EIS Magazine – 2016: a new era for EIS/VCT
Taken from an original article in EIS Magazine, written by Peter Schwabach, Managing Partner of Cyrus Investment Management
The 2015 Finance Act finally put an end to the era of Tax “driven” investments that have dominated the EIS and VCT markets and have ushered in a new era where investors are being offered “risk” investments in new or established businesses where risk is mitigated by specific tax advantages for the investor. Whilst all changes can be unsettling – and this change has certainly shaken the market – I welcome it as a long overdue and very welcome development for both investors and managers alike.
A Loss of the Original Emphasis
The aim of the original Enterprise Investment Scheme legislation was enshrined in the word “Enterprise”; but over the years that focus became sadly lost in the drive for ever greater tax efficiency in the structuring of these products. Whilst the EIS and VCT schemes continued to deliver billions of pounds of much needed capital to the SME market, the money was increasingly diverted from “Enterprise” endeavours into the ownership and retention by investors of passive tax efficient assets. Inexorably, investors’ aspirations were lowered into the retention of their capital rather than the increase in value of their capital. And the effects of this were twofold. Firstly, SME businesses that required risk capital for growth were overlooked as EIS and VCT funds were channelled into predominantly “no growth” tax efficient structures. And secondly, the inexorable focus on tax efficiency and the structuring of ever more complicated products meant that, when a handful of those products were deemed to be tax avoidance by HMRC, the whole market’s reputation became tainted – leaving many investors significantly out of pocket and wary of the schemes.
A Return to First Principles
The new rules establish a new playing field which I believe is to benefit of all parties. Firstly, because the new legislation firmly endorses those managers who have always sought to combine capital growth with tax efficiency and formally puts them on a par with the managers We see a very clear benefit to both central government and tax payers in the new Finance Act of non EIS or VCT funds who are ranked by the investment returns they deliver, rather than by the tax savings they generate. And secondly, because businesses and enterprises that were previously overlooked by the EIS and VCT Industry – notwithstanding the strength of their products and management – are now able to benefit from this low cost capital. Managers’ interests are now more fully aligned with those of their investors: an exit at a premium triggers a tax fee capital gain for the investor but also a meaningful performance fee for the manager if they have passed a returns hurdle. This can only be to the good of all parties.
Our Own Experience
When Cyrus Investment Management was launched in 2014 as an EIS fund manager, the new legislation had not yet been drafted. Notwithstanding the imminent change in the law, I and my two co-founders were committed to building an investment management firm investing in unquoted SMEs where success was defined by the growth in value of the businesses at exit and not in terms of the tax-efficient structuring of the products. Our focus: British precision engineering companies that we turn around and aggregate for exit after 3 years. As we are ‘returns-driven’, the new legislation endorses a strategy we are already committed to. If HMRC should vary the rules on EIS or VCT at some point in the future, it will have no effect on the returns for our investors – merely on the proportion of taxes they pay on them. We see a very clear benefit to both central government and taxpayers in the new Finance Act. In return for investing in smaller unquoted trading companies, central government ensures low cost capital can help those businesses traditionally unable to access capital whilst investors who invest in those businesses through specialist managers can make tax free profits. We think it’s a step in the right direction.