As the tax year-end approaches, Richard Roberts, Director, Investor Relations, Oxford Capital, reminds advisers of the benefits of EIS investments as part of their clients’ balanced portfolios.
Growth of early stage companies in the current environment
As we approach the end of this tax year, it may be time to start talking to your clients about diversifying their portfolios and consider alternative investment opportunities.
At Oxford Capital, we are passionate about investing in early stage technology companies in sectors which the UK is considered a world leader such as fintech, online marketplaces and digital health. While 2020 was a challenging year as start-up businesses navigated the challenges of the pandemic, we have found that it has really concentrated the minds of founders. It has brought out the best in them as they have streamlined and improved their businesses to cope with and take advantage of the situation.
A number of our companies have also capitalised on opportunities arising from the Covid-19 crisis, particularly those that have harnessed technology to meet the changing needs of consumers. Our portfolio company, Moneybox (saving and investing app) has seen significant customer growth and an average of £100m was deposited by customers every month in 2020. In July 2020, it closed a £30m series C fundraise. In addition, Curve (the banking platform that combines multiple cards and accounts into one card), announced this month that it had closed a $95M series C fundraise which it will use to launch the business into the US and expand its reach within Europe.
How is risk managed in an EIS portfolio?
For your clients considering a venture capital investment, it is worth reminding them that EIS investing comes with a high level of risk, particularly because investments in unquoted shares are illiquid and can be hard to value. Although when executed well, venture capital strategies offer the potential for high returns. In addition, only a fraction of VC-backed businesses will go on to be sold at a significant profit, generating nearly all of the investor’s total returns, while some companies will grow more slowly than expected, generating only modest gains or breaking even. A high proportion of companies will fail resulting in a loss for investors but with the right choice of alternative asset manager, there are ways to mitigate some of that risk for investors: Diversification is crucial, and not just based on the number of underlying companies, although that is important. You also have to consider the sector, the stage of investment, and the maturity of the companies. We believe that the right level of diversification for venture capital portfolios utilising EIS is between 8-12 companies.
Timing is also key. At the initial funding round, we will typically invest a small amount of capital, which will translate to approximately 5% of a client’s portfolio. We will then work with that company and typically take a seat on the board to help them grow and develop. If the business meets certain metrics and targets, we will then invest a greater amount, representing say 10%. There is really no better due diligence than working closely with a company for 12-18 months. And if it continues to perform well, we may embark on a third funding round (increasing the holding up to a maximum of 20% allocation).
We also co-invest with other large institutional investors which helps to mitigate the financing risk in the EIS portfolio, and also adds further experience and expertise. Often strategic investors will be involved in the later funding rounds, which adds another potential route to exit.
Patience – realistically, clients should expect the majority of investments within their EIS portfolio to exit within five to seven years (although it may take longer), because it’s important to allow some time for the underlying companies to grow, and to not sell the strong performers too soon.
Why EIS as a vehicle for venture capital?
Through investing in an EIS portfolio, investors can claim back 30% of the amount invested into EIS-qualifying companies against income tax that they have paid, either in the year of investment or carried back against the previous year. Relief can be claimed on EIS investments totalling up to £2m in any given tax year, providing certain conditions are met.
There is also the added advantage of loss relief. This means that the downside risk is mitigated at the marginal rate of the investor’s income tax rate, whilst the upside potential can be significant.
Capital gains can also be deferred from the sale of other assets, in part or in full, by investing an amount up to the value of the gain into EIS qualifying companies. Gains that occurred up to three years before, or one year after, the date of the EIS investment can be deferred. The gain is re-crystallised when the EIS is subsequently sold and CGT becomes payable at the rates prevailing at that time, unless rolled over into another EIS investment. These factors make EIS investing a strong proposition.
Richard Roberts, Director, Investor Relations
Richard has worked in venture capital for over 12 years and is a member of the Investment Committee at Oxford Capital. His experience lies in strategic and financing transactions for UK SMEs within the TMT, property and clean-tech sectors. Richard’s early career was spent at HW Fisher, a UK Top 30 Chartered Accountants firm, providing advisory services in the wealth management and property divisions. Richard is a Chartered Fellow of the Chartered Institute for Securities & Investment, and the Institute of Consulting. He currently sits on several portfolio company boards.