At Harper James, we specialise in providing legal advice to start-up businesses. Many of our clients want to know about attracting investment via popular schemes – raising capital in order to fund the costs of development, whether that be to acquire premises, build IT infrastructure, or simply for working capital while they grow their operations.
Equally, for our more established clients looking to scale their businesses, the question of funding and which kind of investor to target is a growing preoccupation.
- Why you need to know about different types of funding and investors
- Background to EIS, SEIS, SITR and VCT investment schemes
- How do the schemes work?
- The difference between individual investing and investing via a Venture Capital fund
- Conditions imposed on individual investors
- Eligibility criteria to qualify under the EIS, SEIS, SITR or VCT schemes
- If you think your company is eligible under one of the investment schemes, what are the next steps?
Why you need to know about different types of funding and investors
If you want to attract investment via one of the government schemes, it’s very important for founders and CEOs to be aware just how critical the rules relating to the various schemes for raising investment are. It’s crucial to understand the different types of scheme that exist, and how to distinguish between them, so that you can talk knowledgably to potential investors who may be interested in funding you.
Just as any business needs to understand customers’ needs inside out, understanding what drives potential investors is very important when looking for investment under the SEIS, EIS, SITR and VCT schemes.
As well as tailoring your pitches to suit the needs of investors who wish to benefit from the schemes, it is also be possible to target individuals who are not aware of the tax breaks available and entice them to invest for a potentially greater return than they would receive from traditional investments.
Background to EIS, SEIS, SITR and VCT investment schemes
The Enterprise Investment Scheme (EIS), Seed Enterprise Investment Scheme (SEIS), Social Investment Tax Relief (SITR) and Venture Capital Trust (VCT) schemes provide tax relief to private investors and are designed to promote investments into early-stage companies, start-ups and social enterprises (a social enterprise is defined as an enterprise applying commercial strategies to maximise social impact, typically improvements in financial, social and environmental wellbeing).
On top of the income tax relief available to investors, any gains from eligible investments are also exempt from capital gains tax (CGT) provided certain conditions are met. What’s more, eligible investments are exempt from inheritance tax.
How do the schemes work?
The net effect of the tax reliefs is that investors can reduce their capital at risk to less than 40% of the amount invested, and that’s a huge incentive. Figures from HMRC indicate that the total amount invested in companies via EIS alone in 2016/17 was £1.797billion.
On top of the income tax and loss relief benefits, profits from eligible investments are exempt from capital gains tax as long as the shares are held for a minimum of three years and exempt from inheritance tax if held for at least two years.
For example, if an angel invests £10,000 into an EIS company, their capital at risk, after the tax relief at 30%, would be just £7,000. If the shares increase in value to £20,000 then the increase in value of £10,000 would be exempt from CGT.
Looked at another way, the investor whose shares double in value has almost trebled his or her initial investment of £7,000.
And if the company goes bust, then their losses, rather than being the £10,000 initial investment, are reduced by over half, considering the initial income tax relief and further loss relief available. The graphic below shows a broad overview of tax reliefs:
The difference between individual investing and investing via a Venture Capital fund
The EIS, SEIS and SITR schemes are designed for private individuals wanting to invest in small and social enterprises. Some investors prefer to spread their risk and choose instead to invest via a Venture Capital Trust (VCT) that itself invests in eligible smaller businesses, thus offering access to a larger portfolio.
Under a VCT, individual investors buy shares in a quoted company (the VCT), who uses those funds to buy the shares of (or lend money to) unquoted companies. The VCT passes the tax relief available onto the investor, who also benefits from CGT relief on any gains, as well as tax-free dividends.
Conditions imposed on individual investors
Investors looking to claim tax relief must meet certain criteria. The following table summarises the benefits available to investors, and the limitations of each of the schemes.
|Shareholding duration||Must hold shares for at least 3 years||Must hold shares for at least 3 years||Must hold shares for at least 3 years||N/A|
|Income tax relief||Maximum income tax relief of 30% up to maximum per investor per year of £1million (or up to £2million if £1million is invested in a knowledge intensive company).
