Andrew Aldridge: Why it’s Time to Get to Know your EIS Manager

Recent key information document-inspired criticism of the EIS sector is based on a fundamental misunderstanding of how EIS managers can benefit their investee companies, argues Andrew Aldridge

There has been some discussion in the media recently about the nature of key information documents (KIDs) and, in particular, how they relate to Enterprise Investment Scheme (EIS) products – with some critics suggesting there is lack of transparency with regard to this sector.

First of all, I should clarify I agree entirely with the principal of KIDs and greater transparency in general – indeed, it is something we at Deepbridge have called for in our sector since we entered the EIS world back in 2012.

The biggest issue with transparency then, and perhaps now, is that managers disclose what they charge the investor but not always what they charge the investee company. For our part, we have always disclosed what and how we charge investee companies and believe it is important to do so.

Most of the media ‘noise’ at the moment though is coming largely from those providers that charge the investor a fee, with parallels being drawn between the fees charged to an investor and those charged to the investee company. In my view, however, there is a huge and significant difference between the two – in effect, those attempting to criticise are choosing to compare apples with pears.

As an example, the fees charged to an investor are binary. Let’s say we have someone investing £100,000 via an EIS and, for simplicity, let’s say they make a three times return on that investment. If they are charged 5% on the way into the investment, they could claim £28,500 (30% of £95,000) in income tax relief and their three times return would return £285,000 (three times £95,000, excluding any performance fee).

If there is no charge on the way in, however, they could claim up to £30,000 (30% of £100,000) in income tax relief and the three times return would return £300,000 (three times £100,000, excluding any performance fee). There is therefore a potential difference to the investor of £16.5,000.

Given this example, there may be some who would argue that, if the 5% was charged to the investee company instead of the investor, they would have less cash to work with and therefore potentially not grow as quickly or by as much. This is, however, an erroneous assumption that is far from binary – and potentially dangerous to make.

It is essential advisers and investors understand how investment managers work with their investee companies and how they support them. It may be, for example, that investee companies could find cheaper finance elsewhere. Investee companies choose, however, to work with Deepbridge and accept our fee structure because of our hands-on management approach and our sector experience.

If they were to find cheaper finance elsewhere, they may then have to find additional support which itself will bring additional costs. If they wanted mentoring and commercial support, then they may have to look at appointing additional non-executive directors, at a cost, or the chief executive or managing director may have to spend a large proportion of their time focused on additional and future fundraising rather than running the business.

They may also need to find an export consultant, a technical consultant, a marketing expert … the list goes on. Indeed, if the manager is not a sector expert, it is likely a third-party consultancy will need to be bought in, so where does this cost sit? By choosing to use a manager that can offer all of that, the value-add soon adds up.

A sector-experienced manager may bring insight and contacts that expedite the growth of the business and enhance multiples. It is, therefore, a rather more complex comparison than looking at what investment managers in the EIS space charge investee companies and attempting to extrapolate that across the entire investment industry. It is definitely not linear or binary and, as mentioned, it is definitely not comparing apples with apples.

So, while the KID is a step in the right direction, it would be very difficult – for what is a maximum three-page document – to deliver an easy comparison in our sector. Ultimately, advisers and investors should consider the binary and comparable matters but get to know the investment manager.

Real Value
Only by knowing them will you understand how they operate and the real value they bring to investee companies. Not only should you get to know the manager, but good managers will encourage you to meet some of their investee companies as well.

You will then see how happy they are with the support they receive. Working with young growth companies, is fundamentally different to most other products advisers and retail investors will deal with, so take the time to understand it beyond a ‘race to the bottom’ in fees.

Ultimately, it is up to the judgement of the management team of the investee company to decide the source that is most appropriate for them to receive funding from, and cost will only be a part of that consideration. Perhaps, investors and advisers should not be doing their job for them or questioning this judgement. Most EIS companies will have experienced individuals – whether early-stage angel investors, non-execs or the chief executive – who understand what they need and what they are willing to pay for that.

Some EIS managers will invest passively, some will ‘take a seat on the board’ but only ever collect board minutes for their files, and some will work hand-in-glove with investee companies throughout the life of that company – mentoring, assisting with further funding, opening doors, advising and so on.

It is crucial to understand where a manager sits on this scale – to offer Deepbridge as an example, for some life sciences companies having our head of life sciences, Dr Savvas Neophytou, on their board and helping them is priceless.

The important thing is to understand how the manager invests and what their approach is. Fees should be transparent – yes, absolutely – but it is not a simple job to compare anything deemed a ‘fee’, whether that is to the investor or investee company. The only way to compare managers is to get to know them and to get to know how their investee companies perform as a result of their approach.

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Source: Professional Adviser