What is an EIS fund?
The short answer is that it’s an arrangement through which investors can put money into Enterprise Investment Scheme qualifying unquoted companies under the management of experienced investors or corporate financiers. This offers investors diversification in their portfolios and the risk is mitigated (to an extent) by the income and capital gains tax reliefs. (See the HMRC site for more detail on Enterprise Investment Scheme tax advantages and qualifying investments.)
When looking at the tax reliefs, there are two types of EIS fund; approved and unapproved. These are not regulatory terms (and shouldn’t but refer to whether the fund has been approved by HMRC. If it has, the investors qualify for relief when they invest in the fund, if it is not, they only qualify for relief when the fund makes an eligible investment. The predictability of the former makes it attractive to some investors but they are less flexible than unapproved funds and have a limited time in which to make their investments.
How is it structured?
This is where it gets a little more complicated. Firstly it isn’t like most ‘funds’ at all. Unlike companies and other kinds of funds (which are usually partnerships) it doesn’t have a legal personality. It can be a number of parallel investment management agreements between individual investors and the manager of the ‘fund’ or a series of separate portfolios which together are referred to as the ‘fund’.
Typically, the initial investment is kept in cash as ‘client money’ either with the scheme manager, in a client account, or on trust with a bank. The investment manager will then commit a portion of each investor’s cash into each investment in a qualifying company (in line with the investment management agreement). Often the resulting shares will be registered in the name of a nominee and shareholder duties (like voting) will be delegated to the investment manager during the life of the fund.
If that sounds rather like a collective investment scheme, we can understand why. However, the Treasury have the power under FSMA to create exemptions to the definition of a collective investment scheme and they have created one specific to EIS funds.
A Compliance Perspective
From this point of view as well, EIS funds are strange animals. The fact that an EIS fund is not a collective investment scheme (CIS) has its advantages and disadvantages. On the one hand, they do not require an operator in the same way as a CIS, the scheme documents are not as prescribed, and the promotion is not as restricted (at least for an authorised firm). On the other hand, unlike a CIS, it is ‘MiFID business’ which means that firms managing an EIS fund will need to follow rules from which CIS operators are exempt. It also means that unlike a CIS, it is virtually impossible to run an EIS fund without the permission to deal with retail clients.
Retail client permissions are necessary because it is the underlying investor, not the fund which is the client of the firm. Within the MiFID rules under which EIS funds are regulated, it is much harder to categorise an investor as professional. You may find that if retail investors are excluded, it seriously limits the market for the fund.
The regulated activities involved in managing an EIS fund include holding client money, investment management, and safeguarding and administering investments. Firms should also consider whether any particular investment management agrement is likely to involve them in arranging, advising, or dealing in investments. It is possible for firms to outsource some of these activities if they do not have the required permissions to carry them out themselves.
Simon Webber, StypersonPOPE’s Managing Director has experience of both investment management and unquoted corporate finance compliance. If you would like to discuss any aspect of establishing or managing an Enterprise Investment Scheme fund, please contact him directly on 07710 260 717 firstname.lastname@example.org.