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How Raising SEIS and EIS Allowance Could Stimulate Private Equity Investment Into Early Stage Businesses

Posted 3 months ago

How Raising SEIS and EIS Allowance Could Stimulate Private Equity Investment Into Early Stage Businesses
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Author: Sacha Bright and Oliver Murphy 

The Enterprise Investment Scheme Association (EISA) with the support of NextFin is lobbying H.M Treasury for significant short term changes to the EIS and SEIS scheme to mitigate the threat to investors and investee companies from coronavirus. 

While the government has introduced a number of measures to support businesses as they struggle as a result of Covid-19, businesses risk failing due to the current economic climate. As such, the EISA has written to the Government to request that the legislative restrictions on EIS and SEIS investments be lifted and additional income tax relief be made available for a limited period of time to encourage private investments to essential SME’s. 

According to the Director General of the EISA, Mark Brownridge: “The objective for the industry is to continue to facilitate and deliver equity funding from private investors to start-up and scale-up businesses who have been identified as: most in need in the short term and have potential to be long term, high growth businesses”

He added: “Helping these businesses survive the short term crisis should enable them to achieve their long term ambitions. Once in that position, they will start to pay back that short term trust and investment through significant tax revenue and employment for the benefit of the UK economy.”

According to Sacha Bright CEO of NextFin: “It's a no brainer. If you look at the jobs that EIS/SEIS creates, the businesses that grow and the resulting tax revenues the companies generate, it can often make a profit as shown in my case-study below.

“The government should relax the rules, increase the allowances and thousands of jobs and companies will prosper even with the coronavirus epidemic”.   

What is SEIS and EIS?

The SEIS and EIS use tax reliefs as a means to incentivise private investors who are willing to recognise that significant returns could be achievable if they are willing to risk their funds by investing in early-stage businesses. 

SEIS is a maximum investment of £150,000 targeted at helping start-up businesses to attract seed-funding, whereas EIS follows-on and allows a company to take up to £5 million in investment per year. Both of these schemes are capital equity investments in return for shares in a company.  

The schemes play an important role in securing a smooth flow of risk equity capital from private individuals to early-stage businesses. Below are the four current SEIS/EIS tax reliefs available to investors:

  1. Income tax relief

  • An individual with no more than a 30% interest in the company can reduce their income tax liability by up to 30% of the amount invested on EIS, and up to 50% on SEIS. 

  • Income Tax Relief is limited to the amount which reduces an investor’s tax liability for the year to nil

  1. Capital Gains Tax Freedom

  • No Capital Gains Tax is payable on the profit from the sales of the shares after three years, or three years after commencement of trade

  • 14% additional capital gains tax deferred

  1. Inheritance Tax Relief

  • Shares in EIS qualifying companies will generally qualify for Business Property Relief for Inheritance Tax purposes at rates of up to 100%

  1. Loss Relief

  • If EIS shares are disposed of at any time at a loss (after taking into account income tax relief), such loss can be set against the investor’s capital gains, or income in the year of disposal of the previous year 

What funding is likely to be available to businesses at different phases in their life 

Listed below are the available funding routes - time established - for a start-up and early-stage business up to three years. This may vary depending on the business owner and companies assets including the success of the business. However, for the majority of businesses, this is the type of funding that is most suitable and available to you at different stages in the life of your company. 

But ultimately, equity crowdfunding is the best source of funding for early-stage businesses, as is highlighted below, and an increase in the allowances for EIS and SEIS would stimulate equity crowdfunding investment.

  1. Personal Savings (established: 0 months)

  • This is considered an appealing source of finance if you are just starting out, as by using your own money, you don’t owe anyone else in the process of starting your business.

  1. Family and Friends (established: 0-3 years)

  • You can request your friends, family or close associates to help fund your business. This type of funding has more to do with the relationship itself, rather than the assessment of a feasible business plan. The aim of this type of funding is to help kick off a business to a point where it can seek and get other types of funding. Friends and siblings may also get access to SEIS and EIS tax allowances.

  1. Start-up Loan (established: 0-24 months)

  • This involves a loan from a government backed fund set up for start-ups and usually involves a PG and a good credit rating of the founder. 

