SMEs Already Have Help to Grow Through EIS and SEIS Tax Breaks

As General Election fever heightens, politicians are jostling to say what they will do for different parts of the electorate, not least the business community. The latest promise to smaller companies has been the introduction of a Help To Grow programme should the Tories be back in power in May. David Cameron has vowed to bridge the estimated £1 billion funding gap for SMEs in Britain by the Government guaranteeing loans from private lenders, and co-investing public money alongside private funds.

Now, I'm never going to argue against finding more money for growing businesses. But I would posit this Government already has a system in place that's achieving great things for ambitious smaller firms, providing much-needed investment, and that could be expanded further.

The Enterprise Investment Scheme (EIS) (LINK: https://www.gov.uk/government/publications/the-enterprise-investment-scheme-introduction ) and the Seed Enterprise Investment Scheme (SEIS) (LINK: https://www.gov.uk/seed-enterprise-investment-scheme-background) have been boosted in recent years to allow tax relief of up to 30 and 50 per cent respectively on investments in early stage companies. They've been an enormous success. Investors have used the tax breaks to tap into exciting, higher-risk opportunities, and large numbers of enterprises have benefitted.

Investors in companies listed on CrowdBnk's platform can potentially benefit from the EIS and SEIS relief, as we've discussed here before (LINK: https://www.crowdbnk.com/blog/seis-and-eis ).  Research suggests many probably do so. A recent UK Business Angels Association (UKBAA) report (LINK: http://www.ukbusinessangelsassociation.org.uk/nation-angels-research-campaign ) indicated nine out of ten angels have taken advantage of these tax-saving schemes. More than half have invested through EIS, and almost a quarter via SEIS.

This money goes straight to businesses, allowing them to act on plans for expansion, and enriching the economy and investment community along the way. My fear is the introduction of yet another Government funding initiative to add to the many others that already exist - Funding for Lending, the National Loan Guarantee Scheme - could confuse rather than help. These well-intended programmes are already numerous, and of mixed effectiveness.

Quite simply, EIS and SEIS work. We should be building on this success, and seeing what lessons might be learned from this method of feeding money into the enterprise economy that could inform other areas of business finance. I will always argue for more money for growing businesses, but it must be delivered in the right way. EIS and SEIS really reach businesses so that they directly benefit. So do investors. Getting that message across really is a potential vote winner.

CrowdBnk is a leading London based equity and debt crowdfunding investment platform and has raised over £7.5million for 15 companies so far. 

Ayan Mitra, Crowdbnk 

How to hydrate your income before 5th April 2015 

More than one person has commented in recent weeks that they would not mind increasing the income they receive from their investment portfolio.  It is one of the reasons that there is so much appetite for alternative asset investing.  The challenge though when you play in the subset of Venture Capital is finding opportunities that can deliver a reliable income.  VCTs remain one of the best ways to achieve this with tax free dividend yields of around 5+% per annum.  And some VCTs have an additional angle in that they are designed to return predictable lumps of capital on key dates in the future.

Over the last few years my respect for VCT fund managers has grown. They have a difficult task managing portfolios of investments within the complicated rules of the VCT scheme, in order not only to provide capital growth, but also a regular income for their shareholders.  It is to the credit of the industry that so many of them are proving that they succeed with this balancing act year on year.  

In recent years they have been helped, in part, by the opportunities they have had to invest in segments of the renewables sector.  The great advantage of renewables investments is that after the initial capital expenditure they typically show a profile of long term regular income stream.  Initially this was further enhanced by the additional subsidy from the FITs attached to the schemes which enhanced the income profile of solar, wind, hydro and anaerobic digestion, but even without FITs renewable investments underpin dividend flows in many VCT funds.

The FIT scheme was designed to encourage investment into the more marginal renewable energy projects - to get them off the ground if you like, until they became economically productive in their own right.  As we have seen in areas such as solar, as economics of scale and more efficient production of technology has arrived we have seen capital costs shrink. It is therefore right that the government has then taken the decision that these projects are no longer deserving of being included in VCT and EIS funds.  Gradually the government has removed certain renewable investments from the schemes as the specific markets have become sustainable;  VCT and EIS funds, as the home of more risky investing, have done their job in this market.

The end to the "renewables" opportunity for VCT and EIS fund managers will come on 5^th April this year, when hydro and anaerobic digestion will be removed from the permitted investments list.  Fund managers are clever people - they will find other assets to invest in that command the returns investors require, but with six weeks to go until the end of the tax year, readers may wish to lock in access to the funds that are have a suite of hydro and anaerobic investments in their stable.

