Enterprise Investment Schemes aren't being used much by firms outside London and the Southeast, a firm says. Might this cause a political issue down the line?

The weeks leading up to the new UK financial year on 6 April mean purveyors of tax-efficient investment structures are happily marketing their wares and supposed benefits, not least to journalists such as yours truly. This time, there’s a winter chill.

Enterprise Investment Schemes (EIS), created by the Conservative administration of John Major in the early 1990s, and which survived the Tony Blair and Gordon Brown Labour administrations, and also those of David Cameron and now Theresa May, arguably face trouble if a more socialist administration led by Jeremy Corbyn takes charge. While his party hasn’t yet put structures such as the EIS on its hit-list, the rise of political populism on the Right and Left, often sharing a common desire to promote “fairness” in tax, might put tax-advantaged structures in danger. (This is not just about the EIS structure; there are other structures with certain tax advantages, also focused on small firms and start-ups, such as venture capital trusts.)

Quite possibly the EIS sector isn’t yet large enough to draw political ire; even so, more than £14 billion ($19.4 billion) had been invested via the EIS structure in the 2014/15 financial year, based on the latest available data. This is a non-trivial sum, if not major-league stuff. With an EIS, subject to various conditions, individuals can invest up to £1 million per annum in the scheme and obtain income tax relief of up to 30 per cent of the amount invested. From 6 April 2018, the annual EIS limit will rise to £2 million, provided that the excess over £1 million is invested in qualifying “knowledge-intensive” companies. 

There are also “seed EIS” structures: these are targeted at helping early-stage businesses attract seed funding, whereas EIS encourages investment in more established companies. SEIS investors will receive income tax relief of 50 per cent of the cost of the shares, whilst EIS investors receive income tax relief of 30 per cent. EIS and SEIS cannot be used in certain areas, such as coalmining, leasing, banking, forestry, and some others. 

Such investments are typically relatively high-risk – definitely not a “core portfolio” holding for someone nearing retirement, perhaps. What is undoubtedly the case is that for some high-income savers, who have seen lifetime tax-free pension savings allowances squeezed by successive governments, the EIS structure has been an alternative destination of sorts, as some industry figures have told this publication. But that very fact might attract political frowns. 

A divide
One source of potential controversy comes from recent research from accountancy firm Moore Stephens that found that the EIS is “worryingly underutilised by businesses outside of London and the South East”. Basing its comments on official figures from HM Revenue & Customs, Moore Stephens noted that only 33 per cent of investments via EIS were outside London and the Southeast, even though these regions account for 62 per cent of the UK economy. Or, to put that into hard cash, £610 million out of £1.9 billion EIS investments went to businesses in regions outside of London and the Southeast.

“It is extremely concerning that SMEs outside of London are failing to take advantage of the EIS break. If regional economies are to compete with London and the South East, schemes like the EIS need to be utilised to their fullest extent. The latest statistics highlight that this is just not happening,” Tim Fussell, partner at Moore Stephens, said.

The firm says central and regional governments could proactively encourage more businesses to take up relief schemes such as the EIS to help grow their local economies.

Beyond numbers, there are real firms benefiting from EIS funding, Moore Stephens said. EIS-funded companies include Innocent, the smoothie manufacturer, and Chapel Down, the UK wine producer. Innocent was later bought by Coca Cola for an estimated £100 million after raising capital through the EIS. Chapel Down have seen their turnover grow to £11.6 million in 2017 after an initial investment made through EIS.

Asked whether Moore Stephens’ worries are fully justified, Paul Latham, managing director at Octopus Investments, which says it is the largest EIS fund manager in the UK, said its research suggest most firm getting key funding from EIS and VCT structures are outside London and the Southeast.

“If supported with the right type of financing, high-growth small businesses have the potential to punch well above their weight, playing a meaningful role in driving regional growth and contributing to our wider economic prosperity. There is an opportunity for those investors, comfortable with the risks of smaller company investing, to benefit from these growth companies and the compelling tax reliefs available through VCTs and EIS,” Latham said.

“What we are seeing is a growing trend among investors for VCTs, which is why we’re no longer raising new money into our EIS but focusing on financing the next generation of UK business through our range of VCTs,” he added. 

Another firm operating in this space, Calculus Capital, said there is a broad range of EIS-backed investments across the UK. “We’ve been investing in SMEs for nearly 20 years and one thing that’s absolutely clear is that there are talented and dynamic people developing exciting new products and services right across the UK,” John Glencross, chief executive of Calculus Capital, said.

“Our own experience is that most of our investment is outside London and the south east, with investments in Scotland, the Northeast and Northwest, the midlands, Wales and the West of England,” he said.

“In relation to the overall figures from HMRC though, one factor to consider is that the south east is a disproportionately wealthy area and consequently has a higher representation of wealthy business angels. In my experience, business angels tend to invest in businesses that are geographically close,” Glencross said.

“It may also be the case that the statistics are a little out of date. When a lot of EIS investing was in solar and other alternative energies, many of those companies had their registered offices in London even though the solar installations would not have been in the capital. The size of those fundraisings, often in the hundreds of millions, would have distorted figures until a couple of years ago when alternative energy ceased to be a qualifying investment,” he continued. 

“We would though very much support moves to further raise the profile of the Enterprise Investment Scheme, which provides hugely important capital for the innovative and growing SMEs that are the lifeblood of our economy,” Glencross added. 

The UK government, in its latest budget changes, has aimed to stimulate investment in “patient capital”, as set out in its consultation document last August.

“It has been identified that there is a serious gap in the funding market for small to medium sized businesses and venture capital funding in the UK has been in decline since about 1987 when pensions funds and other institutional investors started to divest from venture in pursuit of the globalization story,” Dermot Campbell, chief executive at Kuber Ventures, a UK firm operating in sectors such as EIS’s, told this publication.

“The unsung part of the change in the [latest] budget was that the government introduced a £20 billion package of stimuli to encourage Institutional investors back in the venture sector. This will have a hugely positive impact on EIS and VCT investors as it should develop the exit market for these investments, improving returns and reducing timeframes,” he continued.

“The Chancellor [aka finance minister] took action in the budget to divert these funds into genuine investments by introducing a principles based test. Basically the test looks at investments and makes a subjective decision as to whether they are genuine Patient Capital Investments. If HMRC judges that they fail the principles based test they will not offer advanced assurance which means that investors have to take a chance over securing their tax relief,” Campbell added. 

It may well be the case that a structure able to survive the political and market cycle for almost a quarter of a century will ride out whatever happens in the future. Also, the fact that such schemes are aligned with high-tech start-ups and SMEs in many cases – vital sources of future growth and jobs – gives them a degree of cover. That said, such structures must deliver across the UK, and any perception of imbalance and unfairness, whether justified or not, needs to be addressed. If recent years have taught wealth managers anything, it is that one can never be complacent in making the case for entrepreneurship and rewarding enterprise.