Investing in Britain’s most promising young businesses has become increasingly popular, resulting in record years for venture capital fundraising.
Demand has been fuelled by restrictions on pension allowances for higher earners and tax changes affecting buy-to-let investors. Further changes, including cuts to CGT and dividend allowances from April 6th 2023, may stoke demand further.
But why have start-ups become the go to place for wealthier investors?
Alex Davies, CEO and Founder of Wealth Club, the UK’s largest broker of venture capital investments said:
“The number of privately held companies valued at $1 billion or more, known as ‘unicorns’, has passed 1,000 globally, with the UK home to more than anywhere else in Europe. A sizeable number, including Zoopla, Depop and Many Pets, received funding through VCTs, EIS or SEIS.
These government backed schemes have been key to the UK start-up boom. By supporting the creation and expansion of young companies they create jobs, drive innovation and grow the economy. In return the generous tax reliefs help to offset risks for investors, crucial in a market where many companies will ultimately fail.
Wealthier investors, who are locked out of mainstream tax shelters like pensions and are already maxing out their ISA, should consider tax efficient venture capital investors as an important part of their wider investment portfolio for three key reasons. There is still time this tax year to invest but with many offers closing before 5th April. The clock is ticking.”
- Tax relief
When you invest in start-ups that qualify for the Enterprise Investment Scheme (EIS) you could benefit from several tax reliefs. You get 30% income tax relief upfront, tax-free growth and you can defer the tax on capital gains made elsewhere. In addition, after two years your investment should be free of inheritance tax. If the investment doesn’t go to plan, you can offset losses against your tax bill.
- Potential for impressive returns
Because you are investing at an early stage, super charged returns are possible. For instance, EIS investors in Bloom & Wild have achieved returns of up to 18x their original investment. Meanwhile, investors who backed Oxgene, a UK gene therapy company, in 2013 enjoyed returns of up to 20 times.
- Low correlation to the stock market and also a bit of fun
Investing in start-ups also gives you diversification. The types of companies you can invest in will most likely be very different from those in the rest of your portfolio. It can also be a lot of fun, whether that is from watching one of your companies grow from an acorn to an oak or from investing in a med tech or pharma company that creates something that saves lives or makes people better.
What are the risks?
It is riskier to invest in smaller businesses than in large ones. Statistically, early-stage companies are more likely to fail than to succeed. They are also illiquid. Such investments are only suitable for more experienced investors who can afford to lose the money they invest.
That said, for those type of investors, the risk is vastly reduced by the generous tax reliefs on offer. Indeed, if you are an additional-rate taxpayer, your downside on every pound invested in EIS could be as little as 38.5 pence. Conversely when things go well, the tax relief supercharges returns. See the table below:
The table1 below gives examples of how EIS loss relief might affect your returns, assuming you are a 45% taxpayer.
| Investment falls to zero | Investment falls by 50% | Investment has no growth | Investment grows by 50% | Investment doubles | |
| Initial investment | £10,000 | £10,000 | £10,000 | £10,000 | £10,000 |
| Net cost of investment | £7,000 | £7,000 | £7,000 | £7,000 | £7,000 |
| Investment value on realisation | £0 | £5,000 | £10,000 | £15,000 | £20,000 |
| Loss relief (@45%) | £3,150 | £900 | £0 | £0 | £0 |
| Effective gain/loss after tax reliefs | (£3,850) | (£1,000) | £3,000 | £8,000 | £13,000 |
| Effective gain/loss as % | (38.5%) | (11%) | 30% | 80% | 130% |
