Alt Investments

Funding Post-Virus Recovery – Alternative Financing Options

Jack Rose October 13, 2020

Funding Post-Virus Recovery – Alternative Financing Options

The author of this article makes the case for alternative investment products such as direct lending vehicles, venture capital trusts and enterprise investment schemes at a time when firms are hungry for capital to drive economic recovery.

The global pandemic has wrecked or severely disrupted business and trade. Understandably, there is – or ought to be – lots of focus on how the economic wheels will spin again. Part of that conversation is about how to stimulate new business, form fresh companies and reignite entrepreneurship. The wealth management sector and their HNW clients have roles to play in this.

This article, from Jack Rose, strategic sales director at Triple Point, examines these areas. Triple Point, a UK investments house that oversees areas such as venture capital, is well placed to consider what is involved in seeding and supporting small- and medium-sized enterprises. He talks about the kind of structures – venture capital trusts and enterprise investment schemes – that operate in the UK. These entities have their risks and costs, as well as tax-mitigating features. It is worth noting that both structures have existed since the 1990s, surviving several changes of government. 

The editors of this news service are pleased to share these views with readers; the usual disclaimers apply to views of outside contributors and readers who want to respond with ideas, criticisms or rejoinders should email tom.burroughes@wealthbriefing.com and jackie.bennion@clearviewpublishing.com

This year the COVID-19 pandemic has caused global equity markets to go into shock, trade and industry to stagnate and unprecedented levels of public spending unlike anything we’ve seen in recent history. The main objective of the extraordinary government support is to keep the economy alive. There are profound positive impacts if early stage and small and medium-sized enterprises are to survive and prosper. The benefits include a higher tax base, higher rates of employment and the creation of new markets and consumers. Helping to support good businesses through these challenging times is therefore a priority for us all. 

The pandemic has altered the investment landscape: fears of a second lockdown have wiped more than £50 billion ($65.3 billion) off UK shares and low interest rate policies have become the norm rather than the exception. We have recently seen companies across the world forced to put an end to dividends in attempts to conserve cash with 445 companies listed on the stock exchange either cancelling, cutting or suspending dividends this year. 

Even bonds, the traditional tool to match pension obligations, have left investors scratching their heads in search of positive yield as large pockets of fixed-income have become return-free risks, rather than risk-free returns. This week we saw NS&I announce that it would cut rates for its 186,000 income bonds savers from a market-leading 1.16 per cent to 0.01 per cent, causing millions of savers to see their investment returns plummet. 

Investors may feel forced to navigate the wilderness in search of options, but there remain genuine opportunities to seek positive real yield while also boosting brilliant UK businesses.
 
Alternative investment products such as direct lending vehicles, VCTs and EIS not only offer investors the opportunity for positive returns, but also help support SMEs and growth businesses that will drive the economic recovery. Let’s take a closer look.

Lending and leasing can help hard-pressed SMEs and investors
Even before the pandemic, a huge number of profitable, ambitious and well-managed businesses were struggling to raise the investment they needed to finance their growth plans. A lack of SME funding has been a long-standing problem in the UK. This was exacerbated by the 2008 financial crisis, with traditional lenders suffering significant losses on their SME loan books. 

Given this and the higher capital adequacy requirements now imposed on such loans, banks have been reluctant to lend to growth businesses. From 2015 to 2018, global economic forecaster Oxford Economics found that, despite new facilities for large companies increasing by 43 per cent, bank lending to small businesses in the UK fell by 3 per cent, resulting in SME loans on average accounting for just 2 per cent of banks’ balance sheets (1).

Yet SMEs, which already faced a £22 billion funding gap before the pandemic began, have never needed financial support more: around 73 per cent have either lost revenue or had to stop trading completely during the current recession – the worst since the 1920s (2).

The government acted quickly once lockdowns began to provide them with vital support, but with sovereign debt exceeding 100 per cent of GDP for the first time since 1963 (3) private capital now has an opportunity to provide the country’s SMEs with the debt and equity funding they need.

One way in which investors can contribute is through lending and leasing strategies, commonly referred to as direct lending vehicles. Historically, this asset class was only available to banks and large financial institutions. Now, however, a wide variety of alternative lenders are providing funding through lending and leasing to finance a vast range of organisations, including many of the UK’s smaller enterprises.

Beyond supporting SMEs, direct lending diversifies portfolios and offers a range of benefits to investors. It can provide predictable, market-uncorrelated returns, as well as capital protection since investments usually include debt instruments with covenants and other measures to protect capital. On top of this, advisors who recommend direct lending as an asset class can help their clients mitigate their inheritance tax liability.


EIS and VCTs engender growth and innovation
The companies that are going to thrive during and after this crisis will be the ones that most effectively adapt and respond to the challenges that emerge. Over the coming months we expect there will be more opportunities to invest in high quality, better capitalised companies with lower valuations.

VCTs and EIS are established investment vehicles that have provided vital funding to early stage UK businesses for over 25 years. Some £2 billion was raised through EIS last year alone, and VCTs have raised over £9 billion and created more than 27,000 jobs since their inception. Both VCTs and EIS have a strong track record of empowering early stage businesses. 

Given that times of economic change typically create opportunities for entrepreneurs, along with lower costs and valuations in the venture funding market, VCTs and EIS are well placed to drive growth and opportunity in the UK economy. There was a range of disruptive new companies which emerged from the 2007-2009 financial crisis to become Unicorns (worth $1 billion plus), including Uber and Slack. Others will be born in the next year as a result of an environment which is conducive for innovative thinking and adopting new technologies.

VCTs and EIS also provide investors with tax benefits. VCTs, for example, enable investors to invest up to £200,000 and claim up to 30 per cent income tax relief per year on newly issued shares, pay investors in tax-free dividends and also offer investors relief from Capital Gains Tax when selling their shares at a profit (4).

When it comes to EIS, returns are targeted by investing in unlisted growth companies that are already generating revenue and have the potential to provide a significant capital return over a four-to-seven-year period. Depending on their circumstances, investors can also benefit from tax reliefs associated with EIS, including income tax relief of 30 per cent, inheritance tax relief and tax-free growth.

The COVID-19 crisis has made it more difficult than ever for investors to protect their portfolios and secure robust returns. Alternative investments such as direct lending vehicles VCTs and EIS provide advisors with a way to address this need and help investors access tax-efficient investment vehicles and build high-performing portfolios. The added bonus is that they are also helping to supply young, innovative businesses with the investment they need to grow alongside valuable advice and support to maximise their chances of future success - and the country’s chances of a strong V-shaped recovery.

Footnotes:
1, ”Bank lending to SMEs on decline”, CPA (Credit Protection Association), 09.05.19
2, ”Covid-19 shuts down a quarter of UK businesses”, Financial Times, 17.04.20; ”World economy set for heaviest blow since Great Depression”, Financial Times, 14.04.20
3, “UK public debt exceeds 100% of GDP for first time since 1963”, Financial Times, 19.06.20
4, https://www.moneyadviceservice.org.uk/en/articles/venture-capital-trusts

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