Partner Content by Octopus Investments

How Michael’s financial adviser helped him build a diversified portfolio of early-stage private companies

Investments in early-stage, unlisted businesses are becoming an increasingly attractive part of more client portfolios. This is because many investors comfortable with high risk are looking for investments with the potential to outperform inflation rates and target growth during uncertain times.

They can also be an effective diversifier because they are not always correlated with listed equities or bonds. One reason for this is that the drivers of growth for early-stage companies can be more independent of the economic cycle. Micro economic factors such as supply and demand can influence early-stage companies more than macro factors like inflation. Uncertain economic environments can, however, provide opportunities for early-stage companies, because they can be more nimble than bigger established players.

Investors are taking on more risk when investing in early-stage businesses because, among other reasons, early-stage companies have a higher rate of failure compared to mature businesses.1 So it’s important that clients are well diversified within their overall investment portfolio.

Venture Capital Trusts (VCTs) are a well-known and tax-efficient way clients can gain access to a large and diversified portfolio of early-stage companies. However, as the following scenario explains, investors can consider another potentially powerful way to structure their exposure to venture capital.

Meet Michael, an investor comfortable with risk and looking to target high growth

Michael is a partner at his accountancy firm. Several years ago, he expressed an interest in using a portion of his wealth to invest in exciting companies that had the potential to grow significantly over the long term.

At the time, his financial adviser explained that a VCT would give him access to a ready-made portfolio of early-stage companies. This could complement and diversify his existing portfolio of investments while supporting his tax planning. He could also claim up to 30% income tax relief on his investment and target a tax-free income from his investment.

So each year, Michael invests between £10,000 and £50,000 in VCTs as a means to allocate to unlisted early-stage companies and support his tax planning.

However, over the past two years his accountancy firm has grown rapidly. Michael now has a much larger pot of cash to invest on an annual basis. He’s now looking to allocate closer to £100,000 each year to early-stage businesses.

At his annual client review, Michael and his adviser discuss his current investment strategy and what might suit his needs going forward.

When the topic of VCTs comes up, Michael’s adviser has an idea.

Michael learns of the Enterprise Investment Scheme

Michael’s adviser explains that, because of his capacity for loss, time horizon, broad investment portfolio, and significant amount of capital to deploy each year, he could structure his annual investments in early-stage companies differently.

Michael could participate in multiple fundraising rounds of an Enterprise Investment Scheme (EIS) service. An EIS service is managed by a specialist manager in a similar way to a VCT, but typically invests across 10-15 early stage companies, meaning the investment is more concentrated than a VCT and investors hold shares directly in each young business.

EIS companies have high growth potential because they are beginning their growth journeys. Of course, with this growth potential comes higher risk. To compensate for some of the risk of investing in early-stage businesses, EIS-qualifying investments allow investors to claim several tax reliefs. As with a VCT, Michael should be able to claim up to 30% upfront income tax relief.