21 February 2018

Raising equity funding through EIS

Under the EIS rules, tech start-ups could raise investment of up to £5 million in any 12 month period.

This total applies to all investments made through EIS as well as the Seed Equity Investment Scheme (SEIS), which is designed for companies up to two years old, and Venture Capital Trusts.

EIS funding can be an attractive next step for tech start-ups that are still in their early stages that have perhaps already made use of SEIS funding or which are not eligible for SEIS.

Tax breaks for investors

In order to encourage investment in fledgling businesses, HMRC offers EIS investors attractive tax reliefs. EIS investment attracts income tax relief at the rate of 30%: for every £1,000 an investor puts in, the investment only costs them £700. This relief is not as generous as that offered to SEIS investors, reflecting the fact that EIS companies may be more established. Even so, the 30% relief is still highly attractive to potential investors looking for companies with the potential to grow in value. As long as EIS investors hold onto their shares for at least three years, any capital gain they make on their investment will be tax free.

EIS investment also offers investors the chance to defer capital gains tax incurred from the sale of other assets. In certain circumstances, that deferral could be sustained indefinitely.

Eligible companies

Tech start-ups should meet the trade requirements to qualify for EIS. They must have gross assets of no more than £15 million and less than 250 employees. Companies need to have been trading for less than seven years (although it may be possible for older companies to qualify in certain circumstances).

Scott-Moncrieff can seek Advance Assurance from HMRC that a company will be eligible for EIS, before any investment is made. This gives potential investors peace of mind that they will be able to benefit from the tax reliefs associated with EIS investment.

Potential tax traps

EIS income tax relief will be lost if the investor is ‘connected’ with the company. This means that employees and directors cannot make EIS investments (although there may be an exception for Business Angels who receive no remuneration).

Similarly, anyone holding more than 30% of the share capital or voting rights cannot benefit from EIS income tax relief. The holdings of business partners and certain family members (spouses and civil partners, parents, children, grandparents and grandchildren) will be counted together.

Tech start-ups may complete a number of fund-raising rounds, perhaps beginning with SEIS funds, then EIS funds and then additional equity injections. Note that shares issued to early stage investors – the SEIS and EIS investors – must not have any preferential rights attached.

A final trap that EIS businesses can fall into is that they forget to complete the final step in the investment process – issuing the share certificates to their investors. Without this final step, even if all other requirements are met, the EIS tax reliefs will be lost.

To find out more about the ways to raise equity funding that is attractive for your investors, please contact Kirsty Murray.

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