Tax Advantaged Investments. Draper Esprit EIS December EIS Review

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1 Analysing tax advantaged investments since 1985 EIS Review This is a marketing copy authorised by Allenbridge Draper Esprit EIS December 2016 Encore Ventures LLP ( the Manager or Encore ) is planning to raise funds for Draper Esprit EIS ( Draper EIS or the Service ) with closings in each quarter This service was launched for new and existing investors on 1 October Contents 3 Executive Summary 6 Manager Quality Manager Profile Financial & Business Stability Quality of Governance and Score Card Management team 12 Product Quality Assessment Fund Type Discretionary Non-approved Investment Team Investment Strategy & Philosophy EIS Strategy Generalist Pipeline/Prospects and current Portfolio 85 Fund Structure Evergreen Investment Process Risk Management Manager AUM 31 million Key features Performance EIS Risk Level Medium Closing Dates Investment Minimum subscription 25,000 Maximum qualifying subscription per tax year 1,000,000 - Funds will be raised in tranches that close each year on: - 5 th January - 5 th April - 5 th July - 5 th October Early bird discount No Allenbridge Limited All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form by any means, electronic, photographic or otherwise without prior permission of the right holder. Marketing

2 Risk Warning for EIS Schemes Individuals should always read and bear in mind the risk warning notices that are included within providers investment offer literature/documentation, including prospectuses, information memorandums, securities notes, brochures and other related marketing literature. Whilst the following list is not exhaustive, some of the main risks to be aware of include: Investments are in small, unquoted companies and should be considered as high risk; Investments are illiquid and need to be held for at least three years in order to retain the initial income tax relief; An EIS/Seed EIS investment should be viewed as a long-term investment; Legislation, along with the nature and level of tax reliefs is subject to change. There can be no certainty that investments will be eligible or remain eligible for EIS/Seed EIS Relief; Historic investment performance cannot be used as a guide to future performance, and the value of any given investment may rise or fall; Many EIS/Seed EIS Schemes involve investment in a single company or sector and therefore should only be considered as a small part of an overall portfolio; Investors may not have independent representation on the Boards of investee companies which can mean their interests are not adequately considered relative to the executive team; EIS/Seed EIS investments should only be considered by sophisticated investors who understand, and have given careful consideration to, the underlying investment strategy and associated risks. For help in determining potential investment suitability, professional advice should be sought; Often there will be no regulatory oversight and investors will usually not be eligible for compensation if things go wrong. 2 Marketing

3 Executive Summary Offer: Encore Ventures LLP ( Encore or the Manager ) is seeking to raise funding for Draper Esprit EIS ( Draper EIS or the Service ) to invest in EIS qualifying companies on an ongoing basis. Encore is a subsidiary undertaking of Draper Esprit plc ( Draper, the Group ). The funds will be raised in tranches that close on the 5 th January, 5 th April, 5 th July and 5 th October. The offer was launched in October Manager: Draper established the Encore business as an EIS fundraising conduit for its broader institutional venture capital investment management business, undertaken through its long standing Draper business. Draper was established in 2006 and has employed the same investment process since inception. A change in EIS legislation in 2012 enabled the firm to qualify many of its traditional venture capital investments for EIS contributions. As a result, EIS investors are now able to access a deal size that is typically out of reach of smaller scale EIS managers, via Draper s ability to co-invest EIS funding onto the deals of its institutional venture capital funds. Generally smaller EIS schemes do not have access to the larger amounts of capital to invest, or the investment reputation to be competitive in the larger, higher quality deals. Draper s and Encore s combined average deal size per investment is 5-10 million which is allocated in a fixed ratio of two-thirds, one-third respectively. EIS rules state the maximum EIS tax relief for any one business is 5 million per year, representing a cap on potential Encore participation should Draper/Encore elect to change the allocation ratio. Since 2012, Encore has launched an EIS fund each year but it has now been turned into an evergreen service. Product: The Service is a discretionary managed portfolio service that aims to invest in technology and technology driven businesses. In particular, the Service will invest the majority of funds into late-stage scalable companies that have proven technologies and a go-to-market model. The Manager believes that there is a scarcity of capital to fund these types of venture capital opportunities in Europe (compared to the US) owing to the dearth of European venture capital funds focussed on this deal size. Encore expects to predominantly fund a mixture of young companies alongside one to two start-ups. Through the Service, Encore plans to deploy the funds over months of each close into a portfolio 8 to 12 investee companies per investor. The target investment holding period is between three to five years. The Manager has not set any target returns. Summary Opinion: The Service might suit sophisticated EIS investors who are looking to gain exposure to technology-driven businesses. The Service provides investors with access to investment opportunities in relatively well-established firms that are likely to be beyond the means of traditional EIS managers, through co-investing in companies most of which will have proven business models. Although not possessing a demonstrable track record in EIS, the experience of the broad investment team and demonstrated ability to perform end-to-end investment management provides strong comfort. We have reservations over what is a generous successbased performance fee arrangement, and think documentation of processes could be modestly improved (such as production of a risk policy, or evidence of investment committee deliberations). 3 Marketing

