EIS guide

43 CHARGES AND PRACTICALITIES Investment objectives EIS funds have historically (and very broadly) been placed into two categories: ‘Capital Preservation’ and ‘Growth’ (with some funds offering a hybrid of the two). As the name suggests, funds with a Capital Preservation objective would aim to be lower- risk than those with a Growth objective and would therefore target lower levels of return. Following the Patient Capital Review, which took place during 2017, and legislation EIS PORTFOLIO EXAMPLE £10,000 investment split equally across 10 companies (Net cost of investment after initial EIS income tax relief = £7,000) One company performs very well and quadruples its value £4,000 Two companies perform reasonably well and double their value £4,000 Three companies return the money invested £3,000 Four companies fail completely and the investment is worthless – loss relief can be claimed on the £4,000 invested Assuming the investor is a 45% taxpayer, loss relief amounts to £1,260 Total return to investor is £12,260 excluding income tax relief Assumes all investments held for relevant 3-year period and no income tax relief is withdrawn announced at the Autumn Budget 2017, investments with a Capital Preservation strategy no longer qualify post enactment of the Finance Bill 2018, which came into force for investments made on or after 15 March 2018. From this point, all EIS funds are expected to have a Growth strategy - with some offers targeting high growth (particularly in the technology/science sectors) and others perhaps targeting more modest growth. Growth objectives will also be impacted by levels of diversification within a fund, with most funds investing in a range of underlying small, high-growth businesses and acknowledging that, while some may provide outstanding returns, others may fail. (This is where combining a portfolio strategy with loss relief is very effective). Popular sectors include high-tech firms, retail and general enterprise and it could be argued that these funds are closer to the ‘true spirit’ of EIS. Typical target returns Some funds quote specific target levels of return. Some providers do not publish a specific target return. However, they will usually give an indication of the growth they are seeking to achieve, whether this is 1.5x, 2x (net of fees) or more. (2x (net of fees) is the current average target return). Some of the former Capital Preservation strategies did not target a specific return at all and were, therefore, largely relying on the tax relief to generate value for the investor. This is one of the reasons the government and HMRC were keen to refocus EIS and the wider Venture Capital Tax Reliefs, following the Patient Capital Review in 2017. While the overall risk profile of EIS investments has gone up as a result of the changes announced in the 2017 Autumn Budget, the risk profiles of the offerings still vary. Returns must be placed in the context of the risk, liquidity and level of charges when choosing the most suitable fund for a client. Typical charges Meaningful comparisons between different EIS fund charging structures can be challenging. Funds typically charge: • An initial fee; • An AMC (Annual Management Charge); • A performance fee charged either annually or upon exit, usually subject to exceeding a certain hurdle. Fees are usually charged on the investment amount rather than the value of the investment at the time of the fee. For example, the AMC is often charged on the initial investment sum, even if the value of the investment has decreased. Tax relief is only available on the amount invested in the underlying EIS-qualifying companies. Any fees deducted from the initial subscription amount will reduce the amount actually invested and therefore the value of the tax reliefs. Example: After professional advice Brian invests £100,000 in EIS-qualifying shares. The initial charge from the EIS fund manager is 2% of the gross investment amount = £2,000 Brian has also agreed an adviser fee of 2% of the gross investment amount, which the EIS fund manager has agreed to facilitate from the investment = £2,000 The EIS manager also charges an AMC of 2% of the investment amount and for this offering it takes three years AMC upfront = £6,000 This leaves £90,000 for actual investment into EIS-qualifying companies. Consequently, instead of being able to claim £30,000 income tax relief on the investment (30% x £100,000), Brian can only claim £27,000 income tax relief (30% x £90,000). Other fees to look out for are dealing fees, administration fees, exit fees and fees charged to the underlying investee companies. Low fees in one area may offset higher fees in another, so, when comparing charges, it is important to look at them in total and not to just compare individual fees on different products. It is also necessary to consider the impact of fees charged to investee companies (often the case where there is no fee to the investors) on their ultimate performance. INITIAL FEE 0.35%-10% of the investment amount AMC 0%-4.75% PERFORMANCE FEE 0%-30% of profits above a certain hurdle ANNUAL ADMIN CHARGES 0%-0.5% of the value of the investment MIN. SUBSCRIPTIONS £10,000 to £100,000 MOST COMMONLY APPLIED FEES AND ENTRY LEVELS SOURCE: MICAP (AT SEPTEMBER 2019) Charges and practicalities