Optimising tax efficient opportunities and patient capital investment through EIS

GBI was delighted to sit down recently with Richard Roberts Director of Investor Relations at Oxford Capital. Established in 1999, Oxford Capital is an alternative investment manager passionate about investing in early-stage technology companies. For over 20 years, it has offered private investors and family offices access to some of the most impactful technology companies in sectors which the UK is considered a world leader.

In a focused discussion Richard explained why it is important for advisers to manage the EIS timeframe expectations of their clients and encourage year-round investment to achieve the very best returns.

GBI: Richard, you have a broad remit in your role at Oxford Capital, a central part of this is overseeing engagement with investors and their advisors. What do you think are the most common misconceptions that advisers still seem to have when it comes to EIS investing?

RR: That’s a really good question and I can break it down into three core areas.

The common misconceptions that we continue to see are often around the key timings of these investments and also the holding periods. There still seems to be a bit of confusion because of the different time frames, and it is something that’s worth taking the time to help investors and advisers understand.

So, for income tax investment they need to hold the underlying assets for at least three years to retain the income tax limitation period for EIS. The timeline that people often get confused with is to do with business relief, which is an inheritance tax mitigation element of investing into small companies through EIS. You need to have held the assets and be holding them on death for at least two years to ensure that they fall outside of your estate for inheritance tax mitigation purposes.

Often though advisers and some clients then get that sort of mixed up with the holding period for the investments themselves. So, tax qualification periods is one element, but patient management on the investments timing themselves is also important. To invest in these small, high growth potential companies and to get to a point where they can be an attractive acquisition target is probably going to take five, possibly seven years, potentially even longer in some cases. So, there’s an expectation management exercise around those timelines for investment and capital growth is important as this is not the same as utilising EIS for tax relief.

Within a portfolio you have a basket of high potential companies and we are investing into the future of different disruptive technologies and sectors. Not all of these are going to perform well. Out of say ten companies, advisers and their clients need to know that the bulk of their returns in their portfolio will probably come from a small group of those companies, so having diversification is key. Reasonable expectations that not all companies are going to perform with a 10 or 15% per annum growth is key. There will be some companies that don’t work. Some companies that struggle to get product or market fit or execution on their business plans, and then only a small group of them really excel and drive profitable return. So, timings for holding periods is number one, investment performance and liquidity and then exits from time frames is number two and three.

GBI: One of the things that is key for our readership is the education behind this. Do you think there is enough information available to advisers to get the insights that they need?

RR: Over the last couple of years we’ve been running a programme internally and engaging with our adviser network to try and ensure that they’ve got the resources and the knowledge to make sure they are comfortable making EIS recommendations. There’s a lot of information out there but making it applicable to advisers and their clients is something that is often overlooked. It is quite easy to find out the range of tax reliefs available to investors, but actually putting that into context that’s then applicable for them is less readily available. What we try to do is explain tax relief and investment strategy through case studies, so we actively encourage joining some of the real life practical aspects as well as the theory of the advantages. Often advisers and clients see this just through a tax lens. What we try to do as part of our education package is to give an insight into the venture capital markets itself. So how are companies going to receive funding? How often do they receive something? What does that mean for investors who may need it on the next investment round? What is the ecosystem looking like? By analysing it in this way we take a full holistic view.

GBI: That leads me on to the second question, at what point in the financial year should advisors be discussing this with advisers?

RR: I can’t stress enough that this should be all year round. When you look back across the 20 years of the EIS Scheme being in existence, there has been a temptation to look at this as just a tax planning tool so a lot of investment was often received in the January to March window. Since the patient tax review back in 2019, the risks to capital parameters that have been put in place ensure that money is going to companies that really need it to stimulate this sort of high growth technology ecosystem. The best companies don’t raise money between January and March, they are looking at where their business plan is going to be across the next 12 months. Most investment managers will be looking at 12 to 18 months in the companies’ life cycle to see whether or not they can deliver on strategy for that market fit and the team can execute it well. Importantly they also begin to look at what the next round of growth will be across all 12 months of the calendar year, not just in the tax year. By looking at this across an ongoing basis, it gives far better diversification. You are likely to get access to better companies if you’re investing across the cycle, and you’re going to get access to companies at different stages of their growth, which will potentially mitigate some risk as well. Ultimately, you’re going to allow for risk management because you’re not doing this in a very concentrated period.

