More Risk, More Rewards, More Responsibility

With a renewed focus on growth within EIS, advisers are having to deal with more risk and are increasingly getting under the bonnet of investments.

There is no such thing as a risk-free investment and HM Revenue & Customs (HMRC) was keen to hammer this point home when it changed the rules around EIS to refocus the industry back onto growth companies and ensure tax relief was encouraging investment into UK plc.

This has meant an end to the capital preservation strategies used by some providers that enabled investors to benefit from generous tax relief but also reduce how much risk they took with their money - not exactly within the spirit of EIS.

There are some in the industry reviewing their investment portfolios, but advisers will also have some work to do in educating clients about the changes, and the fact that their EIS investments will carry greater risk.

Speaking at a GB Investments Magazine round table, Dan Perkins, Managing Director at Great Point Investments, which invests in the media and entertainment industry, says one of the key protections afforded to investors by EIS and SEIS qualifying investments is that of share loss relief.

Loss relief allows investors to offset a loss made on an EIS or SEIS qualifying company against their capital gains tax bill or their income tax bill, whichever suits them better.

‘I think share loss relief is a huge benefit of investing via EIS or SEIS when compared to other tax efficient structures out there such as VCT, especially when investing in high risk, early stage businesses,’ he says.

‘If you’re focused on growth, which everything should be now, then you’re going to get businesses that lose. When that happens, you want share loss relief to be available to protect your downside whilst enjoying tax free upside on the ones that win.’

Tony Catt, Compliance Consultant at TC Compliance Services, says as an EIS matures there should be better statistics available for advisers to use to put losses and successes into context for their clients. This means clients can gain a more rounded picture of their investment, and better understand that in a growth-focused portfolio, some of the investments will fail.

‘As the funds mature you should have better statistics available about the failures and successes that have occurred in the fund, so you should be getting a much better picture of where you are, why a particular company in the portfolio has failed, and what support processes were in place that it didn’t take advantage of,’ he said.

‘All of these things are helpful as the EIS market matures.’

Catt adds that there will always be ‘good and bad stories’ but greater transparency within the fund means at least clients ‘get the reasons behind those’.

‘You can produce statistics about whether EIS-based companies fail, especially compared to those that didn’t have EIS investment,’ says Catt.

‘Then, advisers can tell that the company that’s in an EIS has a greater chance of success, which is a great thing to tell their clients. That’s something tangible they can use as a selling point.’

THE NEED FOR INFORMATION

While these statistics are certainly beneficial for advisers, and their clients, getting hold of the information may not be that easy, and smaller oneman-band advisers may find they do not have the time to chase up every fund, forcing them to use an outside source. Even information from external sources can be lacking, however; Fabian Bullen, Senior Partner at wealth management firm St James’s Place, says: ‘We have people that provide us with all the background information but that doesn’t necessarily mean that we’re in the best position to determine whether we have the right information for a client portfolio or not.

‘Sometimes the information is still a bit too scant, and we can’t ascertain whether it will be a useful deal.’

Andrew Aldridge, Head of Marketing at EIS provider Deepbridge Capital, says external independent reviews ‘are a lot better than they were a few years ago’.

‘They have much more relevant information, so hopefully advisers have better tools to do the job,’ he says.

This sentiment was echoed by Daniel Rodwell, Chief Executive of GrowthInvest, a platform which allows advisers to access alternative investments for their clients.

‘There are an increasing number of advisers we work with that are comfortable with the type of work we’re doing,’ he says. ‘Also, the client is taking a bit more risk in this new world.’

There is greater engagement from clients and also from advisers, who have significantly improved their due diligence processes when looking at EIS; grilling providers on the companies they invest in and their own governance.

Dan Perkins, Managing Director at Great Point Investments, says ‘due diligence processes have significantly improved’.

‘A lot of the questions included in the due diligence questionnaires we complete for our products now focus on investment process and governance issues to ensure your strategy is robust and gives the fund the best possible chance of success,’ he says.

‘For us, even as a small business, our biggest clients now expect us to have near institutional levels of governance.’

UNDERNEATH THE BONNET

Once upon a time, tax-efficient investments may have been secret portfolios full of niche companies, but this is no longer the case and funds are increasingly bringing advisers and clients into direct contact with underlying investment companies.

Perkins says that ‘people are interested in what the business is, what it’s doing, and how it’s performing’.

‘All of that is actually very important to the investor and the adviser,’ he says. ‘Having moved into the venture capital space in the past 18 months and made our first investments, it has been interesting to hear from advisers how keen they are to have access to the underlying businesses and entrepreneurs we are supporting with their clients’ capital. Transparency in everything we do is paramount to us and can only be a good thing for the industry as a whole.’

Aldridge agrees that ‘our advisers find it invaluable to meet the underlying businesses’.

‘Because EIS investments are only a small part of what they do, to understand what we’re investing in and the kind of people behind it, is key,’ he says.

‘It’s also about who they are and what their motivations and ambitions are. Having the advisers and investors meeting the entrepreneurs gives them a large degree of comfort.’

Aldridge says Deepbridge funds have invested in a total of 112 companies, including one called Sky Medical that creates medical technology called the ‘Geko’ device, which helps deal with deep vein thrombosis (DVT).

He said as this is an understandable medical issue, clients are willing to buy into it.

‘DVT was one of the largest preventable causes of death in UK hospitals and the western world. This device stimulates a nerve, making the muscles contract and release to pump blood,’ he says.

‘Since we initially became involved with Sky, the Geko is now being utilised in hospitals throughout the NHS. It is a company that went from a great idea to an internationally distributed product.’

Clients are sold on the idea of the Geko because it is a straightforward idea ‘people buy into it because they know what DVT is’, says Aldridge.

People also buy into other people, and meeting the teams behind companies gives EIS fund managers, investors and advisers a good idea of whether they want to hand over their cash.

Aldridge says it is a ‘personality thing’.

‘It’s about making sure you can do business with them,’ he said. ‘You need to get on well with them. The personality test is key.’

GETTING ON BOARD

Personality is certainly key for EIS managers as they are typically far more involved in their investments than a normal fund, often putting their own staff on boards, and offering help outside of the realms of a financial arrangement.

Aldridge says Deepbridge is ‘extremely proactive with our companies’ and ‘we work with them handin-glove’.

‘We might be in daily contact with them if there’s a big project going on, and we work with them across the team as well,’ he says.

‘A lot of our companies will also want particular people on our board, with their insights and opinions. Also, we want to hit key milestones before we do things, which gives a little bit more control.’

Deepbridge provides a ‘suite of services’ to companies it invests in and works with them over a range of areas depending on where a company’s strengths and weaknesses lie.

‘They might need someone to help out with marketing, or product design, whatever it might be we can help them with the biggest things,’ says Aldridge.

‘Often what they need help with is global exports, so we need someone from our board who understands that.’

Going back to the example of Sky Medical, Aldridge says the company has gone through the US Food and Drugs Administration process in order to gain approval and ‘that the company has learnt from how it’s done, and now other companies that we’re involved with can go through that process a lot quicker’.

Through this skills exchange, managers build up a set of skills that can benefit more companies and a network of contacts that can help one another, ultimately boosting future company successes.

Great Point’s Perkins says looking at the bigger portfolio picture is an important part of what managers do.

‘Taking a step back and looking at how a company will fit in with your wider portfolio is key,’ he says.

‘When constructing a portfolio you are also building a network of investee companies that in future may be able to help each other grow and succeed. For us this is an important part of the fund manager’s role, as well as picking the best companies in your chosen sector of course!’