General Background Note

1. The BES was introduced in 1984 as an incentive to private investors to invest long-term equity capital in companies (particularly new and smaller ones), operating in certain sectors of the economy, which would otherwise find it difficult to raise such funding and would instead have to rely on expensive loan finance. The scheme which was originally intended to operate for a three year period has been renewed on a regular basis since and, currently, is due to lapse on 5 April 1999 unless renewed for a further period.

2. Provided that an investor holds his investment for a minimum period of 5 years, the scheme provides individual investors with tax relief, at their marginal tax rate, in respect of investment of up to £25,000 per annum in certain qualifying companies. A qualifying company must be engaged in the following trades: manufacturing (10% companies), certain internationally traded services, certain tourism activities, commercial R&D, plant cultivation, the cultivation of mushrooms, horticultural production, the construction and leasing of advanced factories, certain music recording activities.

3. The scheme was amended in 1989 to combat certain abuses that had become evident. General operational leasing activities and financing/refinancing services were removed from the scope of the relief and arrangements which provided investors with safe or guaranteed exit mechanisms from the BES were banned. In 1991, hotels and shipping - which were highly asset backed and involved little risk were removed from the relief. (As part of the 1989 changes self-catering accommodation in urban areas had also been removed). The changes in 1989 and 1991 and other fine tuning in subsequent years have always been designed to focus the BES on its original intention i.e. to assist the smaller and riskier projects to raise equity finance.

1998 Budget Restriction of the BES

4. In last year's Budget it was decided to reduce the aggregate amount that a company could raise under the BES from £1 million to £250,000. This decision was based on a review of the BES done by the Department of Enterprise, Trade and Employment in consultation with the Revenue Commissioners and involving Forbairt. The survey found, among other things, that amounts in excess of £250,000 raised through the BES were in the nature of a five year loan rather than a genuine equity investment. The review also found that 82 per cent of all projects raised less than £250,000. The cost of the BES to the Exchequer had also been increasing considerably in recent years. The figures for 1997/98 were that a total of £92 million was raised under the BES at a cost to the Exchequer of £44 million (see additional figures at appendix I). Figures are not yet available for 1998/99. However, initial indications are that the restricting the BES should refocus the relief on smaller/start-up firms.

Advance Factories

5. The £250,000 restriction does not apply to companies that build and lease advance factories. This arrangement was made because of the unique nature of advance factories and the fact that advance factories are designed to try and address the disadvantages faced by communities in attracting employers to the regions. In the case of companies falling within the Seed Capital element of the BES i.e. companies starting bone fide new ventures with little or no job displacement, the limit was reduced to £500,000 rather than £250,000.

6. Transitional arrangements were introduced to allow projects that were well advanced prior to Budget day to continue to raise £1 million pounds.

Savings

7. At the time the changes were made it was expected that the savings to the Exchequer in a full year would be about £20 million (£10 million in 1998 because of the transitional arrangements). Because information is not yet available on what is happening in 1998/99 it is difficult to say if the projected savings will be achieved. However, given the fact that the amount raised by designated funds up to 5 April 1998 was £16 million rather than the £58 million in the previous year would suggest that savings to the Exchequer will be realised.

Effect of Budget Day Changes

8. An effort was made to try and determine what effect the Budget Day changes had on companies that raise money under the BES. The Revenue Commissioners provided the Department of Enterprise, Trade and Employment with information on 50 companies, chosen randomly, that had raised money under the BES prior to the Budget Day changes and 50 companies, chosen randomly, that had raised money under the BES after the Budget Day changes. Unfortunately, employment information is only available for the years 1995 to 1997 so they don't take account of employment changes after the Budget. While the conclusions that can be drawn from the analysis are limited and need to be treated with caution the following general points can be made:

- The amount been raised under the BES after the Budget Day changes appears to have

fallen very significantly.

- The larger companies i.e. over 50 employees appear to have gone from the BES.

- While the proportion of BES companies raising moneys from promoters/family members has remained at around 25 per cent, the dominant position of the BES funds compared with companies raising money directly has been reversed.

9. The information provided by the Department of Enterprise, Trade and Employment is attached at appendix II.

Venture Capital

10. When the BES was introduced in 1984 the venture capital market in Ireland was not well developed. This is not now the case. According to Finance magazine Irish venture capital funds will invest in the next 12 months some £173 million. However, a common complaint is that these venture funds tend to concentrate on medium and larger firms rather then smaller/start up firms. The Government has been conscious of this and has tried to address the issue by setting up two major lending programmes, The Small Business Expansion Loan Fund and the Access to Finance Scheme. The Pension Industry and other institutional investors have also undertaken to invest a substantial amount (£100m) for venture capital projects in the period 1994 to 1999 (this we understand is nearly fully subscribed).

11. Thus the refocused BES can have a role to play in assisting the smaller/start up companies which may not be attractive to venture capital funds and may be unable to otherwise obtain funds on reasonable terms.

