UK Investors Underweight Venture Capital: Hardman & Co.

The UK research firm Hardman & Co. has distributed a white paper that says investors are underweight venture capital. The research was published with the support of SyndicateRoom, Deepbridge, One Four Nine, and Nova Growth  Capital.

Once a securities crowdfunding platform, SyndicateRoom now offers a diversified venture fund for smaller investors. According to its website, SyndicateRoom targets a return of £3.50 on each pound invested.

According to Hardman, venture capital is almost as good as bonds when compared with equities in regards to diversification.

Venture capitalists invest in early-stage firms that hold a higher risk in contrast to listed securities. VCs accept that some of these investments will go bust over time but the few that make can drive outsized returns. In the UK, there are several tax benefits that help to drive returns higher while incentivizing investors to support these risky ventures. To quote the document:

“The UK is lucky to have venture capital schemes that offer significant tax reliefs to investors: Venture Capital Trusts (VCTs), the Enterprise Investment Scheme (EIS) and the Seed Enterprise Investment Scheme (SEIS). We show that these tax reliefs hugely improve expected IRRs: almost doubling them in the case of SEIS. Unsurprisingly, these make venture capital even more attractive in our analysis. While there are nuances to applying these adjusted figures in practice, it shows that the original analysis is somewhat conservative.”

The paper provides an example of these tax reliefs using two scenarios:

  • Initial tax relief of 30% (VCT-EIS) applied to scale-up investments. This will increase our expected IRR to 22%, and keep the same standard deviation.
  • Initial tax relief of 50% (SEIS), plus loss relief applied to seed investments. This will increase our expected IRR from 22% to 37%, and decrease the standard deviation to 42.4%.

The UK incentivizes investing in early-stage firms because supporting an innovation-driven economy generates significant benefits including more jobs and wealth creation.

The options in the UK today include EIS or SEIS funds; VCTs; or investing directly into companies as business angels or investment crowdfunding. Securities listed on crowdfunding platforms frequently benefit from either EIS or SEIS.

The paper says that for investors with an average risk profile, venture capital portfolio allocation proportions in the mid-teens is beneficial, allaying concerns that VC investors should only be high-risk investors.

The paper indicates that by including VC in a portfolio expected IRRs can increase by roughly 1.5x to 2x, with a slight benefit to risk.

Brian Moretta, Head of Tax Enhanced Services at Hardman & Co, says “the paper makes a compelling case for venture capital to be a normal part of most investors’ portfolios. Perhaps the VCT/EIS industry can move from ‘tax-efficient’ to venture capital with benefits!”

You may download the white paper here.

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