EIS Industry Report 2019/20

44 45 “At the moment we are seeing the market flooded with EIS fund offers.” — KEVIN WILKS, FINANCIAL RESOLUTIONS Market Research / Adviser Roundtable CC: We have been introduced to some interesting providers in the market, some of whom we are working with, having previously used certain providers before the Patient Capital Review, as they could structure asset-backed opportunities. We look for providers with longevity and experience in the market, which is key, as dealing with HMRC and gaining EIS3s is important and can be problematic under the principles-based regime. We used to look at a three to five-year strategy, anticipating maturities from a diversified portfolio of EISs with possible exits in year four onwards, with the plan being to have a number of maturities every tax year, which can then be reinvested and gain further tax relief. We will map out for clients when their EISs are due to exit, but these can, and do, change and evolve according to the underlying businesses. Now, that is a five to seven-year strategy. Do you still feel comfortable recommending EIS offers and how would you compare them as an offering to VCTs? CC: Absolutely. A lot of our clients have been used to getting tax relief and, while cognisant of the risk, are still very interested. We analyse the risk profile on the basis of the client being able to bear 100% of the loss, i.e. with no downside protection as we assume it could fail to qualify as an EIS. If they do not have the capacity for loss at this level, we do not transact. I have seen some large losses with VCTs and one of the key differences is that you have no control over the underlying assets. We are not doing so much VCT work at the moment, because clients view the potential growth as being lower, with no downside protection. We do consider VCTs for retirees to gain the tax-free income, but VCTs are not IHT effective whereas EISs are, so it also depends on the longer term objectives. RM: If we feel that EIS is a suitable recommendation, we will include a strong and honest discussion with the client on what to expect, but also the impact on them if there were a complete loss. That conversation helps the client to focus on the bigger picture and recognise it is not just about the tax incentives. If they are happy and we are happy after this, then we are comfortable to recommend an investment. When comparing products, it comes back to what is appropriate for the client and what that client is looking for - for example, growth, income, or mitigating an inheritance tax liability. KW: I do feel comfortable in general - although only once I have carried out the due diligence with a fine toothcomb. I prefer EIS because I’m usually looking for an IHT liability relief for most clients and you can achieve that well with EIS, plus I prefer the three-year timeframe for income tax relief retention. I would look to use VCTs potentially if there was no IHT liability issue for high income seekers. At the moment we are seeing the market flooded with EIS fund offers, but I have found that the quality offerings normally rise to the top. NT: I do feel comfortable in recommending EIS offers for the right client. For me the decision as to whether to advise a client to opt for a VCT or EIS investment is only partly driven by the respective tax advantages that the two structures have, but more importantly to ensure that the underlying investments are suitable for the client’s broader circumstances. Whilst the tax advantages of EIS and VCT schemes are in themselves attractive, they are by no means sufficient justification to prompt a client investment. We are seeing more start-up providers coming into this space with targeted investment propositions. These have proved useful for investors with a higher risk appetite for whom the tax benefits are a nice addition rather than a significant driver. What has the reaction been to the various macro economic impacts, such as the uncertainty of recent years caused by the unresolved Brexit position? RM: While we understand the risks, the people we have introduced EIS to have not had a lot of negativity around the macro-economic impacts. It is about drowning out the background noise when looking at any kind of investment. The way most EIS providers operate means the investment is effectively phased into portfolio companies over 12-18 months, so what the macro economic issues might be by the time the final investment is made could be very different from when the initial investment is made. There is always something going on in the world that will have an impact and at least we are aware in advance of ‘Brexit risks’. NT: Investment performance has hitherto been strong, despite various potential headwinds, including Brexit. At this specific point in the currency cycle and the economic cycle there is a significant attraction to investing in early stage UK businesses with a lengthy prospective time horizon. KW: A lot of investee companies target a high proportion of income from international sales. I like that because it provides a support for risks that might impact the UK. Also, the fact that there is no fluctuating market price - unlike on a listed market - can be favourable for clients, because certain events could cause general market falls, which will inevitably make investors nervous. But if the companies are not on a listed exchange, investors don’t see these fluctuations in value in the same way. It is partly about educating investors that the important thing is what the investment will be worth at the end of the journey, not in the middle of it. Some of the popular EIS sectors and business themes will also be able to ride any general market volatility. For example, tech companies that supply groundbreaking products or services that are always likely to be in demand, should be able to ride out almost any macro- economic conditions. CC: Most of our clients are lawyers and accountants who are dealing with these issues day-to-day. My job is to find the best tax planning opportunities for our clients. When we find what we believe to be good opportunities, we then use the specific skills of our clients to look at a proposition and pick it apart from their point of view using the Information Memorandum. In this way, we have the best lawyers and accountants applying their skills to analyse the proposition. We have clients who have the skills to do the due diligence on most offers, so we use them to come to a decision. What do you look for in an EIS offer? KW: I look for four key things. One, a decent track record by the EIS fund provider, but also the previous track record of the entrepreneur running such funds, so that I can look back over 10-20 years and establish their specialisms in the sectors that they promote within their fund. Two, I look to see if the fund managers and investee company founders invest themselves so that they have ‘skin in the game’, with their interests aligned with investors. Thirdly, I look at the charges and I always want to hear the explanation for why they make charges to the investor rather than the investee companies. I want to see how that translates to the targeted return at the end of the journey. Finally, I look for a cohesive exit strategy from the start of the investment, so that when we recommend an EIS fund, we have a fair idea of how and when the manager is looking to exit each constituent investee company. NT: Due diligence is essential in ensuring an EIS scheme is appropriate for a client. I analyse, amongst other areas, the investment experience and track record of the management team, the fundamentals of the company or companies in question, the fee levels, and the experience of the management in controlling a company along EIS guidelines. It is critical to understand the investment process and risk management tools of the management company in question. I would refer to Allenbridge or MICAP reports to supplement the due diligence that we carry out in-house. CC: We are generally looking for the most robust underlying proposition we can find. At the moment, we are looking for tertiary raises rather than brand new investments. With these, you can see a track record of things like good management within the company and most importantly, progression on the income generation, as well as EIS3s having been issued in previous years. We invested clients in a Series D raise with an EIS recently, which we have never seen before, so that was attractive in terms of reducing the risk, which we do whenever possible. These are investments in companies that may be looking to go global, rather than just starting the business. That has created some interesting prospects and these are not often found in the general retail market. RM: Generally, the starting point is looking at the more established providers, especially those with an independent review. As a small company we do our own research, but independent reviews are a great starting point to narrow down our options and are invaluable to us. These reviews go into a lot of detail that would be difficult for a firm of our size to delve. “It is about drowning out the background noise when looking at any kind of investment.” — RICHARD MEATS, TUDOR FRANKLIN INDEPENDENT FINANCIAL ADVICE Market Research / Adviser Roundtable