Numerous other tax incentives have come and gone with the passing of governments and chancellors, but the EIS has remained in place.
And with a total of £466 million of investment raised by the 1,500 companies raising funds under the EIS scheme for the first time last 2019 – 2020, it suggests that EIS has no signs of slowing down.
This article explains what EIS is, why it’s a good investment program and where you can find EIS startups to invest in.
Why EIS is a good investment program
1. Diversifies your investment portfolio
Diversification spreads your risk so that the performance of one investment does not always imply the performance of your entire portfolio.
Experienced investors may choose to diversify their portfolio by making a medium- to long-term investment with tax advantages.
When it comes to investing, putting all your money into one company or a small group of companies can be extremely risky. If one of those companies fails and goes bankrupt, your investment will suffer as well.
You don’t want your investment portfolio’s performance to depend on a single firm, so you can spread your risk by investing in various companies or other asset classes.
And although diversification comes in various forms, when all is said and done, most funds will primarily invest in blue-chip firms, either through stock purchases or corporate bonds when raising capital.
If one fund manager or stockbroker believes that investing in a particular stock or bond is a good decision, it stands to reason that their colleagues will agree.
Take two UK equities or bond income funds with identical strategies, and you’ll almost certainly find at least four of the same companies in each fund’s top ten holdings. This creates portfolio overlap and negates the purpose of a diversified fund portfolio.
Compared to other parts of the investment market, smaller companies often follow different investment cycles.
As a result, EIS can provide an additional layer of portfolio diversity if you’re willing to take risks in investing in smaller companies.
2. High growth potential
You can invest in companies with excellent development potential under the EIS, which offers favourable tax benefits.
EIS investments allow you to have access to companies you might not otherwise be able to hold and have the potential to grow in value.
EIS-funded companies have a long history of providing excellent returns on investment to their investors, but it doesn’t change its high risk.
As a result, it’s essential that you see it as a supplement to your existing portfolio rather than a replacement if you’re considering investing in EIS. It will help if you work with a fund manager with extensive experience and expertise in EIS investment and industries.
3. Double annual allowance for knowledge boost investors
Knowledge Intensive Companies (KICs) refer to companies carrying out research, development, or innovation when issuing shares. They have special status under EIS and can raise more EIS investment with greater flexibility than non-KIC companies.
Here are some of the conditions HMRC has established for a company to classify as knowledge-intensive:
First, there is an ‘operating costs’ condition. When it issues shares, the company must have spent:
- at least 15% of its operating costs on research and development or innovation in one or more of the previous three years or the three years following investment for a new company or
- at least 10% of its operational costs on research and development or innovation in each of the previous three years or the three years following investment for a new company
A new EIS rule went into effect in April 2018 that increased the yearly investment allowance for eligible opportunities to £2 million.
It means that investors who put funds into knowledge-intensive businesses will get twice as much as before. You can invest up to £2 million and get up to £600,000 in income tax relief as long as £1m of your yearly EIS investment is in these knowledge-driven companies.
4. Immediate income tax relief on your investments
There’s a package of valuable tax reliefs as an incentive for taking higher risks. These reliefs include upfront income tax relief, tax-free capital gains, loss relief, capital gains tax deferral, and inheritance tax relief.
EIS offers investors tax relief, including loss relief if your investment in a company fails. This is especially valuable for high-risk investments.
Also, note that tax treatment depends on an investor’s circumstances, legislation, and qualifying status.
5. Added protection
If a business you’ve invested in fails, you will be compensated for your losses.
EIS intends to reward investors willing to take on the risk of investing in a startup. While income tax relief helps mitigate these risks, loss relief provides even more protection.
For example, when your investment performs poorly, and the value of your shares goes to zero
- Your initial investment = £50,000
- Income tax relief (30% of your investment) = £15,000
- At risk capital = £35,000
- Loss relief (with income tax at 45%) = £15, 750
- Total returns = £30, 750
Rather than losing the total amount of your £50,000 investment, EIS tax relief means your loss is reduced to £19 250 due to both the income tax relief on your initial investment (£15, 000) and the loss relief (£15 750).
6. Wealth transfer benefits
Although it may seem bleak, inheritance tax (IHT) is essential for sophisticated investors.
Suppose that the value of your estate is less than £325,000 or that you leave anything above £325,000 to your spouse, civil partner, a charity, or a volunteer amateur sports club. In this case, there is usually no need to pay inheritance tax.
After two years of owning EIS shares, you can claim up to 100% inheritance tax relief. This is only applicable if the shares are not listed on a recognised stock exchange.
Furthermore, instead of being transferred to the immediate control of beneficiaries, EIS assets remain in your possession for the rest of your life.
7. Complements other investments
EIS can complement other long-term investments such as Individual Savings accounts (ISA) and pensions by providing a distinct risk profile.
EIS shares are long-term investments with their own set of advantages and disadvantages.
As a result, some investors see them as complementary to their other investments, such as Individual Savings Accounts, Venture Capital Trust, and pension funds.
However, consider that EIS is a high-risk investment that shouldn’t be used to substitute more traditional long-term investments such as pensions.
8. Supports the UK economy
The UK government backs an EIS to incentivise UK investors to invest in young businesses – the real backbone of the UK economy. Its tax incentives encourage the flow of capital to support young, growing businesses.
Investing in EIS-qualifying enterprises helps the UK to grow. It’s an opportunity to support innovative small businesses to create jobs, prosperity, and economic progress across the UK.
It also assists in funding entrepreneurial ventures, which are a critical source of job creation and economic productivity.
9. Well-established scheme
The more considerable benefits of EIS continue to attract investors despite its risks.
Investors understand that they need to take risks for their investment to succeed. If they can’t accept much risk in their investments, they will earn a lower return.
Where To Find EIS Startups To Invest In
If you’re interested in investing in EIS, we can help you.
Trendscout specialises in the government initiatives of the Enterprise Investment Scheme (EIS). Based in the heart of London, we connect angel investors and founders, building purposeful collaborations that generate profit and growth.
Our 30 years of industry experience and a network of creative entrepreneurs and investors allow us to spot up-and-coming prospects before they hit the masses.
Rest assured that we’ll help you in your investment journey.