investors into SMEs who will be attracted by the tax breaks on offer.

But increasing the tax breaks is not necessarily the answer if we look at the statistics.

EIS has been around since 1994 but in recent years the number of subscriptions has shown a marked decline.  Although it has to be said that data is only available up to 2008 -09, investment dropped by 29% in this period and it is doubtful if 2009-10 will show any increase. The last time we saw a fall of 29% was during the Dotcom crash. In the previous year (2007-08) £692 million was invested via the EIS so a 29% fall is significant.

The financial crisis certainly had its impact and investor confidence will take time to return. This will be of little help to start-ups seeking capital through EIS. VCTs meanwhile where the tax breaks are less are proving more popular.

Why is this the case? To begin with the rules surrounding investment via the EIS are complex.  It also carries a higher risk than going down the VCT route. One of the main differences between the EIS and VCT  is the requirement for the EIS to raise money for genuinely trading companies with fewer than 50 full-time staff. the size of these companies mean investment is much more risky.

Despite the risk, the tax breaks are generous making it one of the most generous tax advantaged investments out there. But going back to the earlier point the appetite for risk simply hasn’t been there, the EIS is certainly not for the faint-hearted. This means further tax breaks are probably unlikely to attract more investors.

The VCT meanwhile provides a steady stream of income with dividends free of income tax. This steady stream of income is one good reason why VCTs are proving so popular. The EIS needs this kind of clear income stream to attract more investors rather than more tax breaks per se.

If we are to have the private sector driven recovery the coalition is hoping for, then it is clear that they need to find a more effective way to attract investment in SMEs. All the indications are at the moment that the EIS will not survive in its present form and the pressure to reduce tax breaks may be too great to resist. Assuming it survives, this would making the EIS even less appealing in the future.

This would be shame as especially for those businesses hoping to raise funds this way. If it is to be simplified, there needs to be the right balance struck between risk and rewards. Many will be waiting anxiously to see what happens come the next Budget.

A recent survey has painted a gloomy picture of the funding options available to UK SMEs. The Annual Credit Check Survey by Venture Finance, has found that almost two thirds (60%) of UK accountants think traditional bank finance is still barely available to UK SMEs.

Only 17% of theose surveyed believe business loans are available and under a third (31%) consider the EFG to be accessible to eligible businesses. Rather than business angels riding to the rescue of SMEs, it appears that the opposite is true with almost a third (30%) of those surveyed believing that business angels are in fact now less accessible as a source of funding.

Professional negotiator and media lawyer, Clive Rich

In these difficult, recessionary times it’s become harder than ever for SME’s to raise money to finance their working capital and expansion.

Banks seem to be closed to business and institutional money is very hard to come by for small companies. So, potential deals with business angels represent a life-line for SME’s.

How can SME’s maximise their chances of closing deals with potential business angel investors? One option rarely discussed is to improve their negotiating skills.

Negotiation is seldom taught or practised, and yet it has never been more important to be a skilled negotiator. So, when raising money from business angels, how can SME’s negotiate more effectively to get what they need?

Firstly, good negotiators bring an effective attitude to the negotiating table. Research shows that good negotiators feel positive about themselves, and believe that they can win. Having worked for many years with Simon Cowell – a winner if ever there was one – I can say that kind of attitude is self-fulfilling.

To be able to believe it can win, the SME needs to marshal its bargaining power.   Who holds the aces?  Un-trained negotiators often under-estimate the bargaining power they have on their side by focusing exclusively on the “market power” of the other side.

Yet there are many other sources of bargaining power – nine to be precise – including expertise, information, and access to influential networks. These sources of bargaining power are rarely distributed 9-0 in favour of anybody, so the SME needs to understand that and not be daunted by the perceived market power of the investor.

Secondly, SME’s need to know how to manage the negotiation process. Most negotiations follow a set pattern, with a number of recognisable and distinct stages. If you know what stage you are at and how to handle that stage then that will automatically give you a big advantage.

It’s often the early stages of a negotiation that get overlooked, because they require an investment of time. These include “Preparation”, and “Exploring “Needs”.  SME’s are always in such a tearing hurry trying to develop business and cash-flow that time spent on preparation can seem like something of a nuisance.

