The Finance Bill has been passed and is on the point of receiving Royal Assent. This is a historic watershed moment for the EIS, as following Royal Assent, all EIS share issues will have to be compliant with the new risk-to-capital rules. A significant portion of the EIS market made up of capital preservation and low-risk schemes will now fall away, leaving only genuine schemes involving risk remaining.
From now on, HMRC will be adopting a principles-based approach in assessing whether companies fulfil the risk-to-capital condition. Instead of disqualifying certain trades, as they have done in the past, or certain types of asset (viz. freehold property based businesses) they will look at EIS Advance Assurance applications “in the round” to assess whether they qualify.
- The following are the key points HMRC will consider:
- The company should be proposing to trade on an ongoing basis, not just to carry out one project.
- The company should have the objective of growing and developing over the long term.
- An investment in the company must carry the risk that an investor will lose an amount greater than the net return.
- The company should not have assured or highly predictable income streams.
- The company should not own an asset held mainly with a view to its disposal.
- The company should not sub-contract all or most of its activities to others.
- The company should not effectively be controlled by the promoter.
- The company should not be one of a number of identical companies all carrying out the same activity – this is referred to as “fragmentation”.
This is good news for everyone involved in Growth: start-up companies, businesses founded by entrepreneurs with a vision to grow, “Knowledge Intensive Companies” (already abbreviated to KICs), i.e. companies established off the back of research and development or intellectual property – these are all the types of businesses which will qualify going forward.
These changes mark a major new direction for the EIS which has been broadly welcomed by most of the leading players in the EIS world. But it’s early days and it’s going to take a while for the new rules to settle in and for HMRC to clear what we assume is a huge backlog of applications for advance clearances. In the meantime, we are predicting a temporary contraction, as the market digests the full implications of the new rules.
But the opportunities going forward are huge. We can see growth funds of all sorts and complexities taking over from capital preservation schemes as a major part of the overall market. Many of these will be generalist but we think there will be a growing number of industry specific funds, like technology, Artificial Intelligence, the Internet of Things on the one hand, or non tech industry specific funds, like food and drink and media.
As a house, we have traditionally focussed mainly on genuine growth businesses, and this focus will now take centre stage. We have recently launched a new fund in partnership with the award-winning Startup Funding Club called the SFC EIS Growth Fund. The Startup Funding Club have been specialising in start-ups for over five years and now need a vehicle to provide the follow-on or scale up investment for the businesses they have been involved in seed-funding in recent years. The Fund will also invest in “new” businesses which the team have not previously backed.
The Fund will focus on fast growth businesses which have come through the start-up phase and are demonstrating significant commercial traction, with potential for significant further capital appreciation. The Fund will target scalable companies operating across various sectors, including digital technology, life sciences and consumer goods, in order to aim to achieve a high level of portfolio diversification. Businesses which solve a real need and challenge the status quo will particularly be favoured. The investment team will be looking for a number of key characteristics, but the principal consideration will be the credibility of the management team, who need to display the right level of skills and experience and have a clear vision for how to drive the business forward towards a successful exit.
At EIP we welcome the recent changes as the new rules will now fall squarely into the spirit of the law, which is to support the UK’s outstanding early stage investment industry. It’s a brave new world for the EIS and we are excited about the many opportunities going forward.
This message has been approved as a financial promotion by Enterprise Investment Partners LLP (FRN: 604439) which is authorised and regulated by the Financial Conduct Authority. Our investment products place your capital at risk and investors should be aware that they could lose the total value of their investment. Investment in unquoted companies carries high risks. No established market exists for the trading of shares in private companies, making it difficult to sell shares. The tax treatment of the investments depends on the individual circumstances of each investor and may be subject to change in future. The availability of tax reliefs depends on the company invested in maintaining its qualifying status. Neither past performance or forecasts are reliable indicators of future results and should not be relied upon.