EIS Industry Report 2019/20

22 23 Under an AIF, an authorised person must carry out an “appropriateness test”, which is a lower threshold than the suitability test required under discretionary portfolio services. Although discretionary portfolio services offer clients greater protection, they also have more onerous requirements attached to them, which may account for the shift. A discretionary portfolio service must conduct suitability tests on the investors, which is a laborious task as the manager needs to understand a client’s financial background and needs. While the tests appear to be more straightforward for AIF managers, the EU directive which created them in 2013 8 requires AIF managers to: • Monitor the liquidity risk of the AIF • Use appropriate liquidity management systems for the AIFs they operate • Conduct regular stress tests under normal and exceptional liquidity conditions • Ensure that the investment strategy, liquidity policy and redemption strategy of each AIF are aligned Therefore, there remain a number of requirements attached to AIFs - although it may be that many of these are carried out as part of good management by investment managers anyway, and as a result the lower ‘appropriateness’ threshold is swinging managers in favour of AIFs. Fees and Charges Although there are a number of different fees and charges that will be applied by different managers, we have chosen to focus here on two common ones that have seen the most notable changes in the past year. AMC The overall average annual management charge (AMC) has risen from 1.3% in 2018 to 1.7% in September 2019. However, what is particularly notable here is the increase in the AMC charged to the investee company, which has doubled, from 0.6% to 1.2%. While charges to the investee company will not directly affect the investor, the companies themselves will receive less fundraising and therefore it will impact the overall investment, pushing up its risk profile. INITIAL CHARGE Similar to the AMC, there is a significant trend towards increasing the initial charge for the investee company. While in October 2018 the average initial charge for the investee company was 1.5%, that had risen to 2.6% in September 2019. At the same time, the initial charge to the investor dropped by only 0.07% to 1%. It appears that fund managers are increasingly focusing their charges on the investee companies instead of the investors, perhaps in recognition that the increased risk being taken on by investors as a result of the rule changes requires a greater incentive to bring them into the market. It’s worth noting that, whoever the fees are charged to, the combined value of these two most commonly charged fees has increased fairly substantially. This perhaps reflects a world where more risk (with the possibility of higher returns) requires more work from investment managers and, with greater chances of failure, managers are looking to take more fees upfront and on an annual basis, while they can. MEDIA & ENTERTAINMENT FOCUS A LOOK THROUGH THE VIEWFINDER AT THE SECTOR’S FUTURE AMC INITIAL CHARGE 10 8 6 4 2 5 4 3 2 1 0 0 AMC (TOTAL) AMC (INVESTOR) AMC (INVESTEE) INITIAL CHARGE (TOTAL) INITIAL CHARGE (INVESTOR) INITIAL CHARGE (INVESTEE) Average Median Max Average Median Max There has been a clear and continued fall in the use of EIS in the Media & Entertainment sector since the the risk to capital rules came into force. When the new risk to capital rules came into force, there was a feeling that this would be the death knell for the scheme’s investment into the film and media sector. Due to the way that many companies in this area structured their offers - companies established for a single production venture with pre-agreed sales, a clear exit route and no long-term growth plan - it was assumed that the need for every pound invested to be at risk and for there to be a focus on long-term growth would not be met. We concluded in our last report that investing in film had become significantly restricted, due to the sector’s project-based nature. While this remains true, there are some signs that the industry is adapting. On the one hand, HMRC has been making relatively positive noises towards the film and media industry since the rule changes were brought in, not least through its support in the background for the British Film Institute-backed UK Creative Content EIS Fund. And in its guidance, HMRC gave an example of a film company that would qualify for EIS investment under the new rules (see our 2018/19 EIS Industry Report). However, a number of those working in the sector have suggested to us that “HMRC is making life difficult”, despite its public pronouncements that it is not deliberately attacking a successful British industry. Part of this comes back to the subjective nature of the new rules and how HMRC is choosing to interpret them. The list of risk factors that may suggest a company is not eligible for EIS funding is not exhaustive, while the existence of one or more of those factors does not immediately bar a company from EIS funding. Therefore, it is perhaps not surprising to see some getting advance assurance, while others have failed. THE FALL OF MEDIA & ENTERTAINMENT 40% 30% 20% 10% 0% 2017 2018 2019 THE RISK TO CAPITAL CONDITION HMRC’s non-exhaustive list: • Increasing number of employees or turnover indicates a growing company • Sources of income: securing a future source of income does not rule out EIS investment, but the investor’s capital must be “significantly at risk” • Money invested in assets created or purchased by the company must be used in that company’s trade, not something that is expected to be sold on • Where an investee company subcontracts all or most of its activities to others, this may indicate capital preservation activity • The expectation is that the company is managed by genuine entrepreneurs, with a long-term view to its growth and development • Many capital preservation investment opportunities are marketed as short-term investments with low risk and good returns and, by itself, the content of such marketing material is likely to indicate that a capital preservation activity is intended • Where a company is carrying out an activity that is closely aligned with that of another company, for example the same activity but in a different geographical area, this may indicate capital preservation % of all open offers Market Update / Sector Analysis SOURCE: MICAP