SA (2012/N) United Kingdom Amendments of the Enterprise Investment Scheme and the Venture Capital Trusts Scheme

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1 EUROPEAN COMMISSION Brussels, C(2012) 3250 final Subject: SA (2012/N) United Kingdom Amendments of the Enterprise Investment Scheme and the Venture Capital Trusts Scheme Sir, 1. PROCEDURE (1) On 2 November 2011, the UK authorities pre-notified two amendments of two existing aid schemes, namely the Enterprise Investment Scheme (hereafter the "EIS") and the Venture Capital Trusts Scheme (hereafter the "VCT"). The existing schemes were authorised by the Commission in April (hereafter "the 2009 decision") and some changes to the EIS were approved in September (hereafter "the 2011 decision"). During the pre-notification procedure, the UK authorities submitted information on the amendments on 3 November 2011, 10 January 2012 and 23 February (2) On 29 February 2012, the UK authorities notified, in accordance with Article 108(3) of the Treaty on the Functioning of the European Union 3 (hereafter "TFEU"), the mentioned amendments. (3) On 13 March 2012, 19 March 2012 and 17 April 2012, the UK authorities complemented the information provided in the notification State aid cases NN42a/2007 and NN42b/2007 (OJ C 145, , p. 6). State aid case SA (OJ C 343, , p. 12). OJ L 115, , p. 92 The Rt Hon William HAGUE Secretary of State for Foreign Affairs Foreign and Commonwealth Office King Charles Street London SW1A 2AH UNITED KINGDOM Commission européenne, B-1049 Bruxelles Belgique Europese Commissie, B-1049 Brussel België Telefón: (0)

2 2. DESCRIPTION 2.1. Objective of the schemes (4) The schemes are designed to encourage private individuals to invest in smaller, unquoted, high growth-potential companies in the UK, which in turn will support job creation, innovation and growth The existing schemes (5) Under the EIS and the VCT, tax incentives are provided to private individuals (natural persons) who are subject to income tax in the UK, although they do not have to be resident there. (6) Under the EIS, investments are made by private individuals directly into a qualifying company (hereafter "target company"). In addition, investments can be made via collective investment schemes managed by specialised fund managers that invest on behalf of investors in a portfolio of target companies. An EIS fund is a transparent vehicle and not a legal entity in its own right. The ownership of underlying shares in the target companies remains with the individual investors, thus satisfying the requirement of investing directly into individual companies. There is no residence requirement regarding the establishment of EIS funds. (7) Under the VCT, investments are made collectively by individuals via investment funds, whose managers invest on behalf of investors in a portfolio of companies. VCTs may be formed by legal trust or by statute and are managed by independent fund managers. They are quoted companies whose shares are traded on the EU Regulated Market. VCTs are supervised by the Financial Service Authority. There is no government intervention to appoint the VCT fund managers. (8) The investors that benefit from the tax incentives provided by these schemes must be independent from the target company. In particular, the tax incentives are not available to individuals or associates of individuals who possess more than 30 % of the company or who work for the company 4. (9) The tax incentives provided by the schemes are the following: 1. Income tax relief at 30 % of the amount invested in new full-risk ordinary shares in target companies (up to a maximum of the individual s pre-eis/vct income tax liability). Under the EIS, tax relief is given for investments of maximum GBP 1,000,000 per year and per investor at certain conditions and eligible shares must be held for at least 3 years. Under the VCT, investments of maximum GBP 200,000 per year and per investor can be eligible and the shares must be held for at least 5 years. 2. Relief from capital gains tax on gains from shares that have qualified for income tax relief (set out above) and which are disposed of after at least 3 years (EIS) or at least 5 years (VCT). 4 Not applicable to an investor who becomes a paid director of the company after the shares are issued. 2

