Enterprise Investment Scheme (EIS) were established by the Government in 1994 as a means of encouraging private individuals to invest in start-up businesses.
According to Ewoud Karelse, tax shelter analyst at Allenbridge, the main incentive of the schemes is the tax treatment of the investments, with the structure giving 20% tax relief on capital gains so long as the money remains invested for at least three years.
Tax on capital gains made in the three years before the investment is made or for one year after can also be deferred.
"People who invest in EIS companies and funds are generally those with capital gains tax issues," Karelse said.
"EISs are normally attractive to sophisticated investors as those with capital gains issues are generally the type of people that have a number of properties or a large portfolio of equity shares and anticipate selling some off."
John Blowers, CEO of Pre-X, added one of the main drivers behind the Government’s EIS drive was to encourage investors to look at small and growing companies, with UK investors generally conservative and drawn to investing in large, established firms.
The tax incentives, he added, are designed to mitigate the perceived risks of investing in such businesses.
Martin Churchill, editor of Tax Efficient Review, explained a number of offerings are available to private investors under the scheme, among them single companies seeking to raise funds.
"These are high risk and should be held as part of a portfolio of EIS companies in order to attempt to spread the risk," he said.
He added portfolio offerings are also available, with a fund manager building portfolios on a discretionary basis, usually either entirely from Aim stocks or a combination of Aim and unquoted EIS companies.
Approved EIS funds are also available, Churchill said, adding that these vehicles must invest 90% of the funds raised in at least four companies within six months.
"In return, investors receive income tax relief in the tax year in which the fund closes, but capital gains tax relief is still related to the date the underlying investments are made," he said.
"In reality, to meet the 90% investment rule, the fund will have to have a pipeline of investment opportunities lined up."
Blowers pointed out that in the 2006 Budget, the Government doubled the amount of EIS investment eligible for tax relief from £200,000 to £400,000, adding that, in addition to CGT relief, EIS investors are eligible for inheritance tax (IHT) and loss relief.
"With loss relief, if one of the firms an EIS fund is invested in goes bust, investors will get 32% of their money back as well as the 20% capital gains tax relief," he said. The IHT benefit is that, after two years, the holding falls outside the investor’s estate, meaning it is not liable for IHT.
While EIS companies are not normally listed on a stock exchange they must be trading companies though a number of areas, such as land, property, hotels and financial services, are not eligible for investment under the scheme.
Like VCTs, the value of a company’s gross assets must not be greater than £7m before the EIS makes its investment though Karelse said EIS companies are generally at a much earlier stage of development than those invested in by VCTs.
Generally EIS companies will be pre-IPO businesses, meaning the capital requirement is more for seed and development purposes, he added.
"Traditionally EIS funds would have invested quite a lot in technology-related companies while at the other end of the spectrum there are asset-backed EIS companies," Karelse said. "A lot of firms raising funds under EIS will be asset backed, such as pubs or nurseries."
As the scheme is only available to high net worth and sophisticated investors, EIS investments can be made either direct to the firm offering them or via intermediaries.
Examples of those currently available in the market are the British Country Inns 2 plc, an EIS company, which, as its name suggests, invests in country pubs across Britain.
The Calculus Capital EIS fund is a micro-cap private equity portfolio structured as an EIS fund, which invests in a variety of companies such as oil and gas exploration firm Edgon Resources and sports stadia caterer Lindley Catering.