4 Positives At the Manager level: The Manager is currently profitable, has no leverage and is supported by a 40% ownership partner, Draper Esprit plc, which is well capitalised post its June 2016 initial public offering ( IPO ); Draper is a member of the Draper Venture Network, a self-governed collective of nine independent growth and venture funds across the world. Draper is the Western European member. The network assists members with market intelligence, origination of deals, investment due diligence and fund raising sources. The Manager has consistently met its fund raise targets over the past four years. The Management board oversees the overall risks of the firm which is monitored via an internal risk monitoring system called the Systems and Control Matrix. The management board reviews each risk (i.e. reputational, business management, money laundering etc.), assigns a probability and formulates mitigation controls. The matrix is reviewed and updated on a yearly basis. This is a good oversight mechanism in our opinion. Following the IPO of Draper Esprit PLC in June 2016, the Group has the visibility and governance of a listed business, and has a Board of Directors which follows the composition guidelines recommended in the UK Corporate Governance Code; Draper has shown a commitment to broadening its product base with an announcement on 24 th November 2016 that it has acquired a stake in a VCT manager. At the Product level: EIS investors are able to access a deal size that is typically out of reach for smaller scale EIS managers through Draper s ability to co-invest EIS funding onto the deals of its institutional venture capital funds; The bulk of the investment capital (at least 50-65%, but likely higher) will be invested into late stage companies with 2-20 million plus revenues at the point of investment. The late stage companies are significantly de-risked with respect to technological development, commercial traction and are in the process of scaling up their businesses. The investment process is comprehensive, well thought-out and has been operating effectively for over ten years; Encore leverages Draper s investment team and resources. All partners across both Draper and Encore have extensive, relevant experience. The Draper/Encore investment team has a strong track record in realising investments. The combined team has successfully exited 36 investments in the past five years across its non-eis funds and the investment performance of those funds has been strong 4 Marketing

5 Issues to consider At the Manager level: Encore s product diversity is limited, offering only EIS products and hence is reliant on the products to generate sufficient revenue. As such, Encore is also heavily exposed to any changes in tax regulation pertaining to EISs; Appendix 2 provides commentary from Draper Esprit plc on potential litigation, drawn from their IPO documentation; Draper has been notified of a potential claim arising from an individual who is an Encore EIS investor. However, no proceedings have been issued and Draper has refuted all claims made against it and has not received any correspondence on the matter since December Based upon commentary from Encore we understand that the potential claimant had several interests in a Draper and EIS portfolio company, not just as an EIS fund investor. Furthermore, investors in Draper Esprit EIS will not have any exposure to this matter. The Service is a very small part of the overall group revenues which may mean there is less commitment to the Service than other managers who are more focussed on tax advantaged products, although Draper s recent announcement regarding the Elderstreet VCT suggests a strong commitment to tax-advantaged investment products. At the Product level: The investment team, comprising partners of both Encore and Draper, are not making exclusive investment decisions for the benefit of Encore; rather it is a dual mandate for both Encore and Draper. Furthermore, as there is a pre-agreed portfolio allocation split between Draper and Encore (which may be changed at the agreement of both parties), the sizing of each EIS investment allocation is not made in the exclusive interest of Encore (as Draper Esprit s interest needs to be considered). From an EIS perspective, the investment track record is too limited to reach any firm conclusions about the team handling the EIS portfolio. Despite having a wider sector mandate within the technology market space, the Manager noted that sector diversification is a secondary consideration to finding the right deals. Naturally this introduces the risk of sector overconcentration within the portfolio given a lack of any defined portfolio limits.. We note, however, that each investment opportunity is considered on the basis of a unique concept and accordingly there is unlikely to be an event that impacts across the portfolio. There is a performance fee charged on a deal by deal basis which we think misaligns the interests of the Manager with those of investors in that it may fail to incentivise the Manager to seek to extract value from underperforming investments. However, we acknowledge the Manager recently achieved an exit (Datahug) in which it was able to secure a modest profitable return (1.3x) for investors from what had been an underperforming asset. We also note the Manager will not receive a performance fee unless the total distributions provided to the investors exceed the net subscription by the termination date for the fund which is 7 years from the relevant fund raising close unless Encore exercise the option to extend the fund. We think this is a modest hurdle. Finally the proceeds deal by deal must also exceed a hurdle rate of return before the performance fee applies. Whilst investing alongside venture capital funds offers advantages it does mean the minimum EIS holding period is less likely to be a priority when looking at potential exits. 5 Marketing

