WE NEED TO TALK ABOUT RISKS James Faulkner is a Director at Vala Capital and has responsibility for the experience of investors and their advisers. James has enjoyed a successful career in sales and marketing for over 30 years primarily within financial services with PwC, ABN Amro and Dun & Bradstreet but with spells in manufacturing and consulting too. James is a Chartered Member of the CISI and holds the Level 4 Investment Advice Diploma. In this article he discusses how to build your clients’ confidence in EIS by helping them understand the risks involved.
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here is no getting around the fact that investing into companies that qualify for the Enterprise Investment Scheme is risky. After all, EIS tax reliefs exist solely to incentivise risk-taking. But it’s also true that risks can seem more severe to clients who do not fully understand them. By demystifying EIS risks for your clients, and by showing them how EIS fund managers try to mitigate risk, you can help them to feel more confident about investing. Some general risk mitigation themes, like diversification and due diligence, are familiar but worth thinking about in more detail. And all sorts of other factors, including the manager’s experience, their approach to mentoring and even the product’s fee structure can have a bearing on risks. This article sets out some of the risk issues you might have thought of before, alongside some that you may not have previously considered. Investing in an EIS fund rather than a single company is the simplest way to manage risk. At the most basic level, this is just about spreading investment across a portfolio, so that you’re not putting all a client’s eggs in one basket. But diversification can work on a number
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GB Investment Magazine · April 2020
of other levels too. Some EIS products seek to diversify a client’s subscription across a number of different industry sectors. This means that if a certain industry is hit hard by economic issues, evolving consumer trends or regulatory changes, it shouldn’t affect the investor’s entire portfolio. At Vala, we tend to invest in the sectors that we know best. And because our investment committee members have a broad range of experience, that means our portfolio is diversified across sectors including technology, engineering, fintech, media & entertainment, lifestyle brands and food & beverages. Further diversification can be achieved by investing in companies that are at different stages of development. Investing in a company that has not yet sold its product to any customers brings higher risks, but it could also eventually yield higher returns when compared to investing in more mature businesses. Companies that are already generating sales revenues command higher share prices at the point of investment, so the later investors will generally achieve a lower exit multiple than the pre-revenue investors. At Vala, our preference is to invest in companies that have already generated at least some revenues. But to maintain the right balance
