The Macmillan Gap: How SEIS Might Be Recreating the Problem It Was Meant to Solve
The same market forces that created the UK's historic funding gap are now eroding the effectiveness of a subsidy designed to counter them.
The Pattern
In 1931, the Macmillan Committee identified what would become known as the "Macmillan Gap" - a persistent funding shortfall for small and medium enterprises seeking capital between £150,000 and £8 million (in today's money). Noted by Keynes in his submission to the committee; investment decisions had moved from small to large investments and from spread out across the country to centred on the capital and its stock market. The problem wasn't new then, and it isn't solved now. But understanding why reveals something troubling about our current approach to startup funding.
The gap emerged from a fundamental economic reality: investigating and managing investments has largely fixed costs, but the returns scale with investment size. Some knowledgeable person has to evaluate the company and monitor the investment. For a £100,000 investment, those costs might represent 10% of the deal. For a £10 million investment, they're 0.1%.
This inexorable force drove capital toward larger deals and more centralised decision-making. Local expertise withered as investment moved to London's emerging financial district. Investment in smaller terms had to have the ‘decision making’ taken out so the cost of evaluation was lower and tick boxing exercises -that ignored anything but the obvious- emerged. The Macmillan Gap was born from these economies of scale.
The 1940s Solution worked!
The government's response was elegant: create the Industrial and Commercial Finance Corporation (ICFC), essentially a small business bank designed to operate profitably across the entire funding gap (sound familiar?).
The ICFC had four crucial elements:
Flexible instruments: By 1953, it deployed 37% of capital in equity (preference and ordinary shares) and 63% in loans (secured and unsecured)
Local expertise: Staff who understood regional businesses and could adapt terms during tough times
Patient capital: No shareholders demanding quick exits, so no pressure to abandon smaller deals
Focus: By statute it was unable to lend larger amounts and was required to support small and medium scale instruments.
Cross-subsidisation was key: profitable larger loans supported loss-making smaller investments. The ICFC could afford to develop expertise in evaluating small deals because the portfolio as a whole generated returns.
It worked. The Macmillan Gap narrowed.
Erosion by market forces
But success contained the seeds of failure. The same economic forces that created the gap began working on its solution. Each time there was a market tightening the ICFC was under pressure to abandon the less profitable small support and focus on the place where there are economies of scale. It was subject to the forces it was meant to address, and over decades, these forces eroded it entirely.
By the 1960s, the ICFC ‘discovered’ that M&A work was more profitable than patient lending. The 1974 and 1981 recessions strained its balance sheet, forcing a choice: either the government could subsidise the boring small-scale banking, or allow the ICFC to focus on more profitable activities. It required a political choice to either support the ICFC or to allow it to be profitable by loosening the constraints that made it effective in addressing the Macmillan Gap.
The ICFC itself declared that it wanted to "behave like its market-based peers." In 1981, its original obligations were formally abandoned. Through the 1980s, it pivoted to management buy-outs and ceased small-scale activity. It became 3i and floated in 1987.
In becoming a commercial success, 3i had reopened the Macmillan Gap. The forces that created the gap had eroded, over time, the institution created to bridge it.
History's Echo (SEIS and EIS)
Today's Seed Enterprise Investment Scheme was designed to counter exactly these centralising forces.
Rather than relying on banks, VCs or other formal investment institutions we have EIS (Enterprise Investment Scheme) and its more generous (but limited) SEIS. With these, investments into the Macmillan gap are directly subsidised by the government with income tax and capital gain benefits; Changing the economic forces back in favour of small, startup businesses.
SEIS (the S stands for Seed) was put in specifically to support that initial round of financing from the three Fs (Friends, Family and Fools) and specialist Angels (individuals who invest time, expertise and capital at the early stage and are often entrepreneurs themselves). By offering generous tax relief (50% income tax relief, CGT exemption, inheritance tax benefits), SEIS should encourage individuals to make small, risky one-off investments that larger funds (who can aggregate returns) ignore.
