01/03/2012

By Modwenna Rees-Mogg, AngelNews

Way back in the mid 1990s amongst the many employees of Kleinwort Benson were two individuals now heavily involved in the EIS world. One was me, in corporate finance; the other was Paul Sheehan in asset management. We did not know each other but it is a happy coincidence that we are both now heavily involved in the EIS world.

The Kleinwort connection is relevant because it was a firm that could always see the bigger picture embracing the corporate world from small caps to some of the largest corporates in the world. We were taught to apply our analytical and other skills with an equal degree of measure to any company we looked at. Even today, years later, this attitude holds well with me. I am sure the same is true of Paul.

It does not surprise me therefore to find it is a former Kleinwort employee who is one of the people who has spotted the enormous opportunity now represented by EIS for both investors and for corporate clients looking to fundraise up to £10m. EIS is no longer a micro company market. It embraces some of the types of company with which we both worked all those years ago.

We came across WH Ireland’s new EIS fund last year via our friends at Harcourt Capital who are managing regulatory and administrative aspects of the fund for WH Ireland. Paul and his colleagues were very involved in our VCT & EIS Investor Forum last November and I think that those of you who were there will agree that their offer is distinct from many of the other funds in the market. It is also symbolic of one of the directions in which EIS funds will head over the next few years.

One of the most noticeable things about the UK Growth EIS Fund 2011/12 is not the size of the fund (£10m), nor the number of companies it intends to build in its portfolio (a minimum of 4). It is the fact that it will be investing all funds in companies quoted on AIM. Another noticeable characteristic is that it is an approved EIS Fund.

An AIM EIS fund is fresh!

The idea of an AIM EIS fund is fresh. And if the VCT market is anything to go by, other fund managers will soon step in on the act. But WH Ireland has definitely stolen a march on them. I like innovation, especially in this market. This type of adaptive innovation is the best type of all because it allows the innovator to have benchmarks against which to judge itself. There are a number of VCT AIM funds out there – some are great, others less so, but all transparent. Access to a wide range of information that their websites, reports and more make publicly available will enable Paul and his colleagues to learn from the successes and failures of others.

Paul tells me that companies are already contacting WH Ireland to see if they will be attractive propositions once the funds are raised. They include many with solid (often family based) shareholder bases who have supported the company through to several £m turnover and profitability, and are now keen to move into their next stage of growth – notably international expansion. The money these companies need is all things related to expansion – sales teams, product extensions, rebranding in local languages for overseas customers and so on. They won’t be spending the £2m odd they raise from the fund for the riskier projects in which earlier stage companies engage.

Attracting new investors

The fund also will likely bring a new type of investor into the EIS market. With a minimum investment size of £10,000 this fund is accessible to lots of smaller ticket EIS investors and may well prove attractive to angels looking for something a bit different. Paul says that many of WH Ireland’s private clients are looking at the prospectus in a very detailed way in the run up the fund’s close on 5th April.

Harcourt Capital is also actively marketing the fund to their client base of high net worth individuals. So it would not surprise me if it closes before then, so I would suggest that if you are interested you to let them know of your interest soon).

Liquidity in EIS – surely not?

Although WH Ireland will be behaving as a professional venture capital fund manager, the big difference will be that its ability to dispose of an investment will be much greater. AIM may be illiquid, but the stocks will have a quote and a market maker or two. I am sure WH Ireland will avoid getting into a position whereby it is forced to sell out of an investment in an untimely way, when the market is down, but it will have the opportunity to dispose (or indeed buy more) of part of a company’s stock in a measured way. This will give them opportunities simply not open to unquoted funds which will typically only get an exit by selling down large chunks, if not all, of the equity in an investment.

New levels of transparency

In its investor presentation, WH Ireland rightly emphasises that there will be greater financial transparency in its fund. With all the companies quoted, investors will be able to see through the fund to the underlying financial performance of the portfolio by accessing the reports and accounts available on the London Stock Exchange and companies’ own websites. (Credit should be given to the AIM team at the Stock Exchange by the way, for the invaluable work it has put into ensuring that AIM companies maintain up to date online shareholder information pages.) The governance that accompanies an AIM quote will also provide another area of comfort for investors in the fund.

