Sunset clause extension: How will it impact private market investing?

Sunset clause extension: How will it impact private market investing?

Chancellor Jeremy Hunt’s Autumn Statement included the extension of the EIS and VCT ‘sunset clause’ that underlined the government’s commitment to both schemes. The schemes had been mandated until April 2025, leaving their future uncertain. However, the extension to 2035 demonstrates the government’s confidence in the ability of EIS and VCT to provide capital to the UK’s innovative early-stage businesses.

The sunset clause extension offers opportunities for investors in EIS and VCTs far beyond the range of tax incentives that the schemes offer.

EIS and VCT act as tools to diversify portfolios

Both VCT and EIS schemes offer a route for investors to access private markets, which can provide uncorrelated returns and diversification to investment portfolios.

The UK contains a far greater number of private businesses than listed companies. The Department for Business and Trade’s recently published an estimate for the number of private sector businesses in the UK with up to 49 employees was 5.51 million at the start of 2023. In contrast, the London Stock Exchange Issuer List shows under 1,900 companies quoted on the stock market. Evidence also shows that companies are staying private for longer, or not choosing to list at all so EIS and VCT provide one of the few ways for investors to access this large asset class.

Capitalising on the ‘tech investment downturn’

Many EIS and VCT managers focus on investing in early-stage technology enabled businesses, often referred to as ‘tech companies’. The extension of the sunset clause comes at an opportune time in the UK tech business market’s cycle. According to Sifted , the amount of capital raised in 2023 by UK tech companies was less than half the level raised in 2021. This downturn has led to lower valuations in a number of the UK’s most exciting tech businesses, despite the fact that many of those businesses have diversified their product offering and experienced strong revenue growth during the same period.

For investors looking to invest in the tech sector, the dip in valuations could boost returns in the long-term if the valuation cycle has hit an inflexion point. Investing in early-stage companies carries greater risk than other investment opportunities, which the tax incentives such as the 30% income tax rebate (EIS and VCT) and the EIS loss relief can help to mitigate.

Increased competition and fund manager differentiation

The extension of the sunset clauses will likely lead to further evolution in the universe of EIS and VCT fund managers with new managers entering the market. Incumbents will have to find ways to differentiate themselves based on investment strategy, service levels and performance amongst other factors.

Ultimately, investors should benefit from increased competition and greater choice. More investment choice will also provide an opportunity for financial advisers to assist clients. Advisers will be able to utilise their due diligence processes and analysis to help their clients reach their desired outcomes.

UK Private Market wider development

The extension of the sunset clauses is not the only recent measure taken to develop the UK market for private investments. The Chancellor’s Mansion House Reforms in July 2023 unveiled a commitment from some of the UK’s largest pension funds to allocate at least 5% of their default funds to private markets by 2030. In June 2023, the FCA re-categorised Long Term Asset Funds (LTAFs), opening them up to retail investors and defined contribution pensions schemes. LTAFs are a relatively new investment vehicle that provide access to long-term, illiquid assets including venture capital, private equity, real estate and infrastructure, which has historically been the preserve of larger institutional investors.

Both announcements are indicative of the government’s desire for private markets to fund UK economic growth and innovation.

Tax incentives and broader investor appeal

The tax incentives associated with EIS and VCT have always been at the core of their appeal to investors and financial planners. Income tax relief and tax free growth for both schemes as well as loss relief, the ability to defer capital gains and business relief qualification for EIS investors continue to make VCT and EIS powerful planning tools.

It is conceivable that with a freeze on personal income tax bands until 2028 and rising wages (that the Office for Budget Responsibility expects to result in over 3 million taxpayers paying higher rate tax for the first time in the next five years and a further 400,000 moving into the additional rate tax bracket), a greater number of investors will seek tax-advantaged investments.

The future for EIS and VCT

Despite the associated risks, access to a private asset class combined with tax incentives have increased the popularity of EIS and VCT in recent years. The extension of the sunset clause is vital to helping UK innovative businesses access the capital they need to grow as well as demonstrating the UK’s commitment to entrepreneurship. Advisers and investors unquestionably see the benefits of investing in private markets via EIS and VCT to help create balance in portfolios with attractive tax benefits whilst also supporting the growth of the UK economy. The sunset clause extension will also encourage entrepreneurs to pursue new business ventures with the more confidence of there being capital available from EIS and VCT managers, which will have a positive impact on investment opportunities.

We expect private markets to feature more prominently across retail investors’ portfolios in 2024 and beyond. A starting point may be accessing a pool of private market assets via a VCT or EIS fund ahead of the upcoming tax year end. Like an ISA or pension, VCT and EIS have an annual subscription allowance that resets each tax year, so there is still time to utilise this year’s allowances and investments start from as little as £3k.