§ Motion made, and Question proposed, That this House do now adjourn.—[Mr. Major.]
§ Mr. Roger Freeman (Kettering)
I am glad to have this opportunity to raise the subject of the business expansion scheme. I am particularly pleased that my hon. Friend the Parliamentary Under—secretary of State for Trade and Industry, the Minister responsible for small firms, is answering the debate, as I wish to deal not with the fiscal terms of the business expansion scheme but with its impact on small business development. The House knows of the great interest that my hon. Friend regularly demonstrates in that.
Hon. Members may find it useful to be briefly reminded of the background and essential features of the business expansion scheme. It was introduced in the Finance Act 1983 as a successor to the earlier and narrower business start—up scheme, which was launched in 1981. The scheme is, therefore in its infancy. It is far too early to make any judgment on its effect on enterprise and employment in the United Kingdom, but we can examine how it appears to be operating, and draw some preliminary conclusions.
The scheme runs until April 1987, and enables an individual and spouse to claim tax relief up to the marginal rate on full risk equity investments in qualifying unquoted and unrelated trading businesses up to £40,000 per annum.
I welcome the exclusion of farming schemes from the business expansion scheme, as announced by the Chancellor in his recent Budget.
Investments must be held for five years to qualify for full relief. Capital gains, if any, are taxed on an increase upon the original gross, rather than the net figure, after tax investment. Capital losses are not available to offset against other non-business expansion scheme capital gains.
Response from the City has been good. City firms are forming business expansion scheme funds to pool individual investors' money and so to spread the cost of administration, and the risk. I estimate that nearly £50 million has been raised—although obviously all that has not yet been invested — by over 30 Inland Revenue—approved funds.
I believe strongly that competition between the funds to raise money is good because that provides the best protection for the individual investor over the level of fees and expenses. I should not like regulations to be introduced. I believe in the principle of free competition in the market place. The investor should be able to make up his own mind where to place his money.
Many funds will continue to raise amounts this year, and I hope in succeeding years, I hope that the £100 million figure can be reached by the end of this fiscal year in April 1985, despite the welcome reduction in the top marginal tax rate from 75 per cent. to 60 per cent.
Investments have been made in a whole range of opportunities from management buy—outs, through franchises to venture capital. To the extent that money raised under the business expansion scheme is invested in venture capital projects, it is in direct competition with the more sophisticated and larger institutions such as the pension funds and insurance companies. By venture capital, I mean newly established commercial ventures, often involving high or new technology.
1197 However, even the combined weight of investors' money from the business expansion scheme and institutions is modest compared with the amounts raised and invested in venture capital in the United States of America. Annually in the United States of America between $2 billion and $3 billion flows into venture capital partnerships. In the United Kingdom the figure is closer to £100 million from private, but probably mainly institutional, sources. Even allowing for our different gross national product, we have a long way to go in terms of investment flows into unquoted companies, particularly venture capital operations when compared with the United States.
At a more appropriate time I shall raise with a Treasury Minister certain other matters related to the scheme, particularly the point at which tax relief is given. I believe that greater incentive, simplicity and perhaps ordinance could be achieved by giving relief at the point of subscription to approved business expansion scheme funds rather than at the point of investment. I shall not argue that tonight because it is inappropriate.
I wish to discuss three areas of concern which fall well within the Department of Trade and Industry's responsibility. First, I should like to make a suggestion to the Minister about advice to investors in business expansion scheme funds. On the cover of the offering circular a warning should be given to investors in much bolder and fuller text than that accepted at present by the Department. We should follow the example of the United States, where the Securities and Exchange Commission requires very clear warnings to be given to investors making high risk equity investments.
When the minimum five—year holding period runs out in 1988–89 I believe that some investors will be disillusioned about the liquidity and perhaps the inherent value of their investments. I am mindful of the great advantages introduced in the last Parliament in provisions enabling companies to buy back their own shares. Clearly that has helped to develop liquidity for equity in unquoted companies. Nevertheless, despite those excellent provisions, it is vitally important that investors are properly forewarned, so as to mitigate any loss of confidence in the business expansion scheme or its successors in later years. Cautious warning noises and, indeed, regulations from the Department are appropriate and are needed now and not later.
