I move: "That the Bill be now read a Second Time".
It is generally accepted that native Irish industry relies excessively on State aid and debt finance. This unhealthy trend was identified in the White Paper on industrial policy as one of the major obstacles to the growth and development of indigenous enterprise. The under-capitalisation of industry makes it ill-equipped to finance the development of new products and markets and thus ensure a strong self sustaining base for growth.
The extent of the problem is clearly demonstrated by the recent NESC report on financing the traded sectors. This report shows that from 1972 to 1982 bank borrowing by manufacturing industry increased in real terms by 6 per cent per annum while production volumes increased by only 3.5 per cent, just half as much. The report also showed that equity capital relative to total assets is much lower in Ireland than in, for example, the UK, Japan or the USA. Small industries are particularly vulnerable to over-reliance on borrowings. They are less capable of weathering the storm than larger well established enterprises, and in times of low profitability, reduced cash flow and high levels of real bank interest rates they are quite simply forced over the precipice. This is not to suggest that the larger industries are immune from the disease, as has been all too clearly demonstrated in recent years.
The reality and extent of the problem has also been recognised and acknowledged by Members of this House. The Oireachtas Joint Committee on Small Businesses stated in their first report on manufacturing industry that "finance is without doubt one of the major problem areas for small companies". In regard to equity finance in particular, the same report concluded that many small firms are under-capitalised when setting up and that because of low profitability and lack of any further equity investment this situation continues throughout the life of the company. Among the committee's recommendations it was stated that the encouragement of additional venture capital through the banks, other financial institutions and through private investors is required. My own views on this topic clearly parallel those of the Oireachtas Joint Committee.
If further evidence is required of the increasing imbalance of the debt equity ratio of Irish industry, I would suggest to Deputies that the problem is no more starkly evident than in the performance of the Irish Stock Exchange in recent years. The number of companies quoted on the exchange has been steadily declining over the past decade. Its activities in recent times have concentrated on trading in a small number of "blue chip" equities and oil share speculation. The Stock Exchange has become irrelevant to the financing needs of Irish industry generally. The market capitalisation of shares quoted on the exchange is under 10 per cent of the country's national output as compared with about 50 per cent in the UK and the US. The most recent statistics available to me show that only 21 of the 77 companies listed on the Stock Exchange are engaged in manufacturing. The unlisted securities market was launched in 1980 to encourage the entry of smaller high-growth companies to the Exchange. Its performance according to any criteria, and particularly when compared to its UK counterpart, has been most disappointing, to put it mildly. The failure of industry and, in particular, manufacturing industry, to utilise the facility of the USM is further testimony to the dearth of equity type capital in Ireland.
One of the cornerstones of this Government's progressive policy for industrial development, as outlined in the White Paper on this topic, is our commitment to encouraging a greater level of private sector investment in the productive sectors of the economy. Given the stark reality of the problems of financing Irish industry, our endeavours in this direction must take on an increasing and continuing importance and urgency.
The first step towards providing a cure however must focus on an analysis of the causes and symptoms of the disease. It would be very wrong to assume that the lack of equity capital in industry is due only to the failure on the part of the investment community to provide the finance. If the dramatic gearing — in other words, excess borrowing — problems of industry are to be rectified, entrepreneurs must become more receptive to the idea of outside investment and overcome their traditional reluctance to dilute their ownership and control in the firm regardless of consequences. Native small industry to a very large extent has been based on the model of the family business. It has usually been the case in such instances that family ownership is considered to be sacrosanct and investment by third parties regarded as an undesirable intrusion in the family's private affairs. Many small businessmen are quite happy to sacrifice the benefits both to themselves and the community, of expansion in favour of a quiet life with an acceptable level of income. This has often been motivated by a reluctance to accept the increased workload — and there is no doubt there is an increased workload — and responsibility to shareholders associated with third party investment.
These are all factors which affect the level of suitable opportunities for investors but which are not within the direct control of the Government. We can merely urge a change in attitude. However, I feel that the harsh realities of economic recession, and the fact that it is far better to own 50 per cent or 60 per cent of a successful business than 100 per cent of one which has failed, will ultimately bring about a reversal of these trends.
