EIS – Considerations for an Investor
What is the Enterprise Investment Scheme (EIS)?
The Enterprise Investment Scheme (EIS) is a government program that helps fund early-stage companies and provides tax benefits to investors. This article explains which companies qualify, the benefits, how to invest, risks involved, tax relief, and the transfer or inheritance of EIS shares.
The Case for Early Investment
Investing in shares of a small business early on can significantly increase personal wealth if the business experiences substantial growth. However, EIS investments come with high risks, as the value can rise or fall, potentially reaching zero and it should be noted that in the UK, it’s been reported that almost 60% of small businesses fail in their first three years of life.
Why EIS Exists
The government encourages people to invest in early-stage businesses with high growth potential through EIS tax reliefs. This support helps smaller businesses become successful, creating jobs and boosting economic growth in the UK.
EIS Qualifying Criteria
EIS offers funding to small companies that might struggle to find investment elsewhere. Qualifying companies must be:
- trading businesses
- unquoted – not listed on any stock exchange (apart from AIM which is considered unquoted for EIS purposes) and meet specific criteria.
Certain business activities are excluded from EIS funding. The government designed EIS to focus funding where it is needed most, and business sectors that qualify for EIS funding can change over time.
Businesses involved in the following activities are currently excluded from EIS funding:
- Dealing in land, property development and leasing
- Dealing in goods other than normal retail or wholesale distribution
- Dealing in financial instruments, banking, insurance, hire purchase, money lending and other financial activities
- Receipt of royalties or licence fees
- Legal and accounting services
- Farming and market gardening
- Operating or managing hotels or residential care homes
- Coal production, steel production and shipbuilding
- All energy generation activities
Knowledge Intensive Companies (KICs) have different criteria and are eligible for additional funding. KICs is defined as a company that considers research and development (R&D) as its main business activity. Following the Treasury’s Autumn Budget 2017, KICs are eligible for more EIS funding compared to other companies.
Rules in Detail
Detailed rules govern EIS investments, including the use of funds, company characteristics, and limits on raising capital. These include, but are not limited to the following:
- The money invested must be used to buy new shares, not shares already in existence.
- There has to be a risk to capital – the investment can’t be structured to provide a low-risk investment. This is to avoid EIS becoming a tax loophole.
- The funds raised must be used to deliver growth such as increasing revenue, customer base, number of employees. The funds should not be used to maintain the business (e.g. covering pre-existing day to day spending).
- The company can’t be trading for more than seven years (maximum ten years for a knowledge-intensive company). It also can’t be controlled by another company.
- It must be permanently established in the UK. However, this does not stop a UK established company from owning or controlling foreign assets or entities from being EIS compliant.
- There company being invested in should have to be fewer than 250 employees (500 for a KIC).
- Any funds raised through an EIS fundraise have to be used within 24 months.
There’s a limit to how much a company can raise through EIS and other similar investment incentives:
- Annually, it mustn’t exceed more than £5 million (£10 million for KICs).
- Over a lifetime, it mustn’t exceed £12 million (£20 million for KICs).
Any company can request advance assurance from HMRC. This is an assurance from HMRC to the company that an investment is likely to be eligible for EIS. Advance assurance generally provides confidence to investors that any shares invested should be EIS-qualifying.
Investing in EIS
Investors can choose to invest directly in a specific EIS-qualifying company or through a specialist manager who handles multiple investments from investors into a portfolio of qualifying companies. Different structures exist for approved and unapproved EIS portfolios/funds. Having a specialist manager offers certain benefits to investors, like ongoing oversight of the companies in the portfolio, the potential to influence board-level decisions (if the manager is large enough to have a seat on the investee company’s board) and the expertise needed to negotiate an advantageous exit.
Direct investments tend to be riskier as the investor will need to do their own research and are unlikely to have any control of the company they are investing in bar the voting rights attached to the shares they purchase.
Benefits of EIS Investment
Investing in EIS-qualifying companies offers high growth potential, tax reliefs, support for innovation, portfolio diversification, and can be viewed as complementary investments to other traditional investments individual investors can make (ISAs, VCTs and pension funds).
NOTE: EIS investments are high risk and not a replacement for mainstream long-term investments such as pensions.
EIS Investment Risks
Investing in early-stage, EIS-qualifying companies is unpredictable and involves high risk. Capital is at risk, and the value of investments can fluctuate. Tax relief is not guaranteed, and exit opportunities may be limited, requiring a long holding period. Investors should be comfortable with these risks.
EIS Investment Risks
Investing in early-stage, EIS-qualifying companies involves inherent uncertainties and is most suitable for investors comfortable with high-risk ventures.
Capital at Risk:
EIS companies are typically early-stage businesses, making investments in them inherently high risk. There is a possibility that investments could depreciate in value, potentially reaching zero, leading to the potential loss of investors’ capital.
Volatility in Smaller Companies:
Shares of smaller companies can experience greater fluctuations in value compared to those of larger, established companies. This volatility introduces an additional level of risk for investors in EIS-qualifying companies.
Uncertain Tax Relief:
EIS tax reliefs, tax rates, and allowances are contingent on existing legislation and interpretations based on case law. Changes in tax rules or shifts in HMRC interpretation may occur in the future, impacting the availability and extent of tax reliefs.
Personal Circumstances Matter:
Tax reliefs are subject to investors’ individual circumstances, and there is no guarantee that qualifying companies will maintain their EIS status. If a company loses its EIS-qualifying status within three years of investment, investors may be required to repay previously claimed income tax relief.
Limited Exit Opportunities:
EIS shares are considered unquoted, potentially making them more challenging to sell compared to shares on the main market of the London Stock Exchange. Investors should be aware of the limited exit opportunities and be prepared for a potentially long holding period, often extending to ten years or more. Investors should carefully consider these risks before engaging in EIS investments, ensuring that they align with their risk tolerance and investment goals.
If you would like to know more about Enterprise Investment Schemes, please contact us to speak to a member of our Corporate Team.
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