It is the tax system, stupid: Why Britain’s entrepreneurs are selling out too soon
Forget state handouts, let success finance itself with an agile tax framework to support entrepreneurs, writes Sam Merullo
Picture Pete. He is 28, bright-eyed and has a business idea. He raises his first few thousand at the absurdly named ‘Friends & Family’ round. The business gains traction, acquires its first 50,000 users and hires a dozen staff. It opens an office in Shoreditch, then another in Manchester. He develops a second product. Capital flows. Momentum builds.
Then comes its ‘Series A’ or ‘B’ funding round, the moment at which startups become big companies. Suddenly the gears grind – domestic liquidity dries up and the struggle begins. Eventually, Pete sells up. The business survives, but the founder’s disruptive energy does not.
This is the recurring premature obituary of too many British startups. These businesses are far from failures; they are victims of a system that does not sufficiently reward the building of empires.
It is perhaps a credit to our national character that British founders are prone to what the late Rupert Hambro once called ‘Rectory Syndrome’: the instinct to exit the very moment the honey-stoned lifestyle becomes affordable. Admirable for the soul, perhaps – but catastrophic for GDP.
We sell out too early, and increasingly to foreign entities who then leverage the very groundwork our British ecosystem has supported.
But the problem runs deeper. When a founder exits, they are advised to ‘invest wisely’ – usually code for wealth management, offshore accounts or passive trackers. At no point are they structurally incentivised to ‘godfather’ the next generation of entrepreneurs or champion the frontier technologies this country excels at generating but too often fails to scale.
The Enterprise Investment Scheme does excellent work at the early stage, providing the vital adrenaline shot a fledgling company requires. But for the scale-up – the engine room of growth – the tank is often empty.
Tax systems are rarely agile, but with the global digital economy moving at its current velocity, ours can no longer afford not to be. What is required is Rory Sutherland-esque ‘nudges’, tweaking tax architecture to nurture a self-supporting ecosystem.
Britain must stop the scale-up brain drain
It is a relief, then, to see a serious proposal emerge from UK Private Capital. They are calling for the Treasury to introduce a Scaleup Reinvestment Relief, or SRR – a new incentive to encourage founders to recycle their gains into British scale-up businesses, where capital is most critically needed. With Entrepreneur’s Relief climbing to 18 per cent from next month, Britain risks becoming an increasingly unattractive jurisdiction for the international founder class. SRR changes that calculus.
SRR is no giveaway, it would be conditional. Exiting founders reduce their tax burdens only by recycling proceeds back into the very ecosystem that birthed them. The Exchequer forgoes revenue only when private money is reinvested into British growth companies. The trade is a fair one.
And the economic prize could be substantial; millions in private liquidity, deployed not by bureaucrats or foreign enterprises, but by individuals with hard-won operating experience – often more agile and commercially attuned than even the laudable British Business Bank.
Scale-ups are simultaneously Britain’s greatest economic strength and a glaring victim of our structural weaknesses. These are validated businesses turning over millions and requiring liquidity to fuel often global expansion. Yet our ecosystem too often abandons them at the critical hurdle, forcing them to look to the Valley or Middle East for cash. It is in our interests to keep them here.
In the Spring Statement, Rachel Reeves set out her intention to back innovation so “entrepreneurs and innovators thrive here in Britain”. There can be no alternative, particularly given the very real flight of talent.
An entrepreneur’s laptop can be opened anywhere. If he is in Milan or Singapore, he will inevitably support the startups in his immediate proximity. Too much expertise is being quietly lost to sun-kissed jurisdictions that have, quite shamelessly, engineered their tax systems to court our talent.
Investors with ‘skin in the game’ and experience in building businesses are the holy grail – providing far more value in mentorship than the sum of their cash. A reinvestment scheme tethers these individuals to the state that supported their birth, schooling and welfare.
The beauty of SRR, in these polarised times, is that it currently belongs to no particular political tribe. It is neither left nor right. It relies not on the begging bowl of the state, but on government providing the framework for an ecosystem to support itself. It is simply right. Nations like Sweden, Estonia and Israel already understand the importance of incentivising the recycling of capital. It is time we caught up.
We need to hold onto the Petes of this country. We need to reward empire-building, not incentivise premature exit. And we need to stop relying on the Treasury’s finite resources when the answer is sitting in the proceeds of our own success.
It isn’t the economy that’s stupid. It’s the tax system.
Sam Merullo is an entrepreneur and investor