This year marks the silver jubilee anniversary of the Enterprise Investment Scheme (EIS). In its 25-year history, the EIS structure has allowed nearly 30,000 SMEs to benefit from over £20bn in investment capital and revolutionised how investors access this part of the market. But how did this acronym make its mark in such a crowded investment vocabulary?
The EIS journey began in 1993 when it was introduced to replace the Business Start-Up Scheme which had been running since 1981. As start-ups and early-stage businesses carry greater investment risk than larger, more established companies, the EIS was designed to be tax efficient and therefore more attractive to investors. At its launch, Chief Secretary to the Treasury, MP Michael Portillo, said: ‘The purpose of EIS is to recognise that unquoted trading companies can often encounter considerable difficulties in realising relatively small amounts of share capital. The new scheme is intended to provide a well targeted means for some of those problems to be overcome.’
SMEs play a vital role in the UK economy – employing over 16 million people and generating £2trn in turnover (accounting for over half of the private sector in total). Several chancellors have made tweaks over the years to help keep these schemes attractive in the eyes of investors.
Some notable changes include increasing the tax relief available under EIS from 20% to 30% in 2011, with the £500 minimum investment limit being scrapped the following year. Around the same time, the maximum possible investment was increased to £1m – and, from 2018, investors have been able to commit a further £1m if they’re targeting knowledge intensive companies, which are businesses carrying out research, development or innovation at the time shares are issued.
These changes doubled capital flows into EIS and, since then, year-on-year investment has continued to grow healthily. According to HMRC, 2017/18 was a record year for EIS, with £1.9bn being invested (expected to finish at £2bn by the time the following tax year concludes).
But the tax benefits of EIS aren’t the only reason it’s become so popular in financial planning. The underlying assets of EIS structures have found favour with investors, as SMEs have low correlation to how other asset classes react in times of market stress. With more attention on SMEs, there has been a knock-on effect in valuations. For instance, according to Beauhurst Data, from 2011 to 2016 the average valuation of a UK start-up company increased from £3m to £13.8m. These factors have all led to EIS becoming a mainstream tool for many financial planners. A recent survey by Intelligent Partnership found 88% regularly recommended EIS to clients, with 56% expecting their use of these structures to increase over the next two years.
EIS allows investors to access a wide array of up-and-coming sectors. A growing focus on knowledge intensive SMEs has driven investor demand and tech names now make up half of all opportunities in these schemes. The tech space includes companies such as medical technology (MedTech) firms – at last count, there were 3,700 of these in the UK and, due to the stretched nature of the NHS, they have blossomed, with industry-wide sales recently hitting £21bn. Tech is now a huge part of the UK start-up scene, with more entrepreneurs using software as a service (SaaS) models to maintain scalability and quickly generate profits.
Looking ahead, strong year-on-year investment flows suggest there will continue to be growth in EIS. Although some investors might be concerned about the prospect of Brexit and market volatility, sentiment is more positive among EIS investors. In a recent survey of 2,000 investors by the EIS Association, 29% of respondents said they expect Brexit to strengthen SME productivity, with 28% predicting it will benefit knowledge intensive companies. And, while 18% of investors have paused until there is greater clarification over how Brexit plays out, over a quarter of respondents admitted they were more encouraged to invest in SMEs as a result.
Knowledge intensive companies are expected to dominate the EIS space following recent changes by the government. From 2018, HMRC began implementing a 'capital preservation purpose test' on EIS projects, aiming to exclude investments undertaken for capital preservation. This has narrowed suitability and forced EIS to be redesigned as originally envisioned, focusing on companies that have the potential to grow quickly and not just being treated as low risk capital shelters. While there have been complaints in some corners of the industry, overall, EIS managers have welcomed this development and its potential to focus investment flows on the most exciting start-ups and early-stage businesses.
In its 25 years, EIS has already changed the face of SME investing in the UK. With billions in regular investment and continued support from the government, the period between now and the golden anniversary of EIS could be very exciting to watch.