Secondly, in regard to the level of funds raised there is what I would describe as a gap developing in the venture capital market. Most of the money raised so far has been via the City of London, and institutions in the City have been responsible for preparing circulars and raising the money and then identifying investments. Inevitably most of the business expansion scheme funds have tended to consider investments of £100,000 or more. This is primarily for reasons of economy of scale because it costs almost as much to examine an investment proposition of £10,000 as it does for one of £1 million.
The other reason why City-based funds tend to look at investment propositions greater than £100,000 is the pressure of time to which I have already referred. There is pressure to invest money as quickly as possible because of the tax relief that arises for individual investors. Therefore, there is a gap. Very small unquoted companies, which may need less than £100,000, are finding it difficult to attract the interest and attention of City-based vehicles. It is often the very small businesses which are badly out 1198 of gear; that is to say, they are borrowing too much debt in relation to their equity base and they need to raise additional outside equity. Such companies are mostly local in reputation and business activity.
One way to ensure that small investments are properly catered for is to encourage what I describe as the regionalisation of business expansion schemes so that more moneys are raised and invested locally rather than through the City of London. I should like to see more county-based business expansion scheme propositions, perhaps linked with local enterprise agencies, or initiated by local chambers of commerce or, indeed, by commercial banks.
Some have started, for example, in south Yorkshire and in Wessex. In my constituency I should like to see, and am working hard to secure the establishment of, a business expansion scheme for the county of Northamptonshire. Any local funds must be based on counties rather than on the relatively small provincial towns. Therefore, I intend to co-operate with my hon. Friends representing other constituencies in Northamptonshire to try to get one launched. My aim is to do that this year.
Raising money locally could be encouraged by local professional advisers such as solicitors and bankers who deal on a day-to-day basis with the local funds, not only of individuals who might have money to invest, but of local companies that might need equity investment. Often there is still great ignorance about the terms and conditions of business expansion schemes, which I regret. Locally based funds might be smaller but could be properly evaluated by those close to them, the advisers and investors who would know the companies in which they proposed to invest. I would like the Department of Trade and Industry and the clearing banks to take the initiative in promoting the creation of county or provincial town-based enterprise schemes.
The original intention of the business start-up scheme in 1981, as modified in 1982, was to concentrate the tax relief on venture capital opportunities. What has actually happened during the past year is that the scheme has broadened and, in a sense, has become simpler to understand and administer. However, the bulk of the money raised has gone into established businesses, rather than into venture capital opportunities. That is a great pity. The Department of Trade and Industry, through its excellent small firms advisory service, should offer advice not only to the business expansion scheme funds of the City but to those that, I hope, will spring up locally. It should help them to identify, and certainly evaluate, venture capital opportunities so that consistent rules of analysis and, indeed, of experience, can be spread throughout the country.
Ultimately, it may be necessary for Government to legislate and say that for business expansion scheme funds that are to be approved in future, tax approval will be granted only if one of the aims is to invest a minimum proportion in genuine venture capital opportunities. Whether that proportion should be 25 per cent. or 50 per cent. I shall not speculate tonight. It is important that, in some senses, we revert to the original intention in 1981–82, which was to offer tax relief and incentives to individuals who wished to invest in genuine start-up operations and businesses.
Over the longer term, I warmly endorse two ideas for further study. The first is the so—called CBI proposal, although it was originally canvassed by the Wilson 1199 [Mr. Roger Freeman] committee, of the small firms investment company concept. That is really an extension of the business expansion scheme. The SFIC, which is modelled on the small business investment company as used in the United States, would be a trading public company with similar tax provisions as apply to the business expansion scheme funds. It would be simpler to administer because investors would get tax relief upon subscription to the small firms investment company and not upon individual investment in the underlying companies.
Investors could sell their shares in the SFIC—one expects readily. This is not so with the business expansion scheme funds. They would, of course, be subject to Inland Revenue restrictions. The SFIC would have both individual and institutional shares—a mix of the two—and invest not only in equity but in debt instruments of companies.
