The Enterprise Investment Scheme Explained

Last updated: 7 September 2020

Estimated reading time: 5 minutes

The Enterprise Investment Scheme (EIS) is a government initiative to help investors balance financial risk when they take an equity stake in a business. Billions of pounds have been invested through the scheme since its inception and it is considered a leading tempter for equity investors because of the many associated tax reliefs. How can you take advantage of the scheme to raise money for your business?

Jump to:

  1. What is EIS tax relief?
  2. How EIS works: the rules
  3. Companies that are eligible for EIS investments
  4. How to apply for the EIS scheme
    1. Cover letter
    2. Amount
    3. Latest accounts
    4. Plans and forecasts
    5. Details of any previous venture capital schemes
    6. Memorandum and articles of association
  5. Where to send your EIS application
  6. What happens next with your EIS application?

What is EIS tax relief?

The EIS is one of four venture capital incentives launched by the government in 1994. It was designed to encourage investing in small and growing businesses that are not yet listed on the stock market.

The idea is to attract more people to invest in companies by providing incentives through the tax system. Exemptions reduce the risk of each investment, essentially meaning that investors lose less money if their gamble fails to make a return, and they get to keep more profit if it pays off.

They can claim 30% tax relief back on an investment either during the year of the deal, or in the previous tax year, if they choose to carry it back. They also get a capital gains tax exemption on profits from shares held for more than three years and an inheritance tax exemption, along with other incentives.

Investors can back EIS-eligible companies to the tune of £1 million per year, or double that if the business operates in high value parts of the economy such as life sciences.

For businesses, the effect of this sweetener is to make them more attractive investment prospects. Newer businesses, or those with a higher perceived level of risk, are better able to attract funding without having to give away too much precious equity.

How EIS works: the rules

  • Your business can raise up to £5 million per year, to a total of £12 million over its lifetime.
  • Businesses can only qualify if they receive investment within seven years of their first sale.  
  • You must be operating, or be preparing to operate, in a qualifying trade (see the Gov.uk website for a list).
  • You must spend the money within two years of receiving the investment and it cannot be used to invest in, or buy outright, other businesses.
  • You must show that the money has been spent on growing or improving the business (i.e. not on salaries and dividends).
  • Investment in your business must represent a risk to investors’ money. In other words, there must be no special perks offered to some investors over others, such as being able to withdraw their money fast or ring-fencing their money and spending cash from other investors first.

Companies that are eligible for EIS investments

There are strict, although broad, rules governing which companies can apply for EIS status. Your business must be established in the UK and it cannot be listed (or soon to be listed) on a stock exchange.

Qualifying organisations must have fewer than 250 full time staff and cannot control another company apart from certain types of subsidiary, a full list of which can be found at Gov.uk. Conversely, your businesses cannot be owned by another business, meaning no other organisation can hold more than 50% of its shares.

Lastly, a business will not qualify for EIS funding if it has assets worth more than £15 million before shares are issued, and £16 million immediately afterwards.   

How to apply for the EIS scheme

If you think you meet the criteria for the EIS, the next step is to apply to HM Revenue and Customs in the form of a compliance statement (EIS1). If you’re unsure, you can apply to HMRC for an advance assurance, which will give you a judgement in principle, if not a guarantee, that your share sale qualifies.  

In the advance assurance document, you’ll be asked to justify your application under the criteria listed above. You’ll declare things like share capital structure, UK residency, whether it operates in a qualifying industry, and so on.

Other details you should provide:

Cover letter

This is a good opportunity to explain the context of your business and see off some follow-up questions HMRC might want to ask you. Here, you should explain how you qualify for the ‘risk to capital’ clause and an overview of trading activity.

Amount

Give a ball-park figure and make sure it’s within the terms of EIS (i.e. not more than £5 million in a single year). Also explain where and how the money will be used, particularly if you have a group of businesses with subsidiaries.

Latest accounts

If you’re applying for EIS, it’s likely that you have filed accounts previously, but if not then it’s a good idea to explain your situation in the covering letter.

Plans and forecasts

Give HMRC the same information you provide to prospective investors and make sure to justify your expectations for growth or improvement.

Details of any previous venture capital schemes

If you have used a scheme previously, explain what it was, as well as the dates and the amounts of money received.

Memorandum and articles of association

For a better chance of being approved by HMRC, ensure these documents are up-to-date and require no further revision before you issue shares.

Other information HMRC requires include declaration and breakdown of any existing shareholders, any literature that explains your proposal to prospective shareholders, plus any other documents you think will be relevant or helpful.

You’ll need to repeat this process for every new share issue.

Where to send your EIS application

You can file an application with HMRC either on email or by post:

Email: enterprise.centre@hmrc.gsi.gov.uk.

Post:

Venture Capital Reliefs Team
WMBC
HM Revenue and Customs
BX9 1BN

What happens next with your EIS application?

If your application is granted, HMRC will send you a unique reference number and a compliance certificate for you to pass on to investors. They must quote these in order to claim EIS tax breaks.

HMRC will also alert you if you fail to qualify for EIS and it will describe the reasons why in its response. You can appeal the decision or ask HMRC to review it if you feel you have been turned down unjustly.

Assuming you are successful, you must create a payment method for investors before you issue shares, because shares must be paid for in full at the same time as they are allocated. Shares must be full-risk ordinary shares, which are not redeemable.

Remember that shares must come with risk to investor capital and should not indemnify them against losses in any way. HMRC also warns against reciprocal share purchases in which you buy shares in an investor’s company to mutually benefit from tax relief.

HMRC expects your business to operate within the EIS rule framework for three years, otherwise your investors will lose their right to the relief. If, for whatever reason, you can no longer comply, then you should let HMRC know within 60 days.

The Enterprise Investment Scheme is a great way to increase interest in your business from business angels, venture capital firms and other institutional investors. Comply with the rules, complete the paperwork and you could be on your way to a successful share sale in no time.

What next?

Whether you’re an investor or business owner looking for support with the entire venture capital process, our specialist corporate solicitors can help. Call us on 0800 689 1700, email us at enquiries@hjsolicitors.co.uk, or fill out the short form below with your enquiry.

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