Worries savers are pouring money into risky schemes designed to support British start-ups in an attempt to foil the expected Budget tax raid.
Demand for the riskiest of these investments is up 177 per cent since the election, according to one provider, Wealth Club.
Early-stage fund manager SFC Capital says investments into its start-up funds are up 90 per cent compared with last year.
Seed Enterprise Investment Schemes (SEIS), Enterprise Investment Schemes (EIS) and Venture Capital Trusts (VCT) all offer generous tax perks, including on capital gains tax and inheritance tax.
Demand is growing ahead of the Budget on October 30 amid speculation that Chancellor Rachel Reeves could increase the tax haul on wealth. ‘We’ve seen a big uptick in investors coming into this market, and it’s because of the threat of capital gains tax increases, as well as inheritance tax changes,’ says Edward Prior, head of investment services at SFC.
Early investment has paid off handsomely in the likes of Wolf & Badger
The schemes are even more attractive because the Government has just renewed their tax status until 2035.
However, as many as nine out of ten investments in the earliest-stage schemes could fail, and investors who take a chance could end up losing all of their cash or being locked into ‘zombie investments’ that they cannot sell. They are recommended only for those who can afford to make a significant loss. ‘These are long-term investments and potentially very risky,’ says Nicholas Hyett, investment analyst at Wealth Club. ‘Your money could be tied up for years.’
Tax breaks and heartaches
Seed Enterprise Investment Schemes, Enterprise Investment Schemes and Venture Capital Trusts all offer different levels and types of tax relief to investors. These incentives are designed to compensate for the risks taken with early investing, and acknowledge the fact that investors into businesses at this stage often get their fingers burned.
‘The schemes allow investors to invest in exciting, innovative companies at that early stage,’ says Christiana Stewart-Lockhart, director general of the Enterprise Investment Scheme Association (EISA). ‘They are an effective way of addressing a gap in investment for early-stage businesses.’
Companies such as fintech giant Revolut and takeaway specialist Deliveroo started off with funding from these schemes. The earliest investors in Deliveroo could have seen their initial investment grow by 600 per cent if they sold when the firm went public, while the first investors in Revolut could have seen the value of their stake increase by an estimated 40,000 per cent. However, for every success story there are many failures.
While investors can benefit hugely from the tax breaks offered for investing in these schemes, they must pass checks that show they are ‘sophisticated investors’ and be prepared to lose all their money, experts say.
‘A client has to have the right level of knowledge, the right appetite for risk and understanding of what they’re doing,’ says financial planner Adam Canavan from Bowmore Wealth.
‘But if they are the right sort of person in terms of knowledge and understanding, and can afford to take the risk, then there are a huge host of benefits.’ He says that his clients tend to use the schemes when they’ve realised a big gain from selling a property or business, or because they are concerned about inheritance tax.
The savings to be made
The earlier the stage of the company you invest in, the greater the tax relief – but also the greater its risk of failure.
SEIS is the newest and most generous scheme, because it targets businesses at such an early stage that they are often little more than an idea. To raise money through a SEIS a company must have fewer than 25 employees and been trading for less than three years, and there is no stipulation for it to have started trading at all.
Investors are rewarded for taking the risk with a 50 per cent discount on their income tax bill up to the amount they invest. So, for example, if you put £20,000 into a SEIS you would get £10,000 off your tax bill.
Any gains you make are also free of capital gains tax and provided you have held the SEIS for two years by the time you die it is inheritance tax free, too.
If you haven’t made a profit when you come to sell your shares, or they become worthless, you can offset that loss against your income tax bill. These benefits are attractive, but advisers say that it is the ability to write off a capital gains tax bill that is attracting investors into SEIS schemes ahead of the Budget.
Pembroke VCT is consumer biased portfolio, which includes companies such as Five Guys
If you’ve made a taxable profit when disposing of an asset, you can cut your capital gains bill in half by using the proceeds to invest in a SEIS. Say, for example, that you sell a buy-to-let property and make a profit of £150,000. If you are a higher-rate taxpayer, you would pay capital gains tax of 24 per cent on everything above your annual allowance of £3,000. That would mean a total capital gains tax bill of £35,280.
But, if you invested the £150,000 straight into a SEIS, your capital gains tax bill would be halved to £17,640. Plus, you could get £75,000 off your income tax liability in that tax year (half the total sum that you invested in SEIS).
