EIS 2018 report (web)

31 30 CONSIDERATIONS FOR INVESTMENT NEW RULES WHAT THEY MEAN FOR INVESTORS A RE-FOCUSING ON INVESTMENT The EIS industry will understandably be relieved that the government has continued to support the scheme and preserve the tax reliefs available. There had been concerns in the run-up to the Autumn budget that the scheme would be completely abolished, albeit in a more extreme scenario. With providers having to squarely focus on growth strategies, underlying companies will have to be chosen that provide a legitimate high-growth investment case, with great potential, but uncertain prospects to match - as opposed to merely a predictable, low level return with a bigger focus on tax relief qualification. Although this inherently improves the justification for EIS, it also raises its risk profile - in a bid to return to the original purpose of supporting genuine risk capital firms. The EISA notes that the EIS scheme is about much more than generous tax breaks. However, the industry body was disappointed with the Patient Capital Review’s (PCR) lack of concentration on the investment case of EIS’ underlying investments: “The PCR focused on the issue of tax to such an extent that other considerations often seemed in danger of being completely overlooked. It was certainly our feeling that the consultation concentrated too heavily on the cost of tax relief, with no analysis of EIS’ many benefits - among them job creation, exports, revenue, the stimulation of the economy, the closing of the skills gap and the generation of wealth for investors 42 .” The government has made it patently clear that the era of using EIS as a means of enjoying tax breaks without taking on a significant amount of risk, is over. However, it’s worth noting that the majority of EIS portfolio providers have been organically moving towards this ethos, and are providing strategies that are growth oriented. This is not really surprising, given the introduction of a growth test in the 2015 budget. And many prudent managers have been including higher risk options as part of their offerings for some time. POTENTIAL FOR PIVOTING Although there has been a significant shift towards growth capital in the EIS industry, there are still some providers that exist, that are largely focused on a capital preservation strategy. According to MICAP data, nearly 22% of open offers display an element of capital preservation (as of December 2017). In order to be compliant under the new rules, these investment providers may have to pivot their strategies, depending on the overall risk associated with their offers. This comes with its own challenges. One issue is that there may be a risk of over bundling assets into companies that are eligible for the EIS scheme, as providers that are focused on capital preservation strategies attempt to pivot themselves to be compliant with the new rules. This may lead to overvaluation of these assets, with potentially a significant amount of cash being deployed over a very short time frame. It’s also worth noting that managers who only have experience of assets that are linked to capital preservation or asset backing, may have little experience in industries that are focused on growth. There are challenges that these fledgeling companies face, and many may be pre-profit or even pre-revenue. Managers who have experience of dealing with growth capital companies will often have sector specialities that will have been built up over a number of years, and this expertise will be difficult to generate overnight. EXTRA HEADROOM FOR KNOWLEDGE-INTENSIVE COMPANIES: WILL IT MAKE A DIFFERENCE? Responses to the PCR revealed that funding for knowledge intensive companies (KICs) had been lacklustre. Respondents identified two specific areas of weakness: Follow-on investment in firms that had already received initial investment, notably in the range between £5m to £10m. Early stage investment in companies outside of London in the creative industries, digital technology, and investment into university spin-outs 43 . INVESTMENT STRATEGY (% OF OFFERS) CAPITAL PRESERVATION & GROWTH GROWTH SOURCE: MICAP 78.46% 21.54%