With EIS, the universe of companies you can choose from is limited to unquoted companies with no more than 250 employees and gross assets of less than £15m. So you cannot make an EIS investment in BP, for example. But there are thousands of well-established, profitable companies that fit the criteria. And many of them are arguably less risky than BP. You cannot use EIS to invest in banks or property companies, but that may be an element of diversity that clients are willing to forgo now that leverage is on the wane.
The essential characteristic to be aware of when investing in EIS companies is their lack of liquidity. By definition, EIS companies are not listed on a stock exchange. Clients and their advisers need to think of a cycle of three to five years, with the investment being made in growing the company so that it can be sold at a premium price to a larger group. In the jargon, this is called an ‘exit’. An exit delivers liquidity for all shareholders at the same time, but the decision to sell is rarely in the hands of any individual shareholder.
Clients do not need to be sophisticated investors to decide how much of their money they can afford to ‘lock-up’ in this way. Whether alone or with the help of an adviser, it is a relatively simple judgement to make.
Another common misconception among advisers is the risk factor of EIS; that it is synonymous with start-up companies and high technology – areas where risks can be very high indeed. It is certainly true that three quarters of all EIS share issues raise relatively small amounts – less than £500,000 – and it is likely that these are very small companies. However, 2012 saw a seismic shift in the EIS landscape, as the limits on size of company and amount raised were massively increased. One recent EIS issue was for a company with a 27-year profit record, revenues of £18m and annual profits of more than £1m. Hardly a risky start-up.
Questions have been raised as to the transparency of EIS investments, and we know that not many private companies include a 15-page section on governance in their annual report. On the other hand, as a shareholder in a typical EIS company, clients and their advisers can probably chat to the chief executive on the phone or go to look around the business if they want to do so. Private companies are not so hemmed in by public market rules, so clients and their advisers can really get a much more personal understanding of the investment.
If clients do not have time to do the legwork themselves, they can invest as part of an investor network that monitors companies for its members. Where a network is involved, you are likely to find that each EIS company’s articles of association gives investors much greater power than is usual with quoted companies, both to access information and to exert influence.
Many investment firms create EIS funds, which channel investors’ money into, say, 10 to 15 EIS companies. This does add a layer of complexity and can make investments less transparent. These funds often follow a specialist strategy – such as renewable energy or technology – which tends to make them less diverse than a typical balanced UK equities portfolio. But these issues are not related to EIS – as in most investment fields, investors have the choice of direct or fund investing. In the advisory industry, there has been debate about whether an EIS is an unregulated collective investment scheme. To make sense of the debate, we need to differentiate between an EIS company and an EIS fund. An EIS company is not a Ucis. A portfolio service enabling clients to invest in EIS companies is not a Ucis. An EIS fund is not a Ucis if it complies with Paragraph two of the Financial Services and Markets Act 2000 (Collective Investment Schemes) Order 2001. However, the FSA consultation on non-mainstream pooled investments suggests that any EIS fund whose investors all get exposure to a single set of companies is likely to be treated as a Ucis.