The changes to the investment criteria for EIS has not dampened the entrepreneurial spirit in the sector, which continues to blossom; Alex Davies, chief executive of Wealth Club, spoke to GBI Magazine earlier this year
Until recently, more than £500 million was invested in conservative EIS funds every year. These funds were filled with predictable, usually asset or contract-backed investments such as crematoria, pubs, wedding venues, film projects or, whilst it was allowed, renewable energy.
The deal was straightforward. Put in £1, get 30p back in tax relief. Then hopefully in three years’ time get at least £1 back and, all being well, perhaps a bit more.
The Patient Capital Review of 2017 sounded the death knell for those types of fund, leaving a hole of more than £500 million each year in the process.
The actual impact cannot be quantified just yet, as EIS fundraising figures for the first year of investment under the new rules have yet to be released.
When they are, it is likely they’ll show EIS business is down, maybe even significantly down.
Is that a blip or the end of EIS as we know it? Has demand waned? Can the hole be filled? And, most pertinently, are the remaining and new EIS funds any good?
When you look at what drives demand, it stands to reason it can only head one way – up.
Yes, the uncertainty around Brexit is having a short-term dampening effect.
But long-term structural changes such as pension restrictions, increased taxes on dividends and buy-to-let have driven – and will continue to drive – wealthy investors to EIS and VCTs.
Not only that. I suspect those changes will push an increasing number of new investors to come into the market making it more mainstream, especially once the market matures and develops a track record of consistent and decent exits.
Investing directly into young, potentially fast-growing businesses is an exciting and tangible exercise. In many ways it is far more engaging and easier to comprehend than investing in the large super tanker companies which make up the main stock market. The popularity of crowdfunding amongst younger investors stands as evidence.
But what’s out there for EIS investors?
Good news – plenty.
In my opinion, the abolition of old-school asset and contract-backed EIS has improved the options for investors. Your money is being invested in genuine entrepreneurial businesses. And whilst riskier, they also give you a greater chance to end up with outsized returns.
Take Parkwalk Opportunities EIS, for instance. It’s one of our clients’ favourites and invests in what are known as ‘university spinouts’. These are companies formed to commercialise the research findings or intellectual property developed at universities. Incidentally, ARM Holdings, which in 2016 was sold to Japanese tech firm SoftBank for $32 billion was a spinout from the University of Cambridge.
Parkwalk has been extremely successful. Lucrative exits include Tracsis, Horizon Discovery, and Vocal IQ. The investment strategy has also worked when things have gone wrong. Part of the attraction of university spinouts is the validation the university gives a technology. So, if the commercialisation fails there might be residual value in the technology.
Another interesting EIS is the Amberside Scientific fund. Although technically a new entrant, it’s been around in some form or another since 2006. It focuses on tech companies, the majority of which are set up by the fund managers themselves.
An example is Seequest, whose technology allows law enforcement officials to scan through and match up surveillance film and tracking footage far more efficiently. The technology was recently credited with solving a high-profile murder case in Australia.
Another is Radio Physics, which has developed technology to unobtrusively identify someone concealing a bomb or weapon from a distance of up to 30 metres. The innovative patented systems can be integrated into security robots or used to extend the “security perimeters” of buildings, airports, schools and military outposts. The potential for this is clearly huge.
An often overlooked EIS offer is Par Syndicate EIS Fund. Based in Edinburgh, Par Equity invests in technology companies typically based in Scotland, Northern England or Northern Ireland. Par Equity Partner Paul Atkinson argues you can find far greater value in those areas than in the overhyped London tech scene.
Par Equity had its first successful EIS exit in June 2016 when PathXL – a company producing cancer detection software – was sold to Philips. This gave EIS investors a 2.7x return.
There are also several new entrants to the EIS funds market. These include Vala Capital, EMV Capital, Velocity, Nexus and Praetura Ventures.
So far, the signs are encouraging. Many of the people coming in are very bright and have already been highly successful in creating their own businesses. This encourages me because it shows a lot of credible people see EIS as a big growth area.
Two funds I have been particularly struck by are the Side by Side Partnership and the O2H Therapeutics fund.
The SidebySide Partnership EIS is run by technology veteran John Bailye. Bailye is an Australian who moved to the US and founded and grew a software business called Dendrite. Dendrite was sold in 2007 for $800 million. He is also a co-founder of the New Jersey Technological Council.
Unlike most other EIS funds which will typically raise money each year and deploy that money into a new set of companies, SidebySide aim to invest in just eight companies and raise follow-on funding for them over the coming years. This should allow them to really focus on growing those businesses to their maximum potential. The businesses it is targeting are those at the later stage allowed by EIS rules.
Sidebyside is targeting 3.7x return after all fees. The fees structure is geared towards incentivising the manager to achieve big things. The performance hurdle, for example, doesn’t kick in until returns have exceeded £1.60. The norm is more like £1.20 or even £1.
Another interesting new entrant is O2H. This Cambridge fund has been set up by brothers Sunil and Prashant Shah to invest in early-stage biotech therapeutic opportunities in the UK. They want to exploit an opportunity opened up by a shift in focus of large pharmaceutical companies. Rather than developing innovation in-house they now tend to acquire small companies that have developed attractive innovation. This means that if you are one such a company, you have a captive audience. If you are an investor in one such a company, you have a greater chance to benefit from earlier exits.
Having founded two successful drug discovery platform companies (one of which they still own) the brothers should be in a very good position to come across and screen potential investee companies. This is a high-risk area but get it right and the returns could potentially be very attractive. They believe theirs is the only EIS fund to specialise in this area.
EIS investors hankering for their old and trusted asset and contract-backed funds should look on the bright side. There’s quality out there. Growth geared funds will take longer to produce a return and failure rates will undoubtedly increase. But the upside will no longer be limited to a fraction over a pound. Investors could win big and will be supporting the type of entrepreneurial businesses EIS was designed to kickstart.
I suspect it will take a while for advisers to be comfortable with the new breed of funds. And it will be even longer before they recommend them to their clients. But it might just be the case that the grass really is greener.