One of the most common problems that new startup companies face is the challenge of securing sufficient investment in their initial growth phase.
In order to capitalise on their first exciting market success, young companies often require a large input of funds in order to scale their products and services.
However investors can often be wary of ploughing significant amounts of money into precarious projects in such an early phase. So new startups are regularly forced to resort to loaning money from banks.
Which then means they're shackled to the debt of repayment, whether their business is successful and hits the anticipated growth targets or not. Plus potentially, or likely, rising interest rates add to the risk.
Furthermore, new companies generally have a limited window of opportunity to raise funds. Whilst their introduction to the market is hot and causing disruption.
And it’s a sad fact that many new enterprises, with fantastic products and talented teams, fail solely because they can’t attract the necessary investment at the critical time.
Luckily for UK business, our country is one of the most startup-friendly countries on earth. Having birthed 72 unicorn companies that have each achieved valuations of over £1 billion, in the past 20 years. And in 2012 the UK government wisely created the Seed Enterprise Investment Scheme (SEIS) to help young startups flourish.
How does SEIS work and what are its benefits?
SEIS is a UK government initiative that encourages investors to invest in early stage companies or startups, via the purchase of shares, by offering highly attractive tax reliefs. Which makes the prospect of investing far more enticing with the possibility for far greater returns.
Eligible companies can receive up to £250,000 through the SEIS scheme.
The key benefits for investors are:
The chance to claim up to 50% of the cost of the investment against their income tax, up to £100,000 in a single tax-year. Provided you have held the shares for 3 years and have not sold within that time.
Zero capital gains tax on a SEIS investment. I.e., if you sell your investment and realise a profit then that profit is 100% tax free. Provided you have held the shares for 3 years and have not sold within that time.
Capital gains deferral - If you have another investment such as a property that you sell, then the capital gains tax you would normally pay can be deferred to a later date if you put the gains from the sale into an SEIS eligible company.
If the company you invest in fails you can claim loss-relief by offsetting the losses against your income tax or capital gains.
The key benefits for the SEIS investee company are:
An easier method to source funding as selling private equity attracts a wider range of investors with more varied, flexible payment structures etc. In comparison to a bank.
Investors are more likely to take a personal interest in the company and its vision. Hence they can provide unique expertise and resources.
A business loan from a bank has to be repaid no matter what, at the risk of repossession of securities and damage to your credit rating. This risk is reduced with selling equity, as investors agree to put funds into a project on the basis that they only receive returns in dividends if it succeeds - i.e makes a profit.
SEIS vs EIS
A common question people ask is, what is the difference between SEIS and another government scheme called EIS?
The main difference is that EIS can apply to established larger companies, as opposed to just startups. But see differences in funding and benefits:
Who can apply?
If a company meets the following criteria then it is eligible for SEIS:
Your company trades a product or service that constitutes a ‘qualifying business activity’ - a new qualifying trade. Which you or, a previous owner of that trade, have been trading for less than 3 years.
Your company meets the permanent establishment condition.
Your company is not listed or quoted on a stock exchange at the time of application, and has no set plans to do so.
Your company has no subsidiaries other than qualifying subsidiaries, and has not been controlled by another company since the date of incorporation.
Your company has not been a subsidiary of another company since the date of incorporation.
Your company’s gross assets must not exceed £350,00 at the time of sale of equity.
Your company must have under 25 staff members employed on a full-time basis at the time of sale of equity.
Your company must not be a member of a partnership.
Your company must not have already received investment through the Enterprise Investment Scheme (EIS) or from a venture capital trust (VCT).
If an investor that meets following criteria then they are eligible for SEIS and subsequent tax-relief:
They pay income tax in the UK
They or their associates are not employees of the company, both at the time of purchase of equity and from then up to 3 years after. Although they are permitted to be a paid director.
They only purchase hold under 30% of shares, including shares held by associates, until 3 years after the date of issue.
They have not bought the shares in return for a related investment - i.e. in your own company.
They or their associates have not taken loans connected to the company they are invested in until 3 years after the date of issue.
They hold the shares for a minimum of 3 years from the date of issue
They pay for all of the shares in full and upfront, not on a staggered payment basis
They do not take any value (repayment of invested capital, other debt or benefit) from the company they have invested in until 3 years after the purchase of equity.
Rules & compliance
Within 3 years issuing shares (selling equity/receiving the investment) the company is required to spend the funds on one of the following; a ‘qualifying trade’, preparation to perform the qualifying trade or research and development that will create a qualifying trade.
There are a few more stipulations to consider when applying for SEIS such as meeting the risk to capital condition and issuing shares. So we recommend that you read HMRC’s dedicated web-page.
As you will see, the definitions of the various qualifying criteria are quite complex. And trying to ascertain exactly what conditions your company meets via the lengthy manuals can get complicated very quickly. Our friendly advisors at Crunch can make this stress-free and simple by clearly answering your questions about SEIS.
How to apply
You, or your company secretary, can apply for SEIS with a Form SEIS1 compliance statement. An authorised agent can also apply on your behalf.
Before you are allowed to submit the SEIS1 form, the application, share issuing company (or qualifying 90% subsidiary of that company) must have:
Performed the qualifying trade and business activity for a minimum of 4 months and spent at least 70% of the received investment from the issue of the shares.
There's also quite a lot of additional information you need to provide. So again, we advise reading the ‘Apply with a compliance statement’ section on HMRC’s dedicated web-page.
In summary SEIS is one of the most helpful funding schemes available for startup companies, with thousands of them now having taken advantage of it. It also offers the most generous and potentially lucrative tax-relief benefits for investors, and so far over £1.5 billion has come through SEIS to aid the development of aspiring young enterprises.
It’s another fine example of how the UK’s business friendly outlook has created a world-class destination for trade and commerce. And an environment ripe for the seeds of ambitious enterprise.