Michael Buckworth on COVID-19: “For the start-up sector, the impact could be devastating.”

Long-COVID: how the risk for start-ups will increase as the recovery kicks in

The Government has provided crucial financial aid to bolster the UK’s struggling economy during the pandemic. The astonishing amount of money spent by the Treasury raises the spectre of significant tax rises affecting all parts of the British economy. For the start-up sector, the impact could be devastating.

In an open letter to the Chancellor of the Exchequer back in the Summer, Buckworths warned of a potential lost generation of start-ups as a result of COVID-19. Our primary concern was that the Future Fund is incompatible with the existing Enterprise Investment Scheme (EIS) making it unattractive for UK angel investors to provide matched funding that is required to unlock the government contribution. To make matters worse, the rules of EIS (namely that EIS investment monies must primarily be used for growth and not solely for working capital) has meant that many debt-laden start-ups have been unable to qualify rounds for EIS. The result has been that many angels have not been as active and so many otherwise viable young businesses have failed.

Yet, despite the pandemic, start-ups in certain sectors including health-tech, ed-tech and gaming have thrived. Many of these start-ups have successfully raised rounds with VCs and non-UK angels and are well-placed to grow in a post-COVID economy. But, there are storm clouds on the horizon. A recent review undertaken by the Office of Tax Simplification, has recommended a series of cuts to Business Asset Disposal Relief (previously Entrepreneurs’ Relief) and a radical overhaul of the Capital Gains Tax regime to fill the large hole in public finances caused by the various pandemic support schemes. Both measures (if adopted) would have a detrimental effect on the start-up sector.

In our modern world, start-ups are effectively “stateless” in that founders can base themselves anywhere and can re-domicile their business with relative ease if their jurisdiction of incorporation ceases to be supportive. Entrepreneurs and start-up investors are risk takers, but they need to see sufficient potential reward for the risks they take. Over the past decade, successful founders and their investors have benefitted from highly optimised tax treatment in the UK when they exit a successful business.

Any attempt by the Government to further limit or remove those reliefs would penalise entrepreneurs and start-up investors and send out the message that the start-up sector in the UK is not valued. The effect would be immediate: we would see early exits by entrepreneurs seeking to take advantage of reliefs while they can, start-ups and their investors would move abroad and would-be entrepreneurs would discouraged from incorporating.

The current focus of the start-up sector is rightly on getting through the pandemic. However, the risk for those start-ups that survive is that the government will use entrepreneurs and investors as a cash cow,  thereby altering the balance of risk and reward that has worked so well over the past decade and singlehandedly destroying our start-up ecosystem in the process.

Michael Buckworth is the founder of Buckworths which is the only law firm in the market working exclusively with start-ups and high growth businesses.