EIS capital preservation schemes disqualified, and government expands Growth EIS
The EIS market is in a period of unprecedented change. Earlier this March, the ability to invest into EIS capital preservation strategies were withdrawn. Historically, over half of all EIS investments were made into these capital preservation strategies (circa £0.75billion per annum), but at the same time the government is expanding the scope of Growth EIS and is aiming to positively impact the UK economy.
The UK government is taking a carrot and stick approach and while it has disqualified EIS capital preservation strategies, it has made it very clear that it wants to encourage EIS capital to be deployed into what it terms “knowledge intensive companies,” abbreviated to KICs. The support for this style of investing is broad ranging, including the extension of the £1.0million personal EIS cap to £2.0million per annum, and increasing the amount that can be invested in a company from £5.0million to £10.0million. These are significant changes that will expand the EIS market and drive capital to be invested in innovative companies, which are often defined as KICs.
The definition of a KIC is related to the amount it spends on R&D, the amount of IP that it produces and the number of highly skilled employees. Therefore, KICs are often highly innovative, high growth companies, which are building intellectual value.
As many of you will know, Mercia has always focused on early-stage, innovative technologies, which often originate from universities. Unsurprisingly, a very high proportion of Mercia’s previous EIS investments have been in KICs and that is not expected to change in the future; in a retrospective review of the 12-month period prior to August 2017, 35 of the 37 investments were into KICS (95%).
Over a number of years, the Mercia Group has been in close consultation with the government, HMT and HMRC on these matters, and it has always been clear that we invest in the manner that the UK government believes can build long term value in our start-up ecosystem. This point is further validated by the fact that Mercia has seeded a unicorn (a $billion company); £900,000 was invested in the automation company BluePrism which brought circa 15% of the equity, and over a number of years it grew well, it was listed on AIM in 2016 and is currently valued at over £1.0billion. It should be noted that BluePrism wasn’t an EIS investment, but the investment team that led that transaction also manage the EIS fund.
The government is now consulting the industry on setting up an “Approved” EIS fund for KICs. This may not sound as exciting as the increased limits for EIS investment, but in our opinion, this could really change the EIS market, and enable it to become more mature and professional. Historically, EIS has been a niche investment strategy, reserved only for the very wealthy and very sophisticated, and was certainly not a mainstream sector. VCT are somewhat more mainstream, as their listed nature means that they are more accessible. There are various options raised in this EIS consultation, but I would like to see the Upfront Tax Reliefs, and then as a secondary choice, Dividend Tax Exemption. If an approved EIS fund for KICs is launched, Mercia would consider launching a product, as we already meet most of the criteria, including using closed-end funds, focusing on KICs and deploying 90% of the cash in under 12 months (or 24 months as the consultation suggests).
The benefits of an Approved KIC EIS fund for investors are considerable, as however many companies are in the fund you will receive just one tax certificate, which is available as soon as the fund is closed. This will facilitate the creation of a diversified portfolio of early-stage technology companies, with each company in isolation being high-risk, the creation of a diversified portfolio with 15-20 investments will mean that the investor will not be overexposed to any one company (portfolio effect). This level of diversification is standard practice in more mature markets, such as mutual funds, however filing 15-20 individual EIS3s is a high administrative burden on the investor, and/or accountant/advisor. The benefit of an Approved Fund with Upfront Tax Reliefs is that all the tax reliefs for the 15-20 investments, could be claimed immediately upon the fund closing, by the submission of one EIS5. The Upfront Tax Reliefs would make EIS very similar to VCTs, which are a more mainstream investment and may even enable EIS funds to be listed on the major fund platforms. There are a number of risks with Approved Funds - if one company becomes non-qualifying then the entire fund is affected, and before we develop a product we will need to see the details behind what the government has proposed in the consultation. However, it is our belief that at this point, subject to the investors being suitable, EIS can enter the mainstream market and this is when KICs can really benefit and drive the UK economy. This is the type of initiative that could drive UK GDP through the troubled water of Brexit.
However, for now Mercia EIS Funds provide a diversified technology EIS fund (unapproved), which aims to triple invested capital in five to seven years. We have an industry-leading investor reporting platform that simplifies the management of EIS3s and we offer to collate them for our investors, so that they can be submitted in a bundle.
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