Undecided whether to choose a VCT or an EIS investment which favours private companies or AIM quoted companies? There is nothing to stop a blend of both split across multiple product providers, but truly understanding the different features of each is often more challenging than envisaged.
Chris Hood, Sales Director at Seneca Partners discusses a few of the realities facing advisers and paraplanners when discussing this issue with their clients.
There is a plethora of information available to reference on this topic including the reports available from independent reviewers. The default position is often that AIM quoted investments are much more volatile than the private company investments – a reason why some investors shy away from AIM. It is, however, well worth looking further into this assumption.
AIM EIS and AIM VCT
Managers of these products will value the inherent visibility with AIM quoted investments. Whilst 2018 rule changes around ‘risk to capital’ have condensed the universe of AIM quoted qualifying companies, nonetheless, investing in IPOs and secondary fund raising comes with a strong level of visibility and due diligence from which to judge valuation and growth potential metrics. Once ‘on the market’, daily pricing is an accurate indicator of value and this usually comes with a decent level of market liquidity which is a crucial element for the exit point.
With VCTs, the ability to trade out of a particular share within the five-year VCT investment term is a compelling option. Equally, for AIM EIS, the minimum holding period is three years meaning that an exit can generally be facilitated within a much shorter time frame than is the case with private companies. This also increases the efficiency of the 30% initial tax relief for investors who have the option to recycle potentially two or three times during the life of a private company investment.
Advisers are usually able to visualise the investment term and plan with a little more certainty than would be the case with a portfolio of open-ended private company investments whose exit points are ironically often publicised to be IPO or trade sale. That exit point becomes the starting point for AIM EIS in particular – a key reason why they are increasingly attractive to investors.
There is another salient point for investors to consider. Investing in AIM mitigates the conflict issues of follow-on rounds. An AIM quoted company, by definition, has a broad range of potential investors to approach for subsequent fundraising. With private companies, the concept of investing to protect against dilution makes no sense with an EIS portfolio where investors are likely to be different each year.
Private company EIS and VCT
Revisiting a point made earlier, let’s consider why independent reviewers often describe AIM as being more volatile. Clearly, an asset listed on AIM with daily pricing, when compared to one that’s valued much less frequently, is always going to be perceived as being more volatile. The indisputable fact is that whilst carrying values of private company investments is more arbitrary, it is the exit value that ultimately informs the success of an investment. How much cash eventually returned to investors is always more informative than unrealised values.
Contentiously, it may be the case that advisers prefer the more static and periodic valuations when reporting to investors, rather than daily pricing fluctuations. However, in the final analysis that does appear to be something of a ‘head in the sand’ mentality.
Referring back to the 2018 rule changes, the trend has seen many managers investing at a much earlier stage in the company life cycle. This tends to stretch the overall investment term as companies at an earlier stage naturally need more time to deliver on their growth plans. Again though, investors are likely to want to know when and what their investment return is likely to be. For private companies, the exit will almost inevitably be an IPO or trade sale as publicised in the Information Memorandum. With an investment term more likely to run to 7-10 years or more, it takes some imagination to view either with any degree of confidence at the investment entry point.
Interestingly, for the ‘AIM Volatility’ theorists, prevailing market conditions and volatility will directly impact on value achieved in a private company exit. Market conditions and volatility are macro-economic factors, not purely features of AIM.
The choice
As is often the case, blending the attributes of both product types is a popular way forward for many investors. There are many tales of excellent successes for investors in both but understanding the reality behind AIM and Private company investments is fundamental and should help investors and advisers alike in both the planning and the expectation – at least in terms of the likely investment horizon.
[Main image: yibei-geng-unsplash]
