If there is a “secret” to successful investing in Enterprise Investment Schemes (EIS) or Seed Investment Schemes (SEIS) it is that investors need to follow two rules.
Firstly, to have a real grasp of the timing of this market. Secondly, to understand and apply one of the unique features of EIS and SEIS: the ability to carry back an investment into the previous tax year.
These two rules are intimately bound up together, because an understanding both of the market’s rhythms and of its special tax status go hand in hand – get them both right and the chances of success are greatly improved.
Let’s take these issues in turn. Firstly, the timing of the market.
The companies seeking VC investment who understand the rhythm of the capital raising market in EIS will typically, around September or October, be putting the finishing touches to their funding propositions, which will then be submitted to a selection of VCs.
The exciting investments that tick all the VCs’ boxes will be snapped up quickly, typically in the Autumn. But that does not spell doom for those that are not. They will often be monitored by the VCs for a while to gauge their appeal.
As the season progresses, so does the competition for the best deals and as the tax year end approaches, the number of transactions occurring will reach its peak.
Most companies looking to raise capital will have their business plans in front of potential investors before April and the number of investment opportunities will gradually deplete, reaching a low point by mid to late July with very little happening over August. The cycle then begins again in September.
But what of the investors? Think of it in terms of a new series of Dragons’ Den. Let’s suppose you lodge your £100,000 to invest at the start of the series. By the last show of the series you will have had exposure to all the deals that have been cut over the various episodes.
By contrast, if you produce your £100,000 right at the end of the run, you will only be invested in those opportunities that crop in the last programme. They could all be marvelous companies with great prospects, but your timing has restricted you to a few rather than the many.
If you absolutely have to invest in a particular tax year, it is sensible to get your money into the system as early as possible so that you get exposure to more of the investments that the VC makes.
Let’s now consider the need to understand the ability to carry back.
It is an observable fact that many people leave it until the last minute to put their money with a VC or on an EIS investment platform. Why?
Tax planning is habitually undertaken at the beginning of the calendar year. Firstly because people pay their tax on 31 January, secondly, it is only at this point that some people know how much tax is owed and thirdly bonuses are paid. But there ought to be no need to join an end-of-tax-year frenzy, to let the tax tail wag the investment dog.
Investors with a spike in income tax last year, will need to consider an EIS or SEIS before the end of the tax year. Equally, if you want to use VCTs you will have to hurry because they may start to run out of capacity and there’s no carry back.
For clients with a capital gain, there is another time consideration. To get the best out of an EIS, you ideally want to optimize your tax reliefs, claiming the maximum income tax relief as well as Capital Gains Tax (CGT) deferral. There is also the opportunity to maximize the previous year’s income tax. The good news is that you have three years from the date of the gain to reinvest and claim CGT deferral allowing you to spread the income tax relief over several years (with SEIS, you can only access CGT reinvestment relief in the current or previous year).
However, by understanding market timing, carry back and how much is required to invest before the tax year will enable you to plan your investments to meet your tax needs and investment needs, in a less frenzied fashion.
There will be plenty of excellent investment opportunities in the EIS/ SEIS space over the next 12 months or so. The carry back rules are such that most people don’t need to panic and get themselves fully unvested before the 6th April and a little patience may yield some great investment outcomes.
But overall, the EIS and SEIS market offers the possibility of investment success, provided there is a thorough understanding of timing and of carry-back.