A ‘knowledge-intensive company’ is a company whose costs of research and development or innovation are at least 15% of its operating costs in at least one of the previous three years, or at least 10% in each of the previous three years (the three years ending immediately before the company’s last accounts); and either:
|Maximum income tax relief of 50% up to maximum per investor per year of £100,000.||Maximum income tax relief of 30% up to a maximum per investor per year of £1million.||Income tax relief at 30% up to maximum investment of £200,000.
Dividends are exempt from income tax provided that in the year of acquisition the market value of the qualifying shares did not exceed £200,000, or if the limit is exceeded, the dividends in respect of the first shares acquired up to the limit are exempt.
|Capital Gains Tax: Initial Investment||Exemption for gains on EIS investment if income tax relief is claimed and if shares held for three years.||Exemption for gains on SEIS if income tax relief is claimed and if shares held for three years.||Exemption for gains on SITR if income tax relief is claimed and if shares held for three years.||A VCT investor is exempt from CGT on the disposal of ordinary shares acquired within the permitted maximum of £200,000 in any one tax year.|
|Capital Gains Tax: Other reliefs, Hold-Over Relief||Hold-over relief for capital gains||100% relief for assets disposed of in 2012/13, 50% thereafter. Assets must be disposed of in the same year as investment.||If individuals have chargeable gains in that tax year, they can defer their capital gains tax liability if they invest their gain in a qualifying social investment. Tax will instead be payable when the social investment is sold or redeemed.||Relief is not available for investments in shares issued after 5 April 2004.|
|Other Tax Reliefs, Allowable Losses||Relief is given for allowable losses on disposal of the shares against income of the tax year of disposal (or of the previous year) or chargeable gains.||As for EIS.||As for EIS.||No relief is available.|
|Type of investment & Restrictions on VCTs||Full risk ordinary shares, no preference or redeemable shares.||Full risk ordinary shares, no preference or redeemable shares.||Full risk ordinary shares. Unsecured debentures. Debt must not offer more than a reasonable commercial rate of return.||The VCT’s ordinary shares must be listed in the Official List of the London Stock Exchange or any other EU regulated market. A listing on AIM is not enough.
The VCT’s income must be derived wholly or mainly from securities.
The VCT must distribute by way of dividend at least 85% of its income from shares.
No more than 15% by value of the VCT’s total investments must be invested in any one company.
At least 70% of the VCT’s investment in unquoted trading companies must be carrying on qualifying trade.
At least 70% by value of its qualifying investments must be ‘eligible shares’.
The VCT’s investment when added to all VCT, EIS and SEIS investments made in that company must be not more than £5million.
|Shareholder restrictions||The investor and associates must not hold a stake in company exceeding 30% of ordinary shares, share capital or voting rights and must not otherwise control the company or any subsidiary. The investor must not be an employee, paid director or partner of the company or its subsidiaries. However, so-called business angels qualify. For shares issued on or after 18 November 2015, investors that already hold shares in the company (or subsidiary) will only qualify if those shares were risk finance shares (that is, shares for which an EIS, SEIS, SITR compliance statement was issued or founder shares).||The investor and associates must not hold a stake in company exceeding 30% of ordinary shares, share capital or voting rights and must not otherwise control the company or any subsidiary. The investor must not be an employee of the company but can be a director (whether or not remunerated). Directors are deemed not to be employees for this purpose.||Investor and associates must not control more than 30% of the social enterprise. The investor must not be an employee, trustee or partner of the social enterprise or its subsidiaries. The investor can only be a paid director if he has never been involved in the social enterprise’s business or controlled more than 30% of the social enterprise. For investments made on or after 6 April 2017, investors that have previously invested in the enterprise (or its subsidiaries) will only qualify for relief if those investments were risk finance investments (that is, investments for which an EIS, SEIS or SITR compliance statement was issued or founder shares). For investments made on or after 6 April 2017, SITR is not available where there are ‘disqualifying arrangements’, similar to those prohibited for EIS and venture capital trust investment.||The VCT must not be a close company (that is a UK company and controlled by five or fewer shareholders).|
Eligibility criteria to qualify under the EIS, SEIS, SITR or VCT schemes
Naturally, your business will need to meet certain criteria if it is to be eligible as a qualifying investment under the schemes. The following table is a summary of those criteria you’ll need to meet:
|Assets||The company must not have gross assets in excess of £15million before the investment, and £16million after.||Gross assets of not more than £200,000 before the investment.