3 3. Capital gains tax deferral. Where the investor has made a taxable capital gain on the disposal of any other asset, the tax charge arising on this gain can be deferred if the gain is invested in shares under the EIS/VCT. (10) The target company must be an unquoted, small company with gross assets of maximum GBP 7 million and with fewer than 50 full-time employees. It must have a permanent establishment in the UK and its business can be all types of trade, except for certain activities 5 which are considered as less risky and thus less affected by a market failure. The annual investment tranche which each target company can obtain under the EIS and the VCT is limited to GBP 2 million. (11) Where capital provided to a target company under these measures is used to finance initial investment or other costs eligible for aid, the relevant aid ceilings or maximum eligible amounts under the applicable legal instrument are reduced by 50 % in general and by 20 % for target companies located in assisted areas during the first three years following the first risk capital investment and up to the total amount received. This reduction does not apply to aid intensities provided for in the Community framework for State aid for Research and Development 6 or any successor framework or block exemption regulation in this field. (12) The legal basis for the two schemes is Parts 5 and 6 of the Income Tax Act (ITA) 2007 and Part C, Chapter 5 of the Income Tax (Trading and Other Income) Act 2005, both as last amended by the Finance Bill (13) The tax reliefs are granted automatically, on a non-discretionary basis, by HM Revenue & Customs once the qualifying objective criteria are fulfilled. (14) The current authorisation of the EIS is valid until 5 April 2016, while the corresponding date for the VCT is 5 April Notified amendments of the existing schemes (15) The 2009 decision authorising the EIS and the VCT was based on evidence from the 2003 Green Paper "Bridging the Finance Gap", which identified an equity gap between GBP 250,000 and GBP 5 million. Whilst agreeing in 2007 to limit the maximum tranche to GBP 2 million per year, the UK authorities have closely monitored the impact of this limit in the light of subsequent market developments. According to them, the equity gap is now larger and extends to a wider group of companies than covered by the existing schemes. The current limits to investment tranches and company size therefore create a barrier that prevents the development of an efficient and free-flowing funding escalator, without which the UK venture capital market cannot develop into a mature market. (16) Therefore, the UK authorities have notified the following amendments of the EIS and VCT, which, subject to the Commission's approval, will be introduced through the Finance Bill 2012: 5 6 E.g. dealing in land, commodities, shares, securities or other financial instruments, banking, insurance, money lending, debt factoring, hire purchase financing or other financial activities, providing legal or accountancy services, property development, operation of nursing homes. OJ C 323, , p

4 (i) Increase of the maximum annual investment tranche to GBP 5 million (ca. EUR 6 million). (ii) Extension of the scope of the schemes so that also investments in medium-sized companies qualify for the tax relief. The UK authorities plan to increase the size of the target companies by allowing investment in companies with fewer than 250 employees and gross assets of GBP 15 million. (17) The UK authorities have confirmed that all target companies will fall within the Community definition of small and medium-sized enterprises 7. (18) The duration of the amended schemes will be from 6 April 2012 until 5 April However, the changes will not enter into force prior to the Commission's approval. (19) In order to control any possible cumulation between the EIS, the VCT and other measures with the aim of easing access to capital for SMEs, the UK authorities will at the same time amend the tax legislation so as to ensure that: If a company which receives investment via the EIS or the VCT has in the preceding 12 months received aid via another UK risk capital measure, the amount of the investment which attracts tax relief will be limited to an amount that does not together with other measures exceed the investment tranche applicable for the tax schemes. All target companies will be warned that the investment in question constitutes State aid and that they must notify the provider of any later risk capital aid of the amount of State aided investment received under the schemes. (20) All other elements and conditions of the existing schemes will remain untouched Budgets (21) The estimated loss of tax revenue stemming from the tax incentives provided under the EIS and the VCT (including the proposed changes) amounts to GBP 2,390 million (ca. EUR 3,490 million) in total for the period April 2012-April Out of this amount, the budgetary impact of the reform is estimated at GBP 545 million with annual budgets of ca. GBP 105 million. (22) It is forecast that, as a result of the EIS/VCT reform, there will be a net increase of investment of ca. GBP 227 million per year benefitting up to 500 additional companies. 3. ASSESSMENT 3.1. Existence of State aid (23) By virtue of Article 107(1) TFEU any aid granted by a Member State or through State resources in any form whatsoever which distorts or threatens to distort competition by favouring certain undertakings or the production of certain goods shall, in so far as it affects trade between Member States, be incompatible with the internal market. 7 See Commission Regulation (EC) No 800/2008 of 6 August 2008 declaring certain categories of aid compatible with the common market in application of Articles 87 and 88 of the Treaty (OJ L 214, , p.3) and Commission Recommendation of 6 May 2003 concerning the definition of micro, small and medium-sized enterprises; OJ L 124, , p

