Follow the Money 2018: an EIS Investor’s Guide to Venture Capital Trends
One of the biggest surprises of the 2017 Autumn Budget was the announcement that the limit for EIS investments is to be raised from £1 million to £2 million for the next tax year. There had been rumours that the scheme, which encourages private investors to invest in growing British businesses through generous tax efficiencies, would be scaled back. However, while the rules around the kind of companies that qualify for EIS status have been tightened up to clamp down on suspected abuse of the system, it has actually been bolstered, not cut.
With start-ups and scale-up companies losing access to significant pots of EU funding due to Brexit, the Government came to the admirable conclusion that the UK’s promising fledgling and quickly growing companies needed that cash replaced. One measure taken has been to double the EIS limit. When a UK resident makes an investment in an EIS registered company, 30% of the invested sum is tax deductible. This means a £100,000 investment practically becomes a £70,000 investment. If the investment eventually turns out to be a losing one, a further 45% of the remaining 70% skin in the game, is also subsequently tax deductible. That all adds up to a total of only 38.5% of an initial EIS investment actually being at risk. Of course, new and growing companies are an inherently risky investment but the tax deductibles provided by EIS is for many investors a game changer in terms of the overall risk profile of such investments.
The most common ways that EIS investors achieve a subsequent exit and return on their investment is being bought out during a subsequent bigger investment round, the company being acquired by a Venture Capital fund or Private Equity or, in rare instances, an IPO. As such, it makes sense for EIS investors to follow the major trends in venture capital and private equity. Of course, not every company acquired by a VC fund will belong to a trending business category but it certainly helps to increase the chances it will. Whether they always like to admit it or not, the evidence shows that VCs are heavily influenced by kinds of business that are currently envogue. Start-ups are well aware of this and will, if at all possible, represent their company as part of a fashionable VC trend, even if the practical connection or value is tenuous.
An admittedly extreme example of this recently made the news. The share price of New York company Long Island Iced Tea Corp jumped in value by 500% when the company changed its name to ‘Long Blockchain Corp’. Does implementing some blockchain technology into a beverage company’s business processes justify a fivefold jump in its share price? Of course it doesn’t but it does demonstrate the old ‘the trend is your friend’ maxim, albeit in an absurdly caricatured way.
So, without further ado, this is our investment guide to the UK’s forecast Venture Capital investment trends over 2018.
Blockchain: this may seem like an obvious place to start but it would be remiss not to mention blockchain. The digital ledger technology was initially invented to power Bitcoin, the leading digital currency that has had such a big 2017. Every other cryptocurrency in existence is also built on variations of blockchain technology. However, it is not cryptocurrencies that are of greatest interest to Venture Capital but blockchain technology itself.
Online media Wired, quotes partners at two different VC companies explaining their interest in blockchain ventures for 2018. David Pakman of Venrock says his company is looking for investments in apps that will run on nascent crypto networks. One successful example of this kind of app has been the CryptoKitties game that is built on the Ethereum blockchain platform and gained popularity towards the end of this year. Venrock is also interested in blockchain companies whose focus is services around cryptocurrencies. These might include institutional custody, security, distribution and storage.
The other interviewee was Rebecca Lynn of Canvas Ventures. Her company is looking at companies building blockchain software that will replace existing technology in areas such as medical records, intellectual property, public and legal records.
Artificial Intelligence: AI is of course a huge field and more of an umbrella term for software that has the ability to ‘learn’ based on patterns of data input. However, while it is impossible to truly do justice to the breadth of the AI field, there are some niches that are of particular interest to VC investors as we move into 2018.
One is companies developing AI solutions that can identify video content. The recent controversy around extremist and inappropriate content posted on social media giants such as YouTube and Facebook has hugely increased interest in companies showing promising progress in the area. The sheer volume of video content posted online means that it is not practically possible for it to be effectively monitored manually. Big tech will be ready to pay big bucks for any breakthrough here and Venture Capital will look to have found the companies they will acquire first.
Big Data was a perhaps overly-hyped trend over the past couple of years. However, there has been less real application of big data analysis than has been expected. One major reason for that is the relatively high barrier to entry when it comes to being able to analyse the huge reams of data available. AI breakthroughs that will allow software to do much of that analysis are coming and of interest to investors.
The Dollar Shave Club Model: when Unilever acquired The Dollar Shave club for $1 billion in 2015, it was expected that a wave of copycat business models would follow. A wave of big business and VC acquisitions of the most successful of those was expected to follow that. So far it hasn’t really happened but VC investors still expect that it will and are looking for verticals that will replicate the Dollar Shave Club’s success.
These could be consumer products like razors that the wider public consider to be more expensive than they really should (birth control is one example). Other examples are niches that companies following the digital-first business model are having success in such as the Smile Direct Club that specialises in invisible braces. However, any product or service for which it is realistic and practical to offer a non-branded, generic alternative of comparable quality to big brand alternatives would be of potential interest to big investors.
Amazon’s Alexa, Google Assistant and Siri have solved most of the ‘hard tech’ limitations that have limited the development of the practical application of voice-controlled tech. Now, investors are looking closely at companies that are developing services for voice-centric devices. The big voice-centric devices have not so far been particularly open to advertising, which has been a conscious decision. However, companies that can find creative ways to inoffensively introduce advertising into increasingly popular voice technology are likely to be sought after.
These are of course just a few examples of what are expected to be the biggest investment trends of 2018. Nonetheless, EIS investors would be wise to keep their eye on interesting opportunities in these and other areas particularly interesting VCs, who in turn are looking for the opportunities that will interest the big corporates further down the line.
Please remember that financial investments may rise or fall and past performance does not guarantee future performance in respect of income or capital growth; you may not get back the amount you invested.
There is no obligation to purchase anything but, if you decide to do so, you are strongly advised to consult a professional adviser before making any investment decisions.