One of the reasons equity investment for start-ups is more available than ever before is that the government has been encouraging investors with generous tax reliefs, in recognition of the highly speculative nature of seed investing; seed funding and pre-seed funding.
No serious entrepreneur would dream of launching a product or service without getting into the heads of their consumers.
You’d want to understand when, where and how often your offer might be purchased and what you are competing against for a share of their purse.
It’s the same with ‘selling’ your business to investors. Best to understand as much as you can about their world, their motivations and what’s competing for their cash.
We’ll pick up on this theme in future columns but for now we’ll explore one important consideration for so called ‘seed investors’.
The Seed Enterprise Investment Scheme (SEIS) for investors
The Enterprise Investment Scheme (EIS) was set up in 1994 and continued to be supported through Labour governments. It has since been made more attractive by the Conservative government, and has established itself as a part of tax legislation that neither of the main parties would be likely to compromise.
The Seed Enterprise Investment Scheme (SEIS), established in 2012, is an extension of EIS and offers even more generous reliefs as an incentive for investors in very early stage businesses.
In the 2014/15 tax year, 2,185 companies raised £168m through SEIS. Significant growth from the 1,995 companies and £148m in funding in 2013/14.
The tax advantages for investors in an SEIS qualifying business are significant. An individual investor can make multiple SEIS investments of up to £100,000 per annum and qualify for:
- 50% income tax relief: say an investor was considering a £50,000 investment, they would claim back £25,000 of tax paid.
- 50% capital gain re-investment relief: say the same investor, considering a £50,000 investment, had a profit from a business they have sold. £25,000 of that profit will be excluded from their capital gains – which will save them between £10,000 and £14,000 of tax.
- 100% capital gains exemption: if the investment does well and the investor sells their equity, the profit they make, after a three-year qualifying period, is entirely free from 20% capital gains tax.
- Loss relief: should a company fails the investor can claim a tax relief on the total investment minus the income tax relief. With our £50,000 example again – the investor has already received back £25,000 in income tax relief. If the business fails they can offset the remaining £25,000 against their current tax bill. If they are a higher rate (45%) tax payer, that will save them a further £22,500 in income tax.
- 100% inheritance tax relief: provided that investments are held at the time of death and have been held for two years can be passed on free from inheritance tax.
How start-ups qualify for SEIS
You can see that these are significant for an investor paying income tax. And even more so if they have a capital gains tax liability and/or are contemplating their own mortality. Therefore it would be a struggle for a start-up without SEIS qualification to attract an equity investor. The good news is that the rules are pretty easy to satisfy. It may be helpful to consult an accountant, but broadly the criteria are:
- Less that two years’ trading: this is the one that most often catches businesses out. The two years is at the time of the equity being purchased, so remember that a fundraise can often take months to complete. And trading means any kind of revenue activity, this could include your small experiment on a weekend market stall before you even registered the company.
- Less than £200,000 in gross assets and few than 25 full-time employees (or part-time equivalent) at the time of the share issue.
- A ‘qualifying trade’: most trades are qualifying, but some, such as some financial services and dealing in land & property development (including property intensive activities such as hotels or nursing homes) are excluded.
Most investors will want certainty about SEIS qualification. An application for ‘advanced assurance’ can be submitted to HM Revenue & Customs for approval. It’s not difficult (the form is here) and makes subsequent paperwork easier.
An application is normally processed in around four weeks, but sometimes there are delays. Anecdotally, we are hearing that applications are taking around six to eight weeks currently. So it’s good to get the application underway as soon as you can.
The maximum raise under SEIS is £150,000. But in most cases this should be enough to get a business up and running and able to create some proof points before needing to raise more money.
Beyond this the business can raise its next funds, up to £5m, under the EIS scheme. The tax reliefs have a similar structure, but are less generous – e.g. 30% income tax relief – to reflect a slightly less risky investment.
HMRC has a guide to SEIS: www.gov.uk/guidance/seed-enterprise-investment-scheme-how-companies-qualify. And a helpline: 0300 123 1083. Both are easier and more useful than you might expect.
Are you seeking investment? Startups.co.uk, with Worth Capital, has launched the Start-Up Series, a year-long competition giving one company the chance to win equity investment of £150,000 every month from a £1.8m SEIS fund. To find out more visit: startups.co.uk/thestartupseries
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