EIS Industry Report 2018/19

42 43 Veteran EIS investors need to change their attitude Investors who previously opted for EIS opportunities that were focused on capital preservation will need to change their expectations, given the change in legislation announced in the 2017 Budget, and affected in the Finance Act 2018. The government’s push for EIS to focus on growth came from the 2015 Budget, with changes announced in order to bring the Venture Capital Schemes into line with EU regulations and ensure they continued to receive state aid approval. 39 In response to the HM Treasury consultation, Financing Growth in Innovative Firms, evidence was provided suggesting that £467m of investment by EIS funds in 2016-17 (62%) was focussed on capital preservation. 40 At the time of the 2017 Budget, based upon our data, just 22% of open EIS offers still incorporated capital preservation in their strategies. As we have mentioned, EIS investments are certainly risky. The rationale for the tax relief is to encourage people to invest in these fledgeling companies that wouldn’t be otherwise able to obtain investment. Although income tax relief and loss relief is available to cushion the blow, investors should be prepared to lose a significant amount of their capital. The new risk-to-capital condition that was set out in the 2017 Budget (and in force for all EIS investments made on or after 15 March 2018) shifts the focus to companies with arguably an even higher risk profile; ones that are unlikely to have secure sources of income, significant levels of assets, or are subcontracting to external specialists. 42 SOME INVESTMENTS WILL FAIL “Last year, a major area of concern was the re- emergence of the equity gap for scaling firms. Over the course of 2017, our fears have been eased: investment into venture-stage firms has increased significantly. Moreover, this is a trend that we think is likely to continue, partly thanks to the Chancellor’s decision to double the limit for tax relief on EIS investment.” 41 — TOBY AUSTIN, CEO AND CO-FOUNDER, BEAUHURST WHAT ARE THE RISKS? EIS MANAGERS CHANGING FOCUS What do new offers look like Since the 2017 Autumn Budget, our data suggests that 17 new EIS offers have been launched, accounting for 31.5% of the mainstream market. Of these new offers, nine are ones that have pivoted into new strategies to comply with the new rules. These offers come from some of the large investment managers, such as Ingenious and Blackfinch. Only 16.7% of the EIS market is made up of pivoted offers. It’s worth noting that some managers are in the process of pivoting their offers. These will be launched in the coming months as we head into the main ‘season’ of tax-efficient investing which culminates in the tax year end. Outside of pivoted offers, there were eight new entrants into the market. Why investors should diversify Investors should naturally expect some of their EIS investments to fail in their portfolio. Because of this, the more that investors can diversify, the better. Investors should anticipate around a third of investee companies to fail. However, if the portfolio of EIS investments is well diversified, the companies that generate high returns, paired with the tax reliefs available, should mitigate any losses. Company fails Company breaks even Company doubles value You invest £10,000 You invest £10,000 You invest £10,000 You receive £3,000 in income tax relief You receive £3,000 in income tax relief You receive £3,000 in income tax relief The company goes bust and your shares are worth £0 If after 3+ years you sell your shares for £10,000, you will owe no capital gains tax on profit If after 3+ years you sell your shares for £20,000, you will owe no capital gains tax on profit You receive loss relief equal to your remaining at-risk capital mul- tiplied by your income tax rate* Your total gain is £3,000 (£0 profit from the sale plus £3,000 income tax relief) Your total gain is £13,000 (£10,000 profit from the sale plus £3,000 income tax relief) *At a tax bracket of 45%, the loss relief would be £7,000 x 45% = £3,150. Therefore, for £10,000 invested, your real loss is £7,000 - £3,150 = £3,850 43 LEGACY OFFERS NEW ENTRANTS PIVOTED OFFERS 16.7% 14.8% 68.5% Considerations for Investment / The Growth Potential