According to HMRC data, during the 2014/15 tax year the amount raised by UK companies seeking funding via the Enterprise Investment Scheme (EIS) was a record £1.7bn. Much of this is raised via financial advisers seeking tax-efficient investment opportunities for clients that either have a specific tax need or have an interest in investing in small UK businesses.
In previous years, the growth in appeal of EIS investments has often been attributed to the rise of renewable energy opportunities within this space and the asset-backed, subsidised nature of such projects offering ‘capital preservation.’ With the chancellor removing subsidised renewable energy projects from EIS eligibility it is good to see that there remains growing appetite for EIS.
However, it is important that advisers and investors understand the unique risks associated with such investments. EIS propositions carry three predominant risks:
1) Investment risk
As with any investment, the value of shares can go down as well as up. Investors should be aware that investment in smaller unlisted companies carries with it a high degree of inherent risk regardless of any steps taken to attempt to mitigate that risk.
EIS shares are usually held in unlisted companies, from which investors might only be able to exit via a reﬁnance or company sale. EIS investments should be considered as a medium-term or long-term investment and investors are unlikely to have access to their capital during the investment period. Having a predetermined exit is not permissible under EIS rules and investors should be wary of any provider suggesting the guarantee of an exit.
EIS providers should be exit focussed and, by understanding the investment rationale and experience of the investment management team, investors should be able to ascertain how focussed they are on generating real exits for real returns. I’m sure most investors would rather wait a few months for an optimum exit rather than a ‘churn’ of an EIS investment at 3 years to just claim the tax reliefs.
3) Tax risk
Over the coming twelve months, it is expected that the Chancellor will continue to scrutinise EIS opportunities which do not adhere to the original spirit of EIS, i.e. seeking to create jobs or innovation. Two things that should be considered on this point are that propositions which do not fund companies that are seeking to generate jobs or innovation will likely cease to be eligible for new EIS funding and there is the chance that the HMRC, with their increased budget and appetite for challenging tax mitigation, may retrospectively review companies that have raised funds via EIS.
Investors should seriously question any EIS proposition where it is marketed as having reduced or little investment risk. Such propositions are likely to be at risk of HMRC review in future and it could be argued that the ‘tax risk’ with such propositions is markedly higher than an investment where the underlying investee companies are genuinely seeking growth and the creation of jobs or innovation.
Investing in Enterprise Investment Scheme propositions is not for everybody but anybody considering such an investment should clearly understand the additional risks associated with such propositions.
As one adviser recently said to me, ‘all EIS investing is high risk and if a client is suitable for such an investment, and is of appropriate net-worth, then they should want to make real returns from their EIS.’ This isn’t the case for everyone but I understand this adviser’s sentiment that as only a small part of a client’s portfolio, why shouldn’t they seek to make real returns from their EIS investment?[vc_separator]
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