here has been a significant uplift in the degree of interest in Enterprise Investment Schemes (EIS) recently, particularly since the Budget and the new measures announced by Chancellor Philip Hammond. The new principle-based approach by Government has changed the EIS market and is designed to ensure investors take a proportionate level of risk in order to qualify for the generous tax reliefs available via the EIS.
These new developments present significant challenges for certain types of EIS investment managers/providers as the days of capital preservation focused EIS investments are now behind us. EIS providers who have previously operated in this part of the market will need to change, but that may take some time, and it’s important that advisers are clear about the questions they should be asking any EIS managers in order to get full and transparent information before recommendation.
With that in mind, below are a number of thematic questions to ask to ensure these providers are not just au fait with the changes but are the right home for your client’s money.
The first consideration is the speed of deployment of funds by the provider. -If your client invests today, how soon is the manager likely to deploy funds? Knowing this, will help with understanding of three key factors:
- Speed of receipt of EIS3s.Investors require an EIS3 certificate in order to claim their tax reliefs, and they can only receive this for each investee company after funds have been deployed and shares allotted (EIS3s may then take roughly 12 weeks to receive thereafter). With some EIS propositions in the market now stating they may take up to 24 months to deploy funds, this could mean investors are waiting well over two years to take advantage of the EIS tax reliefs.
- Speed of exit.Although growth companies are unlikely to exit after three years and a day (like the old-style ‘manufactured EIS companies’), the sooner money is deployed, the sooner a company is likely to exit. If a company is likely to take four years to exit, then you want to have the money deployed as soon as possible in order to shorten this runway to exit. Waiting months until funds are deployed will only further extend the investment period.
- The types of companies that will be invested in.It’s all well and good saying what types of companies the manager ‘hopes’ to invest in, but really advisers should know what is likely to be in a portfolio when they are investing. The longer it takes to deploy funds, the less likely you are to know this fairly important information.
Of course, speed of deployment shouldn’t be to the detriment of the quality of investment opportunities but working with a manager with confidence in their dealflow pipeline is important.
Secondly, what about the fee levels?How does the manager make their money? Do they charge the investee company a fee? Do they charge the investor a fee?
Companies seeking funding will expect to pay for funding and the more savvy entrepreneurs will have built a cost of finance in to their business model at the outset, whether that is bank finance of venture capital.
These fees should still be disclosed to the adviser/investor to ensure there is understanding about how fees are paid and why.
We don’t see the need to charge both the investor and investee company, and by not charging the investor fees (when introduced via an authorised and regulated financial adviser), and disclosing what we charge investee companies, we believe this is in investors’ best interests as it not only ensures they know how the manager is making money but also means 100% of their investment qualifies for tax reliefs and any growth is based on 100% of what they invested.
Thirdly, what about a performance fee hurdle rate? Most EIS propositions have a performance fee payable as a percentage of growth returned to the investor. This is designed to align the interest of the manager with the investor. The key question to ask here, is if the manager is going to start charging a performance fee above just 100% returned, is this really rewarding growth and performance? As a comparison, our hurdle rates at 120p for every 100p at EIS level and 150p for every 100p at SEIS level. We believe having relatively high hurdle rates shows our commitment to delivering real returns to investors.
Fourthly, the adviser should really be aware of the provider’s deal flow.
Where does the manager get their deals from and how do they ensure quality? This also supports the notion of speed of deployment. If a manager says it may take up to two years to deploy, does this show confidence in quality of the deal flow? Having good deal flow is a vital component of any quality manager so knowing how they source deals is vitally important. As an example: recently one of our peers appears to have tried to source deal flow by simply issuing terms to our investee companies. We take this as a great compliment for the quality of our deals but it doesn’t exactly speak volumes for the quality of their own dealflow pipeline.
Finally, what about that all-important sector experience?
Post-Budget we are already seeing a number of industry peers suddenly marketing themselves as experts in ‘tech’ or ‘life sciences’. If a manager has spent the past years specialising in ‘capital preservation’ focused EIS and now miraculously is purporting to be an expert in high-growth sectors such as tech and, particularly the niche world of life sciences, then perhaps they are not the right manager to be looking after your clients’ money. We whole heartedly advocate the use of sector focused managers and suggest advisers should really look at those managers who know their sector inside out. For example, we wouldn’t touch an infrastructure project, a pub or a film scheme but if an investor is looking for a tech or life sciences investment proposition then we are the experts.
The Budget announcement has clearly changed the playing field in the EIS/SEIS sector and some providers/managers are playing catch-up and having to shift away from what they’ve done since they were established. It’s therefore important advisers question the manager’s credentials, their experience, their track-record and their expertise to enable them to adhere to the real spirit of EIS.
Andrew Aldridge is Partner, Head of Marketing at Deepbridge Capital