How to invest in the EIS: the 3 main routes
One of the UK’s most popular venture capital schemes, the Enterprise Investment Scheme (EIS) has long been a favoured route for private investors seeking long term growth and generous tax advantages. As a result of its popularity, a variety of ways for investors to access the EIS have been made available.
Currently, investors are able to invest in the EIS via several routes. From individual investments via co-investment platforms to EIS funds managed on the investor’s behalf, the route an investor selects will largely depend on their level of experience and growth goals.
In turn, understanding how these routes differ and how to minimise their associated risks can have a significant impact on the success of an EIS investment.
How to invest in the EIS
Private investors have access to a wide breadth of EIS investment opportunities at any given point, spanning different sectors, providers and levels of target growth. However all EIS investments tend to be accessed via one of three overarching routes:
The three main routes to invest in the EIS are:
- Direct investments
- Co-investment platforms
- EIS funds
1. Direct investment
When an investor makes a direct EIS investment, they invest in an eligible company without the assistance of any intermediaries.
Most often occurring when a company pitching an investment opportunity approaches an investor or informal angel investor network, this route is followed primarily by highly experienced investors and ultra high net worth individuals (UHNWIs).
Without the added expertise of a co-investment platform or fund in sourcing, vetting and structuring opportunities, this route can require additional due diligence and has the potential to be particularly time consuming.
2. Co-investment platforms
A co-investment platform is a platform that sources, structures and advertises opportunities for investors to select from, and can be accessed both online and offline.
Some co-investment platforms specialise in facilitating venture capital investment opportunities, which can be EIS-eligible should portfolio companies meet the qualifying criteria.
Co-investment platforms can target a range of investor profiles by enacting varying degrees of due diligence and involvement. Where more sophisticated co-investment platforms will research, vet and select portfolio companies against a strict eligibility criteria to ensure growth potential, others may not. Similarly some co-investment platforms will require a minimum investment amount.
Co-investment platforms allow investors to purchase shares directly into an individual EIS-eligible company, unlike EIS funds which spread an investor’s capital across multiple companies. Subsequently such targeted investments can allow investors to achieve considerably higher growth and offer a more autonomous route to diversifying their portfolio.
Alongside this, the potential of a sophisticated investment team facilitating opportunities and the lack of additional fees can make co-investment platforms a preferable route for many experienced private investors.
3. EIS funds
EIS funds, unlike direct EIS investments and those made via a co-investment platform, are managed investment vehicles that are structured and executed by a fund manager.
Accessible both online and offline, investing in an EIS fund involves pledging capital to a fund manager, who will then invest that capital into a portfolio of EIS-eligible companies on the investor’s behalf. EIS funds often access n five to eight companies, although can span considerably more in some cases.
Whilst EIS funds can allow for a less effort-intensive route for achieving a diversified portfolio, the reduced level of portfolio personalisation and often less intensive growth potential (especially in those with a greater number of companies) associated with funds can sometimes make them less appealing to the more experienced private investor.
Where the reassurance of a professional manager handling investments can be an attractive feature to some investors, the upfront and recurring fund fees that EIS funds usually require may counteract this benefit for those seeking maximum profitability.
How to minimise the risk of EIS investments
Once an investor has selected how they wish to access an EIS investment, considering the tools and techniques available to minimise the risk associated with the investment can have a significant impact on its success.
Whilst a broad range of techniques exist for minimising the risk attached to EIS investments, three of the most significant include:
- Make use of available tax reliefs
- Seek opportunities launched by venture builders
- Conduct thorough due diligence
1. Make use of available tax reliefs
A government-backed tax efficient investment scheme, the EIS offers private investors some of the most generous tax reliefs available in the venture capital space.
Including 30% income tax relief, capital gains tax (CGT) exemption, capital gains tax deferral, inheritance tax (IHT) exemption and loss relief, these tax incentives can support investors via a number of means – most notably by minimising investment risk.
