Startup founders worried about proposed capital gains tax changes

Some 85% of British technology startup founders have said they would actively consider moving their company abroad if the UK government’s proposed capital gains tax changes come into effect.

The figure comes from a survey conducted by Beauhurst, a searchable database of the UK’s fastest-growing startups and scaleups, which spoke to 471 startup founders (cumulatively representing more than £1.6bn in funding), investors and advisors.

According to Beauhurst, the UK has roughly 40,000 high-growth businesses which collectively employ around 3.5 million people.

Beauhurst claims the tax reforms – in combination with other factors such as Brexit and the proliferation of remote working, which is already prompting UK businesses to re-evaluate where they are located – will provide further disincentives for small firms to remain in Britain, predicting that up to 90% of jobs within the country’s startup and scaleup ecosystem would be at risk.

“The impending changes to capital gains tax could have a catastrophic impact on UK startups and scaleups. As the results indicate, the negative sentiment of the British entrepreneurial ecosystem towards the reform shows that it could directly result in our most promising businesses departing for more favourable rates abroad,” said Henry Whorwood, head of research and consultancy at Beauhurst.

“If changes have to be made to capital gains tax, it should come accompanied by a reinvigorated form of Entrepreneur’s Relief that protects the current tax treatment for genuine entrepreneurs. We must ensure that what is essentially a fundraising exercise to balance the books as we emerge from the Covid-19 pandemic does not have an adverse long-term effect on the innovative businesses that will fuel the future of the UK economy.”

As it currently stands, capital gains tax rates are 10% on assets and 18% on property for basic rate taxpayers, and 20% and 28% respectively for higher and additional rate taxpayers.

“The impending changes to capital gains tax could have a catastrophic impact on UK startups and scaleups. It could directly result in our most promising businesses departing for more favourable rates abroad”

The tax raises close to £10bn a year for HM Treasury, but in September 2020 the Office for Tax Simplification (OTS) published a review of the capital gains tax after being commissioned by the chancellor to look at how the tax could be reformed, suggesting four changes for an overhaul.

This included aligning capital gains tax rates with income tax levels – which currently stand at 20%, 40% and 45% for basic, higher and additional rate taxpayers respectively – and reducing the annual gains allowance from £12,300 to between £2,000 and £4,000, effectively widening the number of people who would be paying the tax.

According to the survey results, two-thirds (68%) of startup founders said they would be less likely to start another company if the changes came into effect, with 94% of those that would start another company saying they would consider doing so abroad instead.

A further 90% of founders also responded that it would be harder for them to attract talent, as it would make options schemes – which are used to supplement the often lower-than-market salaries offered by early-stage firms – less attractive.

Aside from reluctance to form new enterprises and potential issues with talent, those surveyed believed the proposed changes to capital gains would also affect the early-stage investment landscape. For example, 72% of angel investors said they would be less likely to continue funding UK companies as a direct result of changes to capital gains, while 80% of founders indicated they would be less likely to engage angel investors as well.

Given that 53% of angel investors surveyed funded their investments via the sale of shares from their previous companies, Beauhurst claimed this could significantly impact the pipeline for future investment.

Overall, 81% of respondents thought the proposed changes would have a very negative impact on the high-growth ecosystem.

In terms of the startup cohort surveyed, around a fifth were founded less than two years ago, while startups between two to five and six to ten years made up a third of respondents each. Only a very small portion (3.3.%) had an annual turnover of more than £50m, with the largest portion (37.3%) having an annual turnover of up to £500,000.

Only 19.6% of respondents were from startups with an annual turnover of £500,000 to £2m, while 26% had an annual turnover of £2m to £10m. The remaining tenth had turnovers between £10m and £50m.

Despite the uncertainty related to Brexit and the pandemic, technology startups in London raised near-record levels of venture capital investment in 2020, receiving a quarter of all European technology funding that year.

UK tech firms outside of London raised a further $4.5bn, bringing the country’s total tech investments to $15bn – a significant proportion of the $43.1bn raised by European companies throughout 2020. 

However, despite the upward investment trajectory, most of the investments made during the pandemic went to already established firms.

For example, an analysis conducted by coworking and innovation space company Plexal and Beauhurst found that, between March and September 2020, just £458m of the £5.37bn raised in venture capital went to first-time fundraisers, representing a 55% year-on-year decrease.

This trend has been present since the start of the pandemic, with previous research by the two firms from May showing that only £52m of just over £1bn raised at that point was going to early-stage startups and entrepreneurs who had never raised money before.