What is an EIS fund?
Well, functionally, it’s an arrangement through which less experienced and time-poor investors can put money into unquoted companies which qualify for Enterprise Investment Scheme tax reliefs. This offers investors diversification in their portfolios and the higher level of risk is mitigated (to an extent) by the income and capital gains tax reliefs they get. (See the HMRC website 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 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 itself makes an eligible investment. The predictability of the former makes them attractive to some investors but they’re less flexible than unapproved funds and have a limited time in which to make their investments. Always remember that ‘approved’ EIS funds, have not been approved by the FCA.
Is an EIS fund really a fund?
Well, it depends what you mean by a ‘fund’! Most funds have a particular structure (e.g. a partnership, or an investment company) but EIS funds don’t because the structure would block the tax reliefs for the investors. An EIS fund is therefore normally a number of parallel investment management agreements between individual investors and the manager.
However, in other respects, EIS funds look like a fund, sound like a fund, and act like a fund. It’s therefore FCA guidance (and common sense) that EIS funds fall within the European law definition of an “Alternative Investment Fund” and in that respect at least, they’re very much funds.
How do EIS funds work?
Typically, the initial investment is held in cash by the manager as ‘client money’. The manager will then commit a portion of each investor’s cash into each investment in a qualifying company (in line with the investment strategy and the investment management agreement). The resulting shares will typically be registered in the name of a nominee owned by the manager and shareholder duties (like voting on resolutions) will be carried out by the manager throughout the life of the fund.
Is an EIS fund a Collective Investment Scheme?
If you think EIS funds sound like “collective investment schemes” (a domestic law regulatory category), we can understand why. However, the Treasury have the power under the Financial Services & Markets Act 2000 to create exemptions to the definition of a collective investment scheme and they have created one specific to EIS funds (as long as they meet certain complying fund conditions, mainly related to withdrawal rights). There’s another, wider, regulatory category of “Non-Mainstream Pooled Investments” from which EIS funds are also specifically excluded. This allows them to be promoted slightly more freely than they otherwise could be, but there are still considerable restrictions because of their high risk nature. Ultimately, EIS funds are not for ordinary retail investors and can only be promoted to investors who have the benefit of advice from an authorised person (typically an IFA) or who qualify and certify as High Net Worth or Sophisticated Investors.