  1. Equity Crowdfunding (established: 0 - 7 years) 

  • This involves funding a business by taking small amounts of capital from a large number of people, usually via the internet in return for shares. This type of funding makes use of the vast networks, including but not limited to: your customers,  your friends, family and colleagues via different social platforms to start the funding process and then the crowd provided by the platform co-invest with the above. (An increase in the EIS and SEIS allowances would stimulate equity crowdfunding investment.)

  • Crowdfunding platforms will usually only accept businesses that have been established for at least six months, but have been known to market start-ups. They prefer you to have around 50% of your target already funded with good traction and a large marketing base to attract investors.  

  1. Loan from alternative finance provider (established: 6 months -7 years)

  • An alternative finance provider is typically a business which administers non-bank funding to small and medium-sized businesses through loans, finance.

  • A financer of this kind will usually want to see at least six months trading accounts, but ideally two years. 

  • However, it is highly unlikely you will be able to get a loan if your business is not operational and turning over a suitable level of revenue. 

  1. High street bank (established: 0-7 years.)

  • Banks very rarely fund a start-up without security. And without security, they will rarely fund a business that has not been established for less than two years; that is not yet profitable and does not show significant signs of growth.) 

  • Bank loans are a popular source of funding for many early-stage businesses. Before applying for a bank loan, it’s important to ensure that you are well educated about the various risks to you and your business. 

  • Most banks also require a personal guarantee, security, and first charge over the business. A personal guarantee and a loan secured against your home means that the bank can demand full payment from the guarantor in the event of the business going into liquidation. This also includes repossession of your home if you do not meet the repayments of the loan taken out for your business.

  • Banks are profit-making businesses, and by their nature as such, are risk-averse and are reluctant to lend if there is any possibility they will not get their money back.

  1. EIS & Venture Capital Funds (established: average 2 years)

  • At this stage your business needs to be turning over a significant amount of funds and demonstrate a proven business model with exceptional growth to attract a Series A investor. 

  • Series A equity investment normally amounts to £2 million, and above. 

  • Venture capital companies do not like to exceed 30% equity in the company. Therefore, your business needs to be valued at around £6 million. 

  • (An increase in the EIS and SEIS allowances would stimulate equity investments via EIS funds.)

Investing in enterprise to tackle the effects of coronavirus

With the coronavirus outbreak turning small business upside down, the government needs to stimulate the economy in the most effective way possible. One such way is to ensure that those investing in growing businesses are encouraged to continue to do so, thus stabilising this vital part of the economy. 

Since its inception 25 years ago, the SEIS and EIS have been responsible for almost £20 billion of private investors’ capital to create and drive the growth of over 27,000 businesses. But in these challenging times, the schemes must go much further to attract even more private investors to help keep businesses liquid. 

Indeed, in the last year HMRC approved only 62% of the total of 3,270 requests from SMEs to raise money through the EIS submitted in 2018/19, down from 75% in 2017/18, according to Growthdeck, the private investor network. So far, investors have acted cautiously as a result of Covid-19 with many having ceased investments all-together which has had an impact on companies struggling to raise finance. 

But increasing the threshold for EIS and SEIS investment and increasing the allowance will encourage new and follow-on investments, by mitigating a larger proportion of the risk for investors. At present, businesses can only receive a maximum of £150,000 through SEIS investments, and up to £5 million per year in EIS investments. Depending on the type of business, investors can only invest up to £100,000 on SEIS, and on EIS up to £2 million per year. 

As SMEs struggle with shortages in cash flow, a way to stimulate investments would be for the government to temporarily raise the income tax relief credit to 50% for EIS and 70% for SEIS, and also increase SEIS investment threshold to £250,000 and £5 million on the EIS. Doing so would potentially unlock millions of pounds of extra funding which start-ups can use to fund their survival and allow for potentially hundreds of businesses to crowdfund and further increase revenue. 

In 2018, equity crowdfunding provided £500 million in funding for early-stage businesses. But a result of the Coronavirus epidemic, there was a 75% drop in activity across the whole market. This demonstrates that if the government increased the SEIS and EIS allowances, we would see a dramatic rise in early-stage investments, protecting the future of our rising stars in business.