In fact it is an investment of time – fail to prepare and you prepare to fail. I have seen an SME fail to close a deal with an orderly and detail-minded angel investor by tuning up for the meeting wearing odd socks. If you don’t know what your deal partner expects from you then you won’t get much of what you want.

SME’s also need to take the time to establish the needs on both sides. Good negotiators know that you can’t expect to engineer a win/win outcome if this stage is skipped in the rush to get to the “haggle”. “Needs” are the underlying emotional requirements that each side has from the deal – not to be confused with organisational “wants” such as “price” or “quantity”.

These needs are critical to understand, because they underpin the whole negotiation, and yet they are often unspoken, so they are not easy to spot without a trained eye. Does the investor have a “security” or “reassurance” need?  If so they will be focused on guarantees and risk control in the deal. Do they need to achieve something unique as a result of the deal?

If so the SME needs to focus on the innovative and original nature of its product. Does the investor have a “belonging” need? If so the SME must be sure to make them feel at home as part of the company going forward.

If the parties can get through these early stages and bargain successfully they will arrive at the final stage of any negotiation, “closure”. SME’s need to know how fluid this moment can be. It must be bottled immediately before the investor changes his mind, is impacted by new economic factors, or finds something else to invest in.

I remember an SME failing to close its deal with an investor because it insisted on arguing about commitments for the next round of funding before the deal was closed for the current round.

Finally, SME’s need to grasp the importance of selecting the right behaviour   for the person they are dealing with and the right stage of the negotiation. There are 12 different negotiation behaviours to choose from, but most of us only use one or two – our favourites, irrespective of whether they are working or making things worse.

When seeking funding, much is made of the importance of the management team, the protectability of the product and the credibility of the marketing plan. SME’s should add the importance of negotiation skills to that list. It can be the difference that makes a difference.

This compares with 15 transactions and £474m of funding in the previous quarter (April to June) when activity spiked in the run up to the government’s emergency Budget and the anticipated capital gains tax increase.

The reports authors say the figures provide further evidence that business owners and entrepreneurs, many of whom are thought to have mothballed plans during the downturn, were returning to the market to realise value or secure capital for growth expansion.

This indicates positive news for SMEs and measurable growth in funding from private investors including business angels. The news contrasts sharply with bank lending to SMEs which continues to fall.

Zulfiqar Deo

Much has been written about how angel investors can help entrepreneurs, but who do business angels turn to when they need help?

Business angels are seen as the amateur cousins of professional venture capitalist investors in much the same way as the blue chip business sector is often seen as the core value sector of any economy. In fact, blue chips represent less than 2% of businesses in terms of volume and less than 50% in terms of value.

The same could also be said for the business angel sector, if only the potential of this type of business investment could be realised and better organised. However, as we have seen with the unfavourable changes to capital gains tax thresholds, business angels suffer from the same lack of government support as SMEs who are forced to operate in difficult market conditions with little in the way of help in comparison to larger blue chip companies.

Business angels tend to invest their money in SMEs which means they will need to work harder to achieve the profits they set out for. This is not so for VC investors working with blue chips like for example Goldman Sachs, JP Morgan. They will benefit from advice, and substantial support to help them understand the risks of investment and the risks involved in realising their profits. Their business angel counterparts often only have their intuition to rely on. Business angels simply don’t have the benefit of unlimited access to detailed reports on aspects of the industry they invest in.

So is it possible for business angels to adopt the same techniques and down size them for SMEs?

The answer is no and this is a common mistake business angels make. The SME sector has a different set of dynamics to contend with and different management models to rely on to achieve growth. Business angel relationships with management teams also by their nature tend to be more personal. If things are going well, these relationships can produce great results, but all to often they can be hard, particularly when things go wrong, as they often do.

The trouble is when things do go pear-shaped for business angels there is little support available. The only real support is comes from organisations like the British Business Angels Association. This is a start, but having just a few organisations serving the entire business angel community in the UK is a reflection of how much more support is needed to help business angels to build and nurture their interests in what they do. In my view this current lack of support is reflected in the poor success rates business angels tend to have.

