In the UK, more than 50,000 new companies launch every month; in the US, this figure surpasses 500,000. With so many startups entering the ring, everyone is eager to be in with a chance of spotting the next Facebook. But early-stage investing is different from backing any other asset class and carries an exceptional degree of risk; read, it’s not for the fainthearted.

That said, the UK boasts one of most generous tax breaks for investing in startups – the Enterprise Investment Scheme (EIS).

Why EIS?

EIS is a UK government scheme that helps startups raise finance by offering investors generous tax reliefs. The EIS has been around since 1994, so is a well-established part of the UK tax landscape for investors.

What tax reliefs are available under an EIS?

The tax benefits of investing in an EIS are:

  • Income Tax relief of 30% of your investment. This can be used in the year of investment or carried back one year as long as the limit for relief is not exceeded for that year;
  • Capital Gains exemption on profits earned on shares held for a minimum of three years;
  • Loss relief, should the company you’ve invested in fail, equivalent to your tax bracket multiplied by your ‘at risk capital’ (the total loss on the shares oncei tax relief has been accounted for);
  • Capital Gains deferral on gains realised on the disposal of any asset that’s reinvested in an EIS-eligible company;
  • Inheritance Tax exemption on shares held for a minimum of two years;
  • Investors can claim EIS relief on up to £1m-worth of investments in qualifying companies per person per year (this cap rises to £2m if you’re investing in knowledge-intensive businesses, such as those in the life sciences sector);
  • The scheme’s carry back feature means you can apply your EIS-eligible investments to the preceding tax year. This means that you can make a subscription of £3m EIS shares in 2017/18 with a carry back of £1m to 2016/17 so long as your EIS cap for 2016/17 is not exceeded.

Since launch, the scheme has promoted more than £10bn of private investment. The success of this scheme led to the introduction of the Seed Enterprise Investment Scheme (SEIS), which promotes investments in even earlier-stage (and therefore riskier) companies through an even greater tax relief of 50%.

The risks of EIS investment

There are downsides to investing in an EIS. Early stage businesses are volatile, unproven and unpredictable by virtue of their youth which is why properly researching any startup, its founding team and the market it operates in is vital for any prospective investment.

Below are some of the things you must be aware of if you’re considering investing in EIS opportunities.

It can take years to see a return

The business you back via EIS (or, even more so, SEIS) will need time to mature and so it may take a long time for your shares to increase in value. This in turn impacts on your ability to make a return if you later sell them on.

You’re unlikely to receive dividends

Startups normally don’t make enough profit to be able to pay dividends to their investors. This means you’re unlikely to see any return or profit until you are able to sell your shares, which can take years if it happens at all.

Illiquidity

Any EIS investment will be highly illiquid as there’s no secondary market where you can easily sell on your shares. This means you will most likely have to hold on to your shares until the company you invested in exits or floats on an exchange.

Risk of dilution

If the company you invested in raises more capital at a later date (and it’s almost certain that it will), new shares will be issued to the new investors, thereby reducing (or ‘diluting’) your percentage shareholding within the company. These new shares might also come with certain preferential rights that might work to your disadvantage if exercised. You can guard against dilution by making sure certain investor protections are in place before you invest.

Where to invest

When choosing EIS investments do your own due diligence and consult your financial adviser. There is no shortcut to finding a good investment opportunity, particularly when you want to come into it from the ground floor. Below are some of the high-growth sectors in the tech world that you might want to consider when looking to invest in startups.

Top five tech sectors to watch in 2019

The UK tech startup sector is the fastest-growing in Europe, responsible for spawning 392,627 new start ups in the UK over the past five years alone according to Syndicate research The Top 100 Fastest Growing Businesses 2018  showing that three-quarters of the UK’s top 100 fastest-growing startups are tech businesses. In 2017, the number of new tech businesses being set up in the UK rose by nearly 60% according to accountants RSM. And according to Tech Nation’s 2018 report, tech is expanding 2.6x faster than the rest of the UK economy.

Tech is taking over the startup scene but it’s not just new gadgets catching the limelight; beyond pure tech innovation, a mammoth opportunity lies in the digitisation of existing infrastructures.

Fintech

The first thing to remember for those relatively new to tech startups is that the broader tech sector can be broken down into a series of relevant portmanteaus – medtech is medical technology, proptech is technology for the property sector and so on.

Following that logic,fintech is the term for businesses innovating in financial technology, which is something that’s been a huge game-changer throughout the world over the past few years (eg, Monzo, TransferWise, Starling Bank).

These businesses are making names for themselves by disrupting the status quo, whether that’s through a step change in the actual underlying technology or in the way that existing technologies are used. Outside of the West, these companies are changing lives, making payments possible for the world’s un-banked people (e.g. M-Pesa, Kenya’s first mobile wallet) and helping facilitate microfinancing for those living in remote regions (e.g. DreamSave.

Femtech

Another sector that’s ripe with opportunity for disruption is femtech – the use of technology to improve women’s health. While some may dismiss the need for such specification at first glance, upon delving deeper it becomes obvious where the market gap lies.

The mission statement from Elvie, a pioneering femtech company founded in 2013 reads: “Women shouldn’t have to make do with shoddy design or pink spin-offs when there are self-driving cars in the world.”

Many agree if Elvie’s latest growth figures are anything to go by: the femtech business was just named Top 100 Fastest Growing Businesses 2018.

Cybertech

The greatest threat that most of us face, many without knowing, is that to our personal information. While cybertech was initially focused on stopping viruses, malware and unwanted rubberneckers from accessing our devices and personal information, the risk now extends much further.

In this post-GDPR world there are more popups about data protection, but do you really know what all those sites you willingly registered for are doing with your data? Did you even bother reading their terms and conditions?

There’s an incredible need for technologies that keep the ever-opportunistic hackers from getting in. Fortunately for us, there’s a new wave of cybertech companies coming to the fore to protect us from the shrouded monsters we unknowingly welcome into our homes.

Greentech

From guarding our data to saving the planet. Greentech spans a great many endeavours, whether it’s blockchain technology in electricity supply as Japan’s Kansai Electric Power Co (Kepco) is said to be researching, finding a new way to recycle plastic or helping people switch to green energy. It’s on the rise.

Take, for example, Bulb – a UK provider of energy sourced from renewables. Despite being just three years old, the business tops our annual fastest-growing businesses list and demonstrates a staggering 351x increase in valuation between 2015 and 2018 – well en route to becoming the UK’s next unicorn. Imagine being the investor that backed that EIS round.

Foodtech

When was the last time you used an unusual bit of kit to innovate your dinner?

“We’re really excited by foodtech right now,” say Eamonn Carey, managing director and Marko Sršan, program director of Techstars London, one of the top accelerators in the UK. “There’s a real energy in the sector, some great companies and some amazing innovation that’s going to make a difference to (hopefully) billions of people around the world.”

DYI bug farms mightn’t have made their way into our kitchens just yet, but beyond our front doors, technology is shaking up the food industry. From personalised nutrition plans and the development of plant-based proteins to microbiome research, alternative distribution channels and AI, there’s a smörgåsbord of possibilities for the food sector globally.

 

Ekaterina Bystrova is marketing manager at start up investment platform SyndicateRoom