According to figures from HMRC, over 24,500 companies* have received finance from venture capital sources (VCT, EIS and SEIS) since inception – raising over £14 billion*. Year on year growth in amounts raised under EIS shows no sign of abating and with pension rule changes taking effect in this new tax year, EIS is assuming mainstream importance in the planning process for both advisers and investors alike. Against this backdrop, 2016/17 tax year could see record amounts looking for an investment home.
It certainly seems the case that more people are finding that EIS has a part to play in their wider wealth management and estate planning needs.
However, what has become abundantly clear, as a result of recent legislative changes is that the inherent tax advantages which are available under EIS will not fit every risk appetite and suitability and appropriateness should never be compromised purely because of the tax breaks. The government are committed to ensuring that tax reliefs are used in a well targeted manner aimed at providing much needed capital to growing businesses who may otherwise struggle to access funding from more traditional sources. Within this definition therefore , it is no surprise that ‘renewables’ is no longer EIS qualifying which is historically where large swathes of cash were being invested on the basis that tax reliefs could be obtained for limited risk. Those days are over.
The EIS landscape has undergone significant change and it follows that the tax reliefs are being made available in recognition of the increased risks associated with investing in generally younger, growing companies. This presents a very different risk profile but one that can be very compelling in appropriate circumstances.
Focused on growth
In coming to terms with the fact that EIS cannot be viewed as a tax mitigation tool for high earners, the government looks to be committed for the foreseeable future, to providing tax incentives for investors who have the appetite to invest in British SMEs and who in the engine room of the economy can help to fuel growth and create employment thus achieving an all-round benefit for all UK taxpayers. Whilst that may disappoint some investors, there can be little argument with HMRC’s stance on this which is eminently fair and reasonable.
So with renewables no longer in the equation, and the recently announced withdrawal of the largest EIS promoter from the market, what can we expect to happen?
Rule changes apart, operating a growth capital strategy is a wholly different beast to the more capital preservation type strategies and selecting a manager with the necessary skillsets and capability in a growth capital context will be a major issues for advisers to contemplate. Deploying tens and in some cases, hundreds of millions in growth cap situations simply won’t happen. The 7 year rule probably gives some indication of the size and scale of each investment opportunity with metrics dictating that most deals are likely to be sub £2m.That represents a very substantial number of deals for the market to absorb if the numbers heading towards EIS are to be believed .Seneca have been specialist operators in the SME market for many years and to complete the requisite number of deals, at the right values and get through the necessary levels of Due Diligence is not to be underestimated .This will undoubtedly catch out the lesser experienced operators in the market as will pressure to transact at over inflated valuations. It will be interesting to see in the coming years how exit track records shape up because when all is said and done, that is the only real success measure for investors. Investing now and obtaining the upfront tax reliefs might appear to be ‘job done’ in some quarters but if the underlying investments are poorly conceived then the unwanted and uncomfortable conversations between advisers and their clients will be inevitable 3 or 4 years down the line.
Hitting the wall
So on the one hand the attraction of EIS amidst all the other changes, could potentially see even higher demand this year , yet on the other we could be looking at a much smaller universe of good quality opportunities for the market to invest into. The key for advisers therefore will be to research their chosen providers very carefully and satisfy themselves that the Managers they choose have strong pedigree in a growth cap context. Historic strength in renewables will not automatically passport into growth cap capability, far from it .In this regard, a good quality, ongoing deal flow pipeline will also be an essential consideration.
Seneca’s house view, is that EIS is first and foremost, an investment led proposition. We feel there is merit in having an exposure to this asset class within a portfolio as a non- correlated investment. So each investment we make, has to pass the acid test of standing up on its own investment case. The tax benefits are secondary but at the same time very compelling if the underlying investment is doing its job. For this reason, hoovering up huge amounts of capital from investors and throwing it at sub -standard deals purely to attract the tax reliefs is a complete non -starter. Equally, our charging structure seeks to align with investors’ interests such that our remuneration derives from successful investment outcomes.
The recommendation to advisers is therefore to invest continuously throughout the year rather than waiting until Q1 because good quality deals may not always be easy to come by in a dash for the tax year end. To be fair, a growing number have recognised that investing now for example should see tax certificates coming through in time for January 31st in any event. So that in its own right is a driver for some investors.
We have a team of 70 working from 6 offices in the North West, Yorkshire and Midlands and we see over 500 opportunities each year and typically we will only transact in 20-30 which might give some indication of the deal selection process and the challenges of finding deals of appropriate quality and at the correct value .It is a point I can’t over emphasise and advisers need to be aware of the impact on the market this year.
Watching This Space
So in essence, this is likely to be a very interesting year as the market settles into the changes and it will be interesting for advisers to take a view of the market and assess how and where they plan to accommodate their clients. Indeed clients themselves may need to adjust to the changes as their journey from low risk capital preservation necessarily takes them up the curve to growth capital.
But whatever the outcomes are, there can be little doubt that when used appropriately, EIS is becoming an increasingly potent weapon in the armoury of an increasing number of adviser firms.
Ian Battersby, Business Development Director, Seneca Partners
*Source: HMRC Official Statistics (April 2016)
Article included in the July/August edition of EIS Magazine (Issue 9)
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EIS investment may not be suitable for all potential Investors. Investments in unquoted companies generally carry a high degree of risk and may be of a long term and illiquid nature. The companies in which the Portfolio Service invests will often not be quoted on any regulated market and, accordingly, there will not be an established or ready market for any such shares and the Portfolio Manager may experience difficulty in realising them (for value or at all).
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