Growth EIS investments for beginners – Learn everything you need to know

GROWTH EIS INVESTMENTS FOR BEGINNERS – LEARN EVERYTHING YOU NEED TO KNOW

What are EIS Investments?

Strictly speaking, there’s no such thing as an EIS investment. What you invest in are venture capital backed, early-stage unquoted company deals, and the shares you buy in these companies qualify for Enterprise Investment Scheme tax benefits.

EIS was introduced by the Government in 1994, with the aim of encouraging investments in to early-stage businesses, to help fund them to achieve growth, with a view to boosting jobs and the overall economy. EIS qualifying businesses are high risk, so the tax reliefs afforded to EIS qualifying shares are an incentive for those comfortable with the risk levels to invest.

Sometimes you may hear the term “Knowledge Intensive (KI) EIS”. A KI EIS still has the same tax benefits. However, companies that are classed as KI provide investors with an increased annual contribution allowance (£2m compared to £1m, provided at least £1m is invested in KI investments). Other differences allow KI qualifying companies to raise more EIS funding over their lifetime, and an increase in the amount they can raise per year, and over their lifetime.

What’s the difference between EIS and SEIS?

EIS and SEIS, on the face of it, look broadly similar. However, there are some significant differences. Typically, SEIS qualifying companies will be earlier stage (maximum trading age of the business is 2 years, compared to 7 years with EIS), and therefore higher risk than EIS qualifying companies. As a result of the increased risk, the income tax relief benefit is higher (50% as opposed to 30%), but the annual contribution limit is lower (£100,000 per tax year, compared to £1m for EIS and £2m for KI EIS). The amount companies can raise via SEIS is far lower too, SEIS can raise up to £150,000 in total, whereas EIS can raise £5m in one year, £12m over their lifetime, or £20m if knowledge intensive.

How to invest in start-ups

There are a few ways in which you can invest in start-ups, but the most popular are via a platform, or via a venture capital house, such as Oxford Capital, who will do the due diligence on each company, so you don’t have to. Start-up investments are high risk, so it is important that you enter into investments of this type with an understanding of what you are signing up to and do it through a company with a good track record in picking the right companies to invest in to, and who have managed to achieve successful exits. There is an ever growing number of Venture Capital firms offering EIS for the first time, and it is important to not be blinded by outlandish target returns, when they have no track record of being able to achieve them.

How do I choose an EIS?

There are currently over 50 EIS open for investment, and there a number of factors to be considered before deciding which one is most appropriate.

There are two ways Venture Capital companies can structure their EIS. The evergreen approach is what we at Oxford Capital prefer. Our EIS is open for investment 52 weeks a year. The other approach is a tranched approach, where the VC will look to raise a certain amount of money over a certain period of time, and line up a sufficient number of companies to deploy that money in to on a certain date. Typically, there are 2-3 tranches per year, with the main one being between January and March.

Each VC will invest into a different number of companies, at different stages, and in different sectors. Some will focus on a specific sector such as fintech, or renewable energy, while others will take a more sector agnostic view, to help spread the risk if a sector perhaps falls out of favour. Some VCs will invest into a concentrated portfolio of 3-5 companies, while others will invest in to 10-12, again to offer a higher degree of diversification. Some companies will invest only in to seed stage companies (typically the earliest stage of private funding) while some will only invest in series B,C, or D. These are more mature companies, where the early-stage high risk has been somewhat mitigated. However, the potential huge upside of investing into a seed stage company has also disappeared.

Timing is important too. If you need the cash deployed as soon as possible in order to receive tax reliefs, then the tranched EIS is likely the preferred route. With the evergreen approach, it can take around 12-18 months to fully deploy the capital, so although you will likely receive a decent amount of EIS tax relief in the first year, there is no guarantee that you will be fully deployed. Timing on exits is important too. An EIS that invests only in seed stage opportunities is likely to have a much longer investment lifecycle than an EIS focusing on later stage companies would have.

At Oxford Capital we take a more blended approach. We try to diversify an investors portfolio across 9-12 companies, across a variety of sectors, and across stages too. Typically, an Oxford Capital portfolio would have 3-4 seed stage companies, 5-6 series A or B, and 2-3 series C or D.

 

Estimated reading time: 2 min

 

Due to the potential for losses, the Financial Conduct Authority (FCA) considers this investment to be high risk.

What are the key risks?

  1. You could lose all the money you invest
    1. If the business you invest in fails, you are likely to lose 100% of the money you invested. Most start-up businesses fail.
  2. You are unlikely to be protected if something goes wrong
    1. Protection from the Financial Services Compensation Scheme (FSCS), in relation to claims against failed regulated firms, does not cover poor investment performance. Try the FSCS investment protection checker here.
    2. Protection from the Financial Ombudsman Service (FOS) does not cover poor investment performance. If you have a complaint against an FCA-regulated firm, FOS may be able to consider it. Learn more about FOS protection here.
  3. You won’t get your money back quickly
    1. Even if the business you invest in is successful, it may take several years to get your money back. You are unlikely to be able to sell your investment early.
    2. The most likely way to get your money back is if the business is bought by another business or lists its shares on an exchange such as the London Stock Exchange. These events are not common.
    3. If you are investing in a start-up business, you should not expect to get your money back through dividends. Start-up businesses rarely pay these.
  4. Don’t put all your eggs in one basket
    1. Putting all your money into a single business or type of investment for example, is risky. Spreading your money across different investments makes you less dependent on any one to do well.
    2. A good rule of thumb is not to invest more than 10% of your money in high-risk investments. https://www.fca.org.uk/investsmart/5-questions-ask-you-invest
  5. The value of your investment can be reduced
    1. The percentage of the business that you own will decrease if the business issues more shares. This could mean that the value of your investment reduces, depending on how much the business grows. Most start-up businesses issue multiple rounds of shares.
    2. These new shares could have additional rights that your shares don’t have, such as the right to receive a fixed dividend, which could further reduce your chances of getting a return on your investment.

 

If you are interested in learning more about how to protect yourself, visit the FCA’s website here.