6 Manager Quality Manager Profile Draper Esprit plc was originally founded as Esprit Capital in 2006 by Simon Cook and Stuart Chapman following the buyout of a venture capital business from Cazenove Private Equity ( Cazenove"). This was followed by the acquisition of another venture capital business, Prelude Ventures Limited ("Prelude ) in The two transactions created a portfolio of approximately fifty-two companies and facilitated the establishment of the firm s first two funds (Esprit Fund 1 and Esprit Fund 2 respectively). In 2009, Draper acquired a third fund, Esprit Fund 3(i) from 3i Group plc ( 3i ), which comprised approximately thirty existing company investments. In 2010, the firm launched its fourth fund (Esprit Fund 3), its first fund established solely with the objective of making primary investments. In 2011, Esprit Capital formed a joint venture with Tempo Capital LLP ( Tempo ) to work on secondary venture capital opportunities in Europe. In 2015, Esprit Capital was rebranded as Draper Esprit LLP before its initial public offering on AIM in June As at July 2016, 84% of the company was publicly held by investors outside the Draper Esprit team. Finally, Draper has recently shown a commitment to broadening its product base with an announcement on 24 th November 2016 that it has acquired a 30.77% stake in Elderstreet Holdings Limited, the holding company of Elderstreet Investments Limited ( Elderstreet ), with an option to acquire the balance of the Elderstreet shares in due course. Elderstreet, a UK Venture Capital Trust ( VCT ) manager, manages Elderstreet VCT plc which currently has assets in excess of 25 million. In 2012, the firm made its initial foray into EIS investing, via a subsidiary of Draper Esprit plc called Encore Ventures LLP ( Encore or the Manager ). This was made possible due to a key change to EIS legislation which made many of Draper s venture capital investments eligible to receive EIS funds. Previously, to qualify for EIS investment, a company was required to employ less than 50 full-time staff. In April 2012, this limit was increased to less than 250 full-time staff. Encore was a legacy FCA-regulated company that had originally been used to manage the 3i venture capital portfolio. Once the management contract had been transferred to Draper, the vehicle was no longer required. Its use was purely for administrative and regulatory ease, primarily via its ability to manage funds for retail investors. Each year since 2012, Encore has raised a new EIS fund, raising a total of approximately 31 million across five EIS funds thus far. Encore s EIS funds represent an alternate funding channel for the investments housed historically in Draper s Fund 3 portfolio, and now in the Group s portfolio. This is not to say they are limited to, or must participate in the Group s investments; however, they will most likely do so where permissible, with exclusive Encore-only investments unlikely. Accordingly, Encore conducts no other business other than its EIS fund. 6 Marketing

7 Millions Tax Advantaged Investments CHART 1: ENCORE AUM AS AT MARCH 31, Sep-2012 Dec-2012 Mar-2013 Jun-2013 Sep-2013 Dec-2013 Mar-2014 Jun-2014 Sep-2014 Dec-2014 Mar-2015 Jun-2015 Sep-2015 Dec-2015 Mar-2016 Jun-2016 Sep-2016 Source: Encore; AllenbridgeIQ Draper is a member of the Draper Venture Network 1, a self-governed collective of nine independent growth and venture fund managers across the world. Draper is the Western European member. The principal aim of the network is to collaborate and assist members on market intelligence, origination of deals, investment due diligence and fund raising sources. Simon Cook, is one of the five global board directors. Draper s core business centres upon venture capital investing, in predominantly late stage investee companies which have proven technologies and go-to-market models, as well as investments which are relatively less mature. The key attraction for Encore EIS investors is the ability to access deal flow attractive to financial institutions, corporate investors and sovereign fund investors, and invest alongside the aforesaid partners. The fundraising experience to date has been strong for EIS and compares favourably to peers, largely reflecting the size of the underlying investment opportunities that are available to the investor. The latest fund raising targets million per annum and is simply a result of Encore s internal assessment of its fund raising channels. It bears no limit imposed by the size of the investment market opportunity or its portfolio companies. TABLE 1: FUND RAISING TRACK RECORD OF PREVIOUS EIS FUNDS Vehicle Amount Sought ( m) Amount Raised ( m) EIS EIS EIS EIS EIS Source: Encore With respect to Draper, the fund raising effort largely ceased in 2010 when Fund 3 closed to new investment. However, the firm s IPO in June 2016, which transferred the companies within Fund 3 1 Other firms in the network include Draper Associates, Dalus Capital, and Draper Triangle across the Americas, 3TS Capital Partners and Wamda Capital representing Europe and the Middle East, Draper Athena, Draper Nexus and Wavemaker Partners representing Asia. 7 Marketing

8 Million Tax Advantaged Investments into Draper Esprit plc, raised an additional circa 28.5million for follow-on funding within the existing opportunities as well as for new investments. Draper has roughly doubled this available funding from the proceeds of its exit post-ipo from its Irish semi-conductor business Movidius that was acquired by Intel. CHART 2: FUNDRAISING TRACK RECORD Dec-2012 Aug-2013 Oct-2014 Oct-2015 Oct-2016 Source: Encore; AllenbridgeIQ In terms of client reporting and services, clients will receive bi-annual reports and statements, and be able to attend an annual CEO/Investor Day to which advisors are also invited. Draper also intends to rollout an investor and advisor online portal. Finally, in terms of third party marketing, Draper uses RAM Capital with this being the second year of the relationship. Originally for its first funds, Encore did not have a relationship with a third party marketing firm. Financial & Business Stability We have reviewed the last two years of Encore accounts and note that the partnership is profitable at current levels of AUM. All profit (net) is shared between the three partners, split 60% to Richard Marsh and David Cummings and 40% to Draper Esprit plc. In 2015 and 2016, the partners shared approximately 103,000 and 335,000 of net profit respectively. TABLE 1: KEY FINANCIAL METRICS SUMMARY OF ENCORE VENTURES LLP ( '000) Revenues Net Profit (pre-remuneration charge) Profit Margin 63% 31% Net Balance Sheet Assets Debt to Assets 0% 0% Source: The Financial Statement of Encore Ventures LLP for the financial year ending 30 March Marketing