By focusing on a fewer number of larger companies, the WH Ireland’s team will be spending its time very differently from many of the fund managers who have traditionally played in the EIS market. Pre-investment it will be able to spend more time actively digging out and considering opportunities from a fixed pool. Inevitably it will be on the target list of corporate financiers with an eye to gaining a listing for as yet unquoted clients. It will also be able to spend a disproportionate amount of time post investment, I suspect, on issues such as competitor analysis.

There are still risks, but not in the way you might think. All smaller companies tend to have a more colourful history than the average well established FTSE350 business. The challenge for WH Ireland will be the volatility in the share prices of its portfolio which will translate directly into the NAV of the fund. Timing entry prices and exits will be just as important as for other funds, it is just that the journey on the way through will, to the outside world, look very different from a usual EIS fund when valuations may not move from one fund raising to the next.

For investors in the fund some of this risk however will be mitigated. As an approved EIS fund, investors can make their EIS tax reclaims upfront when they invest in the fund. (NOTE: most other EIS funds are unapproved and therefore investors can only claim tax relief when the fund makes an investment, as opposed to when they invest in the fund itself).

As dividends are taxable under EIS, neither this fund nor any other typically pays its returns to investors via this route. Instead the UK Growth EIS Fund 2011/12 will be more likely to generate cash for investors via capital realisations of parts of its portfolio companies by selling the shares in the market. Therefore judging share sales to achieve this objective will also absorb considerable time and thought by the fund manager.

Conformity where necessary

In other important ways, the fund is conforming to many of the standards of the industry. Its fees and carry terms are in line with the market as are its reporting systems and practices. Operational management and regulatory management will both being undertaken by firms regulated by the FSA and there is an independent director sitting on the fund board.

The three Pauls

Speaking of the people who will actually manage the fund, we all know that whilst brand name is an important signal as to quality, what really matters is the people who will actually be managing the fund on a day to day basis. The UK Growth EIS Fund 2011/12 is the fund of Pauls!

Paul Sheehan to whom I referred earlier has 25 years fund management experience at the likes of Newton, Jupiter and Dresdner. From 2002-2008 he ran the No1 performing Jupiter Primadona Growth Trust which returned 66.2% during this period. He was brought into WH Ireland, a couple of year’s ago by the CEO Paul Compton to work with the firm to build up its investment management credentials.

Paul Compton, although now in financial services, started out his career with a double honours degree in mechanical and production engineering from Cambridge under his belt. Obviously he will be able to relate to “real world” management teams (and be able to understand what the techhies are talking about!).

But he also led a team at Collins Stewart that raised £7.6bn via 234 fundraisings in five years. So he will “get” smaller cap venture capital financing issues. His performance record is pretty respectable too – the Tosca Mid Cap Fund achieved returns of 111.3% in 2009 under his management. As CEO of WH Ireland he has more to incentive than most to get the UK Growth EIS Fund 2011/12 right. There is reputational risk for him and also business opportunity risk too. And lastly and at the end of the phone: a sustainable tech manufacturer entrepreneur

Last, but not least the final Paul – Paul Davies will be acting as independent director. A qualified chartered accountant, with a long history in small cap advisory work at the now Evolution Group, Collins Stewart, Seymour Pierce and Arden Partners, in 2008 he turned away from the City in favour of founding a tech manufacturing start up in sustainable wood products. Perfect! In one fell swoop we know he will understand entrepreneurialism, sustainability/clean tech and the importance of hi tech manufacturing. It would appear that both investors and investees can take comfort that he will be on the end of the phone, if needed.

Final thoughts

I welcome WH Ireland to the world of EIS fund management and think the experience they bring with them will help the market to develop in a profound way. Its fund will force the issue of transparency into the limelight (‘scuse the pun). It will also force the issue of returns generally and timing in particular to the top of the agenda. Both these issues have long been close to our hearts.
We look forward to reporting on how they are getting on sometime soon!