When we reflect on the COVID years, a lot of the companies in the portfolio worked hard to shore up their balance sheet for the uncertain times. They weren’t doing it for tax reasons, they were doing it to ensure their long term business survival and this created an opportunity to provide more capital resources to them to see them through. A lot of them have experienced huge growth because of COVID, as the world rapidly became digitized in such a short period of time. If people were looking at investing just in that narrow window, they would have missed out on some very, very large growth opportunities. Fundamentally, advisers need to shift some of their mindsets and it needs to be an investment across a rolling 12 month period rather than just through the narrow lens of tax year end.

GBI: I was going to ask if there was an optimum time to invest but I presume that the answer to that is simply throughout the year rather than the last three months to tax year end?

RR: Yes and that is because there is a financial planning aspect to this. Some of the clients will be receiving quarterly or annual bonuses so they can plan for the following tax year. We see a lot of our investors and advisors making investments in April for the subsequent tax year so they can maximise EIS in that tax year or potentially carry it back if needs be to previous tax years and therefore get access to diversification. Sometimes tax liabilities will be driven by events and as soon a client can be brought into the tax relief arrangements that EIS can provide, they can begin to plan forward and retrospectively (such as for CGT) and there are certain cases where people could maximise pension contributions. So, EIS can be done as part of portfolio planning as well as just tax efficiency.

GBI: We’re living in very turbulent times at the moment with rising inflation. Should we be looking at how EIS can fit within a modern portfolio, given the background against which we are living at the moment?

RR: It is very uncertain times at the moment across a broad variety of different sectors. I think it’s important to remember that, yes, although the majority of people are feeling the pressure of rising energy costs and so on, not everybody is feeling the effects of a potential recession. EIS is a great insulator within a modern portfolio to provide diversification. It can provide real returns in a high inflation environment because it offers generous tax reliefs. It should not be viewed as just an alternative add-on as it can provide superior returns as part of a diversified portfolio. Brian Moretti, of Hardman & Co, published a study looking at the impact of venture capital in a modern portfolio. He demonstrated that because it involves broadly non-correlated companies these are generally more insulated against movement in the mainstream markets because ultimately they are much smaller. So, when you’re comparing like with like on assets there is a really compelling argument to use EIS, even though it is a high risk asset class.

GBI: You mentioned that access to digital tech is one of the areas that has really boomed because of COVID. The Oxford Capital Growth EIS fund includes access to sectors such as fintech and digital health, could you tell us a little more?

RR: When we are making investments and build portfolios for our clients obviously diversification is key, and we are looking to build a portfolio of at 8 to 12 different companies across different stages of investments and they’re not all at seed stage. We’re investing through the cycle providing risk management and duration management, but we’re also looking at sector diversification and what is going to be the next round of disruption. The digitisation of the world might have taken 15 years plus to happen organically but because of COVID it almost happened in 15 days, as everybody was told to stay away from the office and work from home. It’s an important moment, and effectively we have completely changed our habits. We are much more used to inventing new technologies quickly and new ways of working for health care is something that is increasingly more prevalent. There are some very, very acute problems within the healthcare system, from delivery of primary care right through to more specialist services. We’re looking at how can we identify potential companies that are solving problems in the longer term, and we can really begin to help these nascent companies build great ideas and great technologies. That’s why we’ve invested into healthcare companies such as HelloSelf. This is a mental health company which is looking at a much more assertive use of delivering mental health solutions to a wider range of people, but importantly preventing it re-occurring. We invested into HelloSelf a few years ago now pre-COVID, so the market has grown but this investment is also something that is much more crucial to society as a whole. The impact of private capital going into companies that are really developing innovative ways of solving problems in the future is really what we’re about in terms of our growth and portfolio and why we look at harnessing product contracts and investing into these high[1]tech companies. If you like it’s great example of our investments helping to solve real world problems

GBI: Thanks for taking the time to share your expertise and insights with us Richard.

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For more information on the Oxford Capital Growth EIS Fund, please click here