9 Revenue is comprised entirely of management fees whereby a fee of 2% is paid in the form of an initial fee, whilst a further 2% is payable as an ongoing management fee annually but for years 1 to 4 only. After year 4 no management fees are payable which is intended to align the Manager s and investors incentives around securing exits from the portfolio. Revenues have increased yearon-year due to the increase in funds raised. Thus far, performance fees have been earned and accrued rather than paid out. We note that Encore will only charge management fees for the first four years; hence subject to raising further assets in the years ahead, the revenue stream will decline. Furthermore, given Encore is exclusively focussed on EIS products, the overall risk to the revenue stream is elevated. Finally, we note the introduction of RAM Capital as a supplement to Encore s Independent Financial Adviser and personal networks, as a meaningful fund raising diversifier. Expenses are largely comprised of partner drawings (akin to salaries), staff costs and other business expenses such as rent, accounting fees and administrative costs. Given that Encore Ventures LLP is a subsidiary undertaking of Draper Esprit plc, the firm has a services agreement with Draper to provide back office support. This includes costs of the finance team including Chief Financial Officer, Ben Wilkinson, Finance Director, Graham Redman, as well as office administration and reception functions. Draper has recently hired personnel to strengthen the marketing and administration teams as well as investment associates to assist with deal sourcing. As the bulk of the deal flow is shared between Draper and EIS products, the investment associates are shared resources with proportional costs paid by Encore through Draper Esprit s ownership stake and corresponding profit share in Encore. The balance sheet remains in solid shape, with no debt in the business. No cash flow statement is prepared as all expenditure is written off as incurred and profit closely equates to cash generated. As Encore is a subsidiary undertaking of Draper and operates shared costs with the partnership, it is prudent to also understand the financial position of the Draper Esprit plc business. Prior to its IPO, we noted that the Draper Esprit LLP exhibited declining revenue over the past three years. This was to be expected given the firm had not raised new capital since Accordingly, the flat earnings results were managed by the partners reducing their drawings from the business. However, the recent IPO of Draper has now resulted in a net cash position of 28.5million being available for both deployment into new opportunities and working capital. This amount has been and will continue to be increased by the proceeds from realisations in the Draper portfolio. Furthermore, we also expect that as investments within the funds managed by Draper are exited, the generated carried interest will further bolster financial stability. TABLE 2: KEY FINANCIAL METRICS SUMMARY OF DRAPER ESPRIT LLP GROUP ( '000) Revenues 2,796 3,174 3,780 Operating Profit (post drawings) Operating Profit Margin -5.2% -3.0% 10.1% Net Balance Sheet Assets 2,766 3,610 4,359 Debt to Assets 0% 0% 0% Source: Draper Esprit plc Admission Document From a staffing perspective, Encore is a limited liability partnership whose partners include Draper Esprit plc, with representative members of the firm being Simon Cook (Draper Chief Executive Officer and Encore Partner) and Stuart Chapman (Draper Chief Operating Officer and Encore Partner) whilst Richard Marsh (Encore Partner) and David Cummings (Encore Partner) solely 9 Marketing

10 represent Encore. Richard and David own 60% of the partnership, whilst Draper Esprit plc (as represented by Simon and Stuart) own 40%. Each of the four are members of the Management Committee. Given the ability of any of the partners to manage Encore, as well as their sector specific roles on the investment team (explored below), we assign the key man risk as being low. Quality of Governance and Management team Corporate governance standards at Encore were reasonable, with appropriate policy documentation in place including, inter alia, compliance, allocations policy, conflicts of interest, complaints handling, IT disaster recovery and anti-money laundering. The Management Board meets once a month. Each member has one vote, with consensus to be achieved for a decision to be reached. The mandate is very broad with no formal restrictions in place as matters surrounding operational, regulatory and compliance are discussed. It is comprised of Richard Marsh (Partner), David Cummings (Partner), Stuart Chapman (Partner) and Simon Cook (Partner). Encore also has an Advisory Committee which is comprised of the largest three investors within the EIS funds. The role of the committee is to act as a sounding board and assist the team in evaluating non-routine matters relating to the fund day-to-day operations. Whilst the Advisory Committee may confer with the Fund Manager regarding the Service, it has no power to take any part in the management of the Service. There are no other formal committees in place, with Stuart Chapman, alongside external compliance consultant Bovill Ltd, overseeing the firm s supervisory and compliance functions. In addition, the firm does not adhere to any formal best practice standards, rather noting that many of its current policies were established from the investment and investment management processes established at 3i, an LSE-listed company. A lack of customer complaints, whilst always a positive outcome, also means that the policy document supporting complaint resolution is yet to be robustly tested. From a firm wide perspective, risks are managed through a Systems and Controls Matrix. Each risk is reviewed by the Management board which assigns a probability and impact, and then has mitigation strategies. It is reviewed and revised each year. We reviewed the IT disaster recovery plan which was adequate. The business continuity plan is largely the recovery of the IT systems since the firm operates from two separate sites and all the partners can work remotely as they do in the normal course of business when visiting portfolio companies. Encore indicated that there were no regulatory issues at the time of writing. With respect to litigation, Appendix 2 provides commentary from Draper Esprit plc, drawn from their IPO documentation; Draper has been notified of a potential claim arising from an individual who is an Encore EIS investor. However, no proceedings have been issued and Draper has refuted all claims made against it and has not received any correspondence on the matter since December Based upon commentary from Encore, we understand that the potential claimant had several interests in a Draper and EIS portfolio company, not just as an EIS fund investor. 10 Marketing

