If you’re a small or medium-sized business looking to scale, raising investment can be a stepping-stone to faster growth. The Enterprise Investment Scheme is a UK government initiative that enables smaller trading companies to obtain funding more easily by offering tax breaks to investors that offset the risk involved in funding smaller companies.
Billions of pounds have been invested through the scheme since its inception, and it acts as a strong incentive for equity investors because of the many associated tax reliefs.
So, how can you take advantage of the scheme to raise money for your business?
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What is the Enterprise Investment Scheme
The Enterprise Investment Scheme or ‘EIS’ is one of four venture capital incentives launched by the government in 1994. It was designed to encourage investment 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. These incentives, in effect, reduce the risk of each investment, as investors lose less money if their gamble fails to make a return, and they get to keep more profit if it pays off.
How can the Enterprise Investment Scheme benefit my SME?
Because the EIS is highly beneficial to investors, becoming eligible to receive EIS funding will make your company an attractive option for funders and give you an edge in a competitive market.
These are the tax reliefs that investors can benefit from if they purchase shares in an EIS-qualified company:
Income tax relief
EIS investors can gain relief against income tax by investing through the EIS scheme. Any losses can also be set off against income to reduce income tax.
Capital gains
Tax on any gain an investor makes on their assets can be deferred if they invest the proceeds into an EIS investment. In addition, any gains they make on an EIS scheme are exempt if they hold shares for three years.
Inheritance tax
EIS investments can be exempt from IHT if held for two years.
How does an EIS work?
If you qualify to receive EIS investment, your business can raise up to £5 million per year, to a total of £12 million over its lifetime.
An EIS works by offering investors tax relief. Here’s an example of the benefits an investor can receive if it places £100,000 in your company:
In year one, the investor will get a £30,000 reduction in their income tax bill for that year. Let’s assume your company grows, and three years later, that investor holds shares worth £200,000. Their total gain will be £130,000 comprising £100,000 capital gain plus the £30K tax relief. Plus, if they sell their shares, they will be exempt from CGT on the gain, and they’ll also benefit from 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 can my company become eligible for EIS investment?
There are strict rules governing which companies can apply for EIS status.
- Your business must be established in the U.K. and it cannot be listed (or soon to be listed) on a stock exchange
- You must have fewer than 250 full-time staff (or PTE), and your company must be a stand-alone business, meaning it can’t control another company apart from certain types of subsidiary, a full list of which can be found at Gov.uk
- Conversely your businesses can’t 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 after
In addition:
- Businesses can only qualify if they receive investment within seven years after they first start trading. 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 it, and it can’t be used to buy shares in another business, or buy another business outright
- You must show that the money has been spent on growing or improving the business (i.e. not on paying salaries or 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
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 judgment in principle, if not a guarantee, that you qualify.
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 you operate 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 provide the information that HMRC will need to make sure you qualify, for example how you will meet the ‘risk to capital’ requirement, and details of your trading activity.
Amount
Give a ballpark figure of the amount you’re looking for, 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.
Latest accounts
Provide a copy of your latest accounts. If you’re applying for EIS, you have probably filed accounts previously, but if not then it’s a good idea to explain your situation in the cover 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
Make sure these documents are up-to-date and require no further revision before you issue shares.
Miscellaneous information
Other information HMRC requires includes a 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 do I send my EIS application?
You can apply to HMRC either by email or post:
Email: enterprise.centre@hmrc.gov.uk
Post:
Venture Capital Reliefs Team
WMBC
HM Revenue and Customs
BX9 1QL
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 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 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 you can’t 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.
For more answers to commonly asked questions and advice on the EIS, including expert input into your EIS application or advance assurance request, consult our corporate solicitors. Get in touch on 0800 689 1700 email us at enquiries@harperjames.co.uk, or fill out the short form below with your enquiry.
