Enterprise Investment Scheme – no small thing, anymore

David Cox (Partner) and Mark Allwood (tax director) of haysmacintyre consider the new rules that increase the investment amount and the size of business qualifying for the Enterprise Investment Scheme.

The new changes to the Enterprise Investment Scheme (EIS) for equity investment are a massive boost for both businesses seeking finance and investors looking to back small businesses. Following legislation implemented on April 6 2011, and the EC’s approval of amendments which take effect on April 6 2012, many more companies will be able to qualify as EIS investments.

EIS is an excellent investment incentive as it provides individual investors with various tax breaks, including:

  • a 30% income tax credit on the invested amount (increased from 20% under the new legislation)
  • capital gains exemption when the shares are sold
  • a reduction of risk for additional rate tax payers. Those paying 50% tax are only risking 35% of what they invest; for those paying 40% tax, the risk is 42%.

 

In the past, critics have expressed concern that the qualifying barriers of EIS were set too low. Under the old rules, a company could only qualify for EIS investment if it employed less than 50 full-time staff, and possessed gross assets of less than £7m before investment (£8m afterwards). Consequently only a limited number of companies qualified; the scheme was largely restricted to smaller, higher-risk businesses, and many risk-averse investors were not willing to consider such investments. In addition the annual amount that could be raised under EIS (and venture capital trusts) was limited to £2m – in many cases this was insufficient funding and had the “cliff effect” for companies seeking finance above the first £2m.

With the proposed 2012 amendments these barriers should fall away, as the changes substantially increase the size of business, and investment, that will qualify for EIS. Businesses seeking investment next year will now need to re-evaluate their EIS position, as many companies that currently do not qualify will do so. Private investor funding (individuals or venture capital trusts) will therefore become a realistic alternative to the normal sources of finance for hundreds of businesses.  For those firms currently seeking funding, thought might be given to deferring fundraising, to take advantage of the better funding offers the new rules should create.

The specific changes are as follows:

  • the employee limit will increase from less than 50 to less than 250 full time employees;
  • the maximum amount that can be invested in any 12-month period will increase from £2m to £10m;
  • the gross assets test will change. Under the current rules, a company’s pre-investment assets can amount to no more than £7m; this will increase to £15m (the post-investment asset criteria will be dropped, so the annual investment amount limit is no longer curtailed by this test);
  • the annual amount that an individual can invest will increase from £500,000 to £1m.

 

These changes, especially the increased employee limit (the test many growing companies fall foul of straightaway), should enable many businesses to attract additional funds. Furthermore the changes will vastly increase investment opportunities, so we can expect many more investors to enter the private sector market, thereby generating additional funding.  The changes also apply to qualifying holdings for venture capital trusts (VCTs), so increased activity from them, together with a greater willingness to discuss your company’s financing requirements, can be expected.

However, one possible adverse effect of these changes is that smaller, higher-risk investments no longer have the EIS advantage over their bigger competitors from a fund raising perspective. These changes could temper the appetite of once-eager individuals to invest in such companies – after all, why invest in a 20-person company when you can enjoy the same benefits of investing in a more established company? There is certainly a risk that funding from private individuals may transfer from small to medium-sized enterprises, thereby defeating a key objective of EIS – stimulation of small company investment. Perhaps this is one of the reasons why the government is consulting on a new investment scheme for start -ups, the Business Angel Seed Investment Scheme (BASIS).  Draft legislation is eagerly awaited and is expected to be released on December 6.

The proposed amendments above follow the recent abolition of the “mainly UK trading” requirement, which stipulated that a company must carry out the majority of trade within the UK if it wishes to qualify for investment through EIS. This is a radical change; the need for a company to conduct more than 50% of its business activities within the UK has been replaced with a “UK permanent establishment” condition, which requires the issuing company to have only a taxable UK presence (for example a UK office, branch, a shop). The proportion of the company’s UK activities is now irrelevant, and many companies excluded under the old rules will now qualify. For example, a fashion brand company operating both a shop in London and a larger shop in Paris would have failed to qualify under the old regulations, because the majority of trade was carried out in France. Post-change, the business will meet the EIS criteria as its London shop provides a taxable UK base. This one change has substantially widened the range of companies eligible for EIS. However there is a risk that the above proposals will simply open the floodgates for EIS investments; it is probably fair to state that the majority of UK companies, and companies with a UK presence, can now qualify for EIS, provided they have the right structure in place.

As a result of the new regulations, the investment opportunities for individuals seeking EIS will become enormous. The key for entrepreneurs is obtaining sufficient exposure to potential equity investors, and entice a selection of offers with an excellent pitch (see Growing Business article offering 10 steps to securing investment for your business).

Comments

(will not be published)