11 TABLE 3: OVERSIGHT COMMITTEES Committee Details - Mandate: Oversight of operational, regulatory and compliance Management Board - Members: Richard Marsh, David Cummings, Stuart Chapman and Simon Cook - Frequency: Monthly Advisory Committee each EIS Fund) (for - Mandate: Act as a sounding board and assist the Fund Manager in evaluating non-routine matters relating to the Fund operation. - Members: Three largest investors Source: Encore; AllenbridgeIQ - Frequency: As and when required Product Quality Assessment Investment Team The Investment Team structure is flat within Encore. The team initially came together in 2011 when David Cummings joined the firm, working alongside Richard Marsh who was recruited in Draper commenced its focus on EIS in As noted, EIS funding is just one source of funding into the venture capital investments in which the broader Draper team invest via the Group. Given investment opportunities are common to both Draper and Encore, we consider the investment team applicable to this service to include both Draper Esprit and Encore investment team members. The only difference in team duties occurs post- deal execution, when the Encore Investment Committee determines potential portfolio participation and fit. With respect to Encore, Richard Marsh is fully dedicated to managing the EIS Fund and spends half of his time dealing with matters pertaining to its operations and strategy. The rest of the time, he works as part of the broader investment team, sourcing deals, conducting due diligence and attending board meetings of investee companies. David Cummings spends approximately 50% of his time in the day-to-day management of Encore, sourcing deals and managing portfolio companies. Outside of his involvement with Encore, David is a partner in Trinamo, a consultancy focussed on sales management for technology companies. Both Simon Cook and Stuart Chapman, as representatives of Draper Esprit plc, perform both investment and non-investment related roles. The other relevant Draper investment employees are noted below in Table 3. As noted above, investment associates were recently hired to assist with deal sourcing activities for investment activity across both Draper and Encore. Overall, we thought that the investment team had deep experience and strong credentials to fulfil their investment management and operational duties. Biographies of the key investment professionals can be found in the appendix. 11 Marketing

12 Investment Strategy & Philosophy The investment focus of Draper Esprit EIS ( Draper EIS or the Service ) is to identify companies with 2 million 20 million plus of revenues in which to invest in. The Service will aim to invest in at least 50% of the funds (although preferably 65% or more) in companies receiving Series B or second round/late stage financing. The focus is on businesses that have typically gained commercial traction and are relatively more mature than the remaining up to 50%, of companies in the portfolio. Late stage investing reduces some of key risks associated with start-up companies which do not have a proven technology, product or route to market. From a portfolio perspective, investing 65% or more of the funds into relatively more mature companies is designed to ensure that, upon exit, the entirety of the fund at least breaks even, and ideally makes a profit. No specific investment performance targets are specified. The remaining 35% of the portfolio is invested in relatively less mature venture capital opportunities which essentially have a higher risk, higher return reward structure. Up to 5% of the portfolio may be comprised of seed investments. At the time of writing, more than 70% of the previous offers had allocated funds in late stage companies. The diagram below depicts the desired portfolio allocation for Draper EIS. CHART 3: TARGET FUND ALLOCATION Source: Encore; AllenbridgeIQ The Manager noted a typical client portfolio will have 8-12 investments implying an 8:4 portfolio split, with perhaps one seed investment. The targeted holding period is expected to be three to five years. 12 Marketing

13 The portfolio companies are likely to be trading in the following sectors and subsectors of technology: Enterprise Technology Consumer Technology Hardware Healthcare and wellness. Once invested, in most cases Draper/Encore will hold a board seat and will be involved with the team to build the business through management support and board guidance. Draper/Encore will also typically play a role in the exit of the business via initial public offerings or mergers and acquisitions, and leverage the relationships that Draper/Encore maintains with European and US investment banks, advisors and the Draper Venture Network. The premier advantage of this strategy is that EIS investors are able to access a deal size that is typically out of reach of smaller scale EIS managers: this occurs via Draper s ability to co-invest EIS funding alongside the deals of their institutional venture capital funds. Generally smaller EIS schemes do not have access to the larger amounts of capital to invest, nor the investment reputation to be competitive in the larger, higher quality deals described above. We believe that this is a significant advantage for investors. Pipeline/Prospects and Current Portfolio Based on our discussions with the Manager, EIS 1 to 3 have fully invested the capital raised. EIS 4, launched in 2015, has so far deployed nearly all of its capital pending a final deal obtaining which is almost complete. EIS 5, which closed 30 September 2016, raised 11 million and will likely be 60% deployed by January For the current offering Draper EIS will raise funds in tranches with closing dates falling at quarter end. The Service seeks to fund two to three companies per quarter and it aims to fully allocate client subscriptions within months. Accordingly, investors entering the Service in different quarters may have differences in their portfolio composition, and much will also depend on the timing of deals and the capital required. In this regard, Encore has a broad and detailed allocation policy addressing any issues pertaining to allocation of funds among different tranches. TABLE 4: HISTORIC DEPLOYMENT EIS Capital raised Total number of investments Number of investments that were follow-on Time to full deployment (excluding follow-on reserve) EIS 1 4m months EIS 2 4m months EIS 3 5m months EIS 4 7m 10 6 Expected EIS 5 11m 9 3 Expected Source: Encore As per the table above, investments made by the Service are likely to comprise investments in later rounds of follow-on funding in existing portfolio companies held by the EIS funds as well as new 13 Marketing