The capital gains tax and income tax breaks add up to £92,640, which means your £150,000 investment would cost you just £57,360.
Chancellor Rachel Reeves is widely expected to align capital gains tax rates with income tax rates, which are as high as 45 per cent. ‘If capital gains tax escalates as people expect it to, getting 50 per cent off will become even more attractive,’ says Canavan.
SEIS schemes have the most attractive capital gains tax relief. But Canavan says that EIS schemes are also attractive at the moment in the light of Budget uncertainty. These allow investors to defer a capital gains tax bill by investing the gain made into an EIS fund. The gain can be reinvested and the bill deferred again a number of times, and the capital gains tax liability is wiped out completely on death.
EIS and VCT investments also enjoy income tax relief – and EIS investments have inheritance tax benefits as well.
Potential returns
To gain the tax reliefs, investors must hold their SEIS or EIS investments for at least three years and venture capital trusts for five.
However, in practice, it is often hard to exit from these investments for longer than three years, as you must wait until a company is sold, listed on a stock market or refinanced to get your money back plus any increase in value.
In some cases, companies will continue trading for many years without an exit plan at all, and you will not be able to get your money back, while others fail completely.
The earliest investors in Deliveroo could have seen their initial investment grow by 600 per cent if they sold when the firm went public
One example from Wealth Club, looking at the performance of a SEIS fund with ten investments, showed that after five years, eight out of ten were still trading, with gains of up to 5.7 times, while two had failed and were worthless.
An investor who had £10,000 spread evenly across all ten companies would have a total portfolio worth almost £29,500, but with the tax relief they had received, and the loss relief claimed on the failed businesses, this would be worth nearer £35,000.
Although many fail, occasionally a company does extremely well.
‘When you do have a winner, it has the potential to carry an entire portfolio,’ says Prior at SFC.
Checks and balances
Whether investing in SEIS, EIS or VCTs, it is important to make sure you’ve taken proper advice.
There are additional protections for investors because of the riskiness of these schemes, and you must satisfy requirements that you are either a ‘sophisticated investor’ or a high-net worth individual to invest in SEIS or EIS businesses.
One way to spread your risk is to ensure you invest in a portfolio of companies put together by a specialist fund manager, rather than in a single business. That way if one company fails another can compensate, but you will still be eligible for tax relief on the loss.
Whichever scheme you choose, it is important to be aware of the risks and to understand that you could lose all your money – but in the right situation these could be a way to take more of your money out of the Chancellor’s clutches.
Brave with your money? Then try these
Nicholas Hyett, investment analyst at Wealth Club, suggests the following funds for those keen to take advantage of these sometimes risky schemes.
Seed Enterprise Investment Schemes
- Startup Funding Club – By far the most active SEIS investor the UK, and one of the most active venture capital firms in Europe. Has backed nearly 500 start-ups and aims to give investors a diversified portfolio of about 20 companies.
- Fuel SEIS Fund – SEIS fund from the same manager as the EIS fund below. Enterprise Investment Schemes
Enterprise Investment Schemes
- Fuel Ventures Scale-Up EIS – Investment manager led by MyVoucherCodes founder Mark Pearson, focused on fast-growing digital marketplaces, platforms and software businesses. Uses the team’s operational experience to help accelerate growth.
- Guinness EIS – Focused on more mature businesses, with the average investee over the past three years reporting annual revenue of £5.4 million at the point of investment. Has backed some of the fastest-growing companies in the UK including Popsa, Thriva and Wolf & Badger.
- Parkwalk Opportunities EIS Fund – Specialist investor backing companies and technology spun out of UK universities, working alongside the technology transfer offices of Cambridge, Oxford, Imperial College and Bristol. Past successes include Yasa Motors, which emerged from the University of Oxford and was acquired by Mercedes-Benz.
Venture Capital Trusts
- Mobeus VCTs – VCT manager with £338.5 million invested into 50 companies. Has delivered average returns over the past five years of 71.2 per cent (excluding tax relief).
- Pembroke VCT – A consumer biased portfolio, which includes companies such as the Five Guys chain and Lyma skincare brand, and has successfully exited companies including clothing brand ME+EM, Pasta Evangelists and drinks brand Plenish.
- Maven VCTs – Gives investors access to a diversified portfolio of over 100 underlying companies. It focuses on less cyclical companies which it hopes will offer some downside protection in times of volatility.
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