In parallel with the business expansion scheme, the Government should consider encouraging greater investment in research and development through tax reforms and, specifically, through facilitating and encouraging research and development partnerships, such as exist in the United States. It is vital that we encourage companies in this country with outside finance to invest in research and development. There is a genuine and excellent case for tax relief in that area.
The business expansion scheme is an excellent innovation. It has been successful so far and a tribute to the Government's determination to encourage the private sector. I hope that my hon. Friend the Minister will have one or two comments to make on the modest but relevant suggestions that I have made.
§ The Parliamentary Under-Secretary of State for Trade and Industry (Mr. David Trippier)
I congratulate my hon. Friend the Member for Kettering (Mr. Freeman) on his initiative in raising the subject of the business expansion scheme. With his customary diligence, he deployed a number of interesting suggestions which are worthy of close examination.
As my hon. Friend said, this novel and highly imaginative scheme is one year old. Clearly it is too early to say how successful it has been in achieving its aims, and there is obvious merit in giving it more time to settle down before considering any further changes. My hon. Friend said that, and he was right. The introduction of the scheme has been widely welcomed, and indications of take-up are, generally, most encouraging.
I begin by briefly reminding the House about the underlying aims of the scheme. As my hon. Friend said, the present business expansion scheme replaced the earlier business start-up scheme introduced in 1981. Like its predecessor, the purpose of the present scheme is to encourage individuals to invest on a reasonably long-term basis in new, genuinely additional and full risk equity of unquoted trading companies with which the investor is not otherwise connected.
The scheme recognises the risky nature of this type of investment. The investor gets relief, up front, at his full marginal rate or rates of income tax. He retains that relief, provided only that he holds on to his investment for at least five years and that the company continues to satisfy the qualifying conditions.
1200 The underlying aim of the scheme is to encourage new and expanded activity in the small firms sector. This sector is vitally important as a source of new jobs and prosperity. The aim of the scheme is also, of course, to encourage investment in those high-risk activities to which my hon. Friend referred, where the risks to the investor will be at least to some extent commensurate with the generous level of relief.
There is the wide range of eligible trades spanning all industrial sectors — manufacturing, services and distribution — but the scheme is not for essentially passive or financial operations, so that certain activities are excluded; for example, dealing in land or commodities, leasing and letting assets on hire, banking, insurance and other financial services.
I wish to stress that there is no implication intended that these activities are in some sense unworthy. It is simply that activities of this kind do not need the incentive provided by the expansion scheme for their development.
As the House will know, we are proposing just one change to the scheme in this year's Finance Bill. We propose to exclude farming as a qualifying trade. Again, no implication is intended that this is somehow an unworthy activity. It is simply that the ownership of farmland cannot be said to fall within the kind of high risk areas at which the scheme is directed.
It will be some time before we have firm figures about amounts invested under the scheme in the first year. This is partly because, for administrative reasons, claims for relief in the first year could not be made until 1 January 1984. But there can also be a long gap between the original investment and the claim for relief in the case of start-up companies. This is because, under the rules, relief cannot be claimed until the company has completed four months' trading, and companies are allowed up to two years from the issue of the shares to start trading. But I can give some figures.
Under the scheme, an individual can either invest directly in target companies, or via an investment fund approved by the Inland Revenue. In the latter case, the individual—not the fund—is still the beneficial owner of the shares and, like the direct investor, he gets relief only when his money is actually invested in target companies. Whilst many individuals may be prepared to undertake direct investment, it seems probable that the bulk of investment under the scheme will be channelled via the approved funds. My hon. Friend touched on this matter and I agree with him.
They can offer the investor expertise in the selection of target companies in which to invest, and the opportunity to spread their risk.
So far, 34 funds have been approved by the Department of Trade and Industry under the Prevention of Fraud (Investments) Act 1958 and the Inland Revenue, including six which have been brought forward from the start-up scheme and reapproved. We have firm figures for subscriptions to 29 of these funds, which have actually closed now for subscription. Including about £11 million which has been carried forward by the old start-up funds, the amount so far raised—nearly all of which would have been available for investment in 1983–84—is about £44 million. The remaining five funds which have been approved, but which have not yet closed for subscription, are planning to raise a minimum of £8 million in total, but 1201 hope to raise up to £20 million. The money raised by these funds will, of course, be available for investment in 1984–85.
