The next four weeks are critical for those looking to invest in Enterprise Investment Schemes (EIS) – with capital preservation EIS funds no longer available, investors and Financial Advisers are evaluating capital growth EIS funds.
The Patient Capital Review heralded a new era for EIS, after which tax-efficient investment must be directed towards high-growth technology companies, which have the potential to grow UK gross domestic product. These changes may initially appear to complicate EIS for financial advisors, but there are a number of reasons that EIS remains a vital tool in the financial advisor’s tool kit.
Dr Paul Mattick (pictured above), Director of Mercia EIS Funds, explains why IFAs should be considering EIS for their clients:
- Your most valuable clients need EIS
Within your client base, there will be some who are interested in EIS; perhaps have had a Capital Gain, or are approaching Life Time Allowance in their pensions, or perhaps they are successful entrepreneurs themselves.
We all know that EIS is just the tip of the iceberg for a client’s investment portfolio, and this represents the highest risk, highest reward allocation, which benefits from those attractive tax reliefs. However, if you don’t advise these clients of their options to invest in EIS, then your competitor IFAs will be certain to take advantage of this short-coming, and this could provide them with the opportunity that they need to take your highest value clients.
To keep your highest value clients on your books, you need to understand the new world of EIS (keep reading), and understand that portfolio diversity and identifying the best fund managers, are key to your clients’ experience and investment return.
- EIS is now focused on capital growth
Historically, two types of EIS funds existed:
- Capital preservation EISs
- Where returns were modest, but in theory the risk of capital loss was low.
- It is notable that the number of Capital Preservation EISs have returned less than 100p in the £1 invested, and many of these strategies are not exiting in a “timely” fashion.
- Capital growth EISs
- Where the fund manager or investor sought capital gain over the long-term.
- Investing in a portfolio of high-growth companies, expecting losses and high multiple returns.
Both types of EIS investment benefitted from generous tax benefits, including income tax reliefs on their investment in the short-term, tax-free capital gains and IHT relief in the medium to long term. The portfolios of Capital Growth EISs also benefit from Loss Relief being available on a company by company basis, should any of these investments fail.
The government identified that Capital Preservation EISs were abusing the system, and decided to disqualify these schemes, which previously invested in solar and crematoria. Therefore, investors are looking to their advisors to provide informed advice on switching to EIS funds that target capital growth.
Within any capital growth EIS fund, normally focused on technology companies, you need significant winners to offset the companies that fail. An example of a winner in the Mercia portfolio is Oxford Genetics. Oxford Genetics is a company which has received investment from five Mercia EIS funds, which has become a leader in innovative synthetic biology-based technologies for biologics discovery, development and delivery. Oxford Genetics has also benefited from Mercia’s novel funding model, as in addition to the EIS funding, it has received considerable investment from Mercia Technologies PLC and co-investment from Invesco Asset Management (one of Mercia’s shareholders).
- Simplified advice process
EIS is small part of a financial advisor’s remit, so delivering a simplified process is crucial. Mercia is a multi-award winning EIS fund (Growth Investor Awards 2017, EISA 2018), and is one of the most active Venture Capital funds in the UK (Beauhurst 2018). Therefore, Mercia has the ability to rapidly build well-diversified funds of early-stage technology companies. With a broad portfolio, we aim to capture at least one company that will return ten times the original investment in the company, aiming to triple invested capital in 5-7 years, including the income tax relief.
As the sector EIS has matured, Mercia has become one of the more established providers, with a strong investment track record, including both investing and exiting companies. There will of course be new entrants, but their track record might be harder to evaluate. Against this background, IFAs should use the platforms and independent reviews (Allenbridge, Churchill and MICAP) to compare these offerings, so that they can have confidence in guiding their clients.
- While the government has capped pension contributions, EIS is progressively being expanded
The government is progressively moving against the high burden of attractive pension schemes, lowering the cap of the Life Time Allowance to just over £1.0million. In contrast to this, successive governments have been expanding EIS, and the Knowledge Intensive Classification of EIS (although not relevant to all) which means that up to £2.0million can be invested per year (as opposed to £1.0million as a Lifetime Allowance for pensions)!
In theory, pension funds tend to invest in lower risk assets, whereas individual EIS investments are high risk and offer potentially high return; effective diversification offers the opportunity for EIS investments to provide a more consistent return. Pension tax reliefs are good, but EIS tax reliefs are also attractive, with 30% income tax relief, marginal rates on the remaining £0.70 in the pound that is exposed to risk. For 45% tax payers, 61.5% of capital is protected, and those with CGT tax to defer, more than 61.5% is protected.
With Mercia’s strong processes, experienced investment committees and corporate governance in place, our funds are doing well and are expected to accelerate as some companies achieve their full value. Mercia is a highly experienced investor, and we expect to provide superior returns, in addition to tax benefits for your clients. Our EIS Fund is amongst the top of the market in terms of performance; as Mercia’s EIS Funds average EIS performance is 2.4 x cost, or 2.8x cost with tax reliefs i.e. if you invest £100,000 four years ago, it would be valued at £240,000, or £280,000 with tax reliefs.
Our view? Investment in EIS offers an exciting opportunity for those looking to invest in the technology sector and benefit from generous tax relief.