While venture capital trusts have spent much of the last year in the limelight, their more specialist cousins -enterprise zone trusts and enterprise investment schemes – have so far received little attention.
But for wealthy investors with capital gains to shelter and an appetite for risk, IFAs could do worse than giving EISs and EZTs a look.
EISs were launched in 1994 and give investors exposure to a single start-up or smaller company. Like VCTs, they come with compelling income and capital gains tax breaks. They also include an element of protection on your investment to compensate for the higher degree of risk.
On investments of up to £150,000, there is an income tax kickback of 20 per cent, under the condition that the investment is held for three years. An unlimited amount of capital gains can be sheltered from tax for as long as the investment is held.
But the money must be invested a maximum of three years after, or one year before, the gain is realised. Capital gains tax is then payable when the investment is sold although all gains made within the investment, from dividends or capital growth, are tax-exempt.
Unlike VCTs, EISs come with several extra incentives. Any losses arising on the disposal of EIS shares can be offset against either capital gains or taxable income. Furthermore, shares held for more than two years are eligible for 100 per cent inheritance tax relief on the investment's transferral.
Singer & Friedlander is one of the biggest EIS providers. Its smaller companies fund manager Richard Hallett says EISs have plenty of potential but should not make up too large a part of a portfolio.
He says: “You are talking about fairly risky growth with EISs. So the sort of clients that IFAs should be recommending them to are those with large amounts of wealth, and those that can direct money into these investments which they can afford to lose. You do not want to put a substantial amount of your assets in these.”
To date, EISs have not had many notable successes. But with the oldest EISs still less than seven years old, it may be unfair to pass an ultimate judgement on them yet. With the tax breaks and protection, investors are unlikely to be left nursing heavy losses from EISs and they may well make strong returns over the longer term.
There have, however, been one or two successes already. Night-club chain Po Na Na, launched as an EIS in 1996 at 10p a share. Five years on, it has passed through Ofex and floated on the Alternative Investment Market where it is now trading at around 150p a share.
Aside from the high risk, EISs have several other downsides. The EIS market is illiquid and hence provides no easy exit if things begin to look sticky. Unless the company has floated, investors are unable to trade EIS shares and they can only be released by a trade sale, merger, flotation or share buyback by the company.
Equally, EIS shareholders have no representation on the board of directors, and are unlikely to have much information about the firm before they invest. Moreover, initial charges are high – sometimes as much as 8 per cent – with minimum investments of between £2,000 and £5,000.
Enterprise zone trusts are riskier still. Founded back in 1989, they provide exposure to the commercial property market in Britain's most run-down areas. The few that are launched each year sell out immediately, with many being bought up entirely by individual investors.
Enterprise zones were created to encourage investment in areas of decline. Most are located in the North-east of England and South Wales although perhaps the most well known enterprise zone was London's Docklands. The zones only maintain their status for 10 years and the Government has not created any new ones since 1995. As a result, EZTs – which invest in individual properties within the zones – are an increasingly rare breed.
Like EISs and VCTs, EZTs also come with their share of tax breaks. Investors receive a 40 per cent tax relief on their initial investment – excluding the land element of the property – as long as the investment is held for a minimum of seven years.
The remainder is then usually borrowed from the bank, with loan repayments paid off by the property's rental yield. The rent may also provide a little extra income as well. Any capital gains are also sheltered from tax for the life of the investment, and all gains made within the investment are tax exempt.
The tax breaks, complemented by the bank loan, mean investors effectively have no capital outlay. But the downside is that if the tenants default on their rent, the investor is still responsible for the loan repayments.
Like EISs, there is no easy exit from EZTs. After seven years, the manager will attempt to find a buyer for the property, at which point the investor will realise their investment. But it can often take some time to find a buyer and, furthermore, the investor is still liable for any shortfall on the loan once the property has been sold.
Although there have been no notable successes in the EZT market as of yet, most are still within their seven-year holding period. There have, however, been several notable catastrophes. One Docklands EZT, launched in the early 1990s, saw several high-profile investors – including footballer Chris Waddle and then Next chief executive David Jones – suffer heavy financial losses.
EZTs are a long way from becoming a mainstream investment. Moreover, they are almost extinct. But for those with the money to spare, they may still be worth a look before they disappear.
One IFA that still deals with EZTs is Brooks McDonald & Gayer. Director Jon Gumpel says: “EZTs are still very popular, such that demand has led to unrealistic prices. This Government's refusal to create additional zones, despite their success, has worsened the situation and will lead to the demise of this investment in a few years.”