14 co-investments with other Draper Esprit funds. The expected proportion of follow-on to new investments is likely to be 25-50%. Investment Process We have reviewed the investment process for this Service and were impressed with the structure and clarity of the processes followed. The below graphic illustrates all the different stages of the investment process: CHART 4: SIMPLIFIED ILLUSTRTATION OF THE INVESTMENT PROCESS Deal sourcing activities and first contact (including vreview of business plans) Weekly deal v review Thesis testing with another partner and preparation v of the preliminary IC paper v Investee company presentation and submission of term sheet Presentation of second IC paper v and IC approval Deal completion Deal Source: Based on interviews and documents provided by Encore. Please note that this illustration is a simplified version of the process as agreed with the Manager. As previously noted, the investment team for the EIS portfolio spans the partners at both Encore and Draper given that investments will, in all likelihood, be common to the EIS and venture capital funds. Partners are responsible for generating deal flow for the team as a whole, as well as within their specialist sectors and will use their personal networks to source as many deals as possible. This source has been responsible for approximately 50% of the deal flow. For any deal, the initial stage of due diligence is comprised of a business plan screen, initial meeting or conference call, initiated by the partner. All prospective deals are reviewed each week at the partners weekly meeting. The meetings are held to identify to which projects Esprit/Encore should allocate more resources and the next steps required. If due diligence is continued, the partner responsible for a particular deal will bring in another partner to test the investment thesis for the deal. At this stage, due diligence is primarily focused on interviews and reference checks on the management team, validation of the technology and intellectual property, validation of the business plan and the potential for an exit. The two partners will also submit the first Investment Committee paper. This paper introduces the investment thesis, terms of the deal and the proposed diligence path. During this process, the Investment Committee has the authority to support or reject the investment thesis. If the investment is deemed positive, the Investment Committee supports the deal partner to close the deal successfully by assigning new partners to the deal and using existing networks. The Draper Network is used to provide additional support to the diligence where possible. The next step is a presentation by the management team of the prospective investee companies to the partners of Draper/Encore. After the presentation and subject to IC approval, Draper/Encore submits a term sheet. It is important to note that the partners of Draper/Encore would meet the management of the investee company several times before an investment is made. A final paper is submitted to the Investment Committee, detailing once again, the investment proposal and key findings of the due diligence process. The final approval is through a majority where no member of the Investment Committee has veto powers. To conclude the deal, lawyers are brought in to conduct the final negotiation in order to safeguard the interests of the Service. We reviewed an investment memorandum prepared for the investment committee which was sufficiently detailed. Investment Committee minutes however do not detail any debate or deliberation, other than the voting outcome, thus it is difficult to assess the means by which an investment decision is reached. With respect to deals relating to EIS, the Encore Investment Committee will determine portfolio suitability and fit throughout the due diligence process for all EIS-related investments. This will 14 Marketing

15 occur through participation at the weekly deal flow meeting where the pipeline for deals are discussed. Furthermore, once a deal is approved by Draper for investment, the Encore Investment Committee will meet to discuss portfolio inclusion, if they were not yet already involved in the due diligence process. As noted, it has been agreed that the allocation between Draper and Encore will be split two-thirds and one third respectively hence the decision of the Investment Committee relates exclusively to portfolio inclusion as opposed to position sizing. In terms of post investment monitoring, the Manager informed us that it holds a board seat in most of the investee companies. In addition, the Manager monitors the performance of each investee company via KPIs. Draper/Encore tailors KPIs for each investee company. Finally, partners report weekly progress on underlying investments and there is a full portfolio strategic review every six months. Risk Management There is no formal risk committee, but rather, responsibility falls under the general remit of the Management board. The most broad form of risk management will occur upfront during the due diligence phase as is common practice for venture investing. This is via Encore s multi-staged investment process described above. With regard to portfolio diversification, the target is to invest across 8-12 companies ranging across a number of sectors. However, Encore did note sector diversification will be of secondary consideration to finding the right deals. Naturally this introduces the risk of sector overconcentration within the portfolio given a lack of any defined portfolio limits. However, given the uniqueness of each concept inherent within Draper s investee companies to date, and the firm s ongoing philosophy to unearth such opportunities on an ongoing basis, we believe the materiality of this risk is low. Finally, the main source of risk mitigation is the diversification achieved via investing in companies at differing stages of maturity. To that end, as detailed earlier, approximately 65% of capital (although can be as low as 50%) will be invested into late stage companies with 2-20 million+ revenues at the point of investment. Late stage companies are typically significantly de-risked with respect to technological development, commercial traction and are generally in the process of scaling up their businesses. The balance of the fund will invest into early stage companies, which are relatively less mature in the facets described above. This is designed to balance the overall portfolio risk/reward equation via affording the portfolio a higher likelihood that capital will be returned through the late stage companies, whilst also ensuring a higher level of return potential upside via the less mature portfolio, albeit with a greater level of uncertainty. Whilst we are positive on the size of the investment team spread across Draper and Encore, a natural consequence is that they are not exclusively focussed on EIS products. Furthermore, as there is a pre-agreed portfolio allocation split between Draper and Encore (which may be changed upon agreement of both parties), the sizing of each EIS investment allocation is not made in the exclusive interest of Encore (as Draper Esprit s interest is considered). Nonetheless, the Encore Management Board is comprised of both the Chief Executive Officer and Chief Operating Officer of Draper, in addition to their ownership stake, and we are comfortable that this alleviates any potential conflict of interest. Also, Draper is a participant in the performance fee from the EIS fund which means that it is aligned to delivering successful investment outcomes for EIS investors. The ratio of investment between Draper and EIS will be reviewed if there is a material change in the level of funds that are available to be invested by either Draper or EIS, or otherwise at the end of March and September when the funds undertake their 6 monthly valuations and reporting. 15 Marketing