Certainly, the Government are committed to encouraging a greater acceptance of the need for equity financing. The emergence of a demand for equity among entrepreneurs is evolving, but it must be matched by a supply of finance from private and institutional investors. There has been a marked reluctance on the part of investors to put money into industry and this trend has been particularly noticeable in the last decade. Reasons for this reluctance are easily identified. It is certainly true that there has been a significant disincentive to productive investment by virtue of the more favourable tax treatment of other less risky forms of investment, such as investment in property and Government gilts.
The Government, in the White Paper, committed themselves to an examination of the tax code to see how the elimination of this bias in favour of riskless investments as against risky investments, might be achieved. The Finance Act of 1984 introduced a number of relevant measures such as the elimination of bond washing and the restriction of tax based financing, which encouraged borrowing by businesses. However, by far the most important and far reaching initiative introduced in the 1984 Finance Act was the incentive given to invest in industry by virtue of the business expansion scheme. The scheme provides that individuals who purchase new ordinary shares in unquoted manufacturing companies, namely, those eligible for the 10 per cent corporation tax scheme, or in companies providing internationally traded services should be able to write-off up to £25,000 per annum against their personal taxable income. I should say that the provision of income tax relief is subject to a number of qualifying criteria, but an illustration of the potential benefit is that an individual paying 60 per cent tax and who makes a qualifying investment of £25,000 will find that the net cost of that investment is only £10,000.
Before I go on to discuss this scheme in more detail and to outline why it gives rise to the need for the Bill currently before the House, I should like to dwell a little longer on some further aspects of the equity financing problems of Irish industry. I would beg the House's indulgence in this regard but the issues involved are of sufficient importance and have significant relevance to this legislation as to merit a comprehensive and open debate in this forum.
Many economists, investment managers and other interested commentators have argued that tax incentives such as those provided by the business expansion scheme will not remove one of the principal obstacles to productive investment, which is the lack of suitable, well planned and profitable project ideas in which to invest. This is a criticism one hears frequently when talking to those in the broadly defined banking community. In other words, there is, some say, too much money chasing too few projects. I do not accept this argument which hinges entirely on one's definition of a suitable project. The major difficulty facing most of the enterprises emerging under the IDA's Enterprise Development Programme is that of raising equity finance. The National Enterprise Agency have attracted significant numbers of projects, some of which have already been rejected by the private sector finance houses. My Department are approached almost daily by budding entrepreneurs inquiring about the availability of capital to finance new projects. There is no shortage of projects. Apart entirely from all of these are a large number of established businesses for whom refinancing would be a significant step towards both viability and profitability. What I am attempting to demonstrate is that there is a significant pool of new and established businesses offering opportunities for investment. The problem is that they are not deemed to have sufficient potential to justify the risk. I am informed that at least one private venture capital agency requires applicant companies to have a minimum of at least three years' profitable trading before investment is even contemplated. That criterion would not quality as venture capital in the United States of America. Indeed, one US businessman, who set up a business here with the aid of the business expansion scheme in a place which I visited recently, told me that the venture capital community here could be described as good merchant bankers rather than venture capitalists in the American sense of the term.
The application of this type of criterion narrows the field down quite considerably and leads to claims of "too few project ideas in which to invest". What is required in fact is change of attitude in regard to risk-taking and a lowering of the risk thresholds demanded by the institutional investors. The report of the Oireachtas Joint Committee on Small Businesses concurred with this viewpoint and concluded decisively that "there is an urgent national need which the market has failed to deliver on". I do not comment on the English used there.
I would like to state categorically however that my remarks are not intended as a criticism of the venture capital industry, which is still in an embryonic stage of its development in this country compared for instance, with the US model to which I was referring. It would serve no purpose, I suppose, if the industry were to fall flat on its face by virtue of a rash of ill-advised high risk investments. I am confident that risk thresholds will be lowered and high risk investment will be more readily accepted as the industry evolves and establishes a track record for itself. The Government can clearly contribute to this evolution process by the creation of an environment which is more conducive towards investment generally and through an integrated industrial development policy which will enhance the future profitability of Irish industry.
