Up until now, research into what works best in terms of tax incentives for venture capital and business angels has been fairly limited. With this in mind, the European Commission published a study on 8 June to evaluate existing tax incentives schemes, analyse and assess possible designs for potential new schemes, and put forward policy recommendations for the future.

Alternative sources of funding

Venture capital refers to the provision of capital by an investor to start-ups and small companies with significant growth potential. Business angels are private individuals who directly invest part of their personal assets in new and growing private businesses. The development of these funding channels has become increasingly strategic in the wake of the 2008 financial crisis. As banks cut back on lending, small businesses have relied more heavily on alternative sources of funding to finance their growth, create jobs and innovate. In fact, many studies have shown that venture capital and business angel investment in and of themselves have a positive impact on innovation and productivity. So in its ongoing effort to strengthen the European financial system, the Commission has put promoting venture capital and business angel investment at the heart its flagship Capital Markets Union action plan.

In the current low interest-rate environment, start-ups and growing companies can represent a good investment opportunity due to their high-growth potential. However, there are a number of factors that hinder the development of venture capital and business angel investment. For example, these investments are very risky: out of all the SMEs that receive funding, only a few will end up being profitable and provide their investor with a high return. In addition, venture capital and business angel investors often lack reliable information on the companies that are seeking funding. Public initiatives by national authorities, such as tax incentives, could help to address these barriers and promote venture capital and business angel investment.

In practical terms, an investor will take account of any tax that might be applicable throughout the investment life cycle when making the initial decision whether or not to invest. Any tax incentives aiming to stimulate venture capital and business angel investment should focus not only on reducing their cost, but also on mitigating their riskiness. This can be achieved by offering upfront tax credits or loss relief on a more favourable basis than the baseline tax system. Moreover, some forms of incentives may prove less effective for venture capital and business angel investment, so tax incentive schemes need to be adapted. For instance, reducing taxes on returns generated in the early stages of an investment would have limited to no impact on venture capital and business angels, as start-ups frequently do not generate much – or any – income at first. In addition, tax incentive schemes need to be carefully designed and tailored to a country's specific context if they are to have any positive impact.

What is the EU doing?

Tax incentives have become an increasingly important part of the investment and innovation policy mix in the EU and beyond.  Eleven EU Member States have tax incentive schemes for venture capital and business angel investment. They typically offer investors some combination of up-front tax benefit along with tax relief on income generated over the life of the investment and on gains realised upon disposal of the investment. However, the specifics of how these schemes operate, and who can access them, vary considerably from country to country. In particular, such incentives are less common in Central, Eastern and South-Eastern Europe, primarily because funding through venture capital and business angels is less developed in these countries.

The study, which was published together with the Capital Markets Union mid-term review, is intended to support Member States in designing and implementing tax incentives and should improve their effectiveness and encourage the development of local capital markets.

Read more on venture capital and the study