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What to consider with an Enterprise Investment Scheme

Over recent years we have seen an increased demand amongst our clients for private equity investments. Not only are higher-rate taxpayers and those selling businesses looking for legitimate ways to reduce their tax bills, investors are also considering how they can diversify their portfolio of ‘mainstream’ investments with some allocation towards private companies.

We asked Russell Fryer, of specialist investment managers Mercia, to explain some of the key features of Enterprise Investment Schemes (EIS) and how they can help investors meet their objectives.

On the face of it, almost all investors should at least be aware of EIS investments from two stand points:

  • Firstly, optimising cash flow with effective tax planning is becoming more difficult, as standard tax planning strategies are limited (pension, ISAs).
  • Secondly, investing in an EIS with the right fund manager provides access to the high growth venture capital/private equity asset class.
     

Tax planning 

From a tax planning perspective, EIS has major advantages with up to 30% income tax relief on investments up to £2m in the current tax year. For those business owners who have sold businesses, or very high earners, saving up to £600,000 in income tax each year can be a powerful driver. 

In addition, investment can be carried back to the previous tax year. With enough free capital, you can very effectively manage even very large tax bills and create a growth-orientated investment portfolio.

Further, EIS growth is tax free and if clients do invest in a company that fails, they can claim ‘loss relief’ on their losses. 

There are some more sophisticated strategies with EIS, as you can also defer capital gains tax liabilities which may arise, for example, from the sale of a business or an additional property. 

Even better, any EIS shares held for more than 2 years can qualify for ‘Business Relief’, meaning that they would fall outside of the investor’s estate for inheritance tax purposes.

Simply, any client paying higher rate or additional rate income tax, or anyone who has a capital gains tax liability or even an Inheritance Tax issue, might consider EIS investing. 

Those are the benefits, but what are the risks?

EIS investing is not for everyone as they are very high-risk strategies which invest into small, unquoted UK companies which have a greater chance of failing than, for example, ‘blue chip’ companies listed on the FTSE100. 

EIS investments are illiquid until each company is sold or floated on the stock market, which typically takes 5–7 years from investment, so they should not be considered for those who might need access to their money in the short or medium term.

Access to the Venture Capital/Private Equity asset class

Losses are to be expected when investing within EISs, but there is also the possibility of some strong gains.

One often overlooked benefit of EIS investing is the extra diversification it can bring to an investment portfolio. 

Venture Capital investments have minimal correlation to other asset classes, such as bonds and publicly listed shares, and so extra diversification can help lower risk. 

Russel Fryer
Mercia Asset Management

Cockburn Lucas comment: EISs are high-risk, specialist investment products and they are not suitable for everyone. Typically, they should only be considered for those with large tax bills and significant other liquid assets. That said, we feel that there is a place for tax planning solutions such as EISs in the right circumstances. 

We are proud of our in-house expertise in this area of financial planning – as evidenced by our recent success at the EISA Awards – and would be happy to have a chat if you feel you have any tax planning needs that we can help with.