An essential prerequisite for the development of a healthy equity base in industry is the provision of the appropriate infrastructure through which the stocks and shares of industry can be traded. I commented earlier on the performance of the Stock Exchange and do not therefore propose to dwell on that subject. However the fact remains that the exchange is perceived by the young entrepreneur and the private investor as a rather formidable institution. Its failure to attract any significant new business from either quarter in the past decade is ample testimony to its stagnation. This is particularly damaging given that it is the only official market place for trading industrial shares. If we are serious about encouraging a greater level of private sector investment in industry, we must be prepared to provide the necessary mechanisms through which to channel the investment. In particular, mechanisms with which the private individual can more easily identify are essential.
My Department have only recently completed an important study in regard to the development of a more active market in the stocks and shares of small and medium sized industry. This study has concentrated on three main areas:
(i) the performance of the Stock Exchange in recent years;
(ii) the potential benefits of a properly regulated over-the-counter market such as exists in the UK; and
(iii) the desirability of amending company law to allow companies to buy back their own shares.
I referred to this report in my recent address to the annual general meeting of the Confederation of Irish Industry and in doing so provoked a considerable response. My Department were subsequently inundated with requests for copies of the report. I would like to say for the record, however, that this report was never intended for publication, but rather as a document for internal use within my Department. My reference to it was merely to indicate the seriousness with which my Department were taking this issue. Much of the detailed information contained in the report was provided by third parties on the basis that it would remain confidential. It would be dishonourable therefore not to respect the wishes of those whose co-operation was so vital in the preparation of the report.
Notwithstanding this constraint on publicity, the report is a valuable document and will greatly assist in the development of Government policy for the promotion of an active market in stocks and shares and the promotion of industrial investment generally. It provides important statistical analysis of the over-the-counter markets at present operating in the United Kingdom and the United States. I would like to see a similar market developing here as a means to tackling the poor capital structure of Irish industry. Indeed, I am heartened by some responses made to my Department in this area, even since the speech to the Confederation of Irish Industry.
It would be important however that such a market should develop in a properly regulated manner. This would be essential if investor confidence in the market is to be guaranteed. I would also stress that I would not view such a market as being in any way in competition with, or a substitute for, a thriving Stock Exchange. Indeed, I think a properly structured over-the-counter market could lead ultimately to a rejuvenation of the exchange by providing an interim market for the shares of small and medium sized industries and facilitating their development to a point where they might contemplate a full listing. Essentially, an over-the-counter market is an informal arrangement by which people can buy and sell shares that are not quoted or listed on the exchange. In a way, it is a private market in shares, as distinct from the public market, as is the exchange. There is a tendency to use jargon in this area on the assumption, which is often not correct, that people understand what you are talking about. They are afraid, for fear of showing their ignorance, to ask you what you mean. It is important to explain the difference therefore between the over-the-counter market, the unlisted securities market and the full exchange listed market. These are three separate types of institution, with a rising degree of disclosure requirements and a rising degree of complexities, but also a rising degree of access to funds — lesser funds being available the less onerous the requirements, and the more onerous the requirements the more funds being available.
In considering the report I will also be paying particular attention to the comments by the consultants in regard to allowing redemption of capital. I can assure the House that I will be considering the report as a whole as a matter of priority.
This whole area is of considerable importance to both the institutional investor as well as the private individual. This is particularly so in the context of the business expansion scheme. In order to qualify under the scheme, companies must not be quoted on a Stock Exchange. Stock exchange companies are excluded.
This is not a particularly restrictive provision as the vast bulk of industry, as I have already indicated, falls into this category of unquoted companies in any case. After a period of three years has elapsed, however, the companies may, if they so choose, seek a listing on the Stock Exchange. Given the performance to date of the Stock Exchange one could not predict with any confidence that the BES will lead to a significant increase in the level of activity on the exchange, but it may and I hope it does. In the absence of any alternative exit mechanism, people who have bought shares will want to get out; and, since they are not on the Stock Exchange where they can sell them, investors would be faced with the prospect of being locked into the shares and unable to realise their investment. I do not wish to give rise to false hopes of an overnight solution to this difficulty but I do wish to assure prospective investors that will exists to tackle the problem and tackle it effectively.
