A solution to fill the pension lifetime allowance gap? An overview of EIS – the pluses and the minuses.

Financial Advisory

21 April 2016

Financial Advisory

Facilitated by: Colette Dunn – Milliman Expert: Kieran O’Gorman – Deepbridge Written by: Evie Owen, Owen James Group

Does investing in EIS provide a solution to fill the pension lifetime allowance gap?

This session was introduced by Kieran O’Gorman from Deepbridge Capital. His principle role is to develop new products – to help advisers address the shrinking tax reliefs available following the cap on pension savings of £1M.

What is EIS?

The Enterprise Investment Scheme was established in 1994 borne out of the old Business Enterprise Scheme. It supports four principle tax reliefs: income tax relief; loss relief; capital gains tax deferral; and inheritance tax planning in that after two years it is not liable to inheritance tax. The tax reliefs are there to compensate investors for the lack of liquidity and to encourage investment in early stage businesses.

Our speaker put forward Deepbridge’s approach to investing in EIS saying that they viewed it as venture capital investing rather than as a vehicle to leverage tax relief. The Deepbridge EIS invests up to £5M per company per annum and subscriptions are generally spread across five-six companies. You can however actually invest as little as £10,000 in the Deepbridge EIS.

22,000 companies have benefited from £13bn of investment into private companies since 1994.

  • The principle changes are around scale, size and eligibility of investment. Investors can now invest up to £1m and underlying companies can receive up to £5m per annum, subject to total funding caps. 
  • There are strict rules about eligibility. 
  • Removal of renewable energies that are in receipt of Govt subsidies from eligibility.
  • The Deepbridge Technology Growth EIS focuses upon technological growth and innovation. 

It is healthy for small innovative businesses to access risk capital, in that it addresses the funding gap from traditional funding sources such as banks. 

Deepbridge focus on three particular sectors – renewable energy (wind and hydro, particularly in Northern Ireland), disruptive technology and life sciences.

“EIS is approaching the mainstream investment arena these days. The question is around risk. Is it an appropriate alternative?”

Until last year, SEIS companies had to spend 70% of SEIS investment before it could access bigger funds available under the EIS. This potentially adverse hazard has now been removed. SEIS investors can invest £100,000 under SEIS, and companies can raise up to a maximum £150,000 under SEIS.

Why is it attractive?

For start-up businesses seeking funding the alternatives are:

  •           Angel funding
  •          The three “Fs” - family, funds and fools
  •          The banks? Despite their substantial efforts to build capital reserves, RBS and Standard Chartered both recently             failed their stress testing for the last two years. They are therefore very loathe to invest and less likely to lend               money to small businesses. 
  •          Crowdcube ...  not convinced that suitability requirements are being addressed. 

Why do Deepbridge prefer to get involved at a later stage?

Considering the risk reward trade off, they are able to carry out greater due diligence into underlying companies; they can also get actively involved in these companies. They have experience in the sectors.

When asked if these investments have time horizons, the session leader responded you cannot have a pre-determined exit in line with the HMRC guidelines.

You look at the balance sheet of the company seeking investment and ask the question is the growth feasible? For example, look at their five year plan and instead of taking their three year predictions you make them year five. The common denominator is that they all lack physical access to money. 

They discount valuation by 70% and then if company sells within five years – happy days. Patience is key. 

The investment is for a minimum of three years under EIS rules. “The key thing is to take a view – if you can see a dramatic up tick down the road then stick with it. The extension beyond the minimum holding period may be worth the wait.” 

It is important that the EIS scheme manager is aligned with its investors ie they invest as well.  It is better that they are interested in getting a cut on the success rather than just taking an initial fee.

So our facilitator then brought us back to the key question – does EIS fit well as part of the pension investment piece?

The EIS market is very contrived. It addresses the liquidity issue in that you can invest in it for several years.

The client wants some sort of certainty. They like to know what they are investing in.

Renewables were attractive and some 65% of EIS investing has been in this area but now that has been stopped by the Government the question is what next?

How to grow distribution?

We all know that there are some 5,000 adviser firms, many of whom should be looking at this sort of product. However the professional indemnity insurers don’t understand or like it and compliance officers are nervous.

Our group were critical of professional indemnity providers saying that they share information amongst each other which leads to almost “cartel” type behaviours.

The EIS industry is not very homogenous. It was suggested that some positive PR – perhaps publication of all the success stories - might overcome the reluctance of advisers to consider it.  

Kuber Ventures - solution to the market (https://kuberventures.com)

MICAP – assist advisers to do their own reports/due diligence (https://micap.com/)

It is important to educate the people. We need to work hard to educate the market place on EIS. It is a nearly a mainstream product, although not appropriate for everyone

There is a very clear delineation about what you can do and what you can't do. It is defined in law. It changes over time but it doesn't change retrospectively. 

Another PR angle is the positive social impact of these investments. The younger generation are particularly attracted by this.

Charging structures:

How do these small firms access the market?

Consultation Paper 106 - June 2013 - prohibited the retail distribution of unregulated products. Very late in the day the FCA carved out VCTs and EIS and created a dislocation in the industry.

Fee structure is the first - it is all about alignment - are you on the right rhythm?

Initial fee - flat up to 5%; others will charge 2% per annum plus 5% 

The adviser will take 3% off before the money goes in. Deepbridge doesn’t levy manager fees on the investor, rather it is borne by the investee company. 

Performance fee at exit of investee company: 20% after 120p returned for every 100p invested.

AMCs on the way in ...   you should take it annually in arrears.... 

Not accrue the first three years, and put it in a separate account.

Who are the investors?

It is for the entrepreneurial client, the well-heeled investor. It is imperative that it is made clear that it is a higher risk investment.

Deepbridge has seen the average retail investor [;ace £27K.  However, suitability is everything - clarity around matching client to risk. It is now more attractive due to pension limits.

It is all about pots and cash-flow modelling. Once they have the financial investment piece worked out this is the icing on the cake.

Case study:

In 2012, the Government came up with their strategy for life sciences - knowledge and technology transfer without the normal bureaucracy i.e. the ‘UK Govt Strategy for Life Sciences’.

Deepbridge Life Sciences Seed EIS (SEIS) consists of 10 underlying companies all of which will tap into a core administration service.  In line with market experience, we expect four will fail. Six will go forward to EIS. One will be a superstar. £150,000 into each company. “Philanthropy for Profit.”

SEIS - only raised £80m in 2012/13 and there were a lot of failures. Most propositions are single company SEIS and therefore extremely risky, almost binary in outcome. 

Crowdfunding makes SEIS look like investing in IBM and has been described as “A car crash waiting to happen.” 

The question was asked: “What is the competition - if you weren’t going to sell them EIS what would you sell them?” 

The answer to this was “Probably a small cap fund or a collection of small cap shares; discretionary fund management; property”.