Monday, 31 October 2016

The S/EIS model is broken

We came across someone recently who was in the process of raising money for their business using equity crowdfunding.

The business had a good level of support from HNIs but there was an issue over EIS due the length of time the business had been running.

As part of our conversation I was told that EIS was an essential part of the HNIs participation - they wanted their 30% rebate or they would not back the project.

This strikes us as being back to front. If you believe an idea or business is investible then it has to investible with or without EIS. Receiving a 30% tax break when you lose all of your investment makes you a loser - not a HNI.

Agreed both SEIS and EIS are useful derisking tax breaks but they should certainly not be making the investment decision. This is not the first instance we have come across where ECF investors have leapt blindly off a cliff simply because they know that the fall is not the full distance. Fact is it is still a fall and is still very likely to end in tears.

This reliance on tax rebates is also skewing the market from the entrepreneurs' perspective. Many companies over 7 years old, or outside the time limit for these rebates, would make good investments based on the business fundamentals. A few use ECF but most are scared off by the overwhelming numbers showing how qualifying for S/EIS makes for a successful ECF pitch. Likewise, many non starters get funding simply on the basis of these breaks.

What is the purpose of the 7 year limit? Why 7? Shouldnt we be encouraging businesses that have succeeded for 7 years or more to expand by allowing them also to access this new funding. God knows, it might even produce some decent ROI.


  1. I have to disagree with your comment that a business that is investible is investible with or without EIS/SEIS tax relief.

    A smart crowdfunding investor will have a portfolio of investments, many of which will fail, but hopefully a few will succeed. Including loss relief, the EIS scheme means failed investments cost you half as much as non-EIS scheme failures. Doubling your money on 3 out of 10 investments yields a profit under EIS (even if the other 7 businesses fail completely), without it you could lose 40% of your investment.

    Your blog does a great job of drawing attention to the high level of risk involved in crowdfunding investments. It strikes me as odd that you dismiss the value of EIS, when it can easily double the return to an investor who experiences a high failure rate in their portfolio.

    1. Yes i take the point but its not what i was trying to say. EIS and SEIS have allowed very poor businesses to get funding - which has an enormous knock on effect on other small businesses that have traded with them when they go bust. We have only seen the very tip of problem so far - I know as i have the data from 2011 to 2016. To be able to leverage EIS/SEIS to induce investment (a good idea if done properly), businesses should have to pass a certain level of credibility/worthiness of whatever you like to call it. Not easy, i admit, to hit the balance between sensible scrutiny and unhelpful interference but IMO essential to try. Too many seriously ridiculous businesses are getting funding BECAUSE they have tax reliefs. That is crazy.

  2. Other small businesses trading with loss-making crowd funded businesses should be wise enough not to offer credit terms. I don't buy this as an argument against EIS.

    I'd go further than "not easy" and say it is impossible to independently assess the credibility of a loss making company with a plan to become profitable. This kind of work is carried out by ratings agencies (see the recent credit crisis for news on their track record!) and equity researchers, who would charge tens of thousands, eating up most of the value of the EIS benefit on a typical crowd fund raise. Despite costing a fortune and working with companies with long trading histories and transparency, their ability to predict future failures is very poor.

    The argument that these tax rebates are not a good use of taxpayer money is understandable. But in the context of government expenditure these amounts of money are absolutely miniscule. In the long list of outrageous wastes of money the government commits to each year, EIS rebates doesn't even make the top 50.

    Ultimately it's the responsibility of individual investors to assess the credibility of the companies they invest in. I have no doubt that you're correct that EIS incentives entice people to invest in poor businesses that otherwise wouldn't get funded. I just feel that this is an argument against poor businesses, not the EIS scheme itself.

    1. Again some interesting points. But i am most definitely not arguing against S/EIS I just want it to be used for a more sustainable growth in start up's and SMEs. Its an odd argument that becasue somethign isnt massive it doesnt need attending to!! Why for example are companies that have been trading for more 7 years excluded - who thought up the number 7? Why? I have numerous examples of good companies that required growth funding and looked at ECF as an option but chose not to go down this route because their perception and one that is loudly echoed by the platforms, was that without S/EIS they would never make it. We are now seeing - for the first time, some larger businesses raising successfully without EIS which is good, i hope it builds. But the largest platfrom Crowdcube spends millions on promoting its S/EIS angle which is unhelpful.

      Your first paragraph is just nonsense. The very fact that a company has raised £ on CC or wherever would suggest to a trading partner that this co is creditworthy. On your argument credit would dry up completely everywhere. You cannot know if a loss making company (from the accounts filed 18 months ago with a only a BS to go by) is now a profit making one. Doesnt matter how wise you believe you are it is a physical impossibility. So that argument is entirely misplaced.

      Again your last para ignores the asymmetry of information - see the blog for hundreds of examples. The platforms help this by ignoring or being ignorant of basic due diligence but its compoanded by the system we run in the UK which is not fit for purpose when it comes to ECF - again all in the blog. The evidence is overwhelming. Caveat emptor works with equal information on both sides. Investors simply dont have that and part of that is down to the platforms, part of it is HMRC and part of it just the way things are. The first two can be changed for the better. That would help.

  3. I think my statement on credit is valid. All businesses are responsible for managing their own credit risk. If they choose to extend credit to a business that hasn't published any profit making accounts, on the basis that they raised money on a crowd funding site, that is a naive business decision. Credit hasn't dried up everywhere but small businesses (including crowd funded businesses) do indeed have a very hard time getting any credit terms. The crowd funded businesses I work with rarely receive credit terms from suppliers, and if they do it's from larger firms who can handle the risk.

    I believe caveat emptor works regardless of equal information. If you don't have enough information, you don't buy/invest/lend money. My experience tells me that any attempt at proper due diligence would cost tens of thousands and be ineffectual anyway, so I'd rather the platforms/HMRC don't bother. I'm an investor and I can make my own decision on the information available.

    In any case I only found your website today and I'm a big fan. This is a much needed voice in the debate and I appreciate you going to such efforts to investigate and inform. Keep up the good work!

  4. Having run and indeed now running a large number of start ups and SMEs for the last 35 years, I cannot agree with you. But it has been a good discussion. Thanks for reading. BTW if these companies you talk about have such a very hard time getting credit how is that when I look at all the companies which have failed after funding via ECF, that they all have os creditor lists which are mostly made up of trade creditors (listed). That would seem to me to be irrefutable evidence to quash your assertion.