Obviously, we realise that the success of the business expansion scheme to some degree hinges on finding not only a means by which people can buy shares on a favourable basis but also, in due course, sell them on a favourable basis also.
I would not wish that the business expansion scheme be viewed as a panacea for all the ills I have outlined. The long term solution lies in the creation of an environment which is conducive to investment. This will involve tackling the various aspects of the problem on a systematic basis. I am confident however, that the scheme will have an important catalytic effect in terms of generating a significant flow of capital to the productive sectors of the economy and focusing attention on the benefits of equity investment. It is a significant incentive to the private individual to invest in industry.
An important aspect of the scheme which should not be overlooked is that the tax relief applies to qualifying investments by employees in their employer companies. I have for some time now been advocating the concept of employee shareholding. As Minister for Finance, I was instrumental in introducing tax concessions in the 1982 Finance Act to promote the concept in Irish industry. These tax concessions were made more attractive in the 1984 Finance Act and, I am glad to say, have resulted in increased interest in introducing approved profit sharing and employee shareholding scheme. The additional benefits resulting from the business expansion scheme increase the potential attractiveness of such schemes, but the employees will find this scheme of interest also.
I believe that the adoption of employee shareholding on a wide scale in Ireland would represent a radical change from our traditional thinking in the area of industrial relations — a change which would, in my opinion, greatly enhance our prospects for a profitable industrial base capable of competing successfully in world markets. As a small open-trading economy our competitive edge will be a key factor in ensuring the future employment prospects of our young population. If we are to ensure our industrial prosperity we must guard against becoming complacent or insular and the value of employee shareholding as a means to that end should not be underestimated. By having a stake in the business in which they work employees will have a greater commitment and incentive to ensure that their employer is efficient and profitable. They become more appreciative of the difficulties with which business must cope and develop a greater insight into the factors affecting the prospects for industry.
The framing of the business expansion scheme to extend eligibility to employees is therefore a critically important factor which improves the potential of the scheme to contribute to the equity base of Irish industry and broadens its effectiveness through the promotion of employee shareholding.
Thus far, I have concentrated on outlining the Government's perception of some of the important difficulties facing Irish industry. I have described key initiatives for tackling these problems. I have also attempted to underline the significance and potential of the business expansion scheme. Clearly, if the scheme is to achieve this potential it must be seen to be effective and workable.
Since it was first introduced in 1984 the scheme has faced much criticism from various interested parties who viewed it as much too complex and restrictive. One of the key difficulties relates to the establishment of investment funds. Under the scheme, an individual may make an investment directly in the company of his choice or, alternatively, he may invest in a fund which has been designated for the purpose of the scheme by the Revenue Commissioners. The legislation now before the House is designed to facilitate the establishment of these designated funds and at, the same time, complement the provision of the 1984 Finance Act in that regard.
The designated investment funds have a crucial role in determining the success or otherwise of the business expansion scheme. The experience of the UK scheme has shown that up to 90 per cent of total qualifying investments are made through such funds and we might expect a similar profile of BES investment in this country. Designated investment funds are a particularly attractive proposition to investors for two reasons. First, each participant has an interest in all of the investments made by the fund and so is able to obtain a fair spread of the risk associated with his investment. Secondly, by investing through a fund, the individual has access to the investment expertise of fund managers who identify and actively monitor the companies in which they invest.
Two such funds have been established to date. However, expectations of a greater level of activity in regard to this aspect of the BES have not been realised. The problem lies in the fact that designated investment funds as outlined in the terms of the Finance Act, 1984, come within the scope of existing unit trust legislation and, as a result, have certain constraints imposed on them. The purpose of this Bill, therefore, is to remove these designated investment funds from the scope of the Unit Trusts Act, 1972, and thus avoid a serious legislative anomaly.
