Deepbridge’s Warwick: Osborne reforms put EIS focus on due diligence

Warwick Ian Deepbridge Capital 2015

In his Summer Budget, Chancellor George Osborne once again amended the rules around Enterprise Investment Scheme qualification. Osborne essentially emphasised that in order to benefit from EIS status, the underlying investee companies must be able to demonstrate that they are targeting growth and should be innovative and/or creating jobs.

For many EIS providers this has been seen as a potential challenge to their investment propositions and indeed we saw some of our peers lobbying Government for leeway or amendments to plans. However, we agree wholeheartedly with the Chancellor’s stance that EIS should only be used where the underlying companies are seeking to grow.

One expert recently observed that VCT and EIS providers will have to dramatically increase the level of due diligence they undertake on investee companies. Unfortunately, yet again, our industry fails to surprise me. With any investment, due diligence is vitally important but when investing in EIS qualifying companies this should be even more imperative – otherwise, an investor might as well give their cash to the first company that asks for it.

The level of due diligence a team undertakes on an investee company prior to investment is invaluable and essential to ensure the manager only invests in companies that they believe have the opportunity for growth; and where they believe they can contribute to the success of the business with more than just money.

How can an investor understand what they are investing in if the provider themselves do not understand?

Picking listed stocks and shares of large companies is an entirely different proposition to selecting small companies to invest in and I firmly believe that an entirely different approach should be taken. Investee companies should not be picked purely because they are EIS/SEIS qualifying and because they are available. Instead, they should be carefully selected based on financial due diligence, technology due diligence, legal due diligence and, equally importantly, personality due diligence – managers need to know the mindset, goals and ambitions of the team and be confident that they are looking to grow a business rather than merely creating a lifestyle business.

I for one welcome Osborne’s position that he wants EIS to return to the spirit with which it was intended and his desire to clamp down on abuses. If looking at EIS or SEIS investments, make sure you undertake due diligence on the investment manager and, as part of this, understand the level of due diligence they undertake on investments themselves.

Of course, EIS investing should always be considered a high-risk opportunity, but by understanding the investment criteria and process of the investment manager you can go some way to understanding how some of the risks are identified and reviewed, helping to mitigate some of the investment risk.

Ian Warwick is managing director at Deepbridge Advisers