EIS guide

51 RESEARCH AND DUE DILIGENCE 50 RESEARCH AND DUE DILIGENCE Evaluating the provider Always consider what could possibly go wrong with an investment offering, or events that could lead to a worse return than expected. When considering the investment provider’s experience and track record, verify that it is pertinent to the proposed underlying investments and investment strategy. Advisers must assess the investment provider. The research should cover: Their commitment to the market and level of adviser support Their investment philosophy - a provider’s particular approach to maximising returns Their relevant sector expertise and ability to adapt to changes in rules and regulations Their deal flow access and investment selection process - do they see enough of the market to get the best deals and how much consideration is given to the merits and potential of the companies? Their financial strength and stability Their track record of investment performance, exits and ensuring their investments retain EIS-qualifying status The experience of both the executive and investment teams Evaluating the investment Investment objective Portfolio strategy Anticipated returns (where stated) and gearing Expected minimum duration (where stated) Exit strategy Nature of underlying investments Sector and subsector (there is a range of general and specific EIS funds, although technology investments are a focus for nearly half of the open offers in the EIS market) Expected Deployment timescales, informed by the track record of deployment of funds Evaluating the investment INVESTMENT OBJECTIVE The proposed underlying investments, the perceived risks of the investment and the anticipated returns that can be generated should all be commensurate with the investment objective. ANTICIPATED RETURNS Advisers should assess how returns (without tax reliefs) are generated and take a view on the likelihood of those returns being achieved in different economic conditions. Some trades have a fairly well-known range of gross returns and advisers should consider if the advertised expected return of the EIS is in line with their expectations. The provider’s track record of delivering returns on previous investments should also be assessed. Some funds use gearing (borrowing money to invest), which can enhance returns but also increase downside risk and advisers need to ensure they are aware of the level of gearing the fund intends to use. EXPECTED MINIMUM DURATION AND EXIT STRATEGY There is generally no liquid, tradeable market for shares in EIS companies or independent or objective means of valuing them. Instead, while an EIS company must have no ‘pre-arranged exits’, EIS managers are likely to carefully plan for a possible exit, looking at a range of possible scenarios and outcomes, and then consider what a company would need to do in order to achieve them. Exits will often occur via a trade sale (where an acquirer buys all the company’s shares from investors, management and any other shareholders) but may be in the form of a liquidation, a buy-out or, more rarely, a stock market listing. In the vast majority of cases, this will be after the minimum three-year EIS holding period has passed. Investors may well be keen to see an exit as soon as it is commercially viable to do so after the three-year minimum holding period for the EIS tax reliefs has passed. However, target time horizons will vary and may depend on a range of factors, including the level of return being sought, the overall economic climate and the nature of the companies in which a fund manager invests. A tech start-up might require time- consuming and intensive research and development before its product or service can become commercially viable. A more mature business with a better-established product or service might reach exit sooner – though the tech start-up, if successful, may generate better returns for investors. Advisers should examine what the intended exit strategy is, when it can be reasonably achieved, and what risks exist which might delay or prevent it. Some favoured trades have a track record of exits that can be examined, along with the provider’s track record in the sector.