Whatever your views on Climate Change and the oil price, I am certain that you will be conscious that humanity is continuing to consume energy at an ever increasing rate.  Heating, transport and manufacturing, let alone all our laptops, tablets and phones, are things few would willingly give up in today's world.  Whilst the Energy Crisis is not something that crosses my mind regularly, as I sit writing this article on my laptop, listening to the radio on my iPhone in a lit room (it's a grey day!) and with the heater on (it's cold too!), it's obvious that I alone am using an awful lot more electricity than when I first moved down to Somerset almost 20 years ago.   It makes sense to me that we need to have as many sources of energy production as possible and renewables are a very important part of the mix. 

Personally I think wind turbines, when located in the right place, are things of great beauty as well as being functional.  I like the idea of roofs being energy generators as well as protecting us from the elements, although I struggle with fields full of solar panels when they should either remain as productive farmland or just as part of a beautiful vista; if you want to fill the countryside with man-made "things" why not build houses to deal with our serious housing crisis and stick the panels on their roofs?  However, I am satisfied that my food waste no longer goes to landfill but into gently burping anaerobic digesters to power my home.

Source: www.moviemail.com

The type of renewable that pleases me most however is hydro power.  The great Hoover dam and its ilk are architectural masterpieces.  Who can forget the scene in the Dambusters when the dam finally bursts and you see the magnificent, powerful devastating surge of water head down the Ruhr Valley?  I think of medieval wheels powering mills.  Extracting energy from water works philosophically, environmentally and visually.

Allt Ladaidh: Source: TriplePoint

The first time I heard about smaller "run of river" hydro projects was a few years back when a friend of mine who lived "up a Scottish mountain" set one up.  Scotland is and remains the home of smaller hydro because of its ideal mix of rainfall (growing year on year), the steep gradient of many of its rivers (all those mountains) and its remoteness (projects are out of sight of the masses).  My clever VCT friends spotted the opportunity a while back and now a number of them, including Albion Ventures and Triple Point, now have a number of Scottish hydro investments managed on an operational basis by a company called Green Highland Renewables.

Gleann nam fiadh Source: Triple Point

The joy of these hydro projects is that their environmental impact is small.  Essentially they "borrow" surplus water from a river, divert it through a turbine, collect the energy and then return it to the river.  Visually, once constructed they are barely noticeable.  Ironically in today's world where "tech" is so sexy, they use Turgo turbine technology which is so efficient that the experts have only been able to improve performance by 1.5% in the last 100 years.  (Note: the technology was originally developed by a Brit in Cumbria see http://en.wikipedia.org/wiki/Turgo_turbine !).  With fewer working parts to maintain, they are reliable and cost less to maintain and you cannot whip away a hydro plant in the same way that you can prise a panel off a roof or field.   All this has the effect that investors can keep a greater percentage of the income generated.

Turgo Turbine Source: Gilkes

I have written this article because Triple Point contacted me to tell me about their Hydro VCT which is open until 31st March 2015 for this tax year and 30th April for next tax year applications. It is a pure play investment opportunity in run of river hydro which has achieved pre accreditation (i.e. the FITs are locked in even though production has not yet started) for 9 sites to be operated by Green Highland Renewables. It is Triple Point's second hydro VCT - the one last year raised £14m for 5 schemes all of which are in construction, and Triple Point have another site which became fully operational last month. This Triple Point Hydro VCT has been designed with the income investor in mind.  It has been designed to return, via c.5p annual dividends in years 2-5, a c.50p capital distribution in year 6 and the tax break to return all shareholders original investment by the end of year six.  At that point, investors should have an asset with an NAV of c.50p which will pay a tax free dividend of 7% until 2030 when the underlying hydro assets will be sold and, with the agreement of shareholders, the VCT will then be wound up with a final c.50p payment to investors.   As a pure play investment, it is perhaps better compared with an angel deal than with other generalist VCTs.  I understand from Triple Point that last year's Hydro VCT was taken up particularly by City fund managers attracted by the simplicity and uncorrelated nature of the offer and by 40-50 year olds looking for a reliable income stream but also capital payments just when retirement beckons.

I would like to thank Triple Point who sponsored this article and Ben Beaton who gave me the background to the hydro opportunity in VCTs.  If you would like to get some more information on Triple Point's VCT then do contact the sales team who can be reached on +44 (0)20 7201 8990 or by email at[email protected].  More information is available on their website http://www.triplepoint.co.uk/2014/11/30/hydro-vct/ and you can also find useful information on VCTs more widely at http://www.clubfinance.co.uk/venture-capital-trust.php. 

