The enterprise investment scheme (EIS) offers an attractive mix of tax efficiency and long-term growth potential, but the risk of investing in small early-stage companies can be off-putting. A managed fund approach could offer an alternative and potentially attractive approach to direct investment, suggests Tony Stott
It is now 25 years since the then Chancellor of the Exchequer Kenneth Clarke unveiled a new initiative designed to encourage investors to put money into small companies in need of finance to support their growth plans. Today, the Enterprise Investment Scheme (EIS) continues to offer the same proposition: generous tax reliefs that reward investors for accepting the risk of backing such businesses.
Indeed, while there have been changes over the years to the tax incentives available from the EIS, these reliefs remain highly attractive. They potentially include tax relief on EIS investments at 30 per cent, the potential for tax-free income and capital gains, and exemption from inheritance tax depending on the individual’s circumstances.
Equally, while the rules on qualifying EIS investments have also been modified, the principle of the scheme — that it is to support early-stage companies — remains intact. To be eligible for the EIS today, a company must have assets worth less than £15m, employ fewer than 250 members of staff, and have been trading for less than seven years.
While such businesses inevitably carry a high risk, these early-stage businesses also have the potential to deliver attractive returns as part of a diversified portfolio. A recent study from Beauhurst found that the collective value of the UK’s leading 500 start-ups, even taking account of the losers, rose more than six-fold between 2011 and 2017, delivering an annualised compound return of 30 per cent.
The potential benefit of EIS funds
How, then, to square the undoubted attractions of the EIS against the risks that the scheme carries? Well, it’s important to recognise from the start that this is not a scheme for risk-averse investors, those who cannot afford to potentially sustain a loss or those who cannot afford to tie up their capital for the long term – say at least five years. For many investors, it will represent an opportunity once other tax-efficient investment allowances – individual savings accounts and personal pensions – have been exhausted.
However, for those who choose to embrace the EIS, a managed fund is designed to try and mitigate some of the risks that accompany this type of investment. Rather than selecting individual EIS companies for yourself, you invest in a portfolio of qualifying assets chosen and maintained by a professional manager.
This approach has a number of potential advantages – including the fact that dependent on your personal circumstances you still qualify for all the EIS tax reliefs. Most importantly, the managed fund is designed to give you diversification benefits: rather than investing in an individual company (or a handful of businesses), you spread your risk across a portfolio. In the Beauhurst study, the failure rate was around one in seven for early-stage business, so focusing on only one company is a high-risk strategy; on the other hand, the portfolio of companies in the research collectively delivered stellar returns.
A managed EIS fund is designed to give investors a means to access professional expertise. EIS managers with a track record of investing in early-stage businesses should have access to a pipeline of potentially attractive companies seeking money, as well as the knowledge and resources to make a thorough assessment of their prospects.
For many investors, a well-managed EIS fund is viewed as valuable reassurance in an asset class where it can be difficult to complete your own due diligence. For investors looking to balance risk versus potential return – and to potentially secure tax incentives while managing investment exposure – a managed EIS fund could be an attractive option.
Tony Stott is the Chief Executive of Midven
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