Where do most investors start?
Many investors start building their portfolios with investments in conventional assets such as quoted equities, cash and bonds. While cash investments – we’ll include savings accounts like cash ISAs here – and bonds are generally considered low risk, they only offer modest returns. For this reason, investors seeking a more meaningful return usually turn to investments in publicly traded equities.
These are certainly higher risk, as they are subject to market fluctuations, the fortunes of any given company, the performance of competitors and anything else that might affect the price of stocks and shares, from wars to natural disasters. But in most cases they are highly liquid, so investors can sell their shares and recover at least some of their money when they choose.
The downside of conventional investments
The downside of conventional investments is that they offer limited opportunities for diversification, so if something happens that causes the asset class you hold to be affected negatively, you stand to lose a lot of the value in your investment.
Certainly, you might have bought shares in companies that span a range of sectors, or stocks of many different types, and this may offer a degree of diversification. But to develop a more fully diversified portfolio, many investors turn their attention to alternative investments.
Using alternative investments to diversify your portfolio
Alternative investments are any financial asset that doesn’t fit in the categories above – essentially, anything that isn’t an equity, a bond, or a cash investment. It includes investments in private equity, venture capital, hedge funds, real estate, commodities and other tangible assets.
While some alternative investments – hedge funds and private equity in particular – require significant capital outlay and are aimed primarily at professional investors or institutions, others, like venture capital, commodities and real estate are more accessible.
The key difference with these investments is that on the whole they involve private rather than public markets, and enjoy a degree of separation from the fluctuation of private markets.
Diversifying with venture capital
Investing in venture capital is probably the most straightforward of the alternative investment options available, as it involves buying shares in companies. There are of significant differences between buying shares in early-stage private companies and publicly traded companies, primarily around access to opportunities (gaining access to the best deals takes some research and networking), liquidity of shares (they are less liquid), and risk (early-stage companies are more prone to failure than large public companies, so venture capital investing is considered high risk).
From a diversification perspective, venture capital is one of the best alternative investments because for a relatively small amount of invested capital, you can invest in a large number of startups across multiple sectors. The potential for returns is also significant. Most venture capital funds target 3x, but if you’re fortunate enough to invest in the next Uber (today valued at $158.15 billion) or Airbnb ($81.42 billion), the sky’s the limit.
Because a small proportion of the overall startup population accounts for the lion’s share of the returns, investing in a large number of startups gives investors’ portfolio’s better growth potential, and minimises the impact of risk. Some funds focus more on selecting a small number of companies they expect to do well, and investing time and money in teaching those companies how to grow as fast as possible, however, this doesn’t guarantee that those companies will succeed, or that they will grow sufficiently to deliver a significant return.
EIS, SEIS and VCT investment schemes
If you’re considering investing in venture capital in the UK, there are a number of government schemes in place that incentivise investment into small businesses with tax reliefs.
Most investors invest in these schemes through funds, which take investment and deploy it into EIS or SEIS qualifying companies that they select.
Different funds will offer different types of opportunity. Some may emphasise investing in a small number of companies in a specific sector that the fund managing team is connected to, and knowledgeable of. Another approach is to invest as broadly as possible – within closely monitored quality criteria – to increase the likelihood of investment in a high growth company.
For diversification, it’s a good idea to invest in a fund that will build a large portfolio of sector agnostic businesses.
Read on for more about the tax reliefs offered under EIS and SEIS.
SEIS
Investments in SEIS – the Seed Enterprise Investment Scheme – are at the earliest stage of a company’s journey.
To offset the risk and incentivise investment, the following reliefs are available. 50% income tax relief on up to £200,000 invested. This relief can be applied to the year shares were issued, or one year prior.
50% capital gains tax reinvestment relief which grants investors exemption from 50% of the tax due on any capital gain that arose in the year you made the investment when they invest an amount equal to the gain in SEIS shares.
100% capital gains tax disposal relief which exempts SEIS shares from capital gains tax liability providing they have been held for three years, and income tax relief has been claimed in full.
100% inheritance tax relief on SEIS shares provided they have been held for two years prior to death.
Loss relief on shares that fall in value which can be offset against income tax or capital gains tax.
EIS
Investments in EIS – the Enterprise Investment Scheme – are still early in a company’s journey, but further enough along that they are considered slightly less risky than SEIS investments (though they are still high risk).
To offset the risk and incentivise investment, the following reliefs are available.
30% income tax relief on up to £1,000,000 invested. This rises to £2m if the first million is invested in knowledge intensive companies (KICs) This relief can be applied to the year shares were issued, or one year prior.
Capital gains tax deferral relief which lets investors defer a gain arising up to three years before and one year after the EIS investment, for as long as they hold their EIS shares.
100% capital gains tax disposal relief which exempts SEIS shares from capital gains tax liability providing they have been held for three years, and income tax relief has been claimed in full.
100% inheritance tax relief on SEIS shares provided they have been held for two years prior to death.
Loss relief on shares that fall in value which can be offset against income tax or capital gains tax.
VCT
Venture capital trusts are a little different to the other two options. While EIS and SEIS involve investing into private companies, either directly or through a fund, VCT involves investing in a publicly traded company that holds shares in private companies.
The main advantage of VCT over the other two options is the availability of tax-free dividends. The drawback is that when you invest in VCT, the underlying companies may be at different stages of their development, so some may have already have experienced significant growth and increase in value before you invest, and so you’re paying for growth that has already happened.
30% income tax relief on up to £200,000.
Tax-free dividends when companies increase in value.
Tax free growth when companies are sold.
SyndicateRoom offers the following SEIS and EIS products to investors
Founders Factory B2B SaaS Investment Programme SEIS FUND 1
This fund, powered by Founders Factory, presents an opportunity to invest in a portfolio of eight promising new pre-seed companies in the B2B SaaS sector. Founders Factory will support these companies with a programme designed to help them kickstart their growth at the earliest possible stage, as well as ready them for introduction to its contacts at top technology companies, VCs and corporates. Minimum investment: £10,000.
Find out more about the Founders Factory B2B SaaS Fund.
The Access EIS Fund
We spent three years analysing the UK startup market and found that in its entirety, it grows by around 25% year on year.
We set about devising a method to capture this market growth for our investors by building them the most diverse portfolio currently available on the market. Minimum investment: £5,000.
Register to learn
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