Advisers should start by assessing the risk profile of their client, according to John Thorpe, business line manager for EIS at Octopus Investments.
He says: “Decide how much risk you want to take. All EIS investments have risk attached but some EIS target companies with a focus on capital preservation and others on growth.
“It is then important to understand what the manager is going to invest in and the investment process involved, as different EIS managers adopt different investment strategies.
“Finally, consider the charges involved and compare these with other EIS products.”
Paul Sedgwick, head of investments at Frank Investments, says advisers should really get under the hood of what is potentially driving the performance of the EIS.
He says: “Over-estimating the growth early on is understandable as they have to feel the potential to make it worth their while and to attract investors. When looking at investment of this kind, we usually cut all revenue numbers in half, push up costs a little and see if the investment case still works.
“One question that should always be asked is where will the money be going? Be wary of investments where most of your money goes into paying the employee’s, you want to see your capital invested in the business.”
Finding the right fund manager could require a large amount of research and due diligence on the part of the adviser, according to Daniel Kiernan, director of alternative investment research provider Intelligent Partnership.
But Mr Kiernan says EIS can allow the adviser to add a lot of value to the relationship for suitable clients.
He says: “A fund manager with extensive knowledge of the sector and a solid track record of achieving returns should be the key criteria to look for.”
Having safeguards in place at the point of investment should be second nature and Mr Kiernan says these can include any or all of the following:
1) sufficient accessible emergency funds;
2) capping the proportion of investment at a suitable level;
3) ensuring advisers carry out independent due diligence on recommended EIS;
4) ensuring the client’s tolerance to investment risk is appropriate;
5) diversification across a range of EIS providers and companies; and
6) ensure that the tax tail is not wagging the investment dog.
To take advantage of EIS funds, Mr Kiernan adds the investor is likely to require a substantial investment portfolio of £50,000 or more in order to gain sufficient diversification.
Paul Sedgwick, head of investments at Frank Investments, says he does not like to refer to EIS as risk capital, but he would only recommend someone invest in EIS if they have the capacity to absorb any losses.
At the end of the day, Mr Sedgwick says an investor must always be aware of the inherent risks.
He says: “We always listen to our clients to ensure they get the best EIS on offer. This can be achieved by suggesting to our clients that they try and invest in a business they understand, knowledge of the sector closely correlates with how they can help the business.