Common Pitfalls To Avoid with SEIS and EIS
SEIS and EIS Rules
The rules, whilst binary in nature can be quite complicated if not well understood.
On the face of it founders should be relatively comfortable with the rules, but as with any scheme that requires clearance from HMRC, the devil is in the detail! So to help you understand the common pitfalls associated with SEIS and EIS here is a simple guide.
This is a contentious point because the rules state you cannot file the SEIS1/EIS1 form (and therefore gain full clearance) until your company has traded for at least 4 months, or your company has spent 70% of the investment. So if your company is newly formed or pre-revenue, ensure you manage your investor's expectations. For most tech businesses this could be a grey area as the trade date isn’t necessarily the date you raised your first invoice. For SEIS and EIS this could be the date you had a beta-version available for users even if they are not paying subscribers.
The investor must have held their shares for at least 3 years in an SEIS or EIS company to gain Capital Gains Tax exemption on the rise in value of their holding. The Holding Period for shares has been subject to some debate recently, as outlined in Businessadvice.co.uk there may be changes to the EIS scheme and this could include extending the holding period for investors. We expect there to be some updates in the next Budget and this is undergoing consultation; there are no actual proposed changes yet just general policy intentions. We will keep you posted!
Issuing the SEIS/EIS shares on the same day
There are a few practical points to make about this which is often overlooked by accountants or lawyers that are not familiar with SEIS/EIS, so let's talk about these:
- You must not issue EIS shares on the same day as SEIS. If this occurs, the tax authorities will request that you withdraw from one scheme and given some investors may invest under both schemes this is an important practical point.
- You must make sure you issue the shares once the investment has been received and not before. If you issue shares before the cash in is the company bank account then it is a disqualifying investment.
- If your startup is raising under both SEIS and EIS, i.e. above £150,000 then it is at your discretion which investors receive SEIS.
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This is a complicated area, but investors can only get EIS / SEIS when they invest their money for equity. Loans do not qualify, even if and/or when they convert into equity. This point is often missed by individual investors looking for EIS or SEIS relief. It is possible however that Advanced Subscription Agreements (ASA) can work where the investment made into a company via an Advanced Subscription Agreement (ASA) is purely an equity agreement. The intention is for investors to pre-pay for shares that will be allocated during a subsequent funding round to the pre-money valuation as stipulated in the Advanced Subscription Agreement.
Issuing warrants at a discount to Induce investment
If the warrant instrument is to be issued as an inducement to invest in your company at the same round price as the investment and they receive full risk ordinary shares under the arrangement then this is OK. Care must be taken and advice sought. However, if the warrants are discounted then this is effectively de-risking the investment and it is not a qualifying investment.
Setting up a subsidiary of the overseas company
The overseas company needs to set up an overseas branch in the UK, in order to have a UK permanent establishment and itself qualify for SEIS/EIS. A company will have a permanent establishment in the UK if:
(i) it has a fixed place of business in the UK through which the business of the company is wholly or partly carried on, or
(ii) an agent acting on behalf of the company has and habitually exercises in the UK authority to enter into contracts on behalf of the company.
A subsidiary of the overseas parent wouldn’t qualify because a company cannot be controlled under the SEIS and EIS rules.
Investors must invest for cash, in ordinary full risk shares and any attempt to de-risk the investment would disqualify the investor. This means no liquidation preference and no preferential treatment over dividends.
The 30% rule
If an investor receives more than 30% in ordinary share capital, issued capital or voting power in exchange for their investment then he or she does not qualify. An investor paying UK tax, and who receives less than 30% will qualify for the scheme. There is also an "associates" rule where the 30% takes into account the shareholding of business partners, relatives (spouses, mum, dad, children, grandchildren) if they invest too, but not siblings (brothers, sisters, uncles, aunties).
And, you think Founders cannot qualify for SEIS relief
A founder can qualify for SEIS. The investor (or any associate) must not be an employee of the issuing company (or any subsidiary, at any time during the period from the date the shares are issued to the third anniversary of issue. The investor (or associate) may however be a director (paid or unpaid) as they are not considered as an employee for SEIS purposes.
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