DEMYSTIFYING THE COSTS OF EIS

Ever wonder what some EIS fund Managers aren’t telling you? GBI Magazine’s Alex Sullivan spoke to James D’Mello, The SidebySide Partnership, to dig down into the nitty gritty of the Enterprise Investment Scheme and give you and your clients the inside edge on fees and charges

PERFORMANCE FEES

Performance fees are simply fees on performance, but managers charge them in different ways. Performance fees can be charged against the overall portfolio or against individual investee companies.

The first structure means a fund manager will charge a fee on your client’s investment, while the latter means a fee will be charged on the profits from each company as they exit.

These structures means a client can have two very different investment outcomes from the same investment journey.

Theoretically, when performance fees are charged against individual companies in an EIS portfolio of ten companies, where nine failed and one made a five times return, your client would be charged on that one exit, despite making an overall loss.

PERFORMANCE HURDLES

A performance hurdle is a hurdle over which performance fees are charged. This means that if a fund manager returns over a set percentage through an exit, they will charge your client performance fees for it.

These fees can range from 20-35% and they can serve to align a fund manager’s interest with your client’s.

Performance hurdles are crucial for advisers and investors to understand because charges can apply on modest returns, after inflation and other fees, leaving the client with overall negative returns on a long term investment.

It’s also important for advisers to know two things about performance hurdles. Firstly, if a fund’s performance hurdle is a net profitable return, make sure that's on 100% of the investment not 70%. The 30% tax relief on investment usually isn’t factored into performances fees, but can be and can make a big difference to your client.

Secondly, there are a lot of funds that have performance hurdles and there are some that don’t. It is worth factoring that into your due diligence. Performance fees will have an effect on your client’s returns.

The 30% tax relief on investment usually isn’t factored into performances fees, but can be and can make a big difference to your client

HIDDEN FEES

Fees will always be presented in different ways, but if you convert them into a percentage they can add up quickly.

Most fund managers will say they won’t charge your client fees directly and a lot funds can charge fees to their investee companies. This means that whatever a client invests into the fund, 100% will be available for tax relief purposes, but if the company comes to sell it will still come off the client’s returns.

CoInvestor, along with the EIS Association has published a report revealing thirty six different words managers used for fees and charges. No wonder there is confusion!

Fees can also be absent from a fund manager’s investment memorandum.

Another important question for an adviser to ask is if the fund manager has an uncapped structure.

With all of these potential fees its important you ask the fund manager and do your due diligence to ensure that you have a full picture of the costs that are likely to impact on your client’s overall investment return.

There is a big difference between an internally given valuation of a business and an externally given valuation

INTERNAL VS EXTERNAL VALUATIONS

Business valuations are a key part of the EIS industry. There is a big difference between an internally given valuation of a business and an externally given valuation.

Managers can work company valuations two ways. Some will only change a company’s valuation at the point of an external investment coming in or a third party revaluing the company through a typical audit process.

The other way is for fund managers to internally value the companies themselves. Funds that don’t have highly qualified members in their team to do valuations, and still do them, can lead to difficulties for an adviser who has to manage their client's expectations.

IS TAX RELIEF INCLUDED IN MY CLIENT’S RETURN?

Tax relief is a by-product of EIS and VCTs. If a manager deploys funds into a company under EIS then they qualify for tax relief.

Some managers include that tax relief in their returns forecast which can mean that for example, a target return of 3x is actually only a target return of 2.1x when you take out tax relief. This could affect an advisers recommendation and should be included in the suitability report.

As with all the issues raised, the best way to find the answers is to ask your fund manager, or, of course, you can always ask James D’Mello himself.

WHO ARE THE SIDEBYSIDE PARTNERSHIP?

SidebySide specialises in investments into later-stage EIS businesses already producing over £1m of revenue, helping to mitigate the start-up risk prevalent in a lot of EIS investments.

During the conversation with GBI Magazine, James was eager to highlight that SidebySide is on the right side of all the topics covered above and that he is happy to talk to advisers about them.

Watch the interview on https://ifamagazine.com/article/ what-are-the-hidden-fees-in-tax-efficient-investments/

GBI

About James D’Mello

James has over a decade’s financial services experience from a range of specialisms including banking, pensions & investments. During his time working at one of the major platforms, James oversaw around 5000 EIS transactions, giving him a very unique, behind-thescenes insight into the EIS industry.

Today, James is Head of Business Development at SidebySide, where he joins a management team responsible for over £1.1bn in exits to date.

Email James at; james@thesidebysidepartnership.com