I am delighted to have the opportunity to debate the Designated Investment Funds Bill in this House before it rises for its summer recess. Although this Bill is a relatively short one and is technical in nature, it is extremely important in the context of the Government's promotion of investment in industry and specifically from the point of view of encouraging the provision of high risk equity investment, or venture capital as it is often known.
I will deal with the technical aspects of the Bill and with the reasons for it being necessary at all a little later on, but I would like to dwell for a moment on a particular subject which is recognised as being one of the major obstacles to the growth and development of indigenous enterprise. I am speaking of the gross under-capitalisation of Irish industry and the unhealthy trend which exists in favour of debt finance and State aid.
When I spoke on the Second Stage of this Bill in the Dáil I commented on the performance of the Irish Stock Exchange in meeting the financial needs of Irish industry. I would like to take this opportunity to make my position in relation to the stock exchange quite clear.
In the first instance it is important to recognise that the exchange is the only market-place which exists for trading in stocks and shares of Irish industry and it is, therefore, an important indicator of industrial performance as well as of the financing trends in industry.
For this reason I will restate some of the statistics relating to the performance of the stock exchange in the past decade. At present only 77 companies have a full listing on the exchange and this number has been declining steadily over the past decade. Only 21 of these companies are engaged in manufacturing. The market capitalisation of shares quoted on the exchange is under 10 per cent of the country's national output as compared with 50 per cent in the UK and US.
Furthermore, many of the companies listed on the exchange do not have their shares actively traded and regular trading takes place only in respect of a small number of "blue chip" equities including companies involved in offshore oil exploration. The performance of the Unlisted Securities Market has also been disappointing and it has failed to encourage a significant number of smaller, high-growth companies to the exchange, which is what it was set up to do. The failure of industry and, in particular, manufacturing industry, to utilise the facility of the USM is an important indication of the lack of equity type capital in Ireland.
Now, these statistics paint their own picture and point to a declining level of activity on the stock exchange in recent years and the fact that the exchange is no longer a significant force in meeting the financing needs of Irish industry, particularly the needs of small and medium-sized industries. The blame for this poor performance cannot be laid exclusively at the door of the stock exchange itself. Rather, these statistics are a symptom rather than a cause of the disease with which we are faced and to which this Government are committed to finding a cure.
The causes of the disease on the other hand are manifold but can be summarised as the unwillingness on the part of Irish investors to invest in industry coupled with the unwillingness on the part of many businessmen and entrepreneurs to give up part ownership of their business in return for equity capital. I will expand on both of these points in just a moment.
One of the cornerstones of this Government's progressive policy for industrial development as outlined in the White Paper on the topic is our commitment to encouraging a greater level of private sector investment in the productive sectors of the economy. If we can achieve this we will have achieved a revitalisation and rejuvenation of Irish industry; we will have set ourselves on the road towards industrial prosperity; we will have dealt a major blow to the spectre of unemployment in this country which threatens the prospects of our young population. One of the most marked effects of this increased prosperity will be a dramatic increase in the level of activity on the Irish stock exchange. Therefore, Government policy is extremely supportive rather than critical of the stock exchange. Furthermore, I am pleased to say that the officials of the exchange have responded positively to my call for the injection of new life blood and new liquidity in the Irish capital markets. Indeed, at their initiative, I hope to have discussions shortly with them to discuss our mutual objectives further.
My view on the under-capitalisation of Irish industry is not a controversial one and is merely a statement of the factual position in which industry finds itself. Indeed, I have support from a number of auspicious quarters. The National Economic and Social Council produced a report a little while ago on "The Role of the Financial System in Financing the Traded Sectors". The report shows that between 1972 and 1982 bank borrowings by manufacturing industry increased in real terms by 6 per cent per annum while production volumes increased by only 3.5 per cent. The report also demonstrated that equity capital relative to total assets is much lower in Ireland than it is in the USA, Japan or the UK.