Some understandable confusion may arise as to the precise differences between an investment fund and a normal unit trust. There are, in fact, fundamental differences between the two. In an investment fund each participant will own a particular share in a particular company. In a normal unit trust each participant owns a proportion of the total holding rather than owning a particular asset. Also, in an investment fund all subscriptions must be paid up by a specific date nominated by the manager, after which no further participants may join the fund. A unit trust scheme on the other hand is open-ended and a participant may join or leave at any time by buying or selling units of the scheme. Indeed, the Unit Trusts Act, 1972, requires the manager of a unit trust to buy units of the scheme from a participant on demand. This latter provision would be particularly inappropriate in respect of investment funds and indeed would place an intolerable burden on the fund manager.
The Unit Trusts Act, 1972, provides that unit trust schemes may register under the Act. The Act specifically provides, however, that unregistered unit trust schemes are prohibited from advertising. Therefore investment funds would be required to register under an Act, the provisions of which are wholly inappropriate for their purposes, in order to be able to advertise and invite subscriptions from the public. Essentially that is the nub of the problem this Bill is designed to solve. The two existing funds, to which I referred earlier under existing legislation are considered to be unregistered unit trusts which have chosen not to advertise and so remain within the law. It would, of course, be unreasonable to expect all prospective fund managers to operate within this constraint. If we do not have adequate participation it probably will be because of lack of advertising, leading to lack of knowledge.
In order to provide further clarification let me outline briefly how these funds will operate. Following designation by the Revenue Commissioners, each fund will advertise its existence and invite subscriptions directly from members of the public. It may specify a minimum or maximum subscription to be made by each individual as well as a total target size for the fund. The fund will also specify a closing date by which such subscriptions must be received. No investments may be made by the fund itself prior to the closing date, that is, until all subscriptions have been received. After the closing date the fund manager may make suitable investments in targeted companies on behalf of the participants in the fund. I feel it is important to note that the fund managers will be acting as a nominee of the participant who at all times will retain beneficial ownership of the shares purchased on his behalf. The subscription of each participant will be spread pro rata over all investments by the fund.
The main purpose of this Bill is achieved by section 2 which removes the designated investment funds from the scope of the Unit Trusts Act, 1972. The remaining sections of the Bill are designed to impose certain requirements on designated funds in the best interests of the investors.
The main aim has been to ensure that funds will provide the maximum possible information to prospective investors. Access to information such as that specified in section 5 of the Bill is essential if investors are to make an objective decision as to whether or not investment in a particular fund constitutes a good risk. It is worth noting that the prospectus must highlight the risk involved in investment in industry and advise all prospective investors to consult their accountant, stockbroker, bank manager or other professional adviser before proceeding.
I do not consider it necessary or appropriate to attempt to provide in this instance for more comprehensive investor safeguards. Ultimately, responsibility for assessing the bona fides of a particular fund will rest with the investor himself. Given the likely profile of these investors, that is those on a high income, and the range of information with which they will be provided, it is not unreasonable to conclude that the provisions of this Bill are more than adequate to protect their interests.
I consider it important that I draw the attention of the House to the provisions of section 6 which imposes certain obligations on fund managers in regard to investments in private companies. This section provides important safeguards from the point of view of the investor.
Of course, an investment under the business expansion scheme does not have to be channelled through a fund. In the past 12 months a number of direct investments in qualifying companies have taken place. I recognise, however, as I stated just a moment ago, that there has been considerable criticism of the scheme, much of which I regret to say has been ill-informed. However, I have at all times indicated my willingness to listen to constructive criticism and to consider suitable amendments to make the scheme more effective. I am pleased to say that the Government have accepted my recommendations for some key changes to the Finance Act which will provide a major impetus to the scheme.
First, close relatives who have up to now been excluded will in future be eligible for relief from income tax. Secondly, the statutory ceiling on fees which may be charged by investment fund managers will be removed, providing further incentive for the establishment of such funds. The time limit within which companies engaged in research and development must start trading is being extended in order to encourage investment in this type of activity. Finally, companies with less than wholly owned subsidiaries and those with certain foreign subsidiaries will in future qualify under the scheme.
These changes have been proposed on the basis of discussions which I and my Department have had with a wide range of interested parties in the investment community over the past 12 months. They will, I am certain, result in a much increased level of activity under the BES. Coupled with the measures proposed in the Bill now before the House, I am confident that we have the right recipe for a successful business expansion scheme.
I commend this Bill to the House.
