EIS Industry Report 2018/19

22 23 High-growth targets A year on from when the new rules were announced, we can clearly see that the vast majority of investment managers are focusing on a high-growth strategy. It’s encouraging to see that the average target return is above 2x the amount invested. Of course, this is merely a projection, and these gains may not come to fruition. In fact, the risk of these investments not making these high returns is relatively high. There are eight EIS offers in the market that have a target return of 300% or greater. Two offers are targeting a 500% return, one of them being a technology portfolio and the other a medical technology portfolio. These levels of return signify a high-growth strategy, and will very much be in line with the new risk-to- capital condition. The lowest target return for open EIS offers is 112%, which is a little over returning the investor’s capital. Considering the investment will have to be held for three years to qualify for income tax relief, this return is pretty paltry. There are five open EIS offers that are targeting a return of 120% or lower (which is less than 10% of the market). However, with target returns this low, the question must be asked as to whether these strategies are truly growth capital focused. They may be working at the fringes of the rules. Breaking down the fees Investment managers in the EIS space apply a variety of different fees. This can be somewhat of a minefield for advisers and investors, as there is no industry standard for how fees should be applied. However, in this section, we will provide analysis on the most commonly charged fees, and how they have differed from last year’s levels. Some of the following fees will be applied, regardless of performance (such as AMC and initial fee), whilst others are based on the manager’s merit (exit performance fee). TARGET RETURN OF EIS Average Mode Median Minimum Maximum 215% 200% 200% 112% 500% “Tax reliefs potentially available via EIS should be considered a bonus and should not be taken into account when considering the validity of the underlying investments. EIS investments should stack up as a credible investment opportunity, whether providing tax reliefs or not.” — KIERAN O’GORMAN, TECHNICAL PARTNER, DEEPBRIDGE CAPITAL The average total AMC (which is applied across both investors and investee companies) amounts to 1.34%. Investors tend to take the larger share of fees, with the average AMC to investors being 0.74%, as opposed to 0.6% for investee companies. The maximum AMC displays a rather significant charge. One investment manager charges a 1.75% fee to the investor and a 3% fee to the investee company, resulting in a 4.75% total AMC. Investment managers will have to justify fees as high as this. An AMC is charged annually, so there has to be proof that the investment manager is adding value to that degree. Average Mode Median Minimum Maximum 1.34% 2% 1.5% 0% 4.75% Average Mode Median Minimum Maximum 2.64% 0% 2.5% 0% 8.9% Average Mode Median Minimum Maximum 109% 100% 100% 100% 150% In the same vein as the AMC fee, an initial charge can be either applied to the investor or investee company. The average total initial fee across both investors and investee companies is 2.64%. However, in this instance, the investee company takes a larger portion of the fee burden at 1.51%. One currently open offer applies an initial charge of 8.9% on the investee company. Fees this high can put undue pressure on the amount of fundraising that investee companies can generate. However, nearly a third of open offers apply no initial charge to either the investor or the investee company. The annual management charge (AMC) is a yearly fee that is imposed my almost all of the EIS investment managers. This charge can be applied to either the investor or the investee company (and sometimes both). When looking at annual management fees, we must be mindful of the charges to investee companies, as well as to investors. Although charges to the investee company will not come directly out of the investor’s pocket, it will impact the investment as companies will receive less fundraising. This, in turn, pushes up the risk profile of the investment. In general, in order to collect a performance fee, a manager must beat the hurdle rate that they set up. The most common hurdle rate is 100%, meaning that the performance fee will be triggered when the investor’s capital is returned. Among open EIS offers, 24 managers apply a 100% hurdle rate. Higher hurdle rates are less common, and only four offers apply a hurdle rate of 130% or greater. One offer, focused on the leisure and hospitality sectors, has a hurdle rate of 150%, and a performance fee of 25%. With such high hurdle rates, it is possible that the performance fee will never be triggered. AMC INITIAL CHARGE EXIT PERFORMANCE HURDLE Market Update / Sector Analysis Market Update / Sector Analysis