The problem has also been recognised and acknowledged by Members of this House through the report of an Oireachtas joint committee on manufacturing industry. This report pointed to the under-capitalisation of small industry in this country and added that because of low profitability and the lack of any further equity investment this situation continues during the life of the company. The report states quite clearly that "finance is without doubt one of the major problem areas for small companies". The Oireachtas joint committee's recommendations for bringing about a reversal of these trends included the encouragement of additional venture capital investment through the banks, other financial institutions and through private investors. I am pleased to say that I view the committee's report as being entirely supportive of Government policy in this area.
The White Paper on Industrial Policy outlined the Government's commitment towards the encouragement of a greater level of risk investment in industry. It would be a mistake, however, in tackling this problem, 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. This brings me back to a point I made earlier. Many businessmen and entrepreneurs have a traditional reluctance to give up part ownership of their business in return for equity capital. Many businessmen would prefer to rely on bank borrowings and State aid rather than to dilute ownership of their business. Many small businessmen are quite happy to sacrifice the benefits of expansion in favour of a quiet life with an acceptable level of income and they are often motivated by a reluctance to accept the increased workload and responsibilities to shareholders associated with third party investment.
Much of the reason for this traditional reluctance is the fact that native small industry is to a very large extent based on the family model. In such circumstances, the view often is that family ownership is sacrosanct and investment by third parties an undesirable intrusion into the family's private affairs. However, when faced with the sophisticated business world in which we live and the harsh realities of economic recession this attitude represents a narrow-minded and potentially dangerous approach. There is definite need for a re-think and a need to change the attitudes of some small business people towards accepting outside investment.
An over-reliance on bank borrowings by small industry produces a vulnerability to movements in interest rates with which most small businesses find it extremely difficult to cope. This is particularly so in times of high levels of real bank interest rates coupled with inadequate cash flow which is a feature of many small and particularly start-up businesses. Small businesses also often suffer, not from a lack of commitment on the part of the promoters, but a lack of management expertise. The small businessman will often find himself in a situation where he has to perform the functions of salesman, accountant, production manager, personnel officer, market researcher and will very often have to perform all of these functions, and any number of others, within the course of a single working day. This imposes an intolerable burden on the promoters of small industry and often leads to failure.
However, both of these difficulties can be overcome by a willingness to accept outside investment. Equity capital does not require the repayment of interest on a regular monthly basis and the payment of dividends is related to company performance. Where small industry, and particularly industry in the start-up phase, is concerned many venture capital type investors are prepared to forego the payment of dividends in the initial years in order to ensure the future viability of the company. Furthermore, many venture capital type investors adopt the US "hands-on" approach and are prepared to inject a certain amount of management expertise and guidance into the firm in return for their investment.
Existing businessmen and new entrepreneurs must be prepared to accept third party investment if industry is to survive and prosper. The bottom line is that it is far better to own 50 per cent or 60 per cent of a successful business rather than 100 per cent of one that has failed. The other side of the coin, of course, is the need to encourage both private and institutional investors to put more money into industry and thus satisfy the demand created by the new breed of entrepreneur.
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 past decade. I suspect that there are many reasons for this but certainly one of the most significant has been the disincentive to productive investment by virtue of the more favourable tax treatment of other, less risky forms of investment, such as 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 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.
I am convinced that there is significant potential for increased investment in industry on the part of our institutional investors such as pension funds and life assurance companies. It is estimated that these institutions have an income of somewhere in the region of £400 million per annum and this is available for investment in one form or another. At best, about 20 per cent of this money is invested each year in equities. In the UK, however, similar institutions invest up to 50 per cent of their annual income in equities. Most institutional investment in industry is conducted through the stock exchange and, while the institutions are significant providers of funds to the private venture capital houses, I am not convinced that the potential for channelling investment in this manner has been fully exploited.
In 1984 I had discussions with representatives of the pension funds and the insurance industry on this particular topic and the exchange of views proved very beneficial. I would hope to be in a position to renew this dialogue in the coming months as I would very much like to review progress to date and to discuss the potential for new initiatives.
I mentioned earlier the Government's commitment to reviewing the tax code with a view to removing the bias which exists in favour of less productive types of investment. The most significant initiative taken by the Government to date in this area has been the introduction of the Business Expansion Scheme. Under this scheme individuals who purchase the new ordinary share capital of unquoted manufacturing companies or of companies providing internationally traded services, that is, those eligible for the 10 per cent rate of corporation profits tax, are entitled to write-off the amount of their investment, up to a maximum of £25,000 per annum, against their liability to income tax.