5 (24) In its previous decisions on the schemes in question, the Commission found that the schemes constitute State aid within the meaning of Article 107(1) TFEU to the investors and to the target companies. (25) Through the amended schemes, the UK authorities intend to promote the provision of capital to SMEs by encouraging individuals to increase their investments into such companies. The investments are triggered by tax reliefs which are granted by the State and thus constitute State resources. (26) The tax reliefs tend to strengthen the position of target companies in relation to their competitors on the internal market and thus have potentially distortive effects on competition. Target companies' activities are or might be subject to intra-eu trade and therefore the aid is likely to affect trade between Member States. (27) Consequently, the notified amendments do not alter the conclusion by the Commission in the 2009 decision and the 2011 decision, that the schemes at hand constitute State aid within the meaning of Article 107(1) TFEU. (28) By notifying the amendments of the schemes before the implementation thereof, the UK authorities have fulfilled their obligation under Article 108(3) TFEU Compatibility of the aid with the TFEU (29) The Commission has examined whether the State aid provided through the EIS and the VCT is compatible with the internal market, in particular whether, after the proposed amendments, the schemes are in line with the Community Guidelines on State aid to promote risk capital investment in small and medium-sized enterprises 8 (hereafter the "RCG"). (30) Section 4 (particularly section 4.3) of the RCG sets out compatibility criteria in order to ensure that an aid measure leads to an increased provision of risk capital without adversely affecting trading conditions to an extent contrary to the common interest. For certain types of measures not fulfilling all the conditions set out in that section, the Commission will undertake a more detailed assessment of the measure in accordance with the criteria set out in section 5 of the RCG Compatibility with section 4 of the RCG (standard assessment) (31) In the 2009 decision and the 2011 decision, the Commission concluded that, with the exception of point 4.3.1, which was not fulfilled in , the EIS and the VCT meet all conditions set out in section 4 of the RCG. (32) The amendments forming the subject matter of the present notification concern an increase of the maximum annual investment tranche to GBP 5 million and an extension of the scope of the schemes so that also investments in medium-sized enterprises can benefit from the schemes. 8 9 OJ C 194, , p In 2009, when the Commission originally assessed the schemes, the annual limit of GBP 2 million per target company exceeded the limit set by point of the RCG (EUR 1.5 million) and required thus a detailed assessment under point 5.1(a) of the RCG. However, by Communication from the Commission amending the Community guidelines on State aid to promote risk capital investments in small and medium-sized enterprises (OJ C 329, , p. 4), the safe harbour threshold was increased to EUR 2.5 million and, at the latest approval of the EIS in 2011, the allowed investment tranche thus met the condition laid down in point

6 (33) As for the increase of the investment tranche, point of the RCG provides a safe harbour threshold of EUR 2.5 million for the maximum annual investment tranche. The measure must provide for tranches of finance not exceeding this amount per target SME over each period of twelve months. Since the notified increase of the tranche would exceed this threshold, the amended schemes do not meet the criterion in point of the RCG. (34) With respect to the inclusion of investments in medium-sized enterprises, point requires that the measure is restricted to provide financing up to the expansion stage for small enterprises or for medium-sized enterprises located in assisted areas. For mediumsized enterprises located in non-assisted areas, financing can only be provided up to the start-up stage. The amendments notified do not contain such a restriction for mediumsized enterprises. Consequently, the amended schemes do not meet the criterion in point of the RCG. (35) As for the other compatibility criteria set out in section 4.3 of the RCG, the Commission's conclusion in the 2009 decision and the 2011 decision that these criteria are met is not affected by the amendments notified. In particular: Prevalence of equity and quasi equity investment instruments. The aid schemes provide, in line with point of the RCG, at least 70 % of their total budgets in the form of equity and quasi equity investment instruments into target companies. Participation by private investors. The aid schemes ensure that more than 50 % of the funding is provided by private investors in compliance with point of the RCG; Profit driven character of investment decisions. In line with point of the RCG, decisions to invest into target companies are profit-driven. The significant involvement of private investors is ensured by the fact that the entire capital delivered through the schemes is provided by private investors on a purely commercial basis. Also, the existence of a business plan and of an exit strategy, are considered as pre-requisites for funding. Commercial management. In accordance with point of the RCG, the EIS and the VCT funds are managed on a commercial basis. They are operated by professional fund managers, appointed by private investors on a commercial basis. Under a standard commercial practice, there would normally be a management agreement setting out a performance fee and defining management structure. Private investors will likely be represented in decision-making insofar as their interests are represented in the funds. It would be in the interest of investors and fund managers to apply best management practices, with the view of realisation of profits. Private investors will be responsible for their own investment decisions seeking to optimise investment returns. (36) Consequently, the Commission finds that, while the amended schemes continues to meet all other relevant conditions in section 4 of the RCG, the conditions set out in points and thereof are not fulfilled. 6

