Far from being simply a 'rich man's tax dodge', VCTs and EIS are helping to future-proof the next generation with innovative and bold early-stage investing, writes Tom Hopkins
There are some commentators who appear to think venture capital trusts (VCTs) and the Enterprise Investment Scheme (EIS) have acquired a bad rap for being an overgenerous tax break for the already over-invested middle class retiree. Given the various ‘low-risk' capital preservation schemes involving solar, crematoria, storage facilities and the rest being peddled over the last few years, that is perhaps hardly surprising.
With Royal Assent rubber-stamping new rules governing these schemes, however, and thus forcing a refocus on growth and development - ‘risk-to-capital' being the new mantra - this view can now be painted as a bit cynical.
It should be noted, however, that even before the rules change, investors and advisers were already waking up to the illusion of ‘low risk' EIS and VCT funds and were seeking proper returns on their capital.
Of course, in fairness to the cynics, no adviser in their right mind would put a client into an EIS or VCT unless they were experienced and had an already mature and diversified portfolio. That is simple common sense.
But the reality is these unique tax schemes encourage, now more than ever, the well-off to invest in the new, the explorational and the bleeding edge. As ever, if you pick the right funds, the returns justify the risk. It is always worth reminding ourselves the Government underwrites a large part of the risk and provides tax-free returns.
To find these investment-led funds, however, advisers and clients will have to be willing to look beyond their usual ‘go to' options and should be aware of fund managers who claim to have changed their spots.
The shift in mindset required to go from capital preservation to growth investing is a difficult one. As such, investors should look beyond usual brands and focus on those fund managers who have always focused on growth investing. Now, more than ever, it is about deal-flow and deployment of capital.
There are plenty of examples of VCTs sitting on lots of cash as they change investment strategy or EIS funds returning cash as they cannot find a way to invest in our brave new world.
Stick then with those funds that have always taken the risk - a good example being Pembroke VCT, which is run by Oakley Capital with £1.3bn under management, and is one of very few VCTs not impacted by the rule changes.
One of their most recent deals featured Heist, which was founded in 2015 by a bloke called Toby who was on a mission to create the perfect pair of tights. The company's approach has been to use innovative technology and a fresh approach to design - working through 197 samples - to solve issues that plagued current models. Namely, digging waistbands, itchy legs and poor product longevity.
Since Pembroke VCT's investment, Heist has grown like-for-like sales of tights by 450%. Hose that for performance?
Another portfolio that is ‘sticking to its knitting' is the Parkwalk EIS Fund, managed by Parkwalk, which is owned by IP Group, a FTSE 250 group with more than £1.5bn of assets in the university spin-out sector. A recent investment of Parkwalk's was into Yasa Motors, which has developed a new generation of high-power and high-torque-density electric motors to market.
Business secretary Greg Clark opened the company's new £15m production facility in February 2018 and the Department for Business, Energy & Industrial Strategy said Yasa was working with companies like Jaguar and Williams to give vehicles the "speed of a Bugatti Veyron but the emissions of a Toyota Prius". You might say the company is the torque of the town.
These two investments may be very different, but they are both leveraging technology and helping to build UK Plc and, especially in the current ‘Brexit' environment, that in itself is enough to attract some investors. After all, how many other paper investments can say they directly helped to make the UK, and the world, a better place?
And what about returns? Given the current state of other asset classes - listed equities, bonds, property and so forth - investors are increasingly looking at alternative assets to generate the required growth kicker in the portfolio.
The latest BVCA performance survey shows venture capital performance increasing, catching up on other forms of private equity and on a near par with MBO returns. The five-year venture performance (to December 2016) shows a 12.2% internal rate of return. This increased performance reflects the growth of entrepreneurial culture in the UK.
For the tax years outside the three-years EIS holding period, Parkwalk EIS is showing total returns of 1.88x to 2.65x capital invested while Pembroke's younger portfolio is already showing total returns of 1.06x to 1.20x. All these returns are, of course, excluding the initial 30% tax relief so the return is there for those willing to take the risk.
These are more than ‘tax products' then and the government should be applauded for ensuring it is now investment first and tax second, with the state helping investors mitigate the risk. The government has brewed up a tax break that delivers the returns not only for investors but also the broader UK economy … if Carlsberg were a British business, it would be proud.
Tom Hopkins is co-founder of Kin Capital
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