The theory is sound. The execution is being undermined by the same pattern.
The effect has been to change the risk-return calculus so much it has reversed the Macmillan Gap for formal institutions. Funds can "spray and pray" - where they minimize their own fixed costs by not looking very closely - across dozens of SEIS investments, minimising due diligence costs while maximising tax benefits. A £10 million allocation across 50 companies gets >£5 million in government subsidies while diversifying away most risk. The fixed costs of SEIS compliance are trivial for professional fund managers.
Meanwhile, angel investors - who should be SEIS's natural constituency - find themselves crowded out. Angels typically have:
Smaller portfolios: Can't diversify risk as effectively as funds
Deeper expertise: Sector knowledge and networks that add real value
Meaningful capital: Each investment represents significant commitment
But they can't compete with subsidised capital deployed by funds that treat SEIS as a tax-efficient portfolio construction tool rather than genuine risk capital.
The Irony!
Whilst EIS looks to be a great success and one of the leading factors in UK investment in startup and scale ups; At the early stage we’re witnessing a profound inversion of SEIS's intent. The scheme was designed to overcome the economies of scale that favour large, centralised capital and help get businesses off the ground and investor ready. Instead, it’s brought less intelligent capital in earlier where it can be the wrong type of finance that is exploiting tax benefits for little economic gain.
Speed of decision making is being slowed down with pricing distortions and structural inflexibilities already discussed in this earlier post. The costs are passed to founders too: legal fees for SEIS compliance now routinely consume 5-10% of the round as institutional investors transfer their risk management complexity to the companies they back."
The most sophisticated actors - those best able to aggregate risk and minimise due diligence costs - are harvesting subsidies meant to encourage individual risk-taking. Meanwhile, the angel investors who would provide genuine expertise and committed capital are being priced out of their own market.
The Deeper Pattern
This isn't unique to SEIS or even to the UK. It's a recurring pattern in how market interventions get captured by the forces they're meant to counter.
The ICFC succumbed because larger deals were more profitable. SEIS is being captured because larger funds can exploit the subsidy more efficiently. In both cases, the same economies of scale that created the original problem eventually overwhelmed the solution.
Policy makers seem to consistently underestimate how quickly sophisticated actors will arbitrage well-intentioned interventions. The very success of such schemes - measured by uptake and investment volumes - often signals their corruption.
The implications extend beyond tax policy. If we're serious about supporting early-stage innovation, we need to understand that:
Usage statistics don't equal success: High SEIS uptake might indicate gaming rather than genuine gap-filling
Subsidies get captured: Sophisticated actors will always find ways to exploit generous incentives
The gap persists: Different actors filling the gap doesn't mean the gap is closed
Follow up: policies must be continuously reassessed against their original aims, not just their uptake statistics.
The Macmillan Gap teaches us that sustainable solutions require structural changes that resist capture, not just financial incentives that can be gamed.
Simple solution (my magic wand changes for SEIS)
There is, at least for SEIS, a simple solution to this particular problem;
Cap individual investments in a company to £50k. This means that 5 different investors would need to invest in an SEIS . A large fund would be unable to generate the returns on £250k. If it never gets used up, fine, investors can still benefit from EIS investments at later stages - which works well for more established companies with clearer metrics and longer track records.
Beyond capping individual investments, there needs to be structural simplification. Pre-approved SAFE templates with HMRC blessing could slash legal costs from £20,000 to £2,000 per round, removing the fixed-cost barriers that favour large institutional players over individual angels.
For VC funds SEIS is overly generous and directly inflates startup valuations (which can be problematic for later rounds where they have to converge to an undistorted market price that can be lower than the previous raise). It’s the other side of the forces that the ICFC was put in place to solve; Well-intentioned interventions get captured by the very forces they were designed to counter. Perhaps it's time to ask: Are we solving the funding gap, or just changing who profits from it?