7 Compatibility with section 5 of the RCG (detailed assessment) (37) Since the amended scheme does not fulfil all compatibility criteria set out in section 4 of the RCG, those amendments must be subject to a more detailed assessment as provided by section 5 of the RCG, given the less obvious evidence of a market failure and the higher potential for the crowding out of private investors and of a distortion of competition. (38) As for the increase of the investment tranche, point 5.1(a) of the RCG provides that the Commission, since it is aware of the constant fluctuation of the risk capital market and of the equity gap over time, is prepared to consider declaring measures providing for tranches exceeding the safe-harbour threshold compatible with the internal market, provided that the necessary evidence of the market failure is submitted. (39) Regarding the inclusion of financing for the expansion stage of medium-sized enterprises in non-assisted areas, point 5.1(b) of the RCG provides that the Commission, which recognises that certain medium-sized enterprises in non-assisted areas may have insufficient access to risk capital even in their expansion stage despite the availability of finance to enterprises having a significant turnover and/or total balance, is prepared to consider declaring such measures compatible with the internal market in certain cases provided the necessary evidence is submitted. (40) According to the RCG, a detailed assessment is based on a number of positive elements (market failure, appropriateness of the instrument, incentive effect and proportionality), which are balanced against the potential distortions of competition and the risk of crowding out private investment. The level of evidence required and the Commission s assessment will depend on the features of each case and will be proportionate to the level of market failure tackled and to the risk of crowding out private investment Existence and evidence of market failure (41) According to point of the RCG, for risk capital measures envisaging investments beyond the conditions laid down in section 4 including those providing for tranches above EUR 2.5 million per target SME over each period of twelve months or financing of the expansion stage for medium-sized enterprises in non-assisted areas the Commission will require additional evidence of the market failure being tackled before declaring the proposed risk capital measure compatible with the internal market. Such evidence must be based on a study showing the level of the equity gap with regard to the companies and sectors targeted by the risk capital measure. (42) According to the UK authorities, the UK venture capital market is still relatively immature and has recently been hindered significantly by the economic downturn with the withdrawal of banks and many other investors from financing high risk enterprises. Private equity and large venture capital funds focus on larger and often lower risk, later stage investments, reducing the amount of equity that might have been available to focus on smaller and often high-risk SMEs. In addition, the banks have withdrawn the financing facilities that once provided a source of finance for the larger investments and companies that the current schemes do not support. (43) With respect to the size of the equity gap, the UK authorities submitted a large number of research reports and academic studies supporting their claim that the State support currently on offer is insufficient to help address the equity gap, e.g. the following: 7

