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Martin Churchill: Is now the time to take the venture capital risk?

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A few reports out over the summer suggest the venture capital market might be at an interesting point for investors looking for growth, especially if the early stage investment risk can be mitigated by Enterprise Investment Scheme reliefs.

The quantum and quality of growth businesses seems to be on the rise on the back of various initiatives and innovation. A survey by UHY Hacker Young found that Tech City in London saw 15,740 start-ups created in 2012; an amazing number for one postcode. At the same time a Deloitte report stated that whilst the technology, media and telecoms sector accounts for some 8 per cent of UK GDP there is a lack of funding for business seeking £0.5m – £4m.

The result of the above is that venture capital firms with capital to deploy are seeing strong deal pipelines and completing deals at attractive valuations. This trend seems to be backed up by the industry performance data. A recent Preqin (a market intelligence firm) report showed that whilst the venture capital sector underperformed over the 10 year period to September 2012 versus the S&P 500, it has outperformed over the last five years.

This sector performance excludes those firms allowing investors to claim EIS tax benefits, which enhances returns. The upside benefits are well known (eg 30 per cent tax relief) but also a higher rate tax payer is only exposing 38.5p for every pound invested. This makes it ideal when investing in a diversified portfolio of early stage assets where one expects around 25 per cent of the investments to be written off but the rest to generate strong multiples on investment, especially a ‘home run’ investment.

In addition if you pick the right EIS fund manager the chances of outperformance should increase and investors will get exposure to deals that are hard to access for the retail investor.

For instance MMC Ventures in the last 12 months has co-invested with around 10 institutional venture capital funds, including well known firms such as Highland, Wellington and Index. These funds would require a sizeable investment and a 10 year commitment but by investing in a firm like MMC you get access to some of the same deals at a fraction of the cost and commitment (min subscription £25,000).

Like institutional investors in those funds above, venture capital is a key component of an investor’s balanced and diversified investment portfolio. The risk / return nature of the sector should not be ignored but we seem to be in an exciting time of technical innovation and growth and there is a definite buzz around the industry. It would seem that venture capital performance is benefitting from a buoyant environment, and choosing the right EIS fund manager can enhance the returns further.

Martin Churchill is editor of Tax Efficient Review

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