According to the EISA, while it realised that raising the income tax rate would incur extra costs to the Treasury, it believed the costs were far below those of the loss of revenue that small businesses provided the economy, as well as the human cost from potential lay-offs.  

For example

EIS and SEIS can actually return a profit for the government, as demonstrated below:

Let’s say that a private investor, as a result of the government lifting the SEIS threshold, is able to invest £250,000 in an early-stage business. Once that funding is received, 100% (£250,000) of that money goes to employing 10 staff all earning the living wage.

Those 10 employees earn £25,000 and pay income tax and national insurance which amounts to £4,432.36. The business collects this which totals £44,432.36. 

Over three years, this would equate to: £132,979.80 in tax revenues. 

The employer pays £34,500 in National Insurance contributions and collects £26,592 in Income Tax. 

Over three years, the two figures combined equates to: £266,276.08.

The cost to the taxpayer, with the proposed increase to 70%, is a £175,000 which could generate £61,479.80 in taxation revenues

This is a basic assessment of employing 10 people. Of course, some businessnesses will employ more, some will employ less. Some will fail within two years, others will thrive. 

But in general, as is shown below, the tax revenues generated from just employing people, could repay the investment within three years.

Example: Possible tax revenue generation under present and proposed SEIS and EIS scheme 

Current Allowance

SEIS Investor Allowance= £100,000

SEIS Tax Relief: 50% 

Company Allowance= £150,000

Proposed Allowance

SEIS Investor Allowance: £250,000

SEIS Tax relief: 70%

Company Allowance: £250,000

£150,000 invested via SEIS £250,000 invested via SEIS
£150,000 used to employ 6 staff £250,000 used to employ 10 staff
6 employees= £25,000 per annum 10 employees = £25,000 per annum
Total tax per employee= £4432.36  Total tax per employee= £4432.36

Employer’s NI= £20,700

Over 3 years= £62,100

Employer’s NI= £44,432.36

Over 3 years= £133,297.08

Employer’s Income Tax= £26,592

Over 3 years= £79,776

Employer’s Income Tax= £26,592

Over 3 years= £132,979

Total NI+Income Tax over 3 years = £141,876

Total NI+Income Tax over 3 years= £266,276.08
Cost to the government= £150,000 - 50% (tax relief) = £75,000 Cost to the government= £250,000 - 70%= £175,000
Government Profit= £66,876 Government Profit= £91,276.08

The above flowchart is merely an estimation of how raising the SEIS, EIS allowance and tax credit threshold will result in increased taxation revenue for the government. This should not be taken as an exact figure, but rather an example of how private equity investments using this scheme can result in greater tax yields.

Because the threshold is much higher, it means that more money is available for the business. This means instead of having to lay off staff businesses can hire more employees, thus creating jobs while the government gets its money back. This, combined with a higher level of tax relief means that more follow-up investments are likely, benefitting even more companies. 

Disclaimer:

To the best of our knowledge, the information we have provided is correct at the time of publishing. SEIS and EIS tax benefits are dependent on your financial circumstances. Sacha Bright is not a solicitor or accountant and we recommend that you seek professional advice on any topic discussed. 

Risk Warning:

Investing in equity crowdfunding and early-stage businesses involves high risks, which may include long-term investment horizons, illiquidity, lack of income and potential dilution. Any investor needs to be in the position to afford a total loss of capital invested.

NextFin is targeted at members who have the knowledge and experience to understand these risks and make their own investment decisions. You will NOT invest through NextFin but through the relevant crowdfunding website which also has signed off the content as a Financial Promotion on its own website. NextFin is not the originator of the financial promotions that appear on its site. However, we do to the best of our ability carry out limited compliance checks on the originator and the company seeking funding to ensure they are conforming to FCA regulations and anti-money laundering equity/requirements as appropriate. Business Agent Limited, trading as NextFin, takes no responsibility for this information or for any recommendations or opinions made by the companies or its users. Click here for our full risk warning.





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