8 A review carried out by 3i and ph-group (hereafter "the Rowlands report") concludes that SMEs at growth stage face an equity gap up to GBP 10 million, the threshold below which private equity and venture capital rarely invest 10. Out of the 170,000 SMEs studied in the review, it was estimated that some 25,000-32,000 businesses are growing and/or restructuring and display the characteristics that may make them suitable for growth capital. Up to 5,000 of these firms per annum will be viable SMEs which are likely to experience significant problems in accessing capital. Banks are generally unwilling to take the higher risks associated with financing long-term growth or, if they are, the price is prohibitive for the SME. On the other hand, equity finance is not secured against any asset and does not normally receive a guaranteed yield. Typically target returns for individual equity investments must be set in excess of 40 % so that successful investments can compensate for losses that will inevitably arise on others. According to the Rowlands report, "[i]t is likely that those SMEs which are seeking to access growth capital in amounts above 2 million the upper limit of public/private provision and below 10 million the minimum level at which private equity providers will fund will face particular difficulties." 11 The report further states that the gap is likely to increase as recessionary effects weaken reduce the companies' capacity to take on debt. According to a report by Mason et al, there is a re-emergence of an equity gap between GBP 2 million and GBP 10 million for early stage venture capital 12. There is a lack of seed capital funding preventing new technology based firms from accessing the funding escalator, and also a lack of follow-on funding. As a result, SMEs cannot raise the right levels of equity finance. The inability to access seed capital and raise early stage follow-on funding has implications for the growth of high technology enterprises in the UK, which rely upon equity funding to bridge the gap between early adoption and mainstream market. According to a study carried out by SQW/BIS, only very few venture capitalists now invest below GBP 5 million whilst most angel syndicates only invest up to ca. GBP 500,000. For technically complex developments involving extensive capital expenditure, the early stage gap is perceived as considerably larger, e.g. for cleantech or biosciences, the upper boundary of the gap may be ca. GBP million. Furthermore, even where companies managed to raise finance, it was found that they were not raising nearly enough finance. 13 Similar conclusions were drawn by Pierrakis and Westlake who suggested that there is a specific equity gap that stretches up to GBP 5 million, especially for the medical and pharmaceutical sectors. 14 Also, a recent survey carried out by the Association of Investment Companies (AIC) concluded that there is an equity gap up to GBP 5 million and recommended Rowlands: The Provision of Growth Capital to UK Small and Medium Sized Enterprises, Idem, p. 3. Mason, Jones and Wells, The City's role in providing for the Public Equity finance needs of UK SME's (2010), p. 91. SQW The Supply of Equity Finance to SMEs: Revisiting the "Equity Gap" (2009), p. 8. Pierrakis and Westlake, Reshaping the UK economy: The role of public investment in financing growth (2009), NESTA, p

9 that the current maximum investment tranche should be increased from GBP 2 million to GBP 5 million. 15 (44) According to the studies submitted, there are a number of reasons for this equity gap, namely: (i) First, there are structural market failures due to imperfect information. On the supply-side, this has the effect that costs of researching information in the context of identifying, transacting and exiting deals in SMEs are considered to be prohibitive. In particular, since costs of deal structuring and due diligence are similar for small and large businesses, investors tend to prefer larger deals involving larger businesses where transaction costs are smaller in relation to the investment. Also, the lack of performance measurement data ("track record") on investments in SME growth capital can make investors more risk averse and can result in a higher level of required return for an investment or lower levels of investment being committed. 16 On the demand-side, information failures include lack of "investment readiness" by entrepreneurs (e.g. poor business plans or inadequate management skills), lack of knowledge amongst SMEs on the nature and availability of equity finance and a perception by SMEs' owner-mangers that debt finance is the only form of finance suitable for their business. There is also significant evidence that business owners may not be willing to concede a stake in their business to attract professional investors, preferring to sacrifice potential growth for assured autonomy. 17 (ii) In addition to the imperfect information, there are other market features with a permanent character. Thus, private equity/venture capital industry has sought to limit its risk exposure by focusing on buyouts or secondary purchases and on a smaller number of investments with majority control, giving the fund manager direct influence over business operations and strategic decisions. 18 Also, the remuneration system for fund managers encourages investment in larger transactions. 19 Moreover, according e.g. to the Rowlands report, there is a lack of an established channel for growth capital as well as of funds of a sufficient size to allow institutional investors to make their minimum investment commitment. This is particularly problematic for companies seeking multiple rounds of investment to fund on-going growth, since provision of adequate follow-on funding requires ability to make large individual investments from a fund with the capacity not to be restricted by over-exposure to a single firm. 20 (iii) Finally, due to the bank crisis and the subsequent economic slow-down, the supply of capital has become further constrained as banks retreat to traditional lending practices, possibly reflecting increased risk aversion. Furthermore, equity capital tends to be tied up for increasingly longer periods, which reduces the equity The Association of Investment Companies (AIC), "Closing the finance gap: VCT funding for SME (2011), p. 4. See e.g. Rowlands, p. 14, and SQW, p See e.g. Rowlands, p , SQW, p. 35, and AIC, p. 9. See e.g. Rowlands, p and Mason et al p. 91. See e.g. Rowlands, p and Mason et al p. 40. See e.g. Rowlands, p , Mason et al, p. 44, SQW, p. 34 and BVCA Research Report (September 2009), "From funding gap to thin markets: UK Government support for early stage venture capital, p. 5. 9