Not all of the £44 million available to the funds for investment in 1983–84 will actually have been invested in that year. But, whilst we do not yet have firm figures, it seems probable that at least 80 per cent. — say £36 million—will have been invested by 5 April 1984. To this must be added the amounts individuals have invested directly.
It is also too early to predict now many individual investors and companies have taken advantage of the scheme, or what are the average amounts being invested by each individual and in each company. Like my hon. Friend, I would be very interested in the figures. It seems probable, however, that many different kinds of company have benefited from the scheme. It is the stated intention of many of the approved funds to invest in a mixture of start-up and established companies, and in amounts ranging from as little as £25,000 up to £500,000 and possibly more. The areas covered include manufacturing concerns, a wide variety of service industries, computers, information technology, hotels and shops.
The BES is of course only a part of the range of policies which the Government have developed over the past five years to help small firms. It is essential for the economy that we have a flourishing small firms sector and we have paid too little attention to this area in the past.
This is not the time to review everything we have done to redress the balance in favour of the smaller firm. Nor would I claim that everything possible has now been achieved. My postbag keeps me well aware of how much remains to be done. But looking at the question of availability of finance, which is the area of most relevance to this debate, there have been substantial improvements since 1979.
The BES is an important part of this encouragement and has made a major contribution to the growth of venture capital. It needs to be seen as part of a general policy to ensure that small firms have access to a full range of financial resources, including equity, and are not disadvantaged in relation to larger competitors.
It is, as I have said, still early days for the scheme. We are still seeing new experiments being set up and I welcome these intitiatives. It is, I believe, fair to say that most use has been made of the scheme by the approved funds for making investments over £100,000, which is a substantial sum. Some smaller investments have been made by funds, and of course there are investments made direct by individuals which are limited to a maximum of £40,000 to be eligible for tax relief, but, as my hon. Friend has said, it remains difficult for a firm to obtain an equity investment of, say between £20,000 and £50,000.
I hope that further experiment will result in the BES contributing to this smaller scale of investment, although I recognise that there are high costs involved in this type 1202 of activity. I know that much thought is being given by a number of people round the country to the ways in which locally based investment funds or clubs or syndicates might operate. I am sure that this will bear fruit in the coming months, and I shall be more than pleased if my hon. Friend can encourage this sort of development in his constituency or county.
These local initiatives must come from the business community itself, but my hon. Friend is able and obviously, from what he said, very willing to lead in that direction. I am certainly prepared to consider whether it would be appropriate for my Department to issue noties for guidance on setting up a local fund, but I must emphasise that we are at a stage of experiment. I do not want to stifle local initiatives by Government intervention. I cannot comment on what role, if any, the banks might play in these initiatives, although their support for the local enterprise agency movement, which is well known, is welcomed by me and the Department. It is certainly one way in which they can support local initiatives.
My hon. Friend suggested that my Department should provide specific assistance directed at the evaluation and appraisal of applications for funds from start-ups. Those matters must be left to the commercial judgment of fund managers.
My hon. Friend raised the question whether, given the nature of the investments made, a stronger health warning —my term, not his—should be included in invitations for subscriptions by BES funds. The whole structure of the existing law on investor protection is, of course, under review following the report by Professor Gower on this subject. I do not feel that it is appropriate to suggest individual changes yet. I should point out that the "health warning" used is set out in the Inland Revenue guidelines to approved funds and must be displayed prominently on the front of the document. The invitation must also refer to the risks involved in investments of this kind and some of the difficulties that may be experienced in selling shares in unquoted companies.
As I have said, I believe that the business expansion scheme to be an important and innovative measure which reflects the Government's commitment to the encouragement of the small business sector. Naturally, my right: hon. and hon. Friends at the Treasury and the Department of Trade and Industry will monitor the BES closely to ensure that it continues to operate effectively, but in doing so it will be essential that the scheme is not made too restrictive. Debates such as these are most helpful to the process of evaluating the BES and considering suggestions about its operation. I am grateful to my hon. Friend for drawing the attention of the House to this important matter.
Question put and agreed to.
Adjourned accordingly at seven minutes past Twelve o'clock.