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Investing in a Business

One of the ways that Government attempts to create jobs is to encourage and stimulate small businesses, start-ups or recently started businesses. The Prime Minister wants these to scale up, not simply start up. So as a regular investor (which in my world we call a retail investor) there are various ways that you are incentivized to be part of this wealth creation.

Tax effective incentives

Venture Capital Trusts, Enterprise Investment Schemes, Small Enterprise Investment Schemes are all such investment structures designed to encourage you (with tax incentives) to invest into new businesses. Generally, though not always the case, these would be businesses looking for money, to which traditional banks don’t, can’t or won’t lend. Since the credit crunch, despite the Government pouring billions into the system, most lending to small businesses has not increased. Indeed any chart on the topic would suggest that Banks are positively less than helpful.

A Different Approach

As we approach the end of the tax year, various specialist companies will produce offers for these tax efficient investments. The rules for them are fairly complex, primarily because they (the rules) seem to get changed each year. It would certainly be true to say that the degree of investment risk is generally much higher than say investing into most normal investment funds that track an index. As with most things, there are good and not so good and some downright awful. Despite being 3 or 5 year investments, in reality they are long-term investments, where the positive rewards may take some years to bear fruit, and as with almost every business, extracting money from them requires a carefully considered exit strategy and ideally several potential buyers.

The company you keep

In the latest Trainspotting film, (T2, which is a return to Edinburgh and the characters from 20 years ago) two of the characters (Renton and Simon) decide to have a proper go at running a “business”. Despite being “creative thinkers” and possessing “the gift of the gab” rather more is required to run a successful business. Sadly, their skill set and personal focus do not lend themselves to a successful outcome. Some investors could be forgiven for thinking that the degree of risk being taken is similar to that of investing into non-mainstream investments. However the only thing in common is the capability of the management of the business. Good managers can turn a bad business around, but equally a good business can be ruined by bad management. We all know that there are some very unsavory characters in business, some even cross-over into politics. Trainspotting has a particularly nasty character. As is always the case, people are key. In this form of investing, it is certainly the case that a good business plan requires a good management team to implement it.

Choose wisely

So (and here is where you imagine Ewan McGregor reading this) if you think that you might want to choose to invest in small businesses, choose to create jobs, choose wealth creation, choose something a bit different, choose a dose of tax relief, perhaps you should be thinking about choosing to invest into an EIS, SEIS or VCT. As with T2 it won’t be everyone’s cup of tea, (or drug of choice). Generally, you’ll need a minimum of £25,000 to invest. This is for those that do want to choose some of the companies that will make a mark on the next 20 years. Those that are comfortable with the risk. Those that are choosing to invest for the long-term and have a clear idea of what they are getting into. Then investing in businesses can provide a rewarding experience. But choose wisely. Here is the trailer for T2: Trainspotting.

Dominic Thomas
Solomons IFA

You can read more articles about Pensions, Wealth Management, Retirement, Investments, Financial Planning and Estate Planning on my blog which gets updated every week. If you would like to talk to me about your personal wealth planning and how we can make you stay wealthier for longer then please get in touch by calling 08000 736 273 or email info@solomonsifa.co.uk

Business Owners and EIS

This item is aimed at business owners and how an EIS might be of use.

Many business owners are growing increasingly frustrated about the tax associated with extracting profit from their companies. Often referred to as “double taxation”, a company owner must first face corporation tax on profits made by their business and again when they decide to pay themselves a dividend/salary. It can at times, feel like you are working for HMRC.

An Enterprise Investment Scheme (EIS) can be used to extract profit from a business tax efficiently. EIS was introduced by the UK Government in 1994 in order to induce investment into UK smaller companies. In order to make investing in smaller companies more attractive, compensating the additional risks, there are a number of tax reliefs available through EIS investments (providing you hold your investment for at least three years).

Income Tax Relief	CGT deferral	IHT relief
Reduction in income tax liabilities amounting to 30% of the total investment	Facility to defer paying CGT on all, or part, of a chargeable gain by investing the gain into EIS qualifying shares	EIS companies qualify for Business Property Relief (BPR)
Relief can be applied to the current or previous tax year	Investors can defer CGT by using EIS up to 12 months before crystallising gains or up to 36 months afterwards	As long as shares have been held for 2 of the last 5 years and are held at time of death and remain BPR qualifying, the value of the EIS investment will count as part of your estate but will have a nil value for IHT purposes
The maximum amount of income tax that can be claimed is £300,000 for the current tax year and £300,000 for the previous tax year
Relief cannot exceed the amount which reduces an investor’s income tax liability to nil

Business Owner – Double Tax

Mr Williams, normally a higher rate tax payer, owns a small business. He pays himself a £10,600 salary per year in order to stay within his personal allowance; no income tax is paid on this amount. In addition to this salary he pays himself a dividend each year which attracts an income tax liability. However, he is still frustrated with the amount of tax paid on the dividends.

If Mr Williams pays himself a £50,000 dividend, he will owe 25% (£12,500) in income tax on this (once we take the tax credits into account). This will leave him with £37,500 of net funds in his account after paying the tax.

If Mr Williams invested £50,000 into an EIS, he will be entitled to 30% income tax relief (£15,000). This tax rebate can be used to wipe out the £12,500 due on the dividend. It also leaves him with an extra £2,500 of income tax relief to set against other income tax he has paid across the current and/or previous tax year.

He is left with a £50,000 EIS investment, which he can liquidate once he has held the investment for three years. Providing the EIS investment has, at least, preserved its value Mr Williams has saved £15,000 in tax as a result of this investment.

Any growth within his EIS investment is tax free, as per the EIS rules.

My example, implies that Mr Williams has adequate resources elsewhere, so that he can invest £50,000 rather than it being needed for income. The word or note of caution, is that an EIS is obviously an investment and at the higher end of the risk spectrum (though running your own business obviously carries risk). Whilst investing in smaller companies often involves higher levels of risk and worse levels of liquidity, many investment companies offer EIS investments that target capital preservation. These investments involve companies with long-term, index-linked and stable cash flows.

Want to know more? – get in touch.

Dominic Thomas
Solomons IFA