These failure rates tend to be in excess of 50 %. This high failure rate can be lowered and more business angels can see a higher ROI on their current investments if more support is made available. Unfortunately until the situation changes the failures will continue to outweigh the successes.

Yet if you looked at any industry where the failure rates are in excess of 50% chances are you would see investors fleeing it in droves, this is not so with business angels. They are a resilient bunch who are keen to help companies provided they get a decent return on their investment.

SMEs would love to gain access to more of this type of funding and grow themselves into small then medium and eventually large companies. But to help them business angels shouldn’t have to reinvent the wheel – they need guidance, support and access to skills and expertise and they need it on the same scale available to VCs.

Post by Zulfiqar Deo, SME specialist and Strategy Implementation expert.

CGT rise will put the squeeze on business angels

It’s the day after one of the most eagerly anticipated, or should that be dreaded? Budgets of recent times. Budgets are becoming like buses, normally you wait ages for one and suddenly two come along in just a few months.

There was little in the last one to encourage business angels or entrepreneurs in the UK, but in this latest emergency Budget the Chancellor has gone out of his way to show that Britain may be weighed down by a mammoth budget deficit to reduce, but it is still open for business. Or is it?

Business groups on the whole have welcomed some of the measures introduced to help entrepreneurs and owners of SMEs. The 1 per cent cut to companies’ tax the new £5 million threshold for entrepreneurs’ relief on CGT have been applauded as have measures to reduce National Insurance liabilities.

This all sounds too good to be true, is Mr Osborne really giving a leg up to entrepreneurs so that they can get Britain back on the road to recovery and avoid the possibility of a double dip recession in the UK?

Perhaps, but as with all Budgets, it depends how you look at it. Sure all the headline grabbing measures will show that enterprise is being encouraged. It is also worth noting that entrepreneurs can now claim Capital Gains Tax relief on up to £5m worth of business sales in a lifetime – this is up from £2m in March.

To help fast growing SMEs starved of growth funding the government plans to introduce a new Enterprise Capital Growth Fund to provide a £37.5 million boost of equity finance to SMEs. The Enterprise Finance Guarantee is also being increased by £200 million to support additional lending of up to £700 million to for small businesses until the end of March 2011.

All this funding is great if you are a growing business and able to gain access to it, but as we have seen in the past 12-months start-ups are struggling to secure funding from banks. But the banks have been holding onto their purse strings, which means start-ups have had to turn to business angels for help. The problem is that again there is little in the budget to encourage business angels.

The sharp rise in Capital Gains Tax from 18% to 28% is likely to discourage rather than encourage investment in the UK. Despite the headline ‘good news’ the entrepreneurs relief doesn’t cover all of those involved in the investment chain. Those business angels who are affected by this hike in CGT are likely to decide that the risks outweigh the rewards when it comes to investing at seed stage. This would cut off the vital supply of capital needed by those start-up businesses who can’t secure funding elsewhere, stifling innovation in the process.

Britain had the lower CGT rate (18%) than most other countries, until last night just behind Brazil (15%) and the US (15%). According to a table compiled by Ernst and Young, Britain has now dropped from 7th to 15th with a higher CGT rate than China’s 22%.

Britain’s slide down the scale of competitiveness with these other countries is a concern, and could make it more attractive to invest abroad where the rates are more attractive.

It could have been worse. The worse case scenario of a rise to 40% and without the measures introduced in the Budget to help entrepreneurs would have dealt a heavy blow to hopes of recovery. Everyone in the UK knows that payback time has come, but time will tell if business angels will still be willing to take a risk on early stage growth businesses. The incentives should have been spread more evenly between entrepreneurs and those other links in the investment chain.

A budget that would please Alan Sugar?

Capital Gains Tax will rise less than expected from 18% to 28%, which is what makes the Entrepreneurs relief of just 10% is so attractive.

In addition, to help fast growing SMEs starved of growth funding the government plans to introduce a new Enterprise Capital Growth Fund which will provide more than £37.5 million of equity finance to SMEs. the Enterprise Finance Guarantee is also being increased by £200 million to support additional lending of up to £700 million to for small businesses until the end of March 2011.

And, businesses outside of London and South and East can benefit from no employers national insurance on upto 10 employers.