EIS/SEIS/VCT - where next?

During their lifetimes, the reliefs available have changed somewhat, but the overall concept has been maintained. They intend to encourage investment into new businesses by incentivising the investor at the outset and making the inherent risk attractive to them (or more palatable!).

These incentives have seen many iterations. For example, up until the end of the 2004-05 tax year it was possible to defer gains into Venture Capital Trust (VCT) investments. Why was this changed?

Enterprise Investment Scheme (EIS) investment limits have moved. Between 1998 and 2004 only £150,000 of investments in a tax year was eligible for income tax relief, yet from 6 April 2012 it is possible to invest up to a £1million. This is great news for businesses and investors.

The rates of relief in that period have also moved from 20% before 6 April 2011 (with a minimum £500 investment) to the now heady heights of 30% for both the EIS and VCTs.

Additionally, there is the carry back facility for income tax relief, subject to limitations in the years concerned, which is also beneficial to the investor.

In the wake of the EIS and VCT schemes, Seed EIS (SEIS) has followed, with some attractive quirks for the potential investor but also some limitations which seem strange when compared to the old warhorses of EIS and VCT.

A maximum annual investment in SEIS of £100,000 is a pittance when compared with £1million into EIS but it comes with the very attractive 50% tax reduction.

Additionally there was the capital gains tax exemption for amounts reinvested in SEIS shares, up to the £100,000 limit of the investment in the first year. This has however, since been reduced to 50% of the invested gain.

All new governments like to play around with these schemes, to put their own twist on them and the question has to be whether the next government will also want to have a go?

It may be time to amalgamate the SEIS/EIS schemes, or at the very least increase the investment allowable under SEIS? Or will governments be loath to address this in the current climate when tax avoidance is such a hot topic?

The argument for such a change is strong. SEIS and EIS investments are high risk investments and the rewards can be great where companies do well, but the inherent risks are still there, and perhaps in order to grow the economy and encourage start-ups a more attractive approach should be considered.

Ultimately an investor's decision must be based on a sound knowledge and understanding of a business, but if there are attractive incentives available where someone is risking their own funds, surely this will help encourage people further.

EIS: the end of renewable energy

As the UK reaches its renewable energy obligation targets, it was inevitable that the Government would eventually rule that renewable energy projects are to no longer qualify for EIS status.  By 2020, 15% of UK energy has to be produced from renewable sources and statistics show during Q3 2014 this figure stood at 17.8% [Source: UK Government Energy Trends Report, 9 January 2015]. Some have suggested this is a short term anomaly; but even if that is the case the longer term trend is on an upwardly mobile trajectory and, following the trend of the past 5 years, the UK target of 15% would be hit by 2016 anyway.

The Enterprise Investment Scheme was launched over 20 years ago.  Then Prime Minister John Major, and then Chancellor Kenneth Clarke, created EIS in order to stimulate investment in small UK businesses with the intention of creating jobs and economic growth.  To this end, EIS has been successful with £10bn now raised in total and approximately £1bn now being raised each year the investment has certainly been stimulated.  Equally, some estimates suggest that as many as 70,000 jobs have been created as a result of EIS funding.  However, over the past 6 years we have seen EIS investments in renewable energy rise from approximately 5% of funds raised to over 30%. 

This increase in volume of EIS investments in renewable energy is not surprising.  The government subsidies on offer to renewable energy generators can mitigate investment risk in such unquoted companies.  In addition, The Chancellor increased the maximum EIS investment per company to £5m and thus made this market increasingly interesting for investment managers.

EIS purists may argue that renewable energy projects don't necessarily create the level of jobs intended when Major and Clarke launched EIS but there is no denying the adoption of EIS for renewable energy projects has significantly assisted the UK's Renewable Obligations agreed in 2002.

Investors looking to invest in renewable energy EIS propositions have until the end of the 2014-2015 tax year to do so before these opportunities cease to be EIS qualifying.  However, renewable energy will continue to be an appealing investment opportunity for some.  With reduced nuclear power in the UK, a number of coal power stations to close in the next few years and with Northern Ireland only half way to their 2020 target of 40% generation from renewables; there could still be good reasons to invest in renewables.  Renewable energy is here to stay: the increasing political focus on energy security amidst rising geo-political instability will be major focus of the energy policy for the forthcoming Government.