10 available for new investments. 21 At the same time, on the demand-side, SMEs are likely to have a greater appetite for external finance to fund growth, partly due to reduced ability to make use of internal finance. 22 The effect of the economic crisis on venture capital has been recognised for the European market, where the volume of new funds raised has continued to decline from a peak of EUR 112 billion in 2006 to EUR 20 billion in 2010 and is heavily concentrated on buyouts compared with venture capital. 23 (45) Several reports 24 submitted by the UK authorities further point to the need of providing growth capital also to medium-sized enterprises. This would reduce the risk of fragmentation in the market and provide a more effective escalator of finance for SMEs to secure follow-on funding through multiple funding rounds. At present, fund managers are migrating away from investing in growth capital towards making fewer, larger and later stage investments. This results in an exclusive focus on a single funding round creating barriers between successive rounds of funding, which are compounded by the current limitation of the scope of the schemes to small companies. Since many of the target companies are active in labour-intensive sectors, the limitation to 50 employees therefore prevents business growth and development. (46) According to the UK authorities, the equity gap faced by SMEs is common throughout the entire UK, regardless of location. In line with evidence submitted, with a slight exception for London, the number of SMEs 25 and their distribution within different sectors are evenly spread across the UK 26. Therefore, the UK authorities do not find it appropriate to introduce any regional limitations to the schemes 27. (47) The Commission notes that the standard of the evidence provided is well in line with previous decisions which the Commission has taken following a detailed assessment under the RCG 28. (48) On the basis of the evidence presented, the Commission accepts that there is an equity gap of up to GBP 5 million for SMEs at the early and expansion stages in the UK market, including in non-assisted regions. The Commission considers it positive that the tranche size is limited to the size of the equity gap Appropriateness of the instrument (49) As set out in point of the RCG, an important element in the balancing test is whether and to what extent State aid in the field of risk capital can be considered as an appropriate instrument to encourage private risk capital investment Pierrakis, NESTA (2010), "Venture Capital: Now and after the DotCom Crash" and Mason et al, p. 4. See e.g. Rowlands, p. 17. See European Venture Capital Association, Yearbook 2010, p. 4 and 7. See e.g. Rowlands, in particular p. 16, 18 and 32, the AIC Report: Closing the Finance Gap: VCT funding for SME's (2011), p. 5, and BVCA Research Report (September 2009), p. 5. Source: Small and Medium Enterprise Statistics for the UK and Regions 2009 BIS. Source: SME Market analysis, Local Business, Barclays UK retail banking. See also Pierriakis and Westlake, p. 19 and 29. See State aid cases NN42a/2007 and NN42b/2007 UK EIS, CVT and VCT (OJ C 145, , p. 6), SA UK Finance Wales JEREMIE Fund (OJ C 331, , p. 2) and SA FR Fonds national d'amorçage Régime cadre d'interventions publique en capitale investissement auprès des jeunes enterprises innovantes (OJ C 174, , p. 1) 10

11 (50) As noted in the 2009 decision, tax reliefs of a rather general character, such as the ones at hand, normally have a relatively limited distortive effect. They can limit the distortion to efficient market processes. They ensure that national authorities do not need to assume any role in selecting viable investments ("picking winners"), but instead incentivise investors and allow them to make their decisions in selecting investment opportunities based on purely commercial criteria. Moreover, the UK authorities have regularly monitored and evaluated the schemes and the impact thereof on the supply and demand of venture capital. In addition to the studies referred to in section above (of which some were undertaken for the purpose of governmental evaluation), the UK authorities asked wide-ranging questions about the current access to finance and ways to improve this in its consultation "Financing a Private Sector Recovery" (October 2010). (51) The schemes thus seem to be an appropriate instrument to encourage private risk capital investment Incentive effect and necessity of aid (52) According to point of the RCG, the Commission, when assessing the incentive effect and necessity of the aid, will take into account the criteria mentioned in points to of the RCG showing the profit-driven character of investment decisions and the commercial management of the measure, where relevant. (53) In this regard it should be noted that the measure has a fully profit-driven character and commercial management complying with points and of the RCG, as was already concluded by the Commission in the 2009 decision on the two schemes at hand. It should also be noted that the UK estimates that an extra tax relief of ca. GBP 105 million per year would result in extra private risk capital of ca. GBP 227 million which would benefit approximately 500 target companies. Furthermore, a larger investment tranche should attract more investors, who might otherwise have preferred buy-out and/or buy-in deals. (54) Therefore, the Commission considers that the measure has an incentive effect and is necessary to overcome the identified market failure Proportionality (55) In line with point of the RCG, for the aid to be considered compatible, the amount thereof must be limited to the minimum necessary. Whether this aspect of the proportionality criteria is met will necessarily depend on the form of the measure in question. As recognised by the Commission in the 2009 decision, the fact that there is an open tender for managers and a public invitation to investors should be considered a positive factor. Moreover, any losses are borne entirely by private investors, which should at least to some extent ensure that the aid is limited to the minimum necessary. Furthermore, at the level of the target companies, the general reluctance of SMEs to dilute equity (see paragraph 46 above) should at least to some extent ensure that the aid is limited to the minimum necessary. (56) In this context, the Commission also notes that, in order to address any possible cumulation issues, the UK authorities will reinforce the cumulation rules applicable to EIS and VCT as of April 2012 (see paragraphs 13 and 21 above). 11

