Why Gibraltar needs a venture capital culture
By Eran Shay, Managing Director, Benefit Business Solutions Ltd
The successes of technology start-ups such as Uber, Airbnb and Revolut have inspired governments around the globe to support the development of national start-up ecosystems. The incentives are clear: young innovative enterprises are major drivers of economic and employment growth. Furthermore, start-ups may develop disruptive products and business models that provide the economy with a competitive edge in new technologies. Successful start-up ecosystems do not only depend on the research infrastructure and an entrepreneurship culture but also on the availability of sufficient financing.
Indeed, the HiTech sector presents many growth opportunities for Gibraltar. Realising the compelling advantages that Gibraltar offers to HiTech start-ups, Benefit Business Solutions has already announced it will be launching the first technology Accelerator program in the history of Gibraltar – the Rocket Accelerator – which will be offered to up to 10 cherry-picked start-ups. But attracting start-ups to Gibraltar doesn’t go without its challenges and one of the key challenges is the lack of a local venture -capital culture.
Traditional financing channels for small and medium-size enterprises (SMEs) such as bank loans fail to provide start-ups with sufficient financial resources. From a bank’s perspective a start-up is an opaque and risky investment. It usually has little collateral, its business model lacks a proof of concept and failure is quite likely. The income from interest cannot compensate the riskiness of such an investment. Therefore, start-ups need investors that can profit from the potentially large return on investment if the start-up grows into a successful company. Venture capital (VC) funds and other private equity investors have specialised in this high-risk high return segment and thereby fulfil a critical role not only in the start-up ecosystem but in the economy at large.
Corporate investors and private individuals are the most important sources of private funding. Large institutional investors, such as pension funds, insurance companies, banks and university endowments, which are the most important sources of VC capital in the USA, play however, a less prominent role in Europe. One explanation for the lesser role of institutional investors in the European VC market is a regulatory disincentive for the financial industry to invest in venture capital due to high-risk weights and asymmetric treatment of equity and debt financing. In the USA, but also in Sweden, relaxing regulatory requirements for pension funds and allowing more risky investments has led to increasing investments into the VC industry. While the deregulation of such sensitive financial services is no trivial task, institutional investors with a long-term investment horizon are particularly suitable to support the economy with capital for equity and infrastructure investments because they do not need to sell when asset markets go down and can therefore act as a counter-cyclical stabiliser to the market.
What can public policy do (better) to support VC investment?
In Europe, government agencies are the most significant investor group in the VC market. Over the last decade they provided about 18% of funding. In their role as investors, public agents enjoy a substantial degree of discretion as they are directly involved in the allocation of financial resources. This can help to promote strategic sectors that are not yet competitive but it also carries the risk of inefficient favouritism. Despite mixed evidence of the efficiency of government VC funding and the theoretical question as to whether public actors are as suitable as private investors to select the most promising portfolio companies, public money is undoubtedly an important stabiliser in times of crisis. Indeed, public sector programs, such as matching Pound-to-Pound investment with private funding, have proved to be highly successful in stimulating the growth of a VC industry in countries like Israel, Sweden and Denmark.
Another way in which a Government can encourage Venture Capital investments is through favourable taxation. This is where Gibraltar shines as it offers one of the most attractive tax regimes in the world with no capital gains tax, no VAT, no tax on dividends (for non-residents), no tax on investment income and no inheritance tax, and should therefore be a magnate to VC funds and private investors. However, as highlighted by a recent report by The European Commission, there are cross-border barriers to VC investments such as:
– VC investors need to establish a local presence in the country of the investee firm.
– A cross-border VC investment runs the risk of double taxation (once in the country where the portfolio company is located and once in the country where the investors are based). This depends on whether the national tax authority regards the VC fund activities as permanent or non-permanent, a decision that is not always predictable. As a consequence, VC funds limit their cross-border activities artificially.
VC funds face different tax classification and different tax treatments from member state to member state. Tax authorities frequently discriminate between non-resident and resident VC funds.
What Gibraltar needs to do is to cooperate with other Governments to ensure that fiscal benefits offered for investors in one country can be extended to investments they make in Gibraltar. One example of such scheme is the tax relief offered to investors in start-up companies under the UK Seed Enterprise Investment Scheme (SEIS) and Enterprise Investment Scheme (EIS) which can be extended to a foreign subsidiary of the UK entity. This means that investments can be channelled to a Gibraltar subsidiary of a UK company as long as there is either permanent establishment in the UK or a UK authorised agent.
This is great news for Gibraltar, especially in light of the recent Double-Taxation treaty signed with the UK. However, more can be done locally to stimulate investment in start-ups, such as providing Loss Relief which allows an investor to offset a loss made on investment in a start-up company against their income tax bill. This too is offered in the UK under the EIS relief scheme. Another way is for Government to provide a guarantee scheme for private sector loans provided by the banks, so as to reduce the exposure for the banks and stimulate them to lend more.
Implementing such measures could help positioning Gibraltar as an attractive jurisdiction for Venture Capital investments, which will in turn attract more Tech start-ups and grow the economy as a whole.