In the short term, renewable energy EIS propositions are still open for those appropriate investors seeking potential tax reliefs and a government subsidised investment in a growing market.  For example, UK hydropower electricity output in Q3 2014 was 5.9% higher than the same period in 2013 despite lower rainfall.

Longer term, renewable energy is likely to continue to be an appealing investment for suitable investors looking for potentially stable returns, within a continually growing market.  I find that investors often like investments where they understand the technology involved and to this end hydropower and wind energy will always tick boxes.

The Deepbridge Hydro EIS closes to investors on Thursday 26th March 2015.

The value of an investment may go down as well as up, in which case an investor may not get back the amount invested. Investments in small unquoted companies carry a high level of risk.

SEIS: Time to take away the Punchbowl?

Back when Alan Greenspan was head of the US Federal Reserve he offered a job description for his job in controlling US monetary policy; i.e. "To take away the punch bowl, just as the party gets going". Some would say that it's a pity he didn't follow his own advice and maybe we might have been spared some of the worst consequences of the 2008 world credit bust and the Great Recession (hangover) that followed.

However there are now some parallels beginning to appear on a much smaller stage; i.e. EIS and SEIS - tax driven vehicles designed to encourage the allocation of money by private individuals to small start-up (often tech) businesses. Just to be clear, I believe these are both excellent schemes and are having an increasingly positive effect in securing funds for a vital part of the UK economy. However there are signs that this attractiveness is creating a short term bubble in valuations which should generally concern everybody, but might specifically concern HMRC or Government.

So, are we in danger of the punch bowl being taken away from the SEIS party?

I'm sure that everybody would agree that start-up and early stage businesses in the UK need all the help (and specifically funding) that they can find. Certainly I do. In the 30 years or so I have spent in the early stage tech sector I can't recall a single period (with the possible exception of 2000 - 02) when there was too much money going into early stage deals. I also don't buy the proposition that somehow the UK can't build major businesses from a stone cold start, as per Silicon Valley. The UK can and does build major businesses, but it could do so much more with more funding particularly at the early stage. EIS and SEIS are an important part of that strategy.

No, my reservation about the current early stage market, and SEIS specifically, is that the highly attractive tax incentives are being spread across too few deals and as a consequence current valuations and more importantly future expectations are being driven to unrealistic levels which in the long term will serve nobody's interest; entrepreneurs, investors and even government.

Current statistics are patchy and we will only know the true picture with the benefit of hindsight. From my helicopter view of the early stage investment market, at the moment I see some deals being done at valuations that look unrealistic in the longer term.

There will be those who believe that this just sounds like carping from a VC who objects to paying too much for deals (which I do!). However I would argue as follows. Starting and growing a long term successful business is not a sprint. It is not a 'fast-buck' business; I wish it were. No, the reality is that the very best businesses are built over the long term and for the long term. And critical to this growth is that valuations should realistically reflect the progress that a company has made and can make in the short to medium term. High valuations and rapid growth in valuations make everybody feel good in the short term but they are actually counter-productive if they can't be sustained when reality bites.

I appreciate that this may be difficult to hear when an investor can secure an almost immediate return of 50% of his / her investment, along with other associated tax reliefs (CGT, IHT). Further many entrepreneurs might argue "why are you worried about the high valuation; just feel the tax break". It's also difficult for an individual SEIS investor in a single company. How do you know that the valuation is too high and even if you can, so what? If that's the price of doing a deal in a company you like, either get on with it or get off the pot!

 However there are many examples where a sole focus on valuations has ended in tears. For instance we observe it regularly on the AIM market where companies are listed at totally unrealistic valuations. Such deals are effectively born to fail, and as a consequence the AIM market continues to hold more than its fair share of zombie companies. We really need to avoid this for EIS / SEIS.

Of course an investor looking to make an SEIS investment can work through a fund, run by one of the many quality managers in the market and get the benefit of both portfolio spread and of an active fund manager in both the pre and post investment stage. This approach doesn't eradicate the over-valuation risk, but it can help mitigate it and provide a better chance of ensuring that the investors secures both the short term effect of a major tax break and long term growth in one of the UK's future successes.

In summary, the EIS and SEIS schemes are excellent vehicles for encouraging much needed money into the start-up sector and long may they remain and prosper. Further Government should be congratulated on getting this one right. However I hope that every supporter of these schemes and the companies they support would join me in encouraging more care and a longer term perspective.

Perhaps one less glass of punch before the floor starts to spin!.

Ernie Richardson is a highly experienced long term venture capitalist and is Chairman of Boundary Capital, a manager of EIS and SEIS Funds.