EIS investing: A leap into the unknown
For the uninitiated, investing can often feel like an alphabet soup of different acronyms.
But knowing what they all mean can open up a whole new world of options for how to put your money to work. As investors prepare for a number of government changes to how they can invest in startups, City PM asks: do you know your EIS from your SEIS and your VCT?
What is the EIS?
Introduced in 1993, enterprise investment schemes (EIS) are a form of tax relief designed to get people investing in startups. The idea is to create a win-win situation for both investors and entrepreneurs: people who put funds into fledgling firms get money off their income tax, while those who start those companies get more investment coming in, and a better platform on which to grow.
“The government, like all of us, is keen to see businesses thrive,” says Mark Brownridge, director of trade body the EIS Association. “For this, they frequently need investment when the businesses are insufficiently established and strong enough to attract bank debt — which is where EIS comes into play.”
Since it entered the fray in 1993, investors have poured more than £20bn into companies via the scheme — something which has picked up in recent years after the birth of crowdfunding websites such as Crowdcube and Seedrs, founded in 2009 and 2012 respectively. The sites have made it easier than ever for people to invest through EIS by clearly listing companies which qualify.
Through the scheme, investors can claim 30 per cent of the value of their investment off their income tax. Luke Lang, co-founder of Crowdcube, says: “By allowing more liquidity into the industry, the extra funds that the tax relief generates creates and safeguards jobs, supporting entire communities and ultimately driving wealth and growth.
“It’s a big draw for investors, and the companies that we work with generally like to offer tax relief in order to reward those early backers.”
What’s the catch?
About 660,000 companies are established every year in the UK, and 60 per cent of them fail within three years. Only select few of those become eligible for EIS tax relief, but the fact remains the same: young, fast-growing companies are more liable to hit a roadblock and go down in value than a long-established listed firm.
As a result, investors toying with the idea need to make sure they understand the rules and the risks they are taking, adds Laura Suter, personal finance analyst at AJ Bell. “The incentives on offer through EIS exist because the companies are startups and therefore have a higher chance of failure. As such, it is possible that you will get back less than you put in initially — even when generous tax benefits are taken into account.”
So how does it work?
The good news is that if your EIS investment fails entirely, you can get some of your money back, via loss relief equivalent to your income tax band.
The way this works is as follows. Let’s say you earn enough that you pay 45 per cent income tax. If you then invest £10,000 in a company that eventually fails, you can first claim back your 30 per cent income tax relief of £3,000. Then, on the remaining £7,000, you can recoup another 45 per cent, which comes to £3,150. Your total loss after all this? Just £3,850.
Moreover, if things go well, they go really well. If you win big on a standard, FTSE-listed stock and want to sell it off for a higher price, you can expect to pay a certain portion of that back to the government in capital gains tax. But with EIS-eligible companies, this is not the case.
Investors toying with the idea need to understand the rules.
And for investors looking to pass the shares on to the next generation, you can also claim back any inheritance tax applied to the shares.
But there are rules to bear in mind, including a requirement that investors must keep the shares for three years to qualify for tax relief. In addition, in most cases, you can only invest up to a maximum of £1m in eligible companies over the course of one tax year.
Companies, meanwhile, can only raise a maximum of £5m in total in any 12-month period under the scheme, can only qualify if they have fewer than 250 full-time employees, and cannot have more than £15m in assets before tax.
How is it changing?
The government not only wants to get people investing in startups — it has to be the right kind of startups. From 1 April, new rules will double the amount of money investors can put into companies over a tax year, provided they are carrying out research or are inventing something new. The new regulations will ensure that at least 80 per cent of funds are invested in these so-called “knowledge intensive” firms.
Fund managers will also need to submit annual statements to HM Revenue and Customs to prove that they meet the conditions. However, they will also be able to set their income tax relief against liabilities in the tax year.
“Investors need to be aware of these changes as it could significantly affect the risk profile of the investments,” says Suter.
“The changes mean investors may also want to spread their money across more EIS funds, in order to get more diversification.”
The younger sister
EIS also has a relative: SEIS — which stands for the seed enterprise investment scheme. This operates in a similar way, but on a smaller scale.
Companies must be raising no more than £150,000, while backers enjoy an even higher proportion of their investment — up to 50 per cent — back in income tax relief.
It is also worth looking into venture capital trusts (VCTs) — traded companies which, in turn, invest in startups and EIS-eligible firms.
These schemes are the government’s way of encouraging UK investors to take risks and support our growing entrepreneurial economy.
Backers can still get their tax relief by investing in VCTs, as many of them specialise in EIS.
O’Keefe adds: “It may be wise to find a VCT partner that you like and then, once you are happy, it may be worth exploring their various EIS offerings as well. This offers substantial benefits in terms of the expertise and diversification of risk that these EIS specialists can bring, but it does come at a price.”
Great — how can I get stuck in?
So you want to put your money where your mouth is, but you don’t know where to start? Many have found that traditional EIS or VCT funds have “a high barrier to entry with quite high minimum investment amounts and high fees,” says Kirsty Grant, chief investment officer at Seedrs.
As a result, more and more UK investors are turning to her company or others like Crowdcube to make investments into individual EIS or SEIS eligible companies, which both platforms list clearly.
But even with these websites gaining ground, it is important for would-be investors to do their research before getting their wallet out. For those less-inclined to cherry-pick their own firms, Seedrs offers an automatic investment tool, which allows users to set specific criteria, such as tax relief eligibility, alongside sectors they are interested in. That will go ahead and build a diversified portfolio at the touch of a button.
Clearly, EIS, SEIS and even VCT investing is perilous by its very nature. But the tax breaks make it “one of the most generous tax relief schemes in the world”, adds Grant.
“Investing in startups is risky, and the UK government appreciates that. These schemes are their way of encouraging UK investors to take the risks and support our growing entrepreneurial economy.”