EIS rules and benefits for investors explained
Invest in EIS-eligible companies to get generous tax relief. We set out the rules and benefits for investors.
SEIS/EIS Tax Relief powers early-stage UK funding rounds. The EIS and SEIS schemes were established in 1992 and 2012 respectively with the goal of encouraging private investors to back UK innovation and stimulate growth of the economy. They give investors a tax break for investing in early stage companies. Fast forward 6 years, the UK has one of the most active angel investment ecosystems in the world, and SEIS/EIS is the driver. According to UK Business Angels Association, 90% of angel investors have invested through EIS or SEIS, and 80% of the total investments in angels’ portfolios are SEIS or EIS. These schemes have encouraged angels to invest around £1.5bn annually – so if you’re raising from angel investors you’ll dramatically increase your investability by getting SEIS or EIS Advance Assurance, which you can do on SeedLegals.
It’s commonly assumed that only UK companies can qualify for SEIS and EIS, but companies that have been established abroad can qualify for SEIS/EIS as long as they have a UK branch or subsidiary. In order to qualify, HMRC will investigate to ensure that the company passes their ‘UK permanent establishment test’.
Because this isn’t commonly known, if you have an overseas company and would like to raise funds from UK investors, potential investors will be more likely to want to see advance assurance from HMRC as proof you qualify.
Liquidation preference is the right of an investor to priority in receiving the proceeds from the sale or liquidation of a company. This right is usually attached to preferred shares and gives the holders of these shares a position that is ahead of the ordinary shares if the company is sold or is shut down. Preference shares are frequently given to investors in venture capital rounds, but they aren’t compatible with SEIS/EIS.
However, the finest minds have been working on finding a way for the investors to get their money back first on an exit, without being disqualified from SEIS/EIS. Here’s how:
Broadly, the investors get a different class of Ordinary shares to the founders – they’re usually called A Ordinary shares. And those A Ordinary shares don’t exactly get their money back first, the proceeds actually get shared between all shareholders, except that until their investment money is repaid, the proceeds are split 99.99% to the A Ordinary shareholders, 0.01% to the Ordinary shareholders. Once the investors have received their money back, then any remaining assets are distributed pro-rata – i.e. to each shareholder proportional to the number of shares they have.
This all needs to be worded carefully in the Articles in order to be SEIS/EIS compliant. The good news is that at SeedLegals we’ve done all the the hard work for you, and so if an investor requests a liquidation preference on their SEIS/EIS investment you can set this up in a few clicks, confident that the wording will be correct – here’s how to set up SEIS/EIS compatible Liquidation Preferences in your round on SeedLegals.
Most people think you can only get EIS in the first 7 years of trading. But, if a company has raised some EIS in the first 7 years of trading, they can continue to raise EIS forever more, at least until the HMRC limit of £12m is reached, and no more than £5m in any one 12 month period.
If a company is offering a new product, or service and wants to raise investment to grow this part of the business, they can actually raise under SEIS/EIS since HMRC will treat this new business activity as a startup which therefore qualifies for the scheme. Note, this only applies to EIS, and not SEIS.
Small loans are a common way for founders to kick start their business. More often than not, it’s the founder’s own capital being used to cover everything from web development, design, desk space and even hiring some early employees. Once a company raises their first equity funding round, there is sometimes an opportunity to agree with investors that the loan will be repaid at some point in future. However, according to HMRC regulations, it’s only possible to agree loan repayment terms in SEIS qualified funding rounds, not EIS.
The company can repay 3rd party loans using SEIS (but not EIS) investment – as long as the loan wasn’t from or linked to the investor themselves. The loan must have been used ‘for the purposes of trade’.
Knowledge intensive companies have a special status when it comes to SEIS/EIS. They can raise almost double the lifetime funding limit of EIS (£20m total vs. £12m total), and a longer fundraising window (10 years instead of 7 years) as well as a host of other benefits.The kicker is that HMRC just lowered the bar for what qualifies as a knowledge intensive companies, and at SeedLegals we see a lot of tech startups that are eligible – without even knowing about it.
With SEIS/EIS being the main driver for UK early stage investment there is a lot of money being left on the table by both startups and investors.
Your company qualifies as a knowledge intensive company by meeting one of these conditions:
a) you spent 15% of your operating costs on innovation, research or development in 1 of the last 3 years. Plus, 10% of your operating costs in each of the 3 preceding years leading up to that year. (If you have employed developers, including contractors, you probably qualify for this condition)
b) Creating or using IP to create products that become the companies main business. This includes any hard science innovations, hardware or tech products including software, website code or even an app. (If you have created IP e.g. a proprietary algorithm, you probably qualify for this condition)
c) At least 20% of your company’s full-time employees hold a higher education qualification and their work with you is directly related to that subject. (If you employ a number of Master / PhD holders you probably qualify for this condition)
Not sure whether you qualify as a knowledge intensive company? Hit the chat bubble to talk to one of our SEIS/EIS experts.