Helping entrepreneurs reap the rewards

Cathy Bryant is a partner in the corporate team at Michelmores and heads the corporate tax team.

It may sound trite but “with great risk comes great reward”. Thomas Jefferson certainly believed it when he said it and it remains true today. For startup businesses there are many, many challenges and risks: finance, regulation, borrowing costs, increasing taxes to name a few, and this is before actually running the business!

For some the risk is too great. We know that 60% of UK startups will fail in the first three years with only 42% surviving past 5 years. 38% of UK startups fail because they run out of cash. On the other side of the coin and from an investor point of view, a major difficulty for investors is that the high-growth potential of a startup often comes with a high risk of underperformance or loss, meaning that placing investment capital in startups is very risky indeed!

In an effort to both incentivise the high risk of investing in startups and to help startups smooth their cash requirements through those early years, the UK Government launched the Enterprise Investment Scheme (EIS) and the Seed Enterprise Investment Scheme (SEIS) tax relief schemes.

Substantial sums of money are raised under these schemes. In May 2024, HM Revenue & Customs published the official statistics on the number of companies raising funds and the amounts raised through each of EIS and SEIS for the tax year 2022/23. Despite the figures showing a drop in investment levels (largely considered to be a correction following the “covid bounce”) 4,205 companies raised £1,957 million under the EIS regime and 1,815 companies raised £157 million under the SEIS regime.

These schemes are massive tools in the fundraising arsenal of any startup and considering their eligibility for these schemes should be part of the startup strategy. The extent of the tax reliefs (set out in the table below) offered to the investors are significant and startups which can evidence eligibility for the schemes will have a competitive edge when seeking investment.

Investor (UK taxpayer) EIS SEIS
Income tax relief (reduction of income tax liability) 30% 50%
Loss relief (offset against CGT or income tax bill) Equivalent to the highest rate of income tax paid or CGT rate Equivalent to the highest rate of income tax paid or CGT rate
CGT on the investment itself Exempt (if shares held for 3 years) Exempt (if shares held for 3 years)
‘Rollover’ of other gains Straight deferral CGT relief of 50% on investment in a non-SEIS company, if gains for that investment are reinvested into SEIS-eligible company
IHT treatment Exempt Exempt
Maximum investment p/a £1m £200k
Maximum permitted shareholding 30% 30%

 

Aside from enabling access to finance and being attractive to investors, EIS and SEIS have other benefits for startups.

Overcoming barriers to debt financing

Startups tend to have limited options for raising finance. Bank loans may not be appropriate, either because the company has too few assets over which a bank could take a charge; or because its income is insufficient to meet repayment obligations. By contrast, EIS/SEIS provides a source of growth capital that is not dependent on collateral and has no repayment obligations. Independence and control When approaching angel investors, founders can expect to give up a degree of control. Naturally, the investor will want to protect their interest, which often means sharing responsibility for executive decision-making. This can be uncomfortable for company founders anxious not to loosen their grip on the reins or compromise their original ideas.

EIS and SEIS cap individual investor shareholding to no more than 30% of the shares of the business. Both schemes also require that all shares issued to investors do not have preferential rights so that investors are not treated preferentially to other shareholders in terms of dividends or rights to capital upon a winding up.

Commitment and expertise

EIS/SEIS investors are obliged to hold their shares for at least three years to retain the benefits of the scheme, and often hold them for much longer than this to maximise their return. This offers stability and assurance to startups while they grow and develop their business. Experienced angel investors and/or EIS/SEIS funds may bring expertise and network opportunities to the table which will be of value to the startup.

Scrutinising the business plan
A perhaps less obvious benefit of pursuing EIS/SEIS is that the thorough and detailed application process to HMRC provides an opportunity to consider your growth strategy and fine-tune your investment pitch before meeting potential investors.

As with all tax incentive regimes, they are detailed creatures of statute. As a result, the regimes are complicated and include caveats and provisos which it pays to be on top of. When starting up, an hour spent with an experienced professional who understands EIS/SEIS can be well worth the time and cost when making sure the business qualifies. Professional help will be needed again when funds are being raised, but again, an experienced advisor can ease the process and prevent mistakes from being made which could undermine the startup’s eligibility for the relief.

And lastly, on an item of good news, the extension of the sunset clause of the EIS regime to 2035 has now been confirmed by HM Treasury on 3 September 2024. This means that the reliefs will continue to apply to shares issued before 6 April 2035

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