Investments are risky but returns are rich if you spot the next big thing
(Financial Times, 24th August 2018)
Spotting the next big thing is every investor’s dream, whether that is buying into tomorrow’s trends at the ground level or discovering the next Mark Zuckerberg.
The Enterprise Investment Scheme (EIS) offers high-risk investors generous tax breaks in return for investing in the UK’s early-stage start-ups and has shot up the government’s agenda in recent years as a way of cultivating the UK’s own Silicon Valley.
Wealthier investors hit with cuts to pension tax relief have also embraced it as a way of cutting their tax bills. EIS investors receive income tax relief of 30 per cent on up to £1m per year (rising to £2m for so-called knowledge-intensive companies), tax-free growth, and the potential to offset certain losses against income tax — as well as the chance of stumbling upon the next big company of tomorrow.
As demand has grown, the type of investments that qualify for EIS status has been restricted. However, the spectrum is still broad enough to include everything from space technology to algae farms.
“EIS encourages investment into some of the most exciting and innovative companies, creating jobs and wealth for the economy whilst giving investors a real chance of backing the next big thing,” says Alex Davies, founder of broker Wealth Club.
However, these are high-risk investments. Tax relief is a powerful lure, but savings could be outweighed by investment losses, and EIS investors will need to take a long-term view. Furthermore, specialist fund managers command hefty fees and high minimum investment thresholds.
“A lot of investors are now reaching the lifetime limit they can save into a pension, maxing out their other allowances for the year and are asking what other tax breaks are out there, including EIS,” says Petronella West, chief executive at Investment Quorum.
“But there are people going into this for the tax break and ending up losing a lot more,” she says. “Your starting point has to be are you prepared to lose all your capital?”
Here the FT takes a look at some of the weird and wonderful EIS sectors open to investors:
Algae — the food of the future?
On a sunny day in Rotterdam, Swedish-born entrepreneur Fredrik Adams is overseeing his farm. The crop he is growing is destined for £20 jars of food supplements, high-protein fish feed and meat-free burgers.
This futuristic new foodstuff is a form of algae. The stuff of ponds and puddles, it might not look — or smell — very appetising. But according to Firglas, the company behind this farm, more of us will be eating and drinking it in the future, not to mention smearing it on our faces.
By 2050, the world population is forecast by the UN to grow to 9.8bn, at which point humans will consume around two-thirds more protein than we do today. Algae contains three times as much protein as beef, plus compounds such as omega-3 and iodine, meaning it can be added to meat-free burgers, vitamin pills as well as dietary supplements.
“There are over 200,000 different strains of algae,” says Mr Adams, gesturing to a swirling plastic pipe full of dark green slime. “It is the most simple single-cell organism, meaning it is effective to grow, and it can be used in fuel, food, beauty products and many other things.”
In fact, L’Oréal is the number one patent holder of algae products in the world. Health supplements containing chlorella and spirulina — both forms of algae — are popular with consumers due to high concentrations of omega-3, and already line the shelves of health food shops. Mr Adams says these are “enormously high margin”, attracting price tags of between £10 and £20. More than 70 companies already produce chlorella, and the market for omega-3 is said to be worth $1.3bn. But there are hundreds of thousands more strains of algae not yet commercially developed and the supplement market remains young and fast growing — hence the opportunity for EIS investors.
The fish food market is by far the largest, due to huge consumer demand for commercially farmed fish, and this is where most of the algae grown in Firglas’s Rotterdam farm ends up.
Over the past 40 years, global demand for fish has increased at almost twice the rate of the growth in population and the market for aquaculture feed is worth $42bn. Firglas’s feed will be higher value than the cheapest on the market containing more protein, but is higher cost and higher margin too, says Mr Adams.
Firglas is currently raising £3m to expand its pilot, which consists of a large plastic tube of liquid green algae, winding intestine-like around the floor. Next year, a one hectare greenhouse next door currently teeming with tomato plants should be full of tubes of watery algae, producing up to 100 tonnes of dry algae a year.
The company claims it has created a way of producing algae in water which will enable it to produce greater volumes at a higher quality and lower cost than its competitors.
But so far, Firglas has not proved its ability to produce algae at significant scale and does not yet have a commercial plant up and running. Once it does, it will have to secure contracts from major companies to turn its slime into algae burgers or vitamin pills, and will need to prove it can compete in the global fish food market.
“Many people’s perception of algae may be of green, slimy sludge rather than a viable investment opportunity,” says Patrick Connolly, chartered financial planner at Chase de Vere. “The fish food market is fairly low margin and, while algae can be a valuable source of protein for humans, it would require a significant change in perceptions and behaviour to infiltrate other markets on a wider scale.”
There is a minimum subscription of £10,000. According to Wealth Club, the broker offering this EIS investment, after three years investors in Firglas could achieve returns of 1.7 times before the tax relief is applied — but investors could also earn nothing from the scheme if it fails to bloom.