When the EIS Association were told that the complexity of fees was a barrier to the use of EIS funds in financial planning, it was obviously something we needed to look at. Especially when one of the independent reviewers told us there were 39 different ways of expressing fees in the market!
In discussions with advisers, it became clear transparency and clarity would be warmly welcomed, as would any way of evaluating the fees charged by different funds, so that there was a level playing field.
What are the issues?
The main issues that emerged from our investigation into fees were:
1. Are all fees being disclosed?
It became clear not all fees were being explicitly shown.
2. Is VAT being levied and shown?
There was much inconsistency in what was being shown by the fund managers.
3. Were the fees being levied on the investor or the portfolio company, or both?
This caused much debate. If the investor is being charged fees, then less of the gross investment will qualify for tax relief. On the other hand, if the portfolio company is being charged, then they will have less cash available to invest in the business, which in turn can limit growth. It can, of course be argued both ways.
What is perhaps disingenuous of one or two funds has been to say that an investment is ‘fee free to investors’. Whilst it may be technically true, it does not tell the whole story!
4. What are the total fees charged over 5 years?
Other investments such as OEICS show total fees over 5 years in their KID. So why shouldn’t EIS funds do the same, if this was a format that advisers were comfortable with?
5. What is the impact of performance fees?
All funds charge a performance fee on exit but there are large differences in the way this was done. Are the fees levied on the individual investee company, or on the fund as a whole? And there are many different hurdle rates which may need explaining.
No wonder there was confusion! The problem was compounded by the fact the EIS Association cannot dictate what fees are charged and how they are expressed to its members.
The solution
The solution that we came up with was to create some guiding principles that we felt should apply to all EIS funds in the way that they expressed their fees. And, by giving these principles to advisers, we encouraged them to ask the fund managers key questions, to ensure that they were following these principles.
The principles are:
- All fees should be clearly stated, when they are payable, and by whom.
- Fees charged to companies matter as much as fees to investors. Both have an impact on the final outcome for investors and it is misleading to say fees charged to companies means it is ‘fee free’ for investors. All fees charged to investee companies should be disclosed. For example, fees for services that are needed or mandatory on the investee company, such as consulting or monitoring services, should be disclosed.
- There should be clarity on whether fees are fixed or variable. For example, where monitoring fees might depend on the size of the company. Where appropriate a range can be given but it should be clear as to the basis being used to decide on the final amount.
- It should be clear as to how long fees are payable for, and in what circumstances this can change.
- There needs to be clarity on which elements are subject to VAT and which are not. Just to say that VAT is charged as applicable is not sufficient and each fee should clearly have its VAT status given. The net amount of an investment that will be used to purchase shares should be clearly stated.
- There should be clarity on success fees, and whether these are calculated on returns that include tax benefits, or not. It should be clear whether these are calculated on a per company or fund basis. Disclosure should include the amount of any options or warrants that the manager may receive, as well as any other investment the manager or team may make that is on different terms from those by their customers.
The overall guiding principle is; investors should be able to readily compare fees openly and between different companies, and know all fees are declared.
These principles were launched in September 2020 and have been warmly welcomed by the industry.
We are also delighted that CoInvestor, leading digital investment platform for investors and advisers have been running their own ‘Transparency’ project. CoInvestor volunteered to develop an interactive and digital fee calculator to make the fees charged explicitly clear. This has now been launched and is a very welcome initiative. It really does remove a barrier to recommending EIS funds with confidence.
A final note
It is of course true that fees don’t tell the whole story. It is just as important to understand what the fund manager does with the fees to support and develop their portfolio companies. This is a topic that will be addressed in future articles.