16 Naturally, the major risk facing investors is an underlying company fails and this should be viewed as a potential scenario facing one or more companies over the lifetime of the portfolio. To mitigate the loss of value, Encore/Draper endeavour to liquidate remaining value of losing positions as early as possible. Furthermore, in order to mitigate against the possibility of a company failing, the management maintains oversight over the portfolio via one of three channels. Depending on the size of the investment, Encore/Draper will either take up a position on the Board, maintain a Board Observer position, or at least obtain information rights which provides visibility over board and management activity. It is possible that there may be an insufficient number of target companies to fulfil the 8-12 company portfolio quota above. Whilst Encore notes this would be an unlikely outcome given the broad opportunity set present in the UK and Europe, in a worst case scenario Encore could elect to extend the investment deployment period or in a worst case scenario return investors funds. Other than the above, there are no other risk management procedures in place, nor is there a formal risk policy that stipulates the above portfolio guidelines. Given the small team in place at Encore, it is not unsurprising that there is not a unique risk committee overseeing the above, however, we still think documentation is best practice. With regard to ensuring investments are within EIS guidelines and remain so, Encore employ Philip Hare Associates as EIS advisors. Furthermore, no investment is undertaken unless Advance Assurance has been obtained by the HMRC beforehand. We are comfortable with the above arrangement given Philip Hare s long standing reputation in the industry. Key Features The following fees (number 1-4) describe the fees directly payable by the investors and the product fees (number 5) incurred by Encore. 1. Initial and Ongoing Fund Management Fee TABLE 5: FEES PAID TO THE MANAGER Initial Fees (Fund Setup Fees) 2% of net subscription* Source: Encore Ongoing Annual Management Fees 2% of net subscription** (years 1-4 only) Fees paid to Custodian 0.35% dealing fee 200 (or 0.5% if less) administration fee (years 1-4 only) *Net Subscription is defined by Encore as the Subscription stated in the Draper Esprit EIS application form minus the adviser facilitation fees (if applicable) ** Annual management fees are payable for four years and none thereafter. Operational fees, payable to Encore, are capped at 10% of net subscription, plus VAT, over the life of the fund (i.e. 2% x 4 years plus 2% initial charge). Encore may also elect to charge up to 0.5% of an investor s net subscription for non-recoverable deal costs however is yet to do so on prior EIS funds. 2. Early bird fees and other discounts There are no early bird fees offered from this Service. 16 Marketing

17 3. Subscription/Application Fees TABLE 6: SUBSCRIPTION/APPLICATION FEES Type of Investor Direct Application (investors who make an application, without using a financial advisor or execution-only intermediary) Application through an adviser (investors who make an application through a registered financial adviser with an ongoing fee) Application through an adviser (investors who make an application through a registered financial adviser without an ongoing fee) Initial Application Fee (and initial commissions/initial adviser charges) 2% of net subscription n/a 2% of net subscription Ongoing management charges (and ongoing commissions/ongoing adviser charges) 2% of net subscription (years 1-4 only) n/a 2% of net subscription (years 1-4 only) Application through an execution-only intermediary 2% of net subscription 2% of net subscription (years 1-4 only) Source: Encore, AllenbridgeIQ 4. Performance Fee There is a performance fee applicable for this Service charged on a deal by deal basis. Encore does not guarantee precisely how the performance fee is structured for each deal as the arrangement could be structured via equity participation or through a cash payment, payable out of the sale value of the deal. The performance fee is triggered when the return achieved is greater than the hurdle return. The hurdle return for each deal is the investment commitment (for each separate investment) compounded by 6% per annum until it reaches 125%. Once the total return surpasses the hurdle rate, the performance fee is calculated to be 20% of total returns otherwise accruing to investors from each investment in excess of the hurdle rate. As an example, if a 1.00 investment returned 3.25 after 5 years, then the hurdle would be 1.25 and the proceeds above the hurdle would be The performance fee would be 20% of the 2.00 amount above the hurdle, that is Encore is entitled to the performance fee at the end of the term of the service only if the total distributions provided to the investors exceed the net subscription. If the distributions are less than the net subscription, the Manager will reimburse the exit performance fees that have already been paid that when added to the Investor s Distribution shall make it the same amount as their net subscription. The termination date is 7 years from each fund raising close, with Encore possessing the option of extending this period. Overall, we think a performance fee charged on a deal by deal basis misaligns the interests of Encore with those of its investors given the trigger for Encore retaining all paid performance fees is whether or not the total distributions provided to the investors exceed the net subscription by the termination date of the fund. 17 Marketing

