An entrepreneur’s guide to investing in Enterprise Investment Schemes

What is an Enterprise Investment Scheme?

The Government introduced the Enterprise Investment Scheme (EIS) to help small limited companies raise finance. EIS investments allow eligible investors to claim up to 30% Income Tax relief, up to £1 million each tax year. If investing in knowledge-intensive companies, the tax relief benefits extend by another £1 million, meaning you can gain relief on up to £2 million.

Tax advantages for investors using EIS

To encourage and support young and aspiring UK businesses, the Government offers tax benefits to investors. Initially, there is 30% Income Tax relief which can be carried back to the previous tax year.

As there is an expectation that a percentage of these young businesses will not work out, loss relief is available. If a company is wound up, part of the initial investment can be offset against your current tax liability.

If you have an existing gain subject to a Capital Gains Tax (CGT) charge, you can defer the gain by investing it in EIS-qualifying shares. This can be a great solution when selling a business, investment, or property.

As long as you hold your EIS investment for at least three years, you won’t be charged CGT on any gains. If it comes out early, it can also be re-invested.

Because EIS shares usually constitute “relevant business property” for Inheritance Tax (IHT) purposes, after two years the EIS shares should qualify for 100% Business Property Relief as well as full IHT relief.

What kind of companies qualify for EIS relief?

There are certain criteria that must be met to qualify for EIS relief. Companies that qualify for EIS relief are small, and often privately owned, although they can be listed on AIM. Primarily, to qualify, a company needs to trade with a view to making a profit.

In brief, companies may qualify to raise funding through EIS if they:

  • Made their first commercial sale less than 7 years ago
  • Have less than £15 million in gross assets
  • Have less than 250 employees.

Companies that are considered as “knowledge-intensive” differ and can be up to 10 years old.

Some companies and sectors are excluded, for example, those that deal in land, commodities or shares. Companies that have significant asset backing or contractual revenue streams have also been excluded.

Although the list of exclusions is lengthy, there’s still huge scope for investors.

Who should consider including EIS investments as part of their financial plan?

First Wealth recommend EIS’s for business owners with substantial income who are looking for ways to reduce their tax burden.

While most people are fairly comfortable earning up to around £100,000, once you exceed that, the tax penalties can become substantial. This causes people to leave assets in their business because the idea of having to pay so much tax is quite scary.

Understandably, many people are reluctant to pay such high tax costs for money they have worked so hard to accumulate.

EIS is a really useful tool for business owners who want to take some capital out of the business and into their own name, ahead of when they expect to want to use the money.

2 examples of who can benefit from using EIS

  1. Successful young business owner

A young business owner doing well for themselves found that they were building up quite a lot of capital within their business.

With low personal costs, their current lifestyle costs are around £40,000 to £50,000 a year. This includes their accommodation and although they travel a lot, many expensive costs are transacted through the business.

Clearly, this is a great place to be but the whole point of financial planning is that it is aspirational. It’s all about where you see yourself in the future and planning for that to make it a reality.

This is where EIS comes into play.

In this case, we recommended that the client paid themselves more than they strictly needed, so that they could begin syphoning money into an EIS.

This allowed the client to benefit from the 30% tax relief. For example, for every £10,000 invested into the EIS, she could deduct £3,000 off her Income Tax liability.

Through careful planning and cashflow forecasting, the client can invest money she doesn’t yet need into an EIS knowing she’s unlikely to call on it for at least five years. The timescale also means that she won’t incur any CGT on gains the investment generates.

  1. Business owner approaching retirement

Another client has been in business for years. In his mid-70s, his business is flying. He wants to retire but he’s too busy to be able to.

The business is generating so much money that he and his wife now have the problem that they are struggling to get money out of the business and into their own name before they finally step back.

The other pressing matter is that if they leave too much cash in the business it will fall foul of IHT, so there is even more need to ensure that as much wealth as possible is moved over.

For this client and his wife, we have maximised their pension contributions and an EIS is another really great way to minimise their tax liability while moving money out of the business and into each of their names.

In this particular case, investing in the EIS means that they will gain enormous Income Tax benefits, the CGT benefit, and, as long as they each survive more than two years of making the investment, they will also be shielding the money that lands in the EIS from IHT.

How do I exit and take my money out?

Since EIS shares aren’t usually traded on the stock market, you can’t sell them the way you would sell other equity investments.

Instead, it is the managers’ responsibility to design an exit strategy that allows them to return capital and any tax-free growth to investors.

The manager will usually give an indication of the targeted exit strategy and time frame at the outset. Common strategies you can expect to see include management buy-outs, trade sales, or refinancing.

EIS investments are suited to experienced or wealthy investors

As you have probably gathered, EIS investments are geared towards experienced or wealthy investors and should form part of a diversified portfolio.

As with the clients described above, they can be particularly attractive to investors with a high Income Tax bill who are looking for growth opportunities.

EIS’s could also appeal to investors with substantial CGT liabilities.

Get in touch

We work with business owners and entrepreneurs and work with you to keep your finances on track while you grow your business. While most financial planners focus on your money, we focus on you, your business, and the life you’re working hard for.

Enterprise Investment Schemes are complex and not suitable for everyone. They can be ideal for higher risk investors with a high level of income and a high tax bill. If you’d like to discuss whether EIS could help you achieve your goals, please get in touch.

Email, book a video call, or phone us on 020 7467 2700.

This document is marketing material for a retail audience and does not constitute advice or recommendations. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested.

Let's Talk

Book a FREE 30-minute Teams call and we’ll answer your questions. No strings attached.

Check Availability 

You are now leaving First Wealth's website

First Wealth (London) Limited does not endorse the linked website or any of its contents, and is not responsible for the accuracy of the information contained within it.