Conceived originally for individual investors, SEIS and EIS schemes are now no strangers to investment funds – how do these work?
Raising capital is perhaps one of the toughest challenges entrepreneurs have to face while developing their startups. Although there are many different ways to finance a startup, some types of funding – such as bank loans and credit cards – are often difficult to access for emerging businesses due to the extraordinary risk early ventures entail. Thus, young companies are becoming increasingly dependent on angel investors. Usually, Business Angels buy shares in an emerging business at a low value and expect it to grow over time. This way, they can then sell the shares at the higher price and get a profitable return on their initial investment.
The UK government acknowledges the importance of Business Angels to small businesses’ growth and introduced the Enterprise Investment Scheme (EIS) in 1994. EIS was conceived to encourage individuals to buy and hold new shares for at least 3 years by minimising the risks of early stage investments. With this scheme, if an individual decides to buy shares in an EIS qualified company, they would be entitled to claim 30% back of their investment through income tax relief as well as other tax benefits such as a capital gains tax exemption – if the investment returns a profit – or a loss relief – if the company unfortunately fails.
Following the success of EIS, the UK introduced the Seed Enterprise Investment Scheme (SEIS) in 2012. This new program supports the most early-stage companies’ development by providing investors with more generous tax benefits when compared to EIS. SEIS offers 50% of an investment back through income tax relief alongside further tax benefits to individuals who buy shares in SEIS qualifying companies.
Although the SEIS and EIS schemes were originally designed for individual investors, asset managers spotted the opportunity to encourage passive investors to support early-stage companies by developing SEIS and EIS funds. These funds are designed for investors who are willing to buy risky and illiquid assets, are eligible to claim the tax benefits, but do not have the time or expertise to select emerging companies. Today, there are over 30 SEIS and EIS funds operating in the UK across various sectors such as life sciences, digital technology, or media and gaming.
Asset Managers usually raise money for SEIS and EIS funds from private sophisticated investors. The managers use their expertise to screen and select the most promising SEIS and EIS qualifying startups for their funds. After selecting the companies, they handle the investment process and invest monies in companies on the investors’ behalf.
Once all the investments are completed, investors receive SEIS and EIS certificates corresponding to the underlying fund investments so that they can claim their tax benefits. Usually, asset managers will provide post-investment support to investee companies to support their growth and protect the investors’ interests.
Besides the tax benefits, the time-saving element, and the fund managers’ expertise, there are other advantages to using SEIS and EIS funds for investors. Perhaps one of the most notable benefits is the diversification effect. Asset managers usually select five to fifteen companies per investment portfolio. This allows the investment risk to be spread across a broader portfolio of companies than the one an individual would have achieved by investing directly in companies.
Although SEIS and EIS funds allow investors to diversify their exposure and to claim generous tax benefits, it is still a risky investment that might result in investors losing a portion of their investment. Also, it is worth mentioning that the schemes’ tax benefits are subject to individual circumstances. Thus, investors should always seek independent tax advice prior to investing under the SEIS and EIS schemes.
By Ausra Lukoseviciute