18 5. Product Fees The detailed fees are listed in the following table. TABLE 7: FEE DETAILS Fees Administration Charge (charged by the Custodian) Details 0.5% (capped at 200) Annual Management Charge 2% Arrangement Fee (% of deal) 0% Average Annual Costs 0% Directors Fees 0% Excluded Costs 0% Historical Cap Costs 0% Recent Running Costs 0% Running Costs 0% Dealing costs (charged by the Custodian) Source: Encore; AllenbridgeIQ 0.35% Investors are charged for custodian services offered by The Share Centre; custodian fee and dealing commission. The custodian fee is 0.5% with a maximum of 200 per annum and is payable for four years and thereafter no payment is required. The Service charges 0.35% of the transaction value per investment made as a deal cost. TABLE 8: FEE EXAMPLE Net subscription (example) 100,000 ( ) 2% fund set up fee 2,000 Total annual management fee (4 x 2%) 8,000 Total custodian fee, p.a % Dealing Fee 304 VAT (20%) 2,160 Total amount to be invested 86,736 As a percentage of net subscription 87% Follow on reserve (optional see below) 10% Net invested in initial deployment with Follow on reserve ( Day 1 ) Net invested in initial deployment without Follow on reserve ( Day 1 ) EIS credit per 100p Source: Encore; AllenbridgeIQ Other than the performance fees, the fees charged were not onerous in our opinion. Encore also offers investors the option to put aside 10% of their subscription in a follow-on reserve to fund companies when they do not progress according to plan. The belief is that if existing investors have the capacity to provide small amounts of follow-on funding then this can allow the company to get back on plan, or to achieve an orderly sale of the business and recover value from the 77% 87% 87p 18 Marketing

19 investment. This is a reasonable rationale in our opinion and offers investors the potential for cheaper equity down the track. However, investors also need to be cognisant that only 77% of initial capital will be put to work on Day One if they elect to take up this option, as opposed to 87% if they do not take it up. Performance EIS is a new product and accordingly does not have a track record. Furthermore, earlier EIS portfolios are still too young to make any meaningful inferences. However, as the four Encore staff also have responsibilities for individual investee companies, we can examine their personal track record associated with Draper/Encore. Since joining Draper, Richard Marsh has been personally responsible for five exits over the last five years for companies within his area of responsibility. We note that he did not source the opportunities below, but rather inherited the investments when he joined the firm. Aside from running the EIS Funds, Richard has sold two businesses this year and currently looks after two other investments including one that is included in the EIS portfolio and one legacy Draper asset. We value Richard s ability to source a profitable exit and believe this bodes well for investor s chances of realising liquidity in the years ahead from the EIS funds. David Cummings has been dedicated to sourcing deals. He therefore does not have an exit track record at Draper or Encore, however he was formerly a partner at Lazard and was managing director of the bank s Telecoms, Media and Technology practice in London advising on M&A and IPOs. TABLE 9: RICHARD S EXIT TRACK RECORD Company Name Portfolio Entry Date Sale Date Exit Multiple Polatis Fund 3i Sep-09 Jun-16 Not disclosed. (Profitable) Greenpeak Fund II Jun-08 Apr-16 Not disclosed. (Profitable) Nature of exit Trade sale Trade sale Encore member Richard Richard Garlik Fund 3i Sep-09 Dec x Trade sale Richard Psytechnics Fund 3i Sep-09 Apr x Trade sale Richard Connectivity Fund 3i Sep-09 Feb-11 1x Liquidation Richard Source: Encore Stuart Chapman and Simon Cook originally worked for Private Equity firm 3i plc. Upon establishing Draper (Esprit Capital at the time), they assumed the management contract of Fund 1 (originally a dot-com era fund raised by Cazenove) and acquired the venture capital business of Prelude and management of Fund 2. In 2010 Draper acquired the venture capital portfolio of 3iwhich Stuart had a longstanding involvement with, having been a member of the 3i investment committee when each of the investments was originally made. The performance of Fund 3 and 3i are the most relevant to discuss given Simon and Stuart were instrumental in the sourcing of the deals and their ongoing management, alongside the other Draper staff post acquisition. The table below reveals strong performance across Fund 3i and Fund 3 with a gross IRR of 40% and 23% respectively to April Further, the Draper/Encore team has successfully exited 36 investments in the past five years across Fund 2, 3i and 3 which we consider to be a strong outcome. In totality, the performance thus far provides broad comfort of expertise and experience across the all key criteria of the investment process. 19 Marketing