Guardians of life science businesses in Cambridge and the UK, supported by a prominent Cambridge biotech backer, have urged the Chancellor to overhaul Entrepreneurs’ Relief to persuade disillusioned and disadvantaged investors to stand by the sector and pour more lifeline growth capital into the sector rather than walking away.
One Nucleus in Cambridge is one of five UK biotech membership bodies to urge Phil Hammond to make conditions more attractive for investors – or risk throwing away the UK’s life science edge on the global stage.
Serial life science entrepreneur David Grainger, of RxCelerate, has applauded the initiative but urged the Chancellor to go further and totally overhaul the existing climate so UK biotechs are not starved of lifeline cash and wither on the vine.
Tony Jones, chief executive of One Nucleus, was a signatory alongside counterparts at OBN, BioNow, Medilink Midlands and MediWales – which together represent around 2,000 active life sciences companies – to an open letter to Hammond in regard to recently proposed changes to Entrepreneurs’ Relief, which they argued only scratched the surface of the real issue.
While welcoming changes to Entrepreneurs’ Relief, the group explains that they are unlikely to significantly help UK BioMedTech companies and demand more radical reform.
Entrepreneurs’ Relief reduces the amount of Capital Gains Tax on a disposal of qualifying business assets on or after April 6, 2008, as long as the qualifying conditions are met throughout a one-year qualifying period either up to the date of disposal or the date the business ceased.
Qualifying capital gains for each individual are subject to a lifetime limit. The general rate of CGT on gains is 20 per cent, while Entrepreneurs’ Relief applies the reduced rate of 10 per cent.
If the business is owned by a company in which the entrepreneur disposes of the shares or securities, then throughout the qualifying period of one year the company must be:-
- The entrepreneur’s personal company – either a ‘trading company’ or the holding company of a ‘trading group’
- The entrepreneur must be either an officer or employee of that company (or an officer or employee of one or more members of the trading group).
- A company is a personal company if the entrepreneur holds at least five per cent of the ordinary share capital and that holding gives the entrepreneur at least five per cent of the voting rights in the company.
It’s possible for shares acquired under the Enterprise Management Incentive (EMI) share option scheme to qualify for Entrepreneurs’ Relief where the personal company requirement isn’t met, although in the case of shares derived from EMI share options, there is in fact no minimum five per cent holding required.
The five per cent qualifying threshold limit impacts different sectors in different ways. In particular, BioTech and MedTech companies often have to raise significant amounts of capital – many tens of millions – simply to pass the regulatory hurdles during the pre-revenue product development phase.
The risks for investors during these development phases are high. Consequently, there are few investors willing to support such companies, and entrepreneurs frequently find the value of their company does not increase at the rate that they had hoped (even though the valuations for the few companies that ultimately succeed can be exceptional).
In addition, such BioTech or MedTech companies are often founded by more than one founder with founder shares being divided between them (with the university institutions often claiming a significant proportion of the founding shareholding).
This means that entrepreneurs behind these companies invariably have to accept that their shareholding will drop to below five per cent (and loss of Entrepreneurs’ Relief). As Entrepreneurs’ shareholdings approach five per cent, this dramatically affects behaviour (the founders retain influential voices on company strategy) and they will (understandably) allow personal and financial considerations drive company financing strategy in a way which may not be in the best interests of the company or the national economy as a whole.
Under recently proposed changes, where an entrepreneur’s shareholding drops below five per cent as a result of a dilutative financing round, that entrepreneur can crystallise the gain up to that point with respect to the reduced rate of CGT (subject to the various other qualifying conditions).
However, for many BioTech and MedTech companies, the fall below five per cent will happen before any meaningful gain in valuation has materialised so the crystallisation of any gain is likely to have little effect in preserving the 10 per cent Entrepreneurs’ Relief rate.
The group recommends allowing entrepreneurs to retain their relief so long as they have held at least five per cent of the shares for at least one year during the period of their entire shareholding, and that such relief permanently applies to those shares acquired up to the point that they fall below five per cent.
So once they are below five per cent, any further shares acquired do not automatically benefit from Entrepreneurs’ Relief under this rule, but those held up to that point continue to qualify. This would be subject to all the other qualifying conditions.
The group argues that this change should magnify the impact of Entrepreneurs’ Relief in the BioTech and MedTech sectors, resulting in:-
- An increase in the number of entrepreneurs willing to take the personal risks in starting BioTech and MedTech companies
- Entrepreneurs being incentivised to remain involved with those companies for the longer term
- Entrepreneurs remaining supportive of future dilutative financing rounds which in turn will ensure that more UK companies attract the scale of patient capital required to build large and sustainable BioTech and MedTech businesses, whilst resisting the urge to sell out early
- The consequential growth in these companies which will further contribute to skilled employment in the life science sector and UK GVA.
The group concluded: “The UK has established a vibrant life sciences sector but more needs to be done to secure its longer-term viability, to capitalise on the excellence of the UK life science research base and to ensure the UK maintains its leading position in global healthcare.
“We believe that rapid adoption of the measures we have outlined above will reaffirm a commitment to the UK life sciences sector, send an important message to investors, and ultimately make a significant contribution to UK health and wealth creation.”
Serial life science entrepreneur David Grainger, chairman of RxCelerate – the Cambridge based outsourced drug discovery and development platform – applauded the initiative but urges the Chancellor to go further.
He told Business Weekly: “This is an excellent and long-overdue initiative. For years, life sciences entrepreneurs, particularly those engaged in drug discovery and development, have been at a disadvantage compared to other sectors thanks to vast amount of capital required for drug R & D and the very high risks involved.
“Many entrepreneurs behind successful companies I have been involved with have failed to benefit from this tax relief that is intended to encourage people to take risks with their careers to drive innovation. The changes being called for here would address many of these issues.
“But the Chancellor should consider going further – enhanced tax relief beyond the 10 per cent rate for drug developers is needed to further defray the huge risk of starting a new company in this area.
“Beyond that, current rules often result in returns from share disposal on exit being deemed as income rather than capital gain, which cam result in an unintended increase in tax take from successful entrepreneurs.
“Some relatively small adjustments here, which would have very minimal cost in terms of lost tax take, could provide a huge incentive to the sector and in my view achieve far more than the recommendations of the recent Patient Capital review.”
• PHOTOGRAPH SHOWS: David Grainger
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