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EIS (the Enterprise Investment Scheme) has been an attractive option for investors looking to generate strong, tax-efficient returns. It enables greater access to the UK’s early-stage investment landscape, with a host of risk-mitigation mechanisms to help protect investors from additional risk – such as “loss relief”.
In fact, according to one recent study, EIS is becoming more popular with financial advisers. Below, we explore the possible reasons for this trend in 2024, outlining some key benefits of EIS which investors may wish to consider as they build their portfolios.
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#1 The “talent goldmine”
One puzzling feature of the UK economy over the last two years has been its “tight labour” market – i.e. high employment-to-vacancies ratio. It has been difficult for many sectors to find strong talent for a while. Now, in 2024, there are signs that this may be starting to change.
As the UK formally enters a recession, many large employers have become reluctant to hire permanent staff. Some have triggered redundancies. The technology sector, in particular, has been hit. However, this is great news for the UK’s early-stage companies who can “cherry-pick” some of this talent to fuel their growth.
#2 Continuing innovation
When economic conditions enter a “bust”, large organisations often press the “pause button” on research and development (R&D). Budgets that were formerly allocated to innovation are diverted more into shoring up the balance sheet in case the macro environment worsens.
However, smaller companies tend to “live or die” on innovation as they bring new, disruptive solutions to the market – trying to take market share from existing, large players. Indeed, there has been tremendous innovation since early 2023 – much of it driven by smaller UK companies in the EIS space.
#3 Tax planning opportunities
Many financial advisers deal with wealthy, “high-net-worth” individuals (HNI) who have complex tax situations and asset bases.
Often, these individuals have already exhausted “mainstream” options for mitigating taxes on income and returns (e.g. the annual allowance for pensions and the ISA allowance for interest, capital gains and dividends). This is where EIS can shine.
In 2023-24, EIS-qualifying companies allow their investors to enjoy the deferral of capital gains tax on certain shares. This can allow for more efficient tax planning over the short-medium term if, for instance, an investor expects to fall into a lower income tax bracket in a future tax year.
Financial advisers may also recommend EIS to clients who are considering estate planning. EIS shares held by an investor are exempt from inheritance tax (IHT) if held for at least two years. Therefore, an individual with a particularly large estate – e.g. one which has already “used up” the Nil Rate Band and Residence Nil Rate Band – could keep more wealth within the family by investing certain assets in EIS shares and holding onto them.
#4 Useful diversification
Financial advisers often talk about the importance of diversification – i.e. spreading out an investor’s money across multiple markets, companies and asset types (e.g. equities and bonds). Yet, there is another key component to this strategy.
Investors can also diversify across different stages in various company lifecycles. For instance, could an investor also invest in smaller, growing companies rather than simply investing in large, established companies which are listed on public exchanges (and, therefore, subject to many similar market forces)?
After all, certain smaller companies may still enjoy considerable growth even during harsh market conditions where larger players are struggling. Of course, investors need to be wary (smaller vessels often fare worse during a big storm on the high seas). Yet, with careful due diligence, an investor can enrich their portfolio with more diversification by investing in startups – e.g., many in the EIS space.
#4 Competition and valuation
Early 2024 could be an ideal time for certain investors to venture into EIS. Two or three years ago, a software business turning over $10m in revenue might have been valued at $600m. Today, the common valuation might realistically be less than half of this.
Large, US-based funds have also backed off from the UK venture capital (VC) market to focus on opportunities at home. This has lowered distortions of valuations, and, as wider investor sentiment improves, new EIS investors can enter the market at fairer prices with realistic hopes of rising valuations in the near future.
With that said, remember that nobody has a crystal ball regarding the markets. With EIS investments, you may get back less than you originally invested, and these could potentially fall to zero. Investors can buttress their portfolios by following time-honoured principles, such as diversification, and by participating in a professional EIS investor network.
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