InvestmentsOct 13 2014

Exciting prospects for savvy investors

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The UK and global technology sectors have outperformed many other segments in recent years, both on public markets and in private ventures.

According to a recent report by KPMG, technology companies are consistently more confident about the business outlook than firms in other industry sectors, with 44 per cent of technology firms planning to increase staffing levels in the next 12 months.

The UK technology sector has recorded its best growth performance in almost a decade (see graph opposite).

As a result, the UK has become a breeding ground for dynamic technology businesses across a wide breadth of specialist industries, such as the digital sector, which boasts 25 per cent greater revenue growth than the UK average.

Taking into consideration the long-term growth prospects of the technology sector, combined with the UK’s leading expertise across growth areas such as e-commerce and financial technology, there are considerable opportunities for savvy investors.

Through the Enterprise Investment Scheme (EIS) and its younger sister, the Seed Enterprise Investment Scheme (SEIS), investors have the opportunity to gain access to high-growth UK technology businesses while potentially mitigating a high degree of the associated capital risk and enhancing total returns.

This is achieved via a strategic combination of upfront income relief, exemption from capital gains tax on investment returns – assuming shares are held for a minimum of three years – and loss relief should the business fail or shares reduce in value.

Private investors without significant investment capital or experience can access high-growth and tax-efficient technology opportunities through an EIS/SEIS portfolio. This has a number of key advantages.

A primary benefit is the potential it offers for diversification, whereby investors can spread their risk across a range of EIS/SEIS-qualifying companies. These firms have each been scrutinised by sector specialists, who have the market knowledge to build a balanced portfolio with the requisite breadth and depth to reduce portfolio risk without compromising growth.

In addition, the tax advantages can be maximised through a portfolio strategy, whereby investors can potentially offset any losses from individual companies, regardless of the success of the overall portfolio, which can serve to increase total investment returns.

The experience and expertise of the fund manager is a critical factor in any EIS/SEIS investment. However, this is especially true of early-stage technology businesses, which often need active investors since founders tend to be technologists first and business people second.

Fund managers with access to high-quality personnel with hands-on experience and specialist skill sets across key technology sectors can significantly accelerate the growth and trajectory of each portfolio company, offering informed guidance and support – something a generalist investor cannot.

Deal flow is also crucial to the success of an SEIS and EIS investment. Companies most likely to succeed will be reasonably well established, with strong revenue growth prospects, proven commercial traction and defensible market positions. Can your manager unearth these companies?

It is worth looking closely at the sources of deal flow a technology EIS manager has, in particular any relationships they have with universities, as these can offer an unrivalled pipeline of innovative investment opportunities, where access is often the preserve of institutional investors. Good university relationships can offer further benefits to a manager in the form of technology expertise, grant opportunities and synergistic technology.

Ultimately, of course, success depends on exit, too. A good manager will be thinking about the back door, even while entering the front – identifying potential acquirers helps the fund manager shape the business strategy toward achieving a profitable exit, usually within four to seven years of the initial investment.

In short, the opportunities in technology are exciting and the SEIS/EIS structure considerably reduces client risk. But a specialist portfolio manager with strong sector expertise and access to good sources of deal flow should considerably enhance the likelihood of investment success.

Dr Mark Payton is managing director and chief investment officer of Mercia Fund Management

SCHEME DEFINITIONS

• Enterprise Investment Scheme

EIS is a scheme to help smaller companies raise funding by offering tax relief to investors who buy new shares

• Seed Enterprise Investment Scheme

SEIS complements EIS and provides tax relief to investors who purchase shares in new, early-stage businesses