The granting of income tax relief under the scheme is, of course, subject to a number of qualifying criteria. However, the benefits to an individual who avails of the scheme are extremely generous. This is best illustrated by the fact that an individual who is paying income tax at the rate of 60 per cent and who makes a qualifying investment of £25,000 can write-off £15,000 against his income tax liability. In such circumstances the net cost to the investor of a £25,000 investment is only £10,000.
The introduction of the business expansion scheme is a major incentive to private investors to invest in industry. Many economists, investment managers and others have argued, however, that tax incentives such as this 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. There is, some say, already too much money chasing too few projects. This is an entirely subjective argument which hinges on one's definition of what constitutes a suitable project.
I am entirely satisfied that there is in this country at present a significant pool of new and established businesses offering opportunities for investment. The major obstacle is not, therefore, the lack of suitable ideas but rather the unrealistic risk thresholds demanded by both institutional and private investors. Once again, the report of the Joint Committee on Small Businesses concurred with this point of view when they stated that "there is an urgent national need which the market has failed to deliver on".
The venture capital business in this country has not yet developed to a point where it could be favourably compared with the venture capital business in the United States. So-called venture capital in this country is targeted almost exclusively at better established companies with a good track record. This is not altogether surprising as I would agree that the industry itself must establish a track record before it can become actively involved in genuine high risk investment. I am, however, anxious to ensure that the industry gets every opportunity to evolve along the lines of its US counterpart. The real lack of equity investment in Irish industry is at the start-up and early development stages and this is where genuine high risk investment must take place. There is no lack of suitable project ideas in these phases; it is simply a case that the projects which exist at present do not come within the low risk thresholds demanded by our venture capital institutions.
The Government are committed to encouraging the development of a thriving venture capital industry in this country and I feel we can contribute to this development 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.
As I said earlier, both I and my colleagues in Government fully recognise and acknowledge the value of a thriving stock exchange. However, many small and medium-sized industries are not mature enough to contemplate a listing on the exchange and it is therefore necessary to provide suitable mechanisms whereby the stocks and shares of small and medium-sized industry can be actively traded. Furthermore, if we are serious about encouraging a greater level of private sector investment in industry we must set our sights at generating a greater level of liquidity in our capital markets than exists at present. For this reason I would recommend the development in this country of an over-the-counter market such as operates at present in the UK. I feel that the development of such a market is probably inevitable in any case as the financial community cannot ignore for much longer the hiatus which currently exists between small industry and the stock exchange. The only role which I perceive for the Government in the operation of such a market is a regulatory one. There is a danger that it will prove far too tempting an opportunity for unscrupulous operators and if we are to ensure a high degree of investor confidence in such a market it must be seen to operate in a properly regulated manner. My Department are urgently examining what is required in this area.
I can understand why the stock exchange might view the establishment of an OTC with some trepidation and indeed suspicion. I am sure however that they, no more than the Government, recognise the inevitability of this development and indeed I think that an efficient and properly regulated OTC could be in the best interests of the exchange itself. It has the potential to provide a type of interim market for the stocks and shares of small and medium sized industry and thus facilitate their development to a point where they might contemplate a full listing on the exchange itself. In other words, an OTC has the potential to bring about an active market in industrial shares from which the exchange must ultimately benefit.
I have based my views on this topic, not on some abstract notion, but on the conclusions of a consultancy report on the subject which I had commissioned some time ago. Another feature of the consultants' recommendations for the encouragement of a liquid capital market was the desirability of amending company law to allow companies to buy back their own shares. I view this as another extremely desirable development and as an integral part of the Government's policy for the promotion of industrial investment. I hasten to add, however, that it is an extremely complex area involving not only company law but also issues of corporate taxation and while I cannot promise the immediate introduction of enabling legislation I can assure this House that, in consultation with my colleagues in Government, and the Minister for Finance in particular, I will be examining this issue as a matter of some urgency.