Enabling investors to negate almost a third of the risk associated with the investment by claiming it back in income tax relief, and offering the assurance of loss relief should an investment fail, these reliefs can have a significant impact on the net returns of an investment.
Alongside their risk-mitigating benefits, EIS tax reliefs can also support investors in managing existing CGT bills and planning for later life with advantages such as CGT deferral relief and IHT exemption.
2. Seek opportunities launched by venture builders
A venture builder is a business that specialises in creating, launching and scaling other businesses. Also known as a startup factory, tech studio or venture production studio, experienced venture builders possess a deep domain experience of the conditions required to launch and scale startups successfully.
Where investing in an early stage company launched by a venture builder is not a requisite for a successful EIS investment, doing so can help to mitigate some of the most significant risks of early stage investing.
Accessing EIS investments via a venture builder can signal that the startups have sufficient technical and strategic support, and often have access to a more established business network. Ultimately, accessing opportunities launched by a venture builder can increase confidence that an EIS-eligible business is equipped with the expertise it requires to grow.
3. Conduct thorough due diligence
Conducting due diligence will already form a core part of most experienced investors’ investment process. However, ensuring the right questions are asked and the most appropriate tools are utilised when selecting EIS investments can play a key role in minimising their associated risk.
Tools such as investor due diligence checklists compile the key subject areas investors should consider when exploring early stage investments. Including specific questions on business areas such as the team, the market, product features and legal requirements, DD checklists can enable investors to identify any potential weaknesses of an EIS-eligible company prior to investing in it.
As well as conducting thorough due diligence into a portfolio company, performing due diligence into platforms providing EIS investments is equally as crucial.
Ensuring platforms employ their own sophisticated processes for researching, vetting and selecting opportunities, as well as possessing a demonstrable track record in the space, can help to maximise investor confidence in the legitimacy and growth potential of opportunities.
Timing EIS investments optimally
Alongside ensuring investments are accessed via the most appropriate route and sufficient risk-mitigating techniques are utilised, considering the optimal timing to make an EIS investment can prove particularly beneficial in the long term.
Initially, it is important to note that with early stage venture capital (VC), the average exit window of EIS investments is between five to ten years from the point of investment. Whilst this means that investments can target considerably higher growth than other forms of equity investment, ensuring investors time EIS investments with the vision of long term returns rather than the short term is crucial.
In line with the EIS’s longer return window, some of the scheme’s tax advantages require minimum holding periods in order for investors to access them. Though these are set, the EIS does offer some flexibility in how and when investors claim their tax reliefs, which can make a difference to when an investor chooses to time their investment.
EIS Tax Advantage
Minimum Holding Period
Income tax relief
Capital gains tax exemption
Inheritance tax exemption
Firstly, the EIS carry back feature allows investors to claim their income tax relief against the previous year’s tax bill from when the investment was made. This can be particularly helpful should an investor have: a) not have accrued sufficient tax liabilities in the current tax year to claim the full relief from, or b) have already maxed out their current year’s liabilities with income tax relief.
Secondly, EIS CGT deferral relief gives investors the option to defer a payment of CGT that has arisen from the sale of any other asset to a later year, should its gain be reinvested in EIS-eligible shares. This can be particularly advantageous should investors have accrued considerable CGT liabilities which they wish to defer to later years for tax planning purposes.
Ultimately, understanding these exit windows, minimum holding periods and flexible tax advantages can enable investors to ensure the timing of their EIS investment is best placed to align with their personal investment goals and tax circumstances.
Accessing the most appropriate EIS investment
With a broad range of investment routes, risk-mitigating techniques and tax planning benefits available to private investors when investing via the EIS, understanding how these align to shape the most appropriate investment opportunity for you can be crucial.
Whether this means experienced investors selecting highly-vetted EIS opportunities via sophisticated co-investment platforms, or those seeking minimal involvement investing via an EIS fund, ensuring individual investment objectives fall in line with the appropriate channels and techniques should be a core priority for anyone exploring the space.