The government-backed Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS) continue to hold a prime place in the government’s plan to make the UK the best place in the world to start a new business. For good reason, they have fast become the fundraising facility of choice for UK start-ups. However, with strict criteria imposed by the legislation, it is essential that start-ups structure their businesses correctly in order to qualify for EIS and SEIS. With rising popularity has come rising misunderstanding as access to the scheme has been narrowed by a frequent flow of legislative amendments, including the changes announced in recent Budgets. This brief article seeks to distinguish the myths from the facts in order to assist start-ups structuring their business in preparation of SEIS and/or EIS investment.

Myth #1 – Early-stage companies and start-ups automatically qualify for SEIS and/or EIS

This is perhaps the most important myth to expose as it continues to be the main cause of a significant number of investments falling through. Although SEIS and EIS are designed to benefit early-stage companies, there are extremely strict conditions that must be met before a company can qualify for the schemes. Even when companies do meet the criteria at the date of investment there is a range of seemingly harmless actions companies can take that inadvertently disqualify them from EIS/SEIS leading to a claw-back of tax from the investor and a potential breach of contract by the company. Particular caution is required if you operate a similar trade through another company or if the company receiving the investment is part of a group that has previously operated a different trade. If this applies to you, you may need to restructure your group or receive the investment in a new company outside the group to ensure the investment qualifies for SEIS or EIS.

Myth #2 – SEIS and EIS is only available to passive investors and is not available to directors or founders

Although it is true that a number of the conditions for SEIS/EIS often prevent those who are working in the business from benefitting, both SEIS and EIS remain available to paid directors in certain circumstances (although other employees are disqualified). It is even possible for founders to qualify for SEIS so long as they do not own more than 30% of the company.

Myth #3 – Raise funds now, sort out EIS and SEIS later

It is often too late for investors to benefit from SEIS/EIS after an investment has been made. If the investment is not structured in a way that meets the criteria for SEIS/EIS, it is not possible to make the investment SEIS/EIS eligible afterwards.

Myth #4 – EIS and SEIS doesn’t really matter

Talk of EIS and SEIS may seem like a trivial legal technicality to you but it certainly does not seem trivial to potential investors. The income tax reliefs available under EIS and SEIS and share loss reliefs (in the event that the investment fails) considerably reduces the risk for investors, effectively mitigating any potential loss (if the investment fails) by up to 77.5%! Therefore, where a potential investor has an increasing number of EIS and SEIS qualifying companies to choose from, asking them to choose to invest in your non-SEIS/EIS eligible company is effectively asking for them to increase their risk with no corresponding reward. Complete exemption from capital gains tax on a sale of the shares after 3 years also increases the potential reward for the investor, as well as possible exemption from inheritance tax after 2 years and the potential to roll-over or exempt chargeable gains on a disposal of other assets.

Myth #5 – SEIS and EIS are available to all companies seeking to grow

Both SEIS and EIS are aimed at early-stage companies. There are therefore strict time limits on when companies can utilise the schemes. In the majority of the cases, EIS will only be available to companies within the 7 years following its first commercial sale (excluding limited test sales), with some exceptions for knowledge-intensive companies. SEIS is much more lucrative to investors and therefore much more time-restricted. SEIS will generally only be available for the first 2 years of a new trade carried out by a business.

So what?

In light of the above misconceptions surrounding SEIS and EIS and the significant risk of falling short of the strict conditions, great care and caution should be exercised by companies seeking SEIS or EIS investment. Professional advice from advisors who are experienced in the area should be sought from an early stage in order to structure the company in a way that maximises investment opportunity, growth potential and the likelihood that the company will thrive. We at Freeths LLP are happy to help start-ups in maximizing the benefits of these schemes.