A primer for founders raising EIS and SEIS rounds
What are EIS and SEIS?
In a nutshell they (the Enterprise Investment Scheme and Seed Enterprise Investment Scheme) provide tax incentives for investors to invest in early stage companies. There is a lot of money flowing into startups structured this way. EIS investments in 2014–15 (the last time HMRC published data, see here for the full report) accounted for a total of £1,816 million with SEIS accounting for £175m. By sector, tech companies accounted for the largest proportion.
Generally speaking, EIS and SEIS relief is only available for investors who receive ordinary shares. The theory behind this is such a tax incentive should apply to the earliest and riskiest form of financings. As such, preference shares that carry favourable terms such as liquidation preferences etc. (see this post for more on this) don’t qualify. Due to the requirement for ordinary shares, convertible structures (see this post for more on convertible notes) will also usually not qualify under EIS or SEIS. I say usually because certain forms of advanced subscription agreements (a form of of convertible - see here for more on these) can qualify for EIS and/or SEIS but the discussion of that is beyond the scope of this post.
What are the benefits for Investors?
As mentioned above, the key benefit for investors is the potential tax relief. If they qualify, the tax benefits broadly cover:
1. Income tax:
- For EIS investments — 30% of the amount invested (on an annual limit of £1,000,000 investment) can be used as an income tax reduction.
- For SEIS investments— 50% of the amount invested (on an annual limit of £100,0000 investment) can be used as an income tax reduction.
So, for example, if an individual invested £10,000 in an SEIS eligible investment (see below for eligibility) they would get income tax relief of £5,000 (50%). Thus, the net cost of the investment to them can be thought of as £5,000. Although the limit is £100k per year it’s also possible to carry back. Therefore, if an investor made zero SEIS investments the year before they can make up to £200k in a year. Income tax relief is offset in the appropriate year of claim, up to a maximum of the income tax liability. In other words, initial income tax relief could reduce an investors tax bill to nil.
2. Capital gains tax: When the investors sell their shares they won’t pay capital gains tax on the gain. SEIS Investors can also get CGT reinvestment relief meaning that if an asset is sold (and a potential CGT is payable) and all or part of the amount of the gain is reinvested in SEIS qualifying shares, half of the amount reinvested may be exempted from CGT (see here for a worked example). EIS Investors can potentially defer payment of CGT meaning gains realised on different assets can be deferred if they invest such gain into EIS qualifying shares (see here for a worked example).
3. Loss relief: If the company fails and the investor loses all of their investment, they can reduce their taxable income by the loss.
4. Inheritance tax: Generally, there’s no inheritance tax to pay on shares under EIS.
The upshot of all this for investors is that they effectively get a discount on the investment (income tax reduction), they don’t pay any tax on gains if the company sells (zero cap gains tax) and they also have a nice downside protection (reduce taxable income by the loss). All in, It’s a pretty good deal for investors.
In addition to the Company requirements discussed below, there are a couple of investor requirements that are also worth noting. The investor can’t be employed by the start-up they are investing in or own more than 30% equity in total. Plus, they need to hold the shares for at least 3 years.
For more examples of how the various tax reliefs work check out the handy Enterprise Investment Scheme Association site.
Is my Company eligible?
Not all companies are eligible for EIS and/or SEIS. Firstly founders should consider the type of share they are issuing (as discussed above) to make sure the structure of the financing qualifies. After that there are some simple company requirements (note the below is a summary: for the full list please check out the gov.uk site).
To qualify for either EIS or SEIS:
- The company must have a UK permanent establishment (this does not mean that the Company has to be incorporated in the UK, see here for HMRC guidance on what constitutes permanent establishment);
- Companies carrying on certain excluded activities, including (amongst others) dealing in land, property development and banking are not eligible for the scheme; and
- The company can’t be a public listed company.
To qualify for SEIS:
- The company must not have had any investment under EIS before any shares are issued under SEIS;
- The company’s gross assets must not exceed £200,000 immediately before the investment;
- The company must have fewer than 25 full time employees; and
- Any trade being carried on by the company at the date of issue of the relevant shares, must be less than 2 years old at that date. That condition applies whether the trade was first begun by the company, or whether it was first begun by another person who then transferred it to the company (Note: the company need not have started trading when it issues the shares).
To qualify for EIS:
- The company must have gross assets of no more than £15 million before the investment and £16 million immediately after the investment;
- The company must have fewer than 250 full time employees; and
- The same trade rule as for SEIS but must be less than 7 years.
How much can you raise?
- Up to a maximum of £150,000 under SEIS and the money must be used within three years. So companies can raise their first £150k under SEIS before moving on to EIS.
- Up to a maximum of £5 million under EIS and the money must be used within 2 years.
Sounds good…What are the next steps?
It’s possible to apply to HMRC for advanced assurance that a company will qualify for SEIS and/or EIS. This is a good tactic for founders to check they meet the necessary requirements (see here for a link to the form to apply). Last I heard it takes around 4–6 weeks to receive advanced assurance. Also, whilst advanced assurance isn’t a 100% guarantee that the company will qualify it will can provide an additional level of comfort to EIS or SEIS investors considering investing at the round.
Is this just relevant for Angel investors and small rounds?
Yes and no, EIS and in particular SEIS are usually relevant for individual investors. However, there are also a number of EIS funds that are actively investing utilising the schemes. Also, for most early stage financing rounds I’ve been involved with there is often some SEIS and/or EIS money as part of a larger round. It’s possible with careful drafting (experienced VC lawyers will be familiar with this) to structure equity rounds that bring in SEIS, EIS and institutional money (i.e. VC funds) all into the same round. Therefore it’s good for founders to research and consider these schemes so that they can potentially unlock further investment for their round.
The above points are by no means exhaustive (and, to flag, do not constitute any form of professional advice) but hopefully they provide some useful background for founders considering SEIS or EIS. As with anything technical like this, I’d also recommend founders seek advice from their lawyer and accountant.
- Enterprise Investment Scheme association: http://www.eisa.org.uk/
- Overview of the Seed enterprise investment scheme: http://www.seis.co.uk/
- UK government information site : https://www.gov.uk/topic/business-tax/investment-schemes
I’d love to hear feedback or potential additions. You can find me on Twitter @tom_wils.