A few months ago I attended a round table with my industry peers on Enterprise Investment Schemes (EIS) and Seed Enterprise Investment Schemes (SEIS). We discussed how financial advisers are now beginning to offer these products to their clients as part of their portfolio. You can read about this discussion in EIS: The Pros and Cons. In this post, I’m going to focus on the benefits that early investing can bring for entrepreneurs, as well as the opportunities it provides for investors.
Helping Entrepreneurs Bridge the ‘Equity Gap’
One clear conclusion we drew from the round table discussion was that early-stage investing is not to be entered into lightly. The rewards can be generous but they come with a level of risk which doesn’t suit everyone so if you’re choosing to invest in any of these schemes you need to have access to plenty of information and advice. In particular, a high level of due diligence is crucial to ensuring that all investors go into it with their eyes open. A measure of just how important due diligence is can be found in the practices of a business we work with at First Wealth. MMC Ventures provide backing and advice to ambitious UK entrepreneurs. They have worked in early-stage investing for 17 years, so they know this space well and of the approximately 2000 entrepreneurs’ businesses cases they receive every year, they might choose to invest in just five.
So, what does this level of scrutiny and competition mean for the entrepreneur? How should they attempt to approach and build relationships with venture capital companies like MMC? Anna Slemmings, Director of Marketing and Investor Relations at MMC, explains: “What’s vital first of all is to decide if seed funding or taking venture capital is absolutely right for your business, because it’s not appropriate for everyone. If and when you decide that it is, you’ll need to work hard to get the attention of a venture capital firm in such a competitive environment. Doing your homework and researching thoroughly is obviously vitally important. In addition, venture capital firms are speaking and appearing at events on the circuit regularly and the best entrepreneurs will figure out a way to get a warm introduction to give themselves an edge.”
A big part of what MMC will do when they take on a young business is help them prepare to attract potential investors, and be ready to seize the opportunity when they do. In practical terms this means things like providing strategic advice, formalising reporting methods and making sure there’s a strong board in place to give them the best chance of attracting the funding.
The space in the market that venture capitalists like MMC seek to fill is often called the ‘equity gap’. It’s also known as the ‘scale-up problem’ and it’s an obstacle that can impact significantly on the young tech firms they primarily concentrate on. Henry Emson, Business Development Manager at MMC, explains: “It’s the stage that comes after the very early-stage funding, and typically when a business might consider taking on some bank debt to grow the company. This can be difficult in this climate for a young tech business. The challenge is how to help UK businesses become world leaders in this field and to compete with Silicon Valley. We sit at the start of this scale-up process. We will invest £2m to start with and then £7, or £8 million in the lifecycle of the company to make them into a profitable standalone UK business or to put them in a position where they can then attract significant further funding to drive global ambitions.”
David, meet Goliath
It’s not just individuals or syndicates of investors who might be interested in early-stage investing. Entrepreneurs can also attract interest from multinationals and large-scale corporates keen to co-invest in their ventures. Many of MMC’s tech entrepreneurs get plenty of attention from bigger, more established businesses. One example is Halfords, who have invested in start-up firm ‘Tyres On The Drive’ – an online ordering service delivering and fitting new tyres to customers’ cars at their own properties. Strategic investment from a large-scale corporate into an early-stage tech business helps the entrepreneur to scale their business quickly, while the opportunities for the corporate are numerous. In this instance, for example, Halfords can upsell other items to customers (windscreen wipers etc) while remaining well-placed for any acquisition option which may arise later down the line.
But, it’s not just about the potential buy-out opportunities for the corporate investors. Tapping into the level of innovation on offer at an early-stage disruptive business is a shrewd and healthy attitude to help a corporate stay ahead of the pack. For example, it can be a lot more cost-effective for them than setting up their own R&D department. Henry from MMC explains: “It used to be that challengers in the market could be eliminated by big corporates who could displace them through economies of scale. However, the tech space is so disruptive that all this has now changed. Now it is about them identifying the big threats in their sector and turning them into opportunities.”
Multiple Opportunities for Investors
The tax relief opportunities of the EIS and SEIS are certainly a big part of what makes early-stage investing appealing to investors. For family and friends of the entrepreneurs, for example, who might be keen to help fund their start-up, the SEIS in particular could be a rewarding option. As long as they meet the government criteria, it can provide a tax-efficient vehicle offering relief of 50% on income tax and further relief on capital gains tax. Beyond the tax benefits however, they’re increasingly being viewed as valid investment options in their own right. (Interestingly, MMC now also manage several institutional funds which don’t qualify for tax reliefs but which they co-invest with the tax-efficient funds on the same terms).
Early-stage investing has also grown in popularity following the changes to pensions, which limit contributions made on an annual basis and the amount permitted over a lifetime. The new retirement lifetime savings limit is caped at £1m (reduced from £1.8m in 2010), meanwhile high earners with an income of £210,000 or more have found their annual allowance reduced to just £10,000. Anyone in breach of these faces a heavy tax bill – 55% on any lump sum taken above the lifetime limit, and 25% taken on any income. In these circumstances, the EIS and SEIS have provided a new way to invest this money.
To sum up, there are plenty of opportunities in the early investing space, but it’s important that both entrepreneurs and investors think carefully if it’s the correct option for them – whether they’re scaling up their business or seeking to achieve their investment goals, respectively. At First Wealth, our job as advisers remains to ensure that we use the appropriate tools to guide our clients towards their ideal financial outcomes and to help them build the financial lifestyle they desire.
If you want to discuss whether enterprise investment is a good fit for your portfolio, please get in touch.