Designated Funds

12. Designated funds are generally set up by banks and other financial institutions to raise funds from investors and to form an investment fund. That fund will then seek investment opportunities usually in a small number of larger BES projects so as to spread the risk. The funds tended to invest almost exclusively in larger projects. When the aggregate amount that a company could raise was restricted to £250,000 the designated funds made strong representations that the new limit would make it extremely difficult for them to continue raising funds under the BES.

13. Up to 5 April 1997, 15 designated funds raised £58 million (this had to be invested by 5 April 1998) and in 1998, 8 designated funds raised nearly £16 million (which must be invested by 5 April 1999). There is some anecdotal evidence to suggest that the designated funds which raised nearly £16 million are seeking transitional projects that could continue to raise £1 million rather than projects that can only raise £250,000. Whether the designated funds will continue in the future is not clear at this time.

Claw Back of Business Reliefs

14. The abolition of the BES has been raised as a possible claw back measure in relation to business reliefs generally to offset the cost of the reduction of the standard rate of corporation tax to 12.5 per cent. The case for and against the abolition of the BES may be put as follows:

For Abolition

- Abolition would yield about £20m in a full year.

- It would be seen as an effective curtailment of a relief used almost exclusively by business.

- The tax resources saved could be used to fund additional tax reliefs in the income tax area such as widening the standard band by an extra £125/£250 per annum.

Against Abolition

- The BES is used mainly by those business areas which are not gaining from the corporate tax reductions.

- The relief has already been restricted in 1998 and is now refocused on its original purpose of assisting smaller and start-up firms.

- There is still a need for a targeted BES relief to assist small firms and start-up operations (which may not be attractive to venture capital funds).

15. If it is decided to renew the BES, it may be prudent to renew it on a yearly basis, instead of the current practice of renewing it for three years, in order to keep the option of abolishing the BES under ongoing consideration.

Conclusions

16. Information is not yet available to determine what effect the reduction in the aggregate amount a company could raise under the BES actually had on the BES. However, initial indications are that the Budget day changes had the desired effect in focusing the BES on smaller/start-up companies.

17. In view of the major refocusing of the BES in 1998 it may be felt that no further changes are required at this time. The issue would then be whether the BES, as it stands, should be extended for a further period and what that period should be.

18. The Group may wish to consider the matter further.

• APPENDIX I
• Cost of the BES to the Exchequer
• Year Amount Raised Cost to Exchequer
• 1992/93 £21.897m £10.511m
• 1993/94 £25.258m £12.124m
• 1994/95 £52.292m £25.100m
• 1995/96 £77.457m £37.179m
• 1996/97 £87.050m £41.784m
• 1997/98 £92.664m £44.478m
• 1998/99*
• * Figures for 1998/99 are not yet available.
• The total amount raised under the BES since 1984 to 1997/98 is £606m at a cost to the Exchequer of £302m.

APPENDIX II

Business Expansion Scheme (BES)

Analysis of Employee Numbers

The attached paragraphs represent the result of an analysis of employee numbers which was carried out on two lists of companies supplied by the Revenue Commissioners for the purposes of assessing the impact of the 1998 Budget modifications on the BES scheme generally.

The analysis was only possible in the case of 23 companies on the Prior 1998 Budget list, and 17 companies on the Post Budget list, since the other companies selected do not appear to be registered on the Enterprise Ireland database.

Analysis of 100 Companies

100 Companies were selected at random by the Revenue Commissioners, 50 as having received BES Funding post Budget Day 1998 and 50 received funding prior to Budget Day. The total amount raised by the 50 companies prior to Budget Day was £12,424,071. The total amount raised by the 50 companies Post Budget Day was £4,493,823.

Prior to Budget

Amounts Raised

The total amount raised by the 50 companies selected prior to Budget Day 1998 was

£12, 424,071 (as indicated by the Revenue). Of this total 24 companies raised £3,372,210 from promoters/Family prior to Budget Day equivalent to 27% of total raised. 12 companies raised finance through Designated Funds, amounting to £7,495,000 (60% of the total raised by these 50 companies). The type of investor for the remaining 14 companies was described as various.

Employee Numbers

Employee numbers for the years 1995, 1996 and 1997 were available for 23 companies of the 50 companies listed by Revenue. For these companies the total number of employees increased for 305 in 1995 to 547 in 1997, an increase of 79%. Of the 23 companies 8 (35%) had less than 10 employees; 12 (52%) had between 10 and 50 employees and 3 (13%) had greater than 50 employees.

9 of the 23 companies analysed had raised over the £250,000 limit introduced in the Budget.

• Amounts Raised

• The total amount raised by the 50 Post Budget companies was £4,493,823. Of this total, 24 companies raised the finance from Promoters/Family amounting to £1,113,630, (25% of the total raised). 2 companies raised £450,000 from BES Funds, (10% of total raised). For the remaining 24 companies the type of investor is described as various, raising £2,930,193, (65% of funds raised).

Employee Numbers

Of the 50 companies selected, employee numbers were available for 17. For these 17 companies the total employee numbers increased from 185 in 1995 to 248 in 1997 (34% increase).

A breakdown of the size of the companies by employee numbers for 1997 shows 9 companies had between 10 and 50 employee and 8 had less than 10 employees.