Investment Insights from 1825 – Finding tomorrow’s Unicorn
Lee Moran | August 05, 2019
The information in this blog or any response to comments should not be regarded as financial advice. If you’re unsure of any of the terminology used you should seek financial advice. Remember, the value of investments can go down as well as up, and could be worth less than what was paid in. Past performance is not a reliable guide to future performance. Tax rules and legislation can change and the value of tax benefits depends on your individual circumstances. The information is based on our understanding in August 2019.
This article may be of particular interest to high earners, prepared to accept high risk, who are looking for tax efficient routes to diversify their retirement nest eggs, and those wanting to reduce or defer a large tax bill.
Finding tomorrow’s Unicorn
In the venture capital industry, a unicorn is a term used to describe a start-up company whose value now exceeds $1 billion.
To be in at the start of a new company, providing funding to support what will hopefully be meteoric growth, is probably every investor’s dream. And to then see that start-up company go on to be listed on the stock exchange and become a household name. It’s exciting and offers the prospect of rich returns. The problem is that for every Facebook or Airbnb success, there will be hundreds of other start-ups that don’t make it. It’s a high risk and complicated area requiring great expertise.
At 1825 our planners are qualified to provide advice on some of the more intricate, and high risk, investment products. Niche investments that offer the potential of long term capital growth and generous tax breaks. Complex investments, including Venture Capital Trusts and the Enterprise Investment Scheme, that incentivise investors with attractive tax benefits in recognition of the high risks associated. Let’s have a brief, introductory look at these investments.
Venture Capital Trusts
Venture Capital Trusts (VCTs) were introduced by the government on 6 April 1995, with the aim of supporting small and start-up businesses where funding from banks may be less forthcoming. Since then, VCTs have supported many businesses that have gone on to become household names, for example, restaurant chain, Five Guys, and property website, Zoopla, to name just two. The downside is that small start-up companies are very risky; venture capital investments do have high rates of failure.
A VCT is a company which invests in other companies, typically very small companies which are looking for further investment to help grow the business. And because investing in small, fledgling businesses is high risk, the government has provided VCTs with a number of tax efficient benefits.
- Investors are able to contribute up to £200,000 per year into a VCT which would qualify for 30% income tax relief (capped at the investor’s income tax liability) up front, as long as the investment is held for five years
- Dividends paid are free of income tax, making them an attractive source for income
- VCTS are also tax free from a capital gains tax perspective, allowing investors to fully participate in growth
VCTs are long-term, speculative, investments. They offer a number of tax benefits that could be of interest to investors who are looking to diversify an existing investment portfolio and have exhausted their annual pensions and individual savings account allowances, or are facing challenges with their pension lifetime allowance.
Enterprise Investment Scheme
Another government initiative, the Enterprise Investment Scheme (EIS), was introduced a year before VCTs, with a similar mandate of looking to help start-up businesses.
Unlike VCTs, EIS investments tend to be more concentrated; managed EIS funds typically invest in just five to eight companies per fund and there are single company EIS offerings, making them higher risk than VCTs. They offer the following tax incentives:
- Investors can contribute up to £2m per year with 30% income tax relief (capped at the investor’s income tax liability), provided the investment is held for a minimum of 3 years
- Investors with capital gains made up to three years before or one year after an EIS investment is made, can claim ‘deferral relief’ against those gains as long as the same amount as the taxable gain is invested in the EIS
- Exemption from capital gains tax can be claimed on the disposal of EIS shares, provided the shares have been held for at least three years and income tax relief has been given and not subsequently withdrawn
- If a loss is made on the disposal of EIS shares at any time, loss relief can be claimed (the loss is net of income tax relief)
- EIS shares will generally become IHT exempt after being held for two years
Whilst an EIS investment is not appropriate for most people, it’s increasingly becoming part of the financial planning conversation for high earners who may, for example, require a complex tax planning solution.
Although these products offer generous tax incentives, they are, first and foremost, high risk investments and should be viewed as such. There is a high risk of not getting back what was originally invested. Small, start-up companies are more volatile and more likely to fail than their larger counterparts, so you could lose all the money you invest. This should drive the decision to invest, based on the merit of the underlying investment strategy. They are not suitable for everyone. In addition to investment risk, another consideration is liquidity risk; that is, the ease in which you can cash in your investment – it may be difficult to find a buyer. However, if a VCT or EIS investment meets your specific needs and you are willing to accept the associated risks, they could prove to be a valuable addition to your financial plan.
Please speak to your 1825 Financial Planner if you have any questions or would like to find out more about the investments mentioned in this article.