All eyes on EIS as budget looms

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All eyes on EIS as budget looms

Britain’s got talent, and a lot of its talent is being Enterprise Investment Scheme (EIS) funded. 

The EIS’s combination of upfront tax breaks and capital gains tax benefits mean it is a powerful incentive for investors considering backing entrepreneurial companies.

A combination of factors has led to an increasingly developed ecosystem in the UK concerning EIS investment opportunities. There is a renaissance in UK entrepreneurship funding across a range of markets including software, biotech, robotics, waste-to-energy and even the creative industries.

The alternatives for investors, in a close-to-zero interest rate environment and tightening of other areas of investment, means that there has been an increasing supply of capital by private investors in this space. The EIS scheme has become a critical component of the UK’s entrepreneurial finance ecosystem.

For companies seeking risk finance, EIS investors provide an important source of funding where venture capitalists (VC) or private equity funds might still be unwilling to invest. The growth in popularity of the EIS scheme has also led to the emergence of many specialised EIS funds that provide some of the elements of a VC fund to help allocate and manage EIS investments more systematically.

Numerous platforms have also emerged that make access to individual EIS investment opportunities, as well as EIS funds, easier. 

However, as economists say, there is no such thing as a free lunch. The economic reason for the government to provide this tax break is that investors are backing risky investments – ones that often cannot get access to finance from banks or large institutional investors. It ought to lead to UK private investment directed to UK companies, funding UK jobs and UK tax receipts. 

 

Incentives

The ongoing HM Treasury Patient Capital review discusses – among many other policy tools – how this powerful tax incentive can be used to incentivise more investment in innovative knowledge-intensive companies, for longer. 

The November Budget speech is likely to include some changes to the EIS rules. It is not yet known what these will be, but some options under discussion include an increase in the holding period of the investment above the current three-year period and a narrowing of the qualification criteria. Commentators expect, in particular, a greater focus on high-growth, knowledge-based companies at the expense of capital-preservation schemes. 

Any changes are likely to only come into effect in the next tax year, so potential EIS investors will have time to adjust their investment strategy before any allocations they might make to EIS funds, or direct investments, before the start of the 2018 tax period.

Key points

• EIS tax breaks mean it is a powerful incentive for investors considering backing entrepreneurial  companies. 

• Clients might consider a mixture of investments into individual companies and EIS funds. 

• EIS investments naturally carry a substantial risk.

A good first step for would-be EIS investors is to join one or more of the crowdfunding platforms and research opportunities to get a sense for how different companies are presented and what information is available. It is also possible to access EIS funds on a platform, directly or through an IFA. This lets investors reach professionally managed pools of EIS investment opportunities – akin to a mini-VC fund. Depending on the amounts an investor can commit, they might choose to develop a mixed portfolio of individual company investments and EIS funds. 

The key question is about personal objectives and what the individual wants to get out of their investment. If they are looking to diversify their portfolio and pursue a more passive investment strategy, they might consider a mixture of investments into individual companies and EIS funds. 

If, on the other hand they want to learn more about angel investments, joining an angel group might be a good alternative to a crowd funding platform. Some EIS funds might be willing to give access to deal flow and co-investment rights on larger deals, especially if the investor’s professional skills are useful to the company. Any of your clients who want to go down this route might also consider joining the UK Business Angels Association (UKBAA) to meet like-minded investors and learn more from peers. 

 

Risk taking

EIS investments in entrepreneurial companies naturally carry risk. There are several common-sense risk management strategies that can be considered. Risk can be diversified by investing in a mix of companies and EIS funds. As with any investment, it is important to do due diligence to understand what is being invested in. The specific EIS tax break dynamics can sometimes act as a veil to detract from the type of analysis that investors and their advisers ought to be undertaking. Another important risk mitigator is to invest in companies that have already received an advanced assurance by HMRC regarding their EIS status, but this is not binding.  

There are benefits to co-investing alongside those with greater experience who are putting in more time and money and have the capacity to support the company if it runs into financial difficulty. This can be in the form of a syndicate of experienced investors, or even through a specialised EIS fund offering that has the appropriate infrastructure. Investors should not be afraid to ask for the due diligence pack or the investment paper – at the very least they might have a good conversation with the investment lead.

All investors like to talk to other investors to see if they have missed a trick. If one of your clients is investing in an EIS fund, make sure they read the fine print in the investment memo to understand the selection and management strategy.

Investors should follow and get to know the companies they have invested in. Some of the best opportunities might come from the winners in their portfolio when they come back to shareholders looking for more funds.

Dr Ilian Iliev is managing director of EcoMachines Ventures