Appropriateness and suitability for investors

Mr Kiernan says EIS has a high degree of risk as they target early stage (and start-up) companies and are not appropriate for all investors, with the tax advantages likely to be particularly applicable to higher rate taxpayers.

According to Mr Kiernan, EIS are likely to only be suitable for:

1) experienced investors who are comfortable with taking on a high level of risk;

2) investors with a medium-term investment horizon who understand the illiquid nature of the investment; and

3) investors liable to higher rates of income tax.

Along with venture capital trusts (VCTs), Mr Kiernan says EIS may become more suitable once other tax efficient options such as pension contributions and individual savings accounts (Isas) have been fully utilised.

He says it is unlikely that EIS would be suitable for the majority of normal rate tax payers and it would be prudent to explore mainstream solutions first.

Mr Kiernan says the right approach may be to identify how much a client would allocate to high risk, small UK companies and then use EIS to provide part of the exposure.

He says it is important for potential investors and their advisers to assess the following:

1) the size of the intended allocation to higher-risk EIS companies;

2) whether to make a single investment, discretionary managed investment of EIS fund;

3) what sectors of companies may be of interest; and

4) whether the investor wants passive or active involvement (business angel wishing to use skills).

Jonathan Gain, chief executive of Stellar Asset Management, says it is important to be comfortable with the underlying nature of the investment and not let the tax incentives sway the decision.

Mr Gain says these incentives are put in place by government in order to attract investment into smaller UK companies to compensate investors for the added risk they are taking.

That being said, Mr Gain says for a higher rate tax payer (45 per cent), if they are able to receive the initial income tax relief on their investment and their investment was to reduce totally to zero, the maximum amount of actual money they could lose would be 42 per cent of their initial investment utilising loss relief.

Mr Gain says this means that an investor is not taking as big a gamble as may initially be thought.

He says: “Typical investors are those with income taxable at the highest rate, those looking to shelter capital gains and for some elderly investors with a substantial estate looking to obtain some relief from inheritance tax.”

Although the tax reliefs are hugely appealing, Mr Gain says the underlying investment must be within their asset allocation boundaries and match their income and growth requirements.

He says: “Different investment houses offer different investment strategies, some with income and others capital growth; some more speculative and some more asset-backed.

“It is important to understand the liquidity issues with different offerings as well. As with most investments, a diversified approached should be favoured by advisers and clients alike.”