Are the Proposed Tax Incentives for Early Stage Investors Really That Attractive?

Anthony Millet,

Are the Proposed Tax Incentives for Early Stage Investors Really That Attractive?

Australia has made a step in the right direction into becoming an “ideas and innovation ecosystem”, however, the reliefs offered to investors and backers of early stage businesses are fairly unfavourable compared to the SEIS and EIS relief offered in the UK. It is well documented that the Australian government has used the UK approach as a case study, but has inserted some conditions that potentially drive more investment towards the riskiest of businesses (of which more are likely to fail) rather than incentivise smaller/fast growing existing businesses which have a lot more potential and proven records.

TAX RELIEFS ARE WELCOME, BUT COULD BE BETTER

The 20% tax relief level offered (in the form of a refund) is generous compared to a historic 0% relief, but unfavourable compared to the 50% Seed Enterprise Investment Scheme (SEIS) relief offered in the UK (on the first £150k raised by a company) and the 30% Enterprise Investment Scheme (EIS) relief offered (on the first £12-20m). The 20% is also capped to a max claim of $200k per year in Australia, compared to £100k SEIS and £300k EIS (c. total $800k pa) in the UK. It is unclear on how losses on these investments would be treated in Australia, but they do have significant favourable treatment within the UK.

THE UK IS FLEXIBLE AND NON-DISCRIMINATORY

A concern around what makes an investment eligible for tax relief is around the assessable income of the previous year being less than $200k, and expenditure of less than $1m in the previous income year. In the UK, companies can continue to raise successive SEIS and EIS rounds for as long as they stay within the limits, which enables a company to entice new investors with favourable incentives across multiple rounds, with the assumption that as the business gets bigger and the valuation goes up, the chances of failure reduce.

Investors within the UK normally have different risk appetites, with some not entering a company prior to it having a non-insignificant amount of revenue to those who will invest just in an idea. These smaller and medium sized businesses (SME) are still the bedrock of the British economy, creating jobs and profitable companies, and the UK government rewards investors who invest in these SME businesses with generous incentives.

WHAT ABOUT AUSTRALIA?

The conditions set out by the Australian government (especially the assessable income in the previous year being below $200k) is only providing incentives and concessions for the earliest stage businesses – of all companies, these are the most likely to fail. By offering the reliefs to only on these very early stage businesses, the government is essentially encouraging investors to invest in businesses that are very likely to fail, rather than encouraging them to invest in small businesses, which have a significant proof of concept, a small number of sales (but over $200k) with huge growth potential, which are much more likely to create a stronger Australian economy in the future through job creation and higher tax revenue. It is not to say investors won’t invest in these businesses anyway, but offering a 20% tax relief on the earlier stage ones will certainly give them something to think about. I believe that following the UK model/guidelines here would be much more effective in attracting investment toward more successful earlier stage businesses.

WILL INNOVATION FUNDS HELP DRIVE AUSTRALIAN INNOVATION?

Innovation funds are a clever wrapper which can be used to invest in early stage businesses, benefit from the tax relief where the company qualifies, and pass this on to the fund investor. The concern I have with this, is that these funds can be expensive to manage (require staff to run,  find qualifying companies and make investment decisions etc) and need to be making sizeable investments to get sizeable returns, relative to the costs of running these funds.

The criteria for qualifying companies suggests this will be applicable to very early stage companies with lower valuations – even raising $1m might be near the top of what the majority of companies who meet these criteria could raise. Due to such funding round sizes, the innovation funds will need to make a large number of investments to deploy all their investible proceeds, putting pressure on them to deploy their funds in a large number of investments, which may dilute the quality of their investments. This, of course, assumes funds are set up specifically to only invest in companies where this concession is available (see MMC and Octopus Ventures in the UK for example).

I am also speaking generally here, as not all companies will struggle to raise $1m – some will raise more, many less, but the numbers involved are likely to be smaller compared to EIS eligible rounds in the UK, thus making it difficult for innovation funds that are set up specifically to invest in these types of qualifying companies, to deploy their proceeds if they are of a significant size ($20m+ etc).

CAN ALL AUSTRALIANS PARTICIPATE IN INNOVATION?

There are concerns around the citing that this could potentially be only available to sophisticated investors. On the one hand, I accept these are the riskiest of investments, however, I believe the average person is fed up with not being able to access investments which can generate supernormal returns. To exclude someone based on their assets or salary level implies that you are unable to understand the investment, potential and risks if you are not sophisticated. This is an exclusion policy which will likely be unpopular.

These investments are inherently risky, and education around the risk of them should be communicated when a company is raising any funds (regardless of concessions/tax relief). However, I do believe that people should be able to invest what they are able to lose, without expecting a return as given. This could be performed by way of a cap on investments (say $10,000) for an unsophisticated (retail) investor, which will allow wider investment participation.

Within the UK, there are no restrictions on who can invest in an EIS and SEIS company. Crowdfunding within the UK would likely be many times smaller and less successful than it currently is, were it not for the generous tax reliefs and inclusive environment in which any investor can access a new opportunity.

For a more detailed analyses and comparisons between Australia's Innovation Statement proposals and the UK's SEIS/EIS, click here: Comparisons Table

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Anthony is the former COO of ActivInstinct (formerly Millet Sport), helping to transform the online business with online sales of £2m with heavy losses, into a business with £35m in annual turnover.

Prior to his involvement with ActivInstinct, Anthony was an Associate Director at the international investment bank, UBS.

Anthony has now relocated to Sydney, Australia and is currently on sabbatical, following his passion for advising, mentoring and investing in small to medium sized businesses.

If you'd like to connect with Anthony, please refer to his Linkedin profile at https://au.linkedin.com/in/anthony-millet-9327713

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