The Enterprise Investment Scheme (EIS) appears to be losing popularity with entrepreneurs, if the dramatic decline in firms making offers under the scheme is anything to go by
EIS and its sister scheme the Seed EIS (SEIS) are popular with startup investors because they offer tax breaks on profits and losses. But investment opportunities are thin on the ground in 2016-17. Venture Capital Trusts (VCTs) appear to be affected, too, with investors being turned away.
Intelligent Partnership have just published the third edition of their annual EIS Industry Report, and pundits are picking up on one significant data point: To quote FTAdviser, "between April and October last year there were 60 per cent fewer EIS offers compared to the same period in 2015."
That's a major shrink in the supply of one of investors' favourite opportunities. What's the explanation?
One suspect is the EU Referendum. After the 'Leave' vote, some observers, including the EIS Association, RealBusiness, and IW Capital, argued that the UK would now be free to expnad the use of the EIS and SEIS schemes because we would no longer have to comply with European State Aid regulations. While that point of view makes sense, it ignores the fact that the UK will be bound by all our EU obligations until the treaty negotiations have been completed.
Another possibility is that the sharp drop in EIS offerings was a response to some changes in the rules for the EIS and SEIS schemes, that were announced in Autumn 2015.
The rule changes were partly to tighten up loopholes, where advisers may have been encouraging businesses to try and qualify for the schemes, even though the reasons why the businesses wanted to raise money didn't comply with the inteneded purpose of the tax breaks. The changes were designed to change behaviour, and they definitely had an effect in the short term. Octopus Investments, which had been managing half a billion in EIS funds, pulled out of the market entirely in May 2016
Lisa Best, research manager at Intelligent Partnership, told FT Adviser that it was possible that managers "were waiting until they were comfortable with the new rules before launching offers." She also suggested that investors might choose to shift their money elsewhere, such as into venture capital trusts (VCTs).
That's why we're alarmed to read that Venture Capital Trusts are also turning investors away. According to Fund Strategy, "VCT investors face a squeeze to access funds over the next two months as pension changes fuel demand in a year that many managers are lowering their fundraising targets due to an accumulation of cash."
“Advisers and investors waiting until late in the day are likely to be disappointed and told there is “no room at the Inn” with a number of offers closed for new investment.”
If investors' money is chasing a diminishing number of attractive opportunities, we can expect to see something change in 2017. Will entrepreniural activity pick up again? Can we expect to see a reversion to the norm in EIS/SEIS and VCTs? Or will investors take their funds elsewhere? It's too soon to know if what we're seeing is a short term slow down, or the beginning of something different.