EIS: Take a closer look

The Enterprise Investment Schemes (EIS has been selected by the government as a vital component of its efforts to stimulate economic growth through tax-incentivised investment in smaller, privately-held businesses.

The immediate need to support the economy hardly needs highlighting; we've been through one of the deepest recessions for almost a century and the prospect of a much-feared double dip cannot be discounted.

So just how effective might EIS be in assisting a recovery? And, perhaps more importantly for investors, what are the risks and the rewards?

For the answer to the first question it is worth looking at the work of the National Lottery-funded National Endowment for Science, Technology and the Arts (Nesta, which has a remit to support and develop innovation in the UK economy by various means, including investing directly in businesses.

Of particular note, three reports it has produced, the Vital 6 Per Cent, Vital Growth and Siding with Angels, consider the importance of small, fast-growing businesses to the UK economy.

To boil them down – and drastically oversimplify the findings – they highlight that some 6 per cent of innovatory UK businesses with the highest growth rates have been responsible for generating half of all new UK jobs. The third report, Siding with Angels showed that investment from business angels – which can include funding through the EIS – is hugely important to the development of these small, fast-growing businesses.

There can be no doubt that the economy needs these businesses now more than ever and yet they find investment particularly hard to get in these difficult times. The traditional sources such as banks or venture capital are, respectively, either reluctant to lend or have more pressing concerns keeping existing investments afloat than to put money into new ones.

What this means is that there is now a great opportunity for EIS investors to fill this investment vacuum and potentially reap some very healthy returns in the process.

Investing in small businesses – among which technology start-ups form an important part – is historically seen as high risk. But the Government's desire to encourage private investment into the sector has led it to increase the upfront tax relief available through EIS and to take other steps to increase its attractiveness and minimise potential investment loss.

One of the key aspects of the EIS that mitigates risk is loss relief. For higher rate taxpayers this can mean a maximum loss of 35 pence in the pound once initial 30 per cent income tax relief has been taken into account and the remaining 70 per cent loss is offset against income tax at the 50 per cent rate. Such a government-backed guarantee to limit an investor's losses is incredibly valuable, particularly when coupled with the highly attractive upside to EIS investing whose gains can be capital gains tax free.

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