Other than the contracted exit schemes which were abolished many years ago, it’s hard to recall a perfectly timed exit.
Some have been too early, some too late, some for too little return when a higher return might have been possible; most have satisfied some investors but by no means all. Keeping all the people happy all the time is a challenge. When is the right time to dispose of an EIS or VCT investment? As soon as possible after the expiry of the tax term or wait until the perfect market conditions?
I was reminded of this age-old problem the other day when reading Luke Johnson in his Sunday Times column titled The secrets of selling an investment at the right time. Even he claims to have hardly ever got the timing right! But in the case of EISs and VCTs the issue is complicated by the tax relief. With all tax-efficient investments there is a minimum term required in order to retain your tax relief: 3 years in the case of EIS and SEIS; and 5 years for VCTs. Among tax-efficient shareholders, there is a general preference for an early exit, that’s to say as soon as possible after the 3 or 5 years is up, so investors can take their cash and re-invest to obtain further tax relief. But this is certainly not everyone’s preference. There are cycles in all markets, and the expiry of the 3 year term can often co-incide with a downturn in a particular industry, leading a number of investors to argue for holding on to their shares in the hope of a higher offer.
Is the first offer the best offer?
Occasionally, an offer is made before the expiry of the 3 year term and this can lead to a dilemma: accept the offer and lose your tax relief, or refuse the offer and hold out for a similar offer once the 3 years have passed. But quite often a better offer does not materialise later and you can be left regretting you or your manager didn’t accept the first offer. Many people maintain that the first offer is usually the best offer you are going to receive. A few years ago, I supported an ex-colleague by investing in his SEIS qualifying start-up. Within a year he had received a brilliant offer for the business which he was keen to accept. After much heartache I agreed to the sale, lost my tax relief and ended up with paper in quite a different business, which has performed disappointingly. Should I have refused and let down the ex-colleague?
We have exited from a number of renewable energy businesses in recent years and experienced a similar situation: in waiting for the expiry of the 3 year EIS term, we were disappointed to observe steadily falling asset prices. If we had cashed out early we might well have achieved a higher net return for shareholders, but were not prepared to risk the ire of shareholders complaining they had lost their tax relief. It was a risk we simply could not afford to take.
I am also involved in some Leisure companies where we have simply not been able to find buyers for the assets at reasonable prices. These investments are quite old. After about 5 years we carried out a survey with our shareholders to find out if they would prefer to sell at any price or hold out for better times. The overwhelming majority opted to hold on for better times, but in practice those better times have never really materialised. In retrospect, it probably would have been better to sell up in 2011, return some cash to investors, allow them to claim loss relief and move on.
Venture Capital Trusts
With VCTs, the dynamic is somewhat different, as you collect tax-free dividends as you go along. My view is that in general investors retain their VCT shares for far too long. They might have had back 80p, say, in dividends but they insist in hanging on to a rump worth, say, around 50p. They may hope that it will “flower” into a much greater value on realisation of the last investments. Plus VCTs, unlike EISs, are not IHT efficient, but every year people die with VCTs in their portfolios when they could have sold up and converted into EISs or any unquoted trading company and avoided the IHT.
Recent rule changes in the EIS and VCT regime are re-focusing the spotlight on technology and the Knowledge Intensive sector and the likelihood is that exits will in future take longer to happen. The secret of selling an investment at the right time will be more important than ever.
About Martin Sherwood
020 7843 0472
Martin Sherwood has many years’ experience of small company fundraising and in particular the tax-efficient investment market, specialising in the Hospitality & Leisure Sectors. Martin is currently chairman of the four British Country Inns companies and of Halcyon Hotels and Resorts plc, which was a major investor in Luxury Family Hotels, which he helped launch 20 years ago. He was founder and head of Tax Efficient Solutions, first at Teather & Greenwood (1997-2004) and subsequently at Smith & Williamson (2004-2010), which he left to found Enterprise.
Martin has been closely involved in both Venture Capital Trusts and Enterprise Investment Schemes since their inception. He is a founder director of the EIS Association, the official trade association of the EIS industry.
Martin works very closely with a wide range of Hospitality & Leisure entrepreneurs and has a significant network of investors and professional contacts as well as being a serial investor in his own right.