This is an introduction to the legal structure of Enterprise Investment Scheme (EIS) funds. It’s for investment professionals who are considering setting up a new fund, and for prospective investors who want to understand the mechanics of what’s involved.
16 December 2013
Like any fund, the purpose of an EIS fund is to give investors the benefit of the skills and experience of professional managers, and spread the costs of investing over a broader base of investors. Those costs include finding suitable investments, vetting them, negotiating the investment, managing them and arranging an exit.
Unlike many types of fund, an EIS fund is not a separate legal entity. This is because in order to qualify for the tax benefits, each investor needs to have a direct ownership interest in an identifiable bundle of shares in each investee company.
Subject to complying with the relevant conditions, the tax benefits of investing in EIS qualifying companies include income tax relief, tax-free capital gains, 100% inheritance tax exemption and loss relief.
More information on the tax advantages of EIS investments can be found here:
Here’s a diagram showing the typical structure of an EIS fund.
The fund is usually promoted using an information memorandum or similar document. That document will include the terms and conditions of an investor agreement which each investor agrees to when he or she applies to invest in the fund.
There is no partnership or LLP or company which acts as the “vehicle” for the fund – just a collection of investor agreements on identical terms, which are entered into between each investor separately and the discretionary manager. From a legal perspective, this is the backbone of the fund’s structure.
The investor agreement: the legal backbone of the fund
In the investor agreement, each investor appoints the discretionary manager to manage his or her “portfolio”, and invest it according to the strategy set out in the information memorandum. The discretionary manager is paid fees in return, and these may include a set-up fee, an annual management fee and performance-related fees depending on the returns produced by the investments.
The discretionary manager also receive fees from the investee companies – such as fees for monitoring those companies, providing directors or arranging transactions. Although investors may like the idea of the costs of the fund being picked up by someone else, these types of fees can mean the manager’s remuneration is less transparent, and less aligned to the interests of investors.
Other roles in the fund
A number of other contractual arrangements can be added to that backbone.
Trustee / custodian: The discretionary manager would usually appoint a third party to act as trustee or custodian. This role includes holding the legal title to the shares in the investee companies as a nominee for the investors.
Administrator: The manager may also subcontract certain administrative functions. These may include maintaining accounting records for the fund, arranging periodic valuations of investors’ portfolios and dealing with distributions to investors
Investment adviser: The manager may subcontract the role of identifying potential investments and implementing the fund’s investment strategy generally. If that is the case, then in practice it’s the investment adviser’s connections and expertise which are most critical for the fund’s success – and the fund’s branding would usually feature the investment adviser most prominently.