• 42% of HNW private investors would reduce investment in SMEs if taxes rise
• Prospect of generating capital returns is a critical criteria for private investment
Any future increase to capital gains tax (CGT) could inflict a significant hit on investment into small and medium-sized businesses (SMEs), potentially jeopardising the economic recovery, according to research* by Connection Capital, the specialist private client investment business.
More than two in five high net worth (HNW) private investors (42%) who responded to the survey say they would invest less in unquoted SMEs if CGT is increased to the same level as income tax, as suggested by a Treasury-instigated review of the tax by the Office for Tax Simplification last year. Though the policy has not yet been adopted, many private investors still think it remains a strong possibility, as the Chancellor seeks to repair the public finances, post-Covid.
The survey found that one in four private investors (25%) would reduce their investments into SMEs by 50% or more, while almost one in five (18%) would invest 25% less.
Private investors are a major source of investment capital for UK SMEs. According to the latest figures from the British Venture Capital Association (BVCA), 27% of the £5.4bn of private equity and venture capital funds raised in the UK in 2019 came from private individuals** - equating to around £1.5bn of investment.
Private investors see generating capital gains as one of the most attractive rewards for the risk when investing in small businesses, Connection Capital’s research found. More than seven in ten (71%) said that achieving returns that are capital in nature is an important characteristic when looking for any new alternative asset investment opportunity – far more than said the same for opportunities that produce income (22%).
Claire Madden, Managing Partner at Connection Capital, comments, “It’s not just investors who would be hit by a CGT hike – small and medium sized businesses would lose out too.”
“Private capital was critical to the recovery after the financial crisis of 2008, and it will be again as we repair the economic damage wrought by the Covid-19 pandemic. Cutting off a vital source of funding to SMEs could threaten businesses’ ability to rebound, with a knock-on effect on employment and growth and, ironically, tax receipts.”
“Government support schemes won’t last indefinitely, and there are question marks around how much debt businesses will want or be able to shoulder going forward, so private investment is an important option. Private investors are keen to support SMEs – therefore, it’s vital it remains financially attractive for them to do so. Otherwise, many will conclude that it’s simply not worth it.”
“The risk involved in backing SMEs is greater than more conventional kinds of investment, such as buying listed shares or purchasing a second property and should, therefore, be treated differently in the tax system. Any changes to CGT must take this into account.”
“Headline CGT matters because most investors in UK SMEs are excluded from tax breaks under the Enterprise Investment Scheme, as EIS only covers start-ups and early-stage businesses, not well-established ones.”
“The Chancellor may have kicked the ball into the long grass for now, but there’s no guarantee that he won’t pick it up again. Raising CGT is seen as a soft target, but hitting business investment would be an own goal. There are some serious unintended consequences that need thinking through.”
About Connection Capital
Connection Capital LLP is a Financial Conduct Authority authorised and regulated, specialist syndicator of investment funds from private professional investors into direct private equity, private debt and commercial property deals, as well as alternative asset funds. It currently has some £320 million of funds under management across a diverse portfolio.
Connection Capital provides a specialist managed service to help professional clients build up their own alternative asset portfolios. Private investors self-select which opportunities they want to take a stake in. Opportunities are identified and negotiated by Connection Capital, which also carries out all due diligence and manages the investment from completion through to exit, on its clients’ behalf.
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*Survey carried out among Connection Capital clients between 14 April and 30 May 2021. 203 out of around 1,200 clients took part. Connection Capital clients’ total estimated net worth is over £11 billion.