What is the SEIS / EIS Risk to Capital Condition?
Regardless of whether you’re just starting Advance Assurance, or finishing your fifth Compliance Statement, chances are, you’ll have heard of the Risk to Capital Condition.
Introduced March 2018, this subjective new condition has introduced a heap of new considerations for SEIS / EIS applicants, and is not something to be ignored! HMRC have now made it clear that this is a gateway test, which is the first consideration they will review on any application.
HMRC are clear, the Risk to Capital Condition relates to two separate parts:
- The Company must have objectives to grow and develop over the long term
- There must be a significant risk that the investor stands to lose more than they stand to gain as a return (including the tax relief!)
As of recently, we are now seeing HMRC return applications with a long list of detailed questions, all pertaining to the above two requirements. So it’s best to get this right on the first application!
The objective to grow over the long term
This test was initially thought to be targeted at Film production companies, however, HMRC are clear that this test is applied equally across all trades and activities.
It is essential that the Company demonstrate not just the objective to grow, but that this growth will be as a result of the SEIS / EIS investment. Some of the specific factors HMRC will consider are:
- Is there projected increasing turnover?
- Is there projected increasing Customer Base?
- Is there projected increasing Employees?
- Is the investment being applied towards company infrastructure?
- Is the investment being applied towards subcontractors or specific projects?
A significant risk to the investors’ capital
This second aspect of the condition is more concerned with the security of the company and investors funds.
Some of the essential factors HMRC will look at are:
- What the ROI warranted in the business plan is
- Is there a genuine commercial risk, or is this very low?
- What is the net return to investors, when you factor in any dividends, interest, fees, or other benefits provided to them?
- Does the company have significant capital assets on their balance sheet?
- Does the company have a secure income stream, such as a single major sales channel or partnership already in place?
- Is the business model a replication of a tried and tested business, or is there a genuinely new endeavour?
- Ownership structure - is there an element of genuine entrepreneurship and commerciality, or is the company largely owned by SEIS / EIS investors?
- How have the risks been marketed to potential investors, is it presented as a guaranteed win?
This condition presents quite a balancing act for founders. On one hand, you’ll want to present the Company in the best possible light to investors. On the other, you’ll run into issues with HMRC if you are too idealistic about your projections.
The key is to be realistic about how you advertise the investment, is your Company really guaranteed to be bringing in £50m in revenue in the second year. Is there really no competition or risk factors?
The best question to ask yourself is: Does the company proposition appear so attractive to investors that SEIS / EIS is unnecessary to entice them? If so, you may have issues with the Risk to Capital Condition.
Meeting the risk to capital condition
Unlike the other, more black-and-white, SEIS / EIS requirements there isn’t a singular statement or metric which will prove that you meet this condition. It is intentionally vague, and encompasses a range of considerations. Please see our detailed guide on what to include in a business plan for SEIS / EIS for more helpful tips on meeting this requirement.
If HMRC believe that your company is at risk of failing, they will inform you first, asking for more information on a range of relevant points. In addition, unlike the general rejections - when it comes to rejections based upon the risk to capital there is a right to appeal.
Of course, to avoid that happening, do reach out to us at SeedLegals using our chat feature if you have any further questions. We provide a full review of every SEIS / EIS Advance Assurance done on SeedLegals, so we are always happy to provide our input on your risk to capital eligibility, and make suggestions for improvement necessary!