Four reasons to recommend investments in early-stage companies

Reason 1: A growth opportunity

When someone invests in a company at its initial public offering, there’s a good chance they’ve already missed out on some of the fastest growth that company will ever see.

While there are significant risks when investing in a very young business, that goes hand-in-hand with the potential for significant growth.

By virtue of being small, early-stage businesses have room for substantial growth. They can also be attractively priced, because many big investors and institutions look to invest in established companies with proven returns rather than higher risk small businesses. Should things go well for these businesses, and those large investors later enter the market, they tend to push up the share price.

Taking the risk of backing a company in the early stages of its growth means investors can maximise the growth opportunity. What’s more, the UK is a very attractive market for early-stage investments.

Britain is renowned for nurturing young innovative companies. The UK is now only behind the US, China and India for creating unicorns, which are private businesses valued at over $1 billion (£722 million).

Recent success stories include second-hand fashion app Depop, purchased by US e-commerce giant Etsy in a deal worth $1.6 billion. Another is online used car retailer Cazoo, which listed on the New York Stock Exchange.

Reason 2: Make the most of tax reliefs

There is a way clients can invest in smaller companies and claim tax reliefs to compensate for some of the risk they take. These tax reliefs can be useful to support a client’s tax and financial planning.

Some small, early-stage companies qualify for investment under the Enterprise Investment Scheme (EIS) or through a Venture Capital Trust (VCT).

For clients, investing in a portfolio of EIS-qualifying companies or a VCT provides access to smaller companies and a number of tax reliefs.

These two routes will suit the needs of different clients:

Venture Capital Trust (VCT)

VCTs are listed companies that invest in a large diversified portfolio of 20—90 early-stage businesses. Investors can claim up to 30% upfront income tax relief on their investment. When a VCT pays out a dividend, or if an investor’s VCT shares have grown in value when they come to sell, this is also tax-free.

Learn more about Venture Capital Trusts

Enterprise Investment Scheme (EIS)

Investments that qualify for EIS, involve exciting, progressive young businesses that offer the potential for strong growth. Because these companies carry greater risk for investors, attractive tax reliefs can be claimed.

With an EIS service, investors typically own shares directly in a concentrated portfolio of 1—15 early-stage companies. This concentration means where a company succeeds, investors can really feel the impact of the growth. Equally, any losses will be felt more sharply.

EIS investments have the following valuable tax benefits to compensate for some of the risks of investing in early-stage businesses: 30% upfront income tax relief, tax-free growth, loss relief that can be claimed against income or gains, and the ability to defer capital gains made on the sale of other assets. EIS shares also qualify for relief from inheritance tax.

Learn more about Enterprise Investment Schemes

Reason 3: Exciting, agile companies which diversify a portfolio

You might hear a client say, “Cazoo is one of my investments.”

But it’s less likely a client will feel this kind of connection to the larger listed stocks they hold.

While smaller companies may be a small part of an investor’s overall portfolio, it’s quite common for clients to take a disproportionate level of interest in this area of their investments. That’s natural. Smaller companies tend to be at the forefront of emerging trends, innovating, and shaping the future. And clients can participate in their exciting growth journeys.

Why does that matter?

Well, smaller company investing is a chance to deepen the relationship you have with your client. The client can experience a greater sense of ownership of their investments, and this can help you demonstrate the value you add as their adviser.

It’s also important because smaller companies can offer genuine diversification. Investing in EIS or VCT-qualifying companies allows clients to access investments they won’t normally hold anywhere else.

Many early-stage companies are unquoted, private businesses. Investing in these types of companies is not for every client. However, unquoted investments can bring unique qualities to a long-term portfolio of investments.

Because the share prices of unquoted companies are less affected by stock market sentiment, these investments aren’t as susceptible to volatility caused by the emotions of the herd, as can be the case with listed stocks.

Because smaller companies are less established, they have a higher rate of failure. But this doesn’t mean all smaller companies aren’t resilient. In fact, some early-stage companies can adapt better to shocks than large companies and this helps to diversify a client’s portfolio. When shocks do occur, such as a global pandemic, smaller companies can often be nimble and agile because of their size. New businesses also tend to operate on more modern, technology-driven business models, meaning they can often react quickly to challenging conditions.

Reason 4: Broad support for the UK economy

Small businesses are the backbone of the UK and a critical part of the economy.

Investments in smaller companies provide capital to vibrant entrepreneurs looking to change industries, stimulate the economy and create jobs.

Government-approved investments such as EIS and VCTs play an important role in making sure these companies are given the best chances of growing and succeeding. This is especially true when the wider economy needs stimulus.

Between 2018 and 2024, Venture Capital Trusts have invested more than £2.9 billion across 800 busineesson in small UK businesses.¹

Clients can feel confident that they are helping to nurture young businesses across the UK that may be the next generation of pioneers.