The Enterprise Investment Scheme (EIS) is a useful tax planning tool for investors to take advantage of 5 generous tax benefits*, as well as investing in some of the brightest minds and world-changing innovations in the UK. Our CEO, Moray Wright, and FT Adviser discuss the opportunities the scheme has to offer and its increasing popularity with investors.
You can read the full article in FT Adviser here.
2024 marks the 30th anniversary of the Enterprise Investment Scheme (EIS), offering an opportune moment to reflect on the significant and ranging contribution that the scheme has made to the development of a swathe of UK start-ups. Since launching, the scheme has provided over £23 billion of investment, in the process supporting 33,000 companies to seed and scale.
EIS is designed to funnel vital capital into entrepreneurs looking to scale and grow, as well as enabling investors to get in early on potential winners whilst benefitting from considerable tax relief. In 2022, EIS funding surged and reached record highs, but with the macro-economic challenges in 2023 it is likely to have fallen since then.
However, with the much-welcomed news in November last year of the extension to the EIS sunset clause to 2035, and with the UK tax burden now at its highest level since the second world war, the scheme has definite allure for investors looking to make use of the available tax benefits just before the tax year ends.
Venture capital trust and Enterprise Investment Schemes have become increasingly popular over the past few years, with rising personal tax burdens and investors looking for growth investment outside of the main markets. There has also been an increase in the quality and variety of products available to investors, especially with the Knowledge Intensive EIS Fund structure now a mainstream EIS product, and newer entrants to the VCT market, which has traditionally been monopolised by larger fund managers.
In the Spring Budget, the government was keen to reiterate its support for the UK’s most innovative businesses, delivering several great steps forward. The EIS scheme offers a mechanism for supporting and rewarding innovation, and the greater adoption of novel technologies throughout the economy and our public institutions.
Investing in early-stage businesses
There are several core trends driving EIS investment in the UK:
- Market Recovery and Increased Activity: The recent stabilisation of interest rates has helped the market begin to recover, with activity levels increasing once more. At Parkwalk, we have seen a notable uptick having completed three deals in the past month alone. This trend signifies growing investor confidence and a fertile ground for early-stage investments
- Better Value Opportunities in Deep Tech Sectors: Across various deep tech sectors, there’s a noticeable emergence of better value opportunities. Founders, management teams, and stakeholders are displaying a more realistic approach towards valuations. This shift not only reduces initial investment risks but also positions investors for potentially higher returns as the economic cycle rebounds
- Mitigating Risks through EIS: Early-stage investing inherently carries risks, underscoring the importance of mechanisms like the EIS in the UK technology sector. By providing tax incentives and risk mitigation strategies, EIS encourages investment in innovative ventures, thereby fostering growth and competitiveness in the sector
- Economic Rebalancing and Growth: Supporting early-stage businesses is crucial for the UK’s economic rebalancing efforts and fostering sustainable growth. This investment avenue represents a vital means of diversifying the economy and generating prosperity. The broad-based support across political parties is proof of its significance as a key driver of economic vitality.
- Global Appetite for UK Tech: Anticipation of exits and liquidity events is driven by a consistent appetite among global corporates, particularly those from the US, for UK tech firms. The historic weakness of the pound in the mid-term has also served to enhance the attractiveness of UK-based tech investments, creating favourable conditions for investors seeking lucrative exit opportunities.
How to access early-stage investing: VCT vs EIS
Both VCT and the EIS can offer significant tax advantages for investors, however there are some crucial differences. With VCTs investors are usually buying into an existing portfolio, whereas with EIS, investors are the underlying shareholders in the individual companies. There are also differences in liquidity as investors in a VCT, in theory, are able to sell back their shares after the minimum holding period of 5 years via a buyback mechanism, whereas with EIS an investor is holding investments until exit, and for a minimum of a three-year period.
VCTs are also able to offer tax free dividends to investors, whereas EIS is more focused on generating capital growth – both however have no capital gains tax on any profits made by the investor.
Income tax relief at 30% is available for both EIS and VCTs, and you can choose to take the income tax relief in the year you invest or carry back to the previous tax year. This can help offset the risk normally associated with investing in early stage and higher risk companies.
Capital gains tax deferral is only available through investing in EIS and is not possible through investing in a VCT. Deferral relief can be claimed against any amount of chargeable gain arising on the disposal of any asset where the gain is invested in EIS shares.
Loss relief is one of the key differentiators in terms of tax benefits when comparing EIS and VCTs. VCTs do not offer any loss relief to offset losses, whereas with EIS investments, should the value of EIS shares drop to nil or if the shares are sold for less than the original amount invested, loss relief is available. It allows an investor to offset a loss made on an EIS company against either their capital gains tax bill or their income tax bill, depending on which better suits their individual needs.
