A lot of investors are attracted to EIS by the combination of tax reliefs and the chance for the kind of spectacular returns that only early-stage investments in new businesses – potentially the disruptive, world-altering unicorns of the future – can offer.
But how should investors go about finding the correct companies or funds to invest in; what makes any given EIS investment a good investment, and which investments should you avoid?
(Listen to our podcast with Brian Moretta on reviewing and choosing EIS funds).
The constant - tax breaks
All EIS investments offer the same set of tax reliefs, so outside of confirming whether a company qualifies for EIS, these shouldn’t form part of your decision making process when choosing an investment.
The tax reliefs EIS investments offer are:
Income tax relief.
30% of your investment can be claimed against your income tax, either for the year your shares were issued, or for the prior year.
Capital gains tax disposal relief.
Any increase in value of your EIS shares is exempt from capital gains tax provided you hold the shares for three years.
Capital gains tax deferral.
You can defer the capital gains tax for a gain realised on any asset if you invest an amount equal to the gain in an EIS eligible company or fund.
Inheritance tax relief
EIS shares fall under Business Property Relief, and provided they have been held for two years at the time of death, no inheritance tax is payable on them.
What to look for in a fund
The importance of due diligence
The first step when choosing a fund is always to determine if that fund is legitimate. Look into the Fund Manager’s background and confirm they have the necessary degree of FCA approval. In most cases, the majority of the investment decisions at a fund will be made by a Fund Manager. However, where this is not the case, speak to the fund about how investment decisions are made, and ensure that the decision makers have the necessary approvals to make those decisions.
Importantly, do not make an assumption based on the size of the fund. A large fund isn’t automatically legitimate, and a small fund is not automatically illegitimate.
Who does the fund invest in?
Different funds invest in different things. You’ll find a lot of funds that focus on a specific sector, such as technology or healthcare, on the principle that certain sectors have the potential to grow faster or larger. Others will be sector agnostic, preferring to cast the net wide and avoid limiting their investments to any one sector, and creating more diverse portfolios for their investors.
How do they source deals?
How does an EIS fund choose which companies to add to their portfolio, and do they have access to high quality deals at an early enough stage? This will depend on how established their networks are, as in many cases funds gain access to deals through an introduction from someone connected to that company, accounts, consultants or another investor. If they have a strong network, what criteria do they have in place for assessing the quality of a deal, and are they able to make this assessment fast enough to move quickly and be a viable source of finance for fast moving fund raises?
What is their investment process?
Different funds will approach investment in different ways. Some funds will open to gather investment, then close to deploy it, giving each investor an identical portfolio. Others invest and deploy all year around, meaning that investors have more options about when to invest. This can be important for ensuring your tax relief options can be applied to a given tax year.
It is always worth having a conversation with funds about their investment process to ensure it is as effective as possible, and suits your needs and expectations. Some investors want their investment fully deployed as quickly as possible, while others are happy for it to take longer so that higher quality investments are made. Does their investment process equate to the most efficient method of investing in the best quality companies, with the best chances of returns for the investor? Or is it unwieldy and invasive for startups, meaning the talent pool is limited from the outset? Remember that even if a fund has seen past success, it doesn’t guarantee that their future investments will succeed.
Active vs passive management
Venture capital funds adopt one of two ways of investing, and each have their advantages and disadvantages.
Active - Active funds generally have large investment teams that examine individual company and market data to form an opinion and analysis on the investment opportunity. This data and analysis is presented to an investment team who ultimately decide which to invest in. Post investment these teams often take board or advisor positions in the company with the aim of opening doors and protecting the investment. Given the human resources, required many of the active funds make fewer investments than their passive counterparts.
Passive - For passive funds the investment process is much more streamlined and primarily based on market data or trends. The portfolios created are often larger, more diversified, and firms have less’ involvement with the portfolio companies post investment. In our case, the Access EIS fund tracks the UK startup market as a whole and co-invests with experienced angels who have a track record of making investments that consistently beat the market.
What do you get?
You should always consider how an investment in a fund benefits the investor. While this might seem obvious, there are nuances. Investors might be looking for returns at significant multiples, or they might have maxed out their other investment options, and are looking for a way to put an additional portion of their money to work. The incentive could be diversification, in which case, choosing a fund that builds larger portfolios across multiple sectors would be more suitable than a fund that gives you a handful of tech companies it thinks have a good chance of going the distance.
Part of this question involves transparency, communication and paperwork. Some funds will take your investment and give you a bare minimum of information about what’s happening, while others will go out of their way to update you on the performance of your portfolio, provide updates on the companies and the impact of market conditions. Some funds will be difficult to communicate with. Others will ensure they are always available to talk to their investors and answer questions or act on feedback.
What do they get?
What does an investment in any given fund require of you, the investor? For the most part, the answer to this question will be fees. These will vary considerably from fund to fund, in terms of how much you are expected to pay, when it needs to be paid, and for what. In most cases, there will be initial fees when your investment is made, then fees that are only charged further down the line when companies in your portfolio achieve an exit, but it’s important to know exactly how much you will be paying and under what circumstances.
Investor input
Some funds consider their investors a community and provide opportunities for networking and interaction with other investors and startups. This can provide significant benefits for investors to develop their profile, find out about new opportunities, and on a more human level, to share their expertise with founders that can help them to succeed. In other funds, it’s much more hands-off, and some investors prefer this.
Picking the next unicorn
Investing in EIS is certainly about investing in the kinds of companies that are likely to succeed and go on to do big things, potentially becoming the next unicorn. But don’t fixate on any single company or small group of companies. However good a company might seem to be when you invest, there’s no way to know who will reach unicorn level, and who will fail. Most startups fail, and even the most promising companies can fail too.
A better approach is to cast the net wide and invest in a large number of companies so that your overall portfolio has a greater return potential and more potential unicorns (for more on the importance of large portfolios, and how venture capital returns follow a power law distribution, see our white paper) Obviously, this requires sufficient due diligence to have gone into the selection process, and if you’re investing through a fund, an experienced and well developed network. Large portfolios mean that the inevitable failures that will occur represent a smaller percentage of the whole. For more on the importance of large portfolios.
The Access EIS Fund
Our fund co-invests with proven angel investors to build large portfolios of hand-picked companies for our investors. It’s a high risk investment, and we can’t guarantee that every startup will be a unicorn, but we’re confident that our approach is the smartest on the market. Even better, we can show you the data to prove it.
If you’re interested and would like to find out the benefits of investing towards the start of the tax year, you can call us on 01223 478 558 and we'll be happy to answer any questions you might have.
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