Tech start-ups: Why the type of Limited Company you form is so important
How you incorporate your company could have costly tax repercussions as you grow. Tax expert Tim Housden explains how to get it right
With technology as it stands today, it has never been so easy to set up a new business venture. It’s possible to have a great idea in the morning and be fully registered, compliant and even have a bank account by lunchtime. However, speed does not always give the best tax result or the optimum business structure. Having established whether a concept is viable, the key drivers for the majority of tech start-ups are cost control, equity structuring, rewards, and exit planning. In some circumstances it can prove to be commercially and fiscally advantageous to use a combination of trading or ownership vehicles, such as:
- A Holding Company to protect intellectual property
- A Limited Liability Partnership for early stage loss utilisation
- Offshore vehicles to access other markets or provide a compliance vehicle
However, in 99% of cases the default trading vehicle for tech businesses is a Limited Company and this is explored in more detail below. With all incorporations, there are basically two chosen routes – an off-the-shelf company, or a bespoke new company. With the former you are merely acquiring something that already exists and has a history, albeit subscriber shares being issued. With the latter it is a new creation that records you as first director and shareholder. Bizarrely, in some circumstances, the simple action of choosing the off the shelf company can be the wrong decision between these two options and can cost tax! A number of problems can also arise from those very first share issues when the company is formed, and from other fundraising rounds as well. Amongst, and possibly the most commonly complained about, are valuation and tax problems with HM Revenue and Customs, disparity with perceivably too much dividend or capital being paid to the wrong shareholders, and excessive personal tax being paid as a result of missed remuneration extraction opportunities. From third parties the gripes generally include failure to achieve venture capital reliefs via Enterprise Investment Scheme (EIS) or its more exciting younger sister Seed EIS (SEIS), or missing opportunities to lock in and reward key staff via the very tax advantaged government approved Enterprise Management Incentive scheme (EMI). The above are all avoidable problems if proactive advice is sought before final decisions are enacted. Before charging ahead and incorporating a new company, it is worth considering some different areas that may have an impact later:
1. Be clear on what you are intending to achieve from the business
If it is a growth business rather than lifestyle business, make a decision on what percentage of the business you are ultimately prepared to give to other shareholders, investors or employees to achieve your goal and in what timeline.
2. Prioritise any family and friend tax planning issues before founder shares are issued
It’s usually too late closing the stable door once the horse has bolted.
3.Ensure that any external funding is as tax attractive as possible for the investor e.g. EIS or SEIS
One mistake in the history or paper trail can cause lost tax reliefs and unhappy investors.
4. External funding invariably creates a need for some form of due diligence
This is a protection for not only the investor, but the company and other shareholders as well. Paper trail and compliance is generally key, so don’t forget that legal fees need to be paid.
5. If you intend to have employees, try to tie in key personnel with tax advantaged option schemes
EMI, for example, can be subject to forfeiture or only exercisable on the sale of the business, meaning no immediate equity issue and no unwanted shareholder if the employee leaves.
Register your company with a formations agent
6. Regularly review how remuneration and benefits are drawn
Structuring effectively can lead to a higher net personal disposable income at no extra cost to the business i.e. less tax and national insurance burden for the company and the individuals concerned.
7.Don’t forget that tax law changes
‘Being cute’ today does not always have the desired effect in five years time. Watch for legislative change and talk to your professional advisers on a regular basis.
8.Think carefully about your financing options
If you do need money to get the venture off the ground, is it better to finance it all personally, raise money from external shareholders, or traditional loan and finance mechanisms such as banks or mortgages. Part of the decision process here is clearly what funds are available and at what cost. From the investor’s point of view, it is gambling and they have to balance their risk and reward too.
9.Allow for the unexpected
As in life, business is ‘fluid’ as well. But don’t always use the unexpected as an excuse to prevent you from doing something. The best ideas of today and tomorrow are probably concepts that were thought of a long time ago, but were side-lined as technological or scientific proof at that time, which rendered them unachievable.
10.Research and Development Tax Credits are only available to a Limited Company
Like all government approved schemes, the legislation is quite harsh in determining what make a qualifying activity. If you don’t understand what your accountant or adviser is explaining, ask again. As owner of the business you are responsible for making informed decisions, which is difficult to do if you don’t understand what the problem is or what the information means. That said, a good adviser should ensure the information and explanations are relevant to you and in a format that will give you the detail you need. In some respects, it is easier to approach building a business like building a wall. Good foundations are necessary, and it generally helps to know how high you want the wall, what colour the bricks will be and what the purpose of the wall is. Trying to change things afterwards can be nigh on impossible and, in some cases, you have to demolish and start again. Tim Housden is a tax director at London, Surrey and Essex-based THP Accountants, a top 100 firm specialising in corporate and personal tax planning. www.thpcity.co.uk