12 (57) Considering that the maximum annual investment tranche does not exceed the equity gap identified in the evidence provided and described in section above and that the UK authorities have undertaken to tighten rules on potential cumulation, the Commission sees no reason to deviate from its conclusion in the 2009 decision and the 2011 decision that the aid is proportionate Analysis of the distortion of competition and trade (58) According to point of the RCG, the risk of private investors being crowded out increases with the higher the amount of an investment tranche, the larger the size of an enterprise, and the later the business stage, since private risk capital becomes progressively available in these circumstances. (59) In the case at hand, the size of investment tranches corresponds broadly to the established equity gap. In fact, according to the submitted studies, venture capital seems to be generally available only for larger tranches, normally above GBP 10 million, but in any case above GBP 5 million. Therefore, the risk of crowding-out investors who would invest in SMEs in any event is very limited. The incentives provided under the EIS and the VCT do not appear to be to the detriment of the wider scale private equity market and they do not appear to crowd out investors or draw money away from nonqualifying companies. (60) As target companies must be SMEs, it is unlikely that they will have a significant market power on the market in which they are present and thus that any significant distortion of competition would be incurred in this respect. Since the schemes are crosssectoral, the choice of investment is decided entirely by private investors and the private investors bear fully the risk of their investments, the distortion of competition such as keeping inefficient firms or sectors afloat does not seem to be present. Moreover, the measure does not seem to over-supply the target companies with risk-capital. Therefore, the risk of artificial increase of the valuation of inefficient companies in non-competitive sectors is limited Conclusion (61) Having analysed the positive and negative elements of the amended schemes in line with section 5 of the RCG, the Commission concludes that the overall balance of these elements is positive, especially as there is no evidence of possible crowding-out of private investment and other distortions of competition are minimal, if not non-existent. It therefore finds that the amended EIS and VCT are compatible with the internal market pursuant to Article 107(3)(c) TFEU. 4. DECISION (62) The Commission concludes that the notified State aid measure SA (N/2012), amending the Enterprise Investment Scheme and the "Venture Capital Trusts Scheme", is compatible with the internal market, pursuant to Article 107(3)(c) TFEU. The Commission decides accordingly not to raise objections to the notified amendments. (63) In light of the forthcoming revision to the RCG, the Commission notes that the UK Government undertakes to modify the EIS and VCT schemes to the extent that would prove necessary to comply with a possible Commission proposal for appropriate 12

13 measures following the entry into force of revised risk capital guidelines after the end of (64) The Commission reminds the UK authorities that, in accordance with Article 108(3) TFEU, all plans to refinance, alter or change this aid scheme must be notified to the Commission. (65) The Commission further reminds the UK authorities to submit annual reports on the implementation of the notified aid scheme, as amended. If this letter contains confidential information which should not be disclosed to third parties, please inform the Commission within fifteen working days of the date of receipt. If the Commission does not receive a reasoned request by that deadline, you will be deemed to agree to the disclosure to third parties and to the publication of the full text of the letter in the authentic language on the Internet site: Your request should be sent by registered letter or fax to: European Commission Directorate-General for Competition State Aid Greffe B-1049 Brussels Fax No: Yours faithfully, For the Commission Joaquín ALMUNIA Vice-President 13