No upper limit post investment.
|Gross assets of not more than £15million.||VCT similar to EIS in each case.|
|Constitution||The company’s shares must be unquoted, with no arrangements in place for them to become quoted.
Not be controlled by another company during the three-year investment period.
Companies whose shares are listed on Aim are treated as unquoted.
|As for EIS.||As for EIS.
Company must be a social enterprise, that is a charity, community interest company, or certain type of community benefit society with a statutorily defined asset lock.
|Trade activities||The company must carry on trade on a commercial basis with a view to profit. The following activities are not permitted:
|As for EIS.||The company must be engaged in a qualifying trading activity, as for EIS and SEIS (can be via a controlled subsidiary if the funds are invested in the trading subsidiary).
Be a charity or carry on a trade on a commercial basis with a view to profit. The following activities are not permitted:
For investments made on or after 6 April 2017, the following activities are excluded:
Note that legal and accountancy activities are permitted.
|Subsidiaries||Control all of its subsidiaries at all times from incorporation until the end of the three-year investment period.||As for EIS.||As for EIS.|
|Location||UK resident company or overseas company with a UK permanent trading establishment.||As for EIS.||As for EIS.|
|Financials||Not in financial difficulty.||Not in financial difficulty.||For investments made on or after 6 April 2017, the social enterprise must be in financial health (not in difficulty).|
|Headcount||Fewer than 250 employees (FTE) (or 500 for a knowledge intensive company).||Fewer than 25 employees.||For investments prior to 6 April 2017 fewer than 500 FTE, following that date, fewer than 250 FTE.|
|Fundraising limits||Can’t raise more than £5million in total over twelve-month period under the EIS, SEIS, SITR and VCT scheme.
Lifetime limit of £12million, or £20million for knowledge intensive companies.
|Can’t raise more than £150,000 in a three-year period.||Formula to calculate the maximum amount it can raise based on the value of the tax reliefs, less any state aid already received in the three-year period (approx. £275,000).
From 6 April 2017, £1.5million lifetime limit for enterprises up to seven years old.
Can raise debt or equity.
Debt must be unsecured and no pre-arranged exit for at least three years, subordinate to all other debt and no more than commercial rate of interest.
|Restrictions relating to prior funding arrangements||No EIS or VCT investments previously.|
|Age of company||EIS or VCT investments must not be made in a company which made its first ‘commercial sale’ more than seven years before the date the investment is made (or 10 years for a knowledge intensive company).
This age limit is waived where the aggregate amount to be invested by VCTs and EIS Investors exceeds 50% of the company’s (or group’s) annual turnover averaged over the last five years, and all VCT and EIS monies are to be used to enter a new product market or a new geographical market.
The age limit is also waived if the company raising the investment had previously received state aid funding (including VCT or EIS investment) within seven years of the date the first commercial sale was made and some or all of the new investment is to be employed for similar purposes.
|As for EIS.||As for EIS.|
If you think your company is eligible under one of the investment schemes, what are the next steps?
This article summarises the various reliefs available, and the relevant qualification criteria. If you feel that you would like to pitch to investors, and ensure that your company qualifies, we advise you to our corporate solicitors who have experience advising on the schemes. You might also find our additional advice on financing your business via investment useful.
Just as you would on any approach to a bank for lending purposes, it’s vital to draw up a detailed business plan with revenue and growth projections so that you can demonstrate the investability of your business.
It’s also possible under each of the schemes to apply to HMRC for ‘advance assurance’ so that potential backers can have confidence that the various reliefs will apply. Again, we advise that you seek legal advice first so that you make this application in the correct format.