Does the ESIC Scheme need to be tweaked to better support early stage investors?
In 2015, the Australian Government passed legislation that provided tax incentives for investments in Early Stage Innovation Companies (ESICs). Investments in ESICs may be eligible for a 20% tax offset, and gains on the sale of an ESIC investment may be capital gains tax free if shares are held for between 1 to 10 years. For further information, refer to https://www.ato.gov.au/Business/Tax-incentives-for-innovation/In-detail/Tax-incentives-for-early-stage-investors/)
Having ESIC status makes a start-up more attractive for investment. Indeed, two of Uniseed’s investments, Perkii Probiotics and Kinoxis Therapeutics, have both raised significant initial capital rounds from family offices and high net worth investors, with the ESIC scheme being pivotal in the investor’s investment decision. At the time of fund raising, Perkii had developed a range of probiotic drinks but had not entered the market, while Kinoxis was at the pre-clinical drug development stage.
Whilst the R&D tax rebate provides significant support to early stage start-up companies (by the way the rate for this rebate should remain unchanged, despite the current legislation before parliament), the ESIC scheme has been pivotal in getting Perkii and Kinoxis off the ground as it was a major contributing factor that got investors across the line in their final decision to make an early stage, and thus more risky investment.
Unfortunately, one aspect of the ESIC scheme seems counter-intuitive to stimulating investment activity – the reason the scheme was set up. A significant drawback to the scheme is that “The company (plus any wholly-owned subsidiaries of the company) must have total expenses of $1 million or less in the previous income year”.
In many start-ups, including the life sciences/biotech/medical device space, it is very easy to have expenses totalling over $1m a year, given the high cost of launching a product (Perkii) or developing a drug (Kinoxis).
If the Government wants to continue to stimulate investment into early stage start-ups, they need to consider increasing this limit to a more realistic figure – such as $5 million. This would allow many companies to retain their ESIC status for a longer period of time – perhaps beyond their first fundraising round – and further stimulate the innovation sector.