By director Martin Cook and trainee solicitor Brandon Wong from the Fintech practice at independent UK law firm Burges Salmon

Investment

In our third article on the Kalifa Review, we examine the recommendations concerning investment into the fintech sector.

Our third article in the Kalifa Review series looks at the lifeblood of the fintech industry: investment. This topic, which has always achieved a lot of focus within the industry and in discussions with government, is vital and relevant at each stage of growth; start-up, scale-up and maturity.

At an early stage, many fintechs are bootstrapped and looking for support from angel investors, progressing through seed funding rounds and onwards. This stage of business development is high risk, and schemes to encourage risk taking (and rewarding success from that) are important to early stage investors. Examples of tax treatment in this space to encourage and support investment include the highly tax efficient ‘enterprise investment scheme’ (EIS), ‘seed enterprise investment scheme’ (SEIS) and use of Venture Capital Trusts (VCT) relief.

The pressures for many firms are particularly pronounced when it comes to scaling; securing capital to fuel the critical growth stage – including where investment in people and, often, new more scalable technology platforms is needed to push forward the business proposition. It is often in this context that research and development (R&D) tax credits are beloved of finance directors, to seek to increase the efficiency of investment made in innovation designed to propel business growth.

Looking even further in the corporate lifecycle, many fintechs intend to look to the public markets for financing activity; indeed, listed status is often a key target to reach as a key part of their ‘story’. The review highlights, however, the decline in the number of companies choosing to list on the London Stock Exchange (LSE), down 45 per cent since 1997 and accounting for only 4.5 per cent of global IPO listings between 2015 and 2020. 

Given the above, it is no surprise that the review provides recommendations targeting each growth stage; start-up, scale-up, and maturity, and generally to clear the obstacles currently perceived to impede investment. 

The review also delves into the current funding gap across multiple UK high-growth sectors and references the industry’s reliance on foreign inward investment. Both regulated and unregulated fintechs require capital to scale and cater to an international market, but the former must also contend with regulatory capital requirements with which smaller fintechs often struggle. Emphasis is placed on increasing domestic investment and retaining the benefits of job creation, market attractiveness and tax revenue within the UK. 

As mentioned, the decline in the number of companies listing in the LSE is a concern to some – particularly as leading fintechs have often developed international operations and make calculated choices on where to launch an IPO. The UK trails dramatically behind the US in fintech listings and the requirements to have a single class of shares and to maintain at least 25 per cent of shares as a free float are identified as shortcomings of the UK’s Premium Listing rules. The recommendations of the review sit alongside the commissioning of Lord Hill’s separate review into the listing regime which has also been recently published. 

With that in mind, the review’s three proposals in relation to investment comprise the following:

• R&D Tax Credits and EIS
• Fintech Growth Fund
• Fintech public listings

R&D Tax Credits and EIS

The recommendations:

• Expand R&D tax credits to include the cost for developing financial data sets.
• Expand the EIS, SEIS and VCT tax reliefs to apply to regulated fintechs.

Our thoughts:

We know that there has been concern for a number of years as to whether certain tax efficient schemes – those that are focused on benefitting those who take risks in establishing and/or funding early-stage businesses – will continue to be available, particularly in times of strained public finances. It is therefore welcome to see recommendations that confirm what industry has been saying for some time; that these schemes are vital to continued start-up and scale-up activity.

The review’s focus on expanding the role of tax efficient investment schemes coincides with the government’s recent announcement at Budget 2021 of its review and consultation into R&D tax reliefs. The government’s target is to raise total investment in research and development to 2.4 per cent of UK GDP by 2027. Given the levels of current innovation in the UK market, fintech could play a key part in achieving this target.

The review reports that improvements to the tax regime will unlock effective restrictions as to the ways in which established financial services firms can partner with fintechs, and so partnership opportunities (including for the less visible business-to-business fintech segment) should become more available. If borne out, this has to be welcomed by the industry.

The review also highlights that 47 per cent of company founders are concerned about qualifying for tax reliefs if their business models pivoted from unregulated to regulated in future. The recommendation of expanding the applicable tax reliefs to regulated fintechs aims to ameliorate these concerns, and seems entirely justifiable. It would be encouraging to see fairly quick progress in this space, not least because of steps to expand the regulatory perimeter into areas which are prime fintech territory (such as in relation to cryptoassets and ‘Buy Now Pay Later’ products). It will be important for fintechs to get clarity of the availability of tax-efficient structures in parallel with developments in financial regulation to allow effective forward planning.

Fintech Growth Fund

The recommendations:

• Creating a £1bn market-led Fintech Growth Fund modelled on the Business Growth Fund (BGF) and funded by holders of domestic institutional capital to plug around 10 per cent of the growth funding gap over a five year period.

Our thoughts:

For many reasons (including domestic demand, the availability of specialist skills, a stable regulatory and legal environment, largely supportive governmental and regulatory policy and global connectivity), the UK has historically been a good place to start a fintech business. Given some headwinds (such as Brexit) there is a risk that the UK will be considered less suitable as a place to grow a business or to scale it internationally. There is a role to play in encouraging additional and focused funding sources that, it is hoped, will have a broad impact on developing the fintech ecosystem.

The review’s references to regulatory concessions around defined contribution pension schemes to unlock significant domestic institutional capital, as well as flagging interest from the broader investment and asset manager sector, could be really important; as much as the capital injection through a growth fund would be invaluable in the short term, the prospect of longer-term strategic investment support by those managing major domestic pools of capital would be the aim.

Fintech public listings

The recommendations:

• Reducing free float requirements on the Premium segment from 25 per cent to 10 per cent for a limited time post-IPO or instigate a minimum threshold.
• Allowing dual class share structures for Premium listings.
• Maintaining the relaxation of pre-emption rights.
• Creating a global family of Fintech indices.

Our thoughts:

As mentioned above, the recommendations on changes to the UK Listing Rules coincide with Lord Hill’s recently published report. Perhaps unsurprisingly, similar sets of recommendations appear in both. Lord Hill’s report calls for allowing dual share structures in the premium listing segment, reducing free float requirements from 25 per cent to 15 per cent (although still higher than the 10 per cent suggested in the review), liberalising the rules regarding special purpose acquisition companies (SPACs) and rebranding the standard listing segment. The report also recommends considering how technology can be used to improve retail investor involvement in stewardship. In terms of next steps, it is now incumbent on the FCA to publish a consultation paper and to consider whether to adopt any of the proposals suggested. Whether, and to what extent, the review’s and Lord Hill’s recommendations are taken remains to be seen – though it is possible that this is an area that might move fairly quickly relative to other areas. 

There is an interesting discussion to be had around the role of dual class share structures in the context of fintechs, and the Listing Rules proposals are likely to be one of the more controversial aspects of the Review’s recommendations. As in many industries, fintech founders may want to retain control of the companies they have built and so might prefer the ability to demarcate rights. Others, however, would prefer to see maintenance of the one share/one vote principle; some players in the fintech industry have publicly stated their resistance to the proposals instead preferring – as they see it – a more egalitarian and democratised ownership structure that is consistent with their view of responsible capitalism and closer to their stated business mission.