Investing in entrepreneurs

Published: 5 September 2019

The life of an entrepreneur isn’t for everyone. But if you’re interested in supporting others on this road, there are several options to consider.

In the 21st century, advances in technology have, arguably, made it much easier to set up a company, build a brand and achieve success without employing vast numbers of people or needing eye-watering levels of start-up capital. And with the BBC’s Dragon’s Den now on Series 171 it’s clear many of us are fascinated by the fortunes of would be entrepreneurs.

The dream of entrepreneurialism can often be associated with new, disruptive ideas and technology. For many of us though, the financial risks involved in becoming an entrepreneur mean the only thing likely to be disrupted by us striking out alone would be our sleep.

The same may apply to the idea of backing businesses as an angel investor (using your own capital to invest in a specific enterprise) – a particularly direct way of supporting a start-up.

There are though less direct ways to invest in start-up businesses and their budding entrepreneur founders.

1
Venture Capital Trusts

Venture Capital Trusts (VCT) are listed companies that invest in portfolios of unlisted businesses. By diversifying across more than one unlisted business, VCTs can help to manage the risk of investing in early stage businesses to a certain extent. But those risks are still very high, speculative even, making this type of investment suitable only for investors who fully understand what they are getting in to, can afford to stay invested for the much longer term (at least five to ten years) and who are prepared to accept the very real risk of capital losses.

To understand the risks of any VCT it’s essential to read its Prospectus. Shares in a VCT may not be as easy to sell as for other types of listed companies and their prices are likely to be very volatile (that is, tend to go up and down in value, sharply and frequently). Not all VCTs are covered by the Financial Ombudsman Service and Financial Services Compensation Scheme either.

For those who have done their research and are willing and able to accept the risks, 30% income tax relief can be claimed on up to £200,000 invested in newly issued VCT shares each year, provided your investment is then held for at least five years. Dividends are also tax-free as long as you stick with that five-year period, and there’s no capital gains tax (CGT) to pay on any growth proceeds2. If you need to sell your investment within five years, you’ll need to repay the tax relief you’ve received.

2
Enterprise Investment Schemes

Enterprise Investment Schemes (EIS) offer similar tax benefits to VCTs, with income tax relief of 30% on up to £2 million invested per tax year, provided the investment is held for three years or more (the annual limit is £1 million, but income tax relief can be carried back by one year).

Exemptions from CGT and Inheritance Tax (IHT) – the investment isn’t included in your estate if it’s held for at least two years – are also available in return for investing in unlisted businesses of fewer than 250 people and valued at below £15 million3.

The risks of investing in EIS are similar to those for VCTs, and like VCTs they are only suitable for investors who fully understand what they are getting in to, can afford to stay invested for the much longer term (at least five to ten years) and who are prepared to accept the very real risk of capital losses associated with investing in early stage businesses. So while the tax case can seem compelling – especially for those who have maxed out their pension allowances - it’s important to do your research and go into EIS investing with your eyes open. Don’t be tempted to let the tax tail wag the investment dog.

3
Alternative Investment Market companies

The FTSE AIM Index was opened in 1995 as an exchange on which small companies could raise capital from investors4. As of July 2019 there were 895 companies on AIM, with a combined value of just over £100 billion5.

When it comes to Inheritance Tax, many AIM companies currently qualify for Business Property Relief, meaning investments in them become exempt from IHT when held for two years or more6. AIM company shares are also exempt from stamp duty7 and since 2013 can be held in an ISA8, where they will be sheltered from CGT and income tax on any growth or income.

Again, however, the investment risks should be taken seriously. While AIM firms are listed, meaning a good level of financial disclosure on which to base your investment decisions and the option to sell your shares on should you wish, the exchange has fewer regulatory requirements than other markets (companies don’t need a pre-listing trading record for example) and AIM shares tend to be on the illiquid side (difficult to sell).

So while the tax benefits are attractive and there’s potential for investment growth, there’s also a high risk of incurring losses.

4
Peer-to-peer and crowdfunding

We don’t offer access to these types of investment through Alliance Trust Savings, but a review of the routes for investing in fledgling businesses wouldn’t be complete without covering them.

Peer-to-peer (P2P) services specialise in matching savers and investors with individuals or businesses wanting to borrow money, with the interest rate dependent on the level of risk the borrower is judged as representing.

Meanwhile, crowdfunding platforms are used by companies to issue debentures or bonds through which investors can lend money to small firms or projects. Investors are offered a pre-arranged interest rate over the term of the loan, as with other bonds, but the borrowing, lending and repayment is typically arranged by the platform.

Both P2P and debt-based crowdfunding are eligible for investment in the Innovative Finance ISA. However the investment risks can be significant – as illustrated by the recent collapse of P2P provider, Lendy9 – and there’s likely to be no recourse to the Financial Services Compensation Scheme (FSCS) if things go wrong.

Be sure you are willing and able to take the risk

While the different options all have their own advantages and disadvantages, one clear theme runs through them – whatever the structure and the tax benefits, investing in fledgling enterprises can be a high-risk pursuit.

Investing in start-ups can offer potential for growth and generous tax perks but they are suitable only for those comfortable with the risks involved and even then, ideally forming just a small part of a diversified portfolio.

Important information

This is provided for general information only and takes no account of personal circumstances. It is not a recommendation to buy or sell. It is provided solely to support you in making your own investment decisions. If you have any doubts as to their suitability you should seek expert advice. Alliance Trust Savings does not give financial or investment advice.

Please be aware that the value of investments can fall as well as rise so you could get back less than you invest.

Laws and tax rules may change in the future without notice. This information takes no account of your personal circumstances which may have an impact on tax treatment.


1 BBC, Dragon’s Den.
2 Money Advice Service – Venture Capital Trusts.
3 Enterprise Investment Scheme Association – What is the EIS?.
4 Scotsman – Taking aim at alternatives is riskier – 24 June 2015.
5 London Stock Exchange – AIM – August 2019 – see link to 2 August stats table under Statistics.
6 Money Observer, How to use AIM shares to guard against inheritance tax risk – 21 February 2019.
7 London Stock Exchange, Stamp Duty exemption.
8 Guardian, ISA investors can now take aim at the Alternative Investment Market – 6 August 2013.
9 The Times, Investors lose millions in Lendy collapse, 17 July 2019.

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