An EIS investor will be able to offset a loss against their income tax bill for the current and/or previous tax year. The loss is deducted from the investor’s income before income tax is calculated. The value of this relief can be worked out by multiplying the value of their effective loss by their marginal rate of income tax.
How are Knowledge Intensive EIS Funds different?
The differences between standard EIS and Knowledge Intensive EIS Fund lie within fund structure and also when tax reliefs are available. A Knowledge Intensive EIS Fund is a closed-ended fund and will have a close date, usually at the end of the tax year. Put simply, KI EIS funds and standard EIS funds differ primarily in their investment focus, eligibility criteria, and the types of companies they target.
Eligibility
For standard EIS funds, the issue of eligibility is rather broad. Companies are still required to meet criteria around their size, age and structure but they aren’t required to be involved in knowledge-intensive activities. Conversely, KI funds are more stringent, and companies looking for this type of investment need to be concerned with requirements related to innovation, intellectual property ownership, and the proportion of operating expenses spent on research and development activities. For KI funds, 80% of the portfolio needs to be in companies involved in research and development (R&D) or innovation. This usually means that there are greater operating costs and slightly more protracted development cycles as a result of their work in R&D.
Type of investment
While standard EIS funds usually invest in a variety of early-stage businesses across a number of sectors, KI funds specifically target companies engaged in activities that require a high level of knowledge or intellectual capital. These may include sectors such as technology, life sciences, engineering, or advanced manufacturing. The focus is on companies with innovative products, processes, or services that demonstrate a significant level of intellectual property. Standard EIS funds on the other hand will not necessarily require businesses to meet specific criteria related to innovation or intellectual property.
Tax benefits
Where the funds are similar however is in their tax relief. Investors in both funds can benefit from various tax incentives offered by the EIS scheme, including income tax relief, capital gains tax deferral, and exemption from capital gains tax on investments held for a certain period.
Although EIS is often a small part of an investor’s portfolio management, it can generate outsized returns that can help with overall portfolio performance.
Impact of combined EIS reliefs
Take the example of a client selling a buy-to-let property with a £100,000 gain. If invested into EIS, this gain not only results in £30,000 initial income tax relief but a deferral of the £28,000 capital gains tax (CGT) liability. This liability can be deferred indefinitely by reinvesting future proceeds back into EIS investments – gaining 30% initial tax relief on each reinvestment.
On the death of the client, the CGT is not continued. Given EIS investments are inheritance tax free (IHT), this investment has therefore potentially benefited from: 30% initial tax relief, 28% CGT and 40% IHT – a combined tax benefit of 98%.
Clearly the returns must justify the risk – and there is a risk the EIS investment fails, and the investor is left with a crystallised CGT liability (albeit with loss relief available in the year of exit). But there are few instances where an adviser is able to deliver quite such a comprehensive list of benefits.
Valuations
How EIS and VCT assets are valued is often a point of contention, with different managers using different valuation approaches and methodologies. Transparency is key, and knowing the liquidity risks when looking at the asset class for a client portfolio is essential.
The higher interest rate environment in 2023 has created difficulties for some company valuations, with slightly less risky types of investments like gilts making it hard for EIS and VCT as growth stocks to compete. The flipside to this however is that market stress can often lead to opportune conditions to invest in venture capital – often we see a stronger pipeline of experienced founders who are in control of businesses after large technology companies strip back their staff.
The scale of the opportunity from investing in Britain’s advanced technologies hasn’t gone unnoticed by venture capitalists, who have been increasingly focusing on disruptive companies. 2023 Pitchbook data showed that Quantum Computing start-ups for example secured nearly quadruple the level of funding in the UK last year compared to 2022. In the face of a challenging economic environment in 2023, young and innovative companies proved themselves capable of weathering turbulent times.
Conclusion
Crucially, the funds heading into Knowledge Intensive EIS investments are to companies looking to solve major global issues like food and water security, climate change and pervasive health challenges. EIS investing should be viewed not just in terms of financial rewards, but also the wider positive impact on society it can have, by investing in some of the brightest minds and world-changing research coming out of the UK’s university network.
The UK’s universities are recognised globally as producing some of the most cutting-edge inventions and academic successes from; DNA at Cambridge Graphene in Manchester, to Fibre Optics at Imperial College London. Technological innovations like Quantum Computing, Genomics, and Projectile Fusion are on course to change the world. But this type of deep tech or clean tech could also be game-changing for UK productivity and go on to employ tens of thousands of people in the jobs of tomorrow. This, combined with the considerable tax reliefs on offer, makes the EIS a truly unique and valuable prospect for the UK economy, start-up ecosystem, and investors alike.
Please visit the FT Adviser’s website for the full article here.
*Personal tax circumstances may differ. See our Investment Memorandum for further information. Tax reliefs accurate as at March 2024.
