Change is often greeted with fear and trepidation. This was certainly the case when HM Revenue & Customs announced changes to the qualifying rules for EISs that came into force recently and it's easy to see why.
The updated qualifying rules mean EIS managers can no longer invest in more established companies (those older than seven years or ten years for 'knowledge-intensive' firms) or fund replacement capital, but the major change is the ineligibility of subsidised energy firms such as those investing in wind or solar.
The latter is significant as, built on such assets, the EIS market had expanded beyond recognition in the years prior. In 2010/11, EIS investment was c£600m. In the final year of renewable energy investment (2015/16), this had trebled to around £1.8bn.
These changes to EIS rules are perceived as ushering managers and investors toward greater uncertainty and increased risk, threatening what has become a booming market.
For investors, the appeal of generous tax breaks with 'managed' risks was substantial, while managers enjoyed the merits of a product that, in large part, sold itself.
In this context, the legislative changes seem to present a dual threat; would investors find the risk of 'true' EIS investment palatable and could managers who built a reputation on 'capital preservation' assets offer appealing alternatives?
These concerns miss three key realities. First, that EISs were never intended to offer risk-mitigated access to generous tax breaks. Second that the UK must do more to scale small businesses. And finally, the volume and quality of high growth businesses in the UK warrants greater investment. Let's explore these points in turn.
Only the door has changed
In general, the purpose of EISs is well understood; it's a way for small businesses looking to grow to access capital that may otherwise be unavailable (as investors shy away from small, illiquid firms) or unaffordable (as firms lack the revenue or profit to manage debt effectively). The emphasis is on enabling UK businesses to grow.
To attract this capital, the government offers tax benefits to entice private investors. For those who can take full advantage, the appeal is unparalleled.
An EIS can offer up to 98% tax relief, all but returning the full value of investment in tax breaks. This is before we consider the value of loss relief that mitigates downside risk to a maximum of 42% for a higher-rate tax payer or indeed the enhanced benefits of SEISs.
These benefits haven't gone away. It is only the door through which investors can access them that has changed.