EIS 2018 report (web)

33 32 Respondents argued that technology- rich companies and KICs had been most acutely affected by funding issues. Clearly the government agreed, and implemented additional support for these companies. Dr Ilian Iliev, chief executive at EcoMachines Ventures, suggested that the government’s focus on supporting and encouraging investments into KICs was a positive move: “Its a direct response to the UK’s ‘scale-up’ challenge - the finding that there are simply not enough funds for Series A and B investments into knowledge intensive companies going from first revenues to scale-up/growth. So this is very welcome indeed.” 44 Iliev predicts this may lead to increased use of EIS funding for Series A or early B funding for growth companies, which he notes is much less risky than seed investment, but where the capital needs are greater. However, one question that is being asked is whether the increased annual investment limit of £2m (from £1m) per investor, will make any real difference. In reality, very few people will be able to take advantage of the extra headroom. In most instances, standard portfolio construction would suggest the ‘alternative’ nature of EIS investments, means that they should account for only up to around 10% of a portfolio. This means that, in most cases, an investor would have to have £20m in investable assets to take advantage of the extra KIC investment limit. Property consultant Knight Frank, which classifies ultra high net worth individuals (UHNWIs) as people with assets of at least $30m (£21.79m), reveals in its latest wealth report that there were 9,470 UHNWIs in the UK in 2016. Although this seems significant, this only accounts for 1.45 UHNWI per 10,000 people. 45 “EIS investments can be complex so it is vital to take the time to educate advisers, equipping them with the tools they need to competently advise clients.” — MATTHEW BUGDEN, INGENIOUS “These types of tax efficient investments are particularly high risk and will almost certainly not be suitable for all investors, even those who might be higher earners.” — MARY TIERNEY, BENNETT BROOKS UK UHNWIs 2016 SOURCE: KNIGHT FRANK Of course, the tag of sophisticated investor, which generally applies to HNWIs, may well mean that their portfolio strategy is governed more by their own experience and expertise, than by accepted vanilla criteria. Under these circumstances, the additional £1m investment allowance may well generate extra funding for some KICs. IS SEIS OVERVALUED? The status of the SEIS scheme came out of the Chancellor’s Autumn budget relatively unscathed. However, the scheme received somewhat mixed feedback during the PCR consultation. It is widely agreed that SEIS has led to a surge of new business creation. Nevertheless, there has been criticism that the generosity of the tax breaks involved with SEIS have inflated the valuations of some of these companies. Kealan Doyle, CEO at Symvan Capital, said: “Given that a lot of these startups at this level are financed by friends and family, it would not be too surprising if the valuations were not at a level that a fund manager like Symvan would entertain. However, this becomes a problem for future financings if these companies become successful.” 46 Nevertheless, it’s worth noting that HMRC’s latest fundraising statistics indicate that SEIS only saw modest increases of investment of £0.5m in 2015-16, vs the previous year. This suggests that the criticism of the scheme may be unwarranted. It will be interesting to see what the future holds for SEIS in terms of demand: Before the recent changes, SEIS could be seen as the riskier cousin of EIS as it typically focused on earlier stage investments, hence the greater tax benefits on offer. But now, with the increasing risk profile of EIS, could the higher level of tax relief available through SEIS attract more investors who now feel that the comparable risk profiles are much more similar? And could this be a mechanism for driving up SEIS valuations, bearing in mind the much lower investment limits and therefore, available capacity? ADVANCE ASSURANCE CHALLENGES One interesting aspect of the new Advance Assurance conditions is that, as of 2 January 2018, HMRC does not provide Advance Assurance on speculative applications. The company is required to have approached potential investors, and name the individuals, fund managers and other promoters who are expected to invest. This requirement generates some potential outcomes: Smaller firms could be put off from applying for Advance Assurance, as the bar is being raised as to what they need to prove regarding their company. The bar has already been raised - the 2015 changes required much more paperwork, stipulating requirements such as a business plan and growth plan. The 2017 changes already add the requirement of proving the necessary risk profile. The question is - will this narrow the field of attractive EIS investments (bearing in mind Advance Assurance is not compulsory)? There is a possibility that this could lead to less choice and diversification in the market. On the other hand, advisers and managers may well have greater confidence in any company that receives Advance Assurance, because as well as confirming that it qualifies for EIS, Advance Assurance will now also give a good indication of genuine investor interest. SUITABILITY AND APPROPRIATENESS With the additional risk level of EIS present after the Autumn budget, the question over whether the scheme is suitable for retail investors comes to the forefront. As discussed later in this report in our adviser roundtable discussion (p.46), most advisers see the scheme as only being suitable for high net worth individuals (HNWIs). Adrian Lowcock, Investment Director at Architas, said: “EIS is really more suitable for HNWIs who have used their ISA allowances, who have used their SIPP allowances, have a very diversified portfolio and are willing to take on a much higher level of risk - so this really isn’t for everyone. One of the criticisms of EIS is that it’s very much for HNWIs.” 47 It’s paramount that advisers position the risks of EIS to investors, as the scheme may even be risky for higher earners. On the other hand, the scheme can act as a mechanism for diversification away frommainstream asset classes. There has certainly been an increased demand from investors for allocations towards alternatives in their portfolios - and the EIS scheme has that extra incentive in the form of tax relief. Mary Tierney, tax director at Bennett Brooks, noted: “These types of tax efficient investments are particularly high risk and will almost certainly not be suitable for all investors, even those who might be higher earners. An adviser should know which of their clients can afford to take the increased risk or not. “While both SEIS and EIS are very valuable tax reliefs and quite rightly encourage investment to help developing companies grow, they come with a huge amount of detailed legislation and (sometimes vague) HMRC guidance, and so while they are to be encouraged, both companies and individuals need to take detailed advice from advisers who have a good and deep knowledge of both schemes.” 48 We can assume that those advisers who recommend EIS frequently, have that kind of knowledge. Since our adviser survey shows that, before the changes, almost half felt that EIS was suitable for retail investors, they are the ones most likely to have the know-how and confidence to continue to recommend EIS investments to that demographic. And there are certainly some schools of thought that, within the right overall mix of investments and at the right proportion, EIS may continue to present useful opportunities for non-HNWIs and sophisticated investors: Tom Hopkins, partner at Kin Capital, noted that, if the allocation in a portfolio is small, the upside potential is worth the risks that are present in EIS: “Increasingly, investors are looking at alternative assets to generate the required growth kicker in the portfolio so why not do it in an attractive tax wrapper? “The risk / return nature of the sector should not be ignored and the suitability procedure for recommending these funds can be onerous, but we seem to be in an exciting time of technical innovation and growth, and the recent announcements will only stimulate returns further. “Furthermore, a small allocation of an overall portfolio is unlikely to have much impact on the downside given the tax reliefs available yet could potentially provide the necessary upside for a portfolio.” 49 WHERE THE SCHEME COMES INTO ITS OWN Although investors have to be mindful of the risk profile of EIS, there are certainly use cases where the scheme is very beneficial. Three significant applications include: A replacement for reduced pensions tax reliefs Mitigating Capital Gains Tax (CGT) Managing inheritance tax (IHT) Pension savers have seen HMRC reduce the annual allowance on pensions contributions from a generous £255,000 in the 2010/2011 tax year to £40,000 in 2017/2018, while the highest earners are now restricted to tax relief on contributions of just £10,000. The lifetime allowance has also been reduced from £1.8m in 2010/11 to £1m in this tax year (rising to £1.03m next tax year). TOTAL POPULATION (M) UK GDP (US$bn) UHNWIs PER 10,000 PEOPLE UHNWIs ($30m+) 65 2,849 1,45 9,470