The Enterprise Investment Scheme (EIS) and Venture Capital Trusts (VCTs) might be attractive investment propositions to your clients. Their potential for greater returns can be very appealing, especially if your clients are seeking higher-risk avenues to achieving significant growth on their current wealth.
However, it is important they never lose sight of the balancing act of “risk versus reward”.
VCTs and the EIS could offer potentially lucrative rewards to investors, but they also come with much higher levels of risk.
Read on to discover the pros and cons your clients should consider before opting to invest.
The benefits of investing in VCTs or the EIS
1. There is the potential for substantial growth on your clients’ initial investment
VCTs and the EIS are both typically funds made up of small companies, usually fledgling start-ups, which have the potential to grow significantly in value over the lifetime of the investment.
Some examples of successful companies to emerge from the EIS or VCT are:
- Koru Kids
- Gousto
- Five Guys
- Everyman Cinemas
- Zoopla
These businesses have now become household names and are likely to have generated significant returns for their initial investors.
For example, in 2012 Gousto had fewer than 50 customers but, by 2020, the company had achieved “unicorn status” when its valuation exceeded £1 billion for the first time.
If your clients require significant growth on their investments to help them reach their goals, it might be worth considering the EIS or a VCT.
2. Your clients could benefit from significant tax relief on their investment
One particularly attractive aspect of both the EIS and a VCT is their respective tax relief benefits, as shown by the table below:
If your clients have hit their Personal Allowance — and utilised the tax benefits of their pension Annual Allowance — they might be able to pursue further tax relief through investing in an EIS or VCT, while staying true to their goal of generating considerable growth on their investments.
The Income Tax savings could be considerable, especially for higher- and additional-rate taxpayers. Additionally, the dividends exemption for VCTs — as well as the potential CGT exemptions for both — could significantly boost the returns generated from your clients’ investment.
3. Your clients could provide essential funds to help grow innovative start-ups
This is sometimes known as the “Dragon’s Den effect” — the desire for investors to not only get in on the ground floor of a potentially lucrative investment, but benefit from the emotional boost of helping a business get off the ground.
Having greater control over the nature of their investments is becoming increasingly important to potential investors. This has helped drive areas such as environmental, social, and governance funds to the forefront of the modern investing world.
It is possible that your clients could receive considerable emotional wellbeing benefits from knowing their valuable funds are being put to good use helping entrepreneurs and start-up companies succeed.
The downsides of investing in VCTs or an EIS
1. They are typically made up of small, fledgling companies with a greater risk of failure
As mentioned above, companies within the EIS or a VCT are typically start-ups that are seeking funding to help them grow. This can see them grow significantly over time, but also means that the risk of their failure and collapse is considerably greater.
A report by Money Marketing estimates that between 20% and 30% of investments in a VCT will not generate the expected returns.
It is an investment area that Money Marketing refers to as “not for the fainthearted”.
Considering the increased probability of losses, it is important that your clients ensure their investment aligns with their own tolerance for risk before parting with any funds.
2. They can require more active oversight and a greater degree of due diligence, which can be time-consuming
As there is a greater potential for loss or collapse with a VCT or EIS, there also comes a greater need for thorough research, ongoing due diligence, and regular oversight of the investment.
This might be increasingly time-consuming for your clients and see them pulled away from spending their valuable time focusing on their loved ones and personal goals in life.
At Grey Parrot, a core part of our investment philosophy is passive or smart investing.
It is important to remember that very few active fund managers beat the market in the long run.
So, adopting a low-cost, buy-and-hold approach to investments could see your clients generate the returns they need over the long term while keeping the time they spend overseeing those investments to a minimum.
This ultimately leaves them with far more time to do what is actually important — living and enjoying their lives.
3. As the Lifetime Allowance has been effectively abolished, it might be more tax-efficient for your clients to save into their pensions
Two of the major changes to emerge from the UK government’s spring Budget were the effective abolishment of the Lifetime Allowance (LTA) on pension savings and the increase of the Annual Allowance threshold from £40,000 to £60,000 (as of the 2023/24 tax year).
While the EIS or a VCT offer plenty of beneficial tax incentives, the removal of the LTA means that saving into a private or workplace pension scheme might offer greater tax relief rewards for those clients who pay higher- or additional-rate tax.
Get in touch
It is important that your clients carefully weigh up any potential risk versus the possibility of rewards before making a high-risk investment. The benefits of a healthy degree of caution should never be underestimated.
If your clients are interested in pursuing an investment in the EIS or a VCT, they should seek out professional advice first. So, whatever they decide, they are as well-informed as possible.
To find out more they could email us at info@grey-parrot.co.uk or call us at 02039 871782.
Please note
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
Enterprise Initiative Schemes (EIS) and Venture Capital Trusts (VCT) are higher-risk investments. They are typically suitable for UK-resident taxpayers who are able to tolerate increased levels of risk and are looking to invest for five years or more. Historical or current yields should not be considered a reliable indicator of future returns as they cannot be guaranteed.
Share values and income generated by the investments could go down as well as up, and you may get back less than you originally invested. These investments are highly illiquid, which means investors could find it difficult to, or be unable to, realise their shares at a value that’s close to the value of the underlying assets.
Tax levels and reliefs could change and the availability of tax reliefs will depend on individual circumstances.
A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits.
This article is no substitute for financial advice and should not be treated as such. To determine the best course of action for your individual circumstances, please contact us.