What is the Impact of Brexit on EIS?

It is difficult to be sanguine about Brexit if one currently resides in the UK, not least because it seems to infect every aspect of the national conversation. Irrespective of whether one is a Leaver or Remainer or even something closer to a compromise between the two, there is a clear national sense that this matter needs to come to a head sometime in the near future.

The sheer uncertainty generated by the political situation has certainly had an impact on sentiment of the EIS market. However, my personal interaction with wealth managers over the past months indicates a sense that this is almost irrelevant compared to the negative consequences of a Corbyn-led government if that were to pass.

Leaving the last point aside for a moment, I am of the opinion that Brexit-related EIS anxiety is misplaced: the direct impact on UK tech SMEs will be less than on many other sectors of the economy. A so-called ‘hard’ Brexit or a ‘soft’ Brexit will have negative consequences for certain sectors of the UK economy, mostly but not entirely confined to larger enterprises. UK industries with complex and deep Euro-integrated supply chains (e.g. auto), just-in-time supply sensitivities (e.g. food and manufacturing), or industries with complex non-tariff barriers (many services but particularly financial services) will be adversely affected. Jobs will be lost, output will suffer and this will have a negative impact on the entire economy, and probably shave approximately 0.5% from trend growth of the economy. Austerity is dead! Long live austerity!

Yet these developments should have at best an indirect impact on EIS investing in the medium-to-long term. The short-term damage that the economy has experienced (sterling down 20%, central London property down 20%, business investment decreasing for over a year) all point to a possible recession this year and this should continue to create uncertainty in the UK stock and bond markets. However, EIS investors have a long-term outlook for whom short-term volatility should be seen as more of an irritant than a reason not to invest.

Notwithstanding personal suitability, investors look at early-stage venture capital EIS funds for three reasons:

1) The tax benefits are very compelling;

2) the possibility of achieving higher returns than in other asset classes; and

3) venture capital returns are largely uncorrelated to traditional asset classes.

Not one of these three should be adversely affected by Brexit in the medium term in a direct sense. Individuals with relatively large income tax liabilities or recent capital gains will continue to proliferate and those planning to use IHT products will have other considerations in mind and should not be swayed by short-term political events.

Furthermore, the outlook for the SME sector in the UK looks very bright and this is not expected to change, providing a vibrant backdrop for the EIS investor. Even fears of a shortage or reduction of the flow of skilled migrants (a significant concern for technology companies) is overblown as there will certainly be much emphasis on attracting this human capital to UK shores. GBI Investments recently noted: "While there is clearly stock market nervousness about investing in the UK, over a quarter of affluent investors feel more encouraged to invest in UK SME opportunities as a result of Brexit, while 18% are holding back until after Brexit." There may be some EIS investors who hold back whilst Brexit sorts itself out in the short run, but anyone not scared away from the sector by the Patient Capital Review is likely to return to the fold.

The final consideration for EIS investors must be placed in the context of their overall portfolio. The low correlation of venture capital to traditional asset classes is increasingly prized in a volatile environment. Irrespective of the tax benefit, alternative assets such as EIS technology investments should remain part of most wealth management portfolios.

In sum, there is every chance that political and economic events disrupt investors over the coming six months, but tax-efficient investors should remain relatively immune to whatever happens in stock, bond and currency markets. There is every chance that tax-efficient investing is actually more popular in the 2019/20 tax year than the previous tax year, as the move for investors towards growth investing from the asset-backed paradigm was considerably more profound than worries over the current political situation. Many investors sat on their hands and did not invest in tax-efficient products following the 2018/19 tax year, but perhaps the lure of tax relief, and a well diversified EIS/VCT portfolio will overwhelm previous inhibitions and this may well be the most bullet proof section of the UK economy.