However, a stock market listing is unlikely to be suitable for most companies, due to the costs concerned. From the would-be investor’s perspective, investing in an unquoted company is likely to prove more risky than investing in a listed company.
It has been recognised that this type of investment requires encouragement, with enterprise initiatives to encourage growth.
Initiatives to encourage growth are the Enterprise Investment Scheme (EIS), the Venture Capital Trust (VCT) scheme and Seed Enterprise Investment Scheme (SEIS). They are aimed at different business sizes and types of business and offer tax relief to the investor.
The Enterprise Investment Scheme (EIS) exists to encourage investment in unquoted companies. For a company to qualify for EIS the total assets of the company cannot exceed £15,000,000 and it cannot employee more than 250 staff. The benefits of the scheme are in the income tax and capital gains tax reliefs associated to the scheme.
Investment under the EIS scheme is generally made by entrepreneurs, wealthy individuals or friends and family who provide capital in return for a proportion of your company’s shares. For many investors, the tax reliefs attached to the EIS scheme make investing under the scheme particularly attractive.
An individual may invest £1,000,000 per tax year from 6 April 2012 (£500,000 previously), although if the investor has also made an investment into a VCT, the amount of investment would need to deducted from the £1,000,000 maximum limit, since it is a combined EIS/VCT limit.
Although the tax reliefs available to a would-be investor are extremely attractive, the rules of the scheme are extremely complicated. If you are intending to raise money under the EIS scheme, taking professional advice from a suitably qualified adviser is essential.
Unless would-be investors are already in place, the business will normally produce a prospectus and circulate this to brokers who specialise in the EIS scheme. This, again, would require specialist advice.
There are three main direct costs that need to be considered:
- compliance costs
- professional advice
- reporting obligations.
Much of the initial cost will be incurred by the preparatory work. This includes working with the company on its structure (eg of its management). A business plan will form the cornerstone of any negotiations.
Legal fees will vary depending on the complexity of the business, its size and risk to the lender, and if a business angel is involved, it may instruct a due diligence exercise prior to investing.
Fees to prepare management accounts will vary depending on whether other services are provided – eg bookkeeping – and on the complexity of the business.
It is also advisable to have an exit plan for the investor; it shows that there is a longer-term plan in place.
For the business:
- access to equity capital to consolidate or develop business
- an alternative form of long-term finance that would not be available without the tax relief
- raising finance in the form of equity strengthens your balance sheet
- it can lead to additional finance being made available from other sources such as banks
- the scheme can encourage investment from business angels who can bring wisdom as well as money, such as how to run a successful business or an intimate knowledge of your industry.
For the investor:
The main advantages of the EIS scheme for the investor come in the form of the generous tax reliefs available. The EIS scheme offers four tax reliefs in one and covers both income tax and capital gains tax. The reliefs available are as follows:
- income tax relief: from 6 April 2012, the investor may invest up to £1,000,000 (combined maximum for EIS and VCT investment) in a tax year and obtain a tax reducer of 30% of the amount of investment
- capital gains tax exemption: if the investor has received income tax relief (which has not subsequently been withdrawn) on the cost of the shares, and the shares are disposed of after they have been held for at least three years from the date of issue of the shares (or three years from the date of commencement of the qualifying trade, if later), then any capital gain on the disposal of the EIS shares will be exempt from capital gains tax
- capital gains tax deferral: capital gains realised on the sale of any asset may be deferred against investments in an EIS scheme; the gains crystallise when the EIS investment is disposed
- loss relief: if the shares are disposed of at a loss, you can elect that the amount of the loss, less any income tax relief given, can be set against income of the year in which they were disposed of, or any income of the previous year, instead of being set off against any capital gains.
The scheme rules are complex and there are strict criteria to be met by both the business and the investor.
- Qualifying investors:
the investor must not be ‘connected’ with the company. For the purposes of establishing whether an individual is connected with a company, a 30% test applies. If an individual, together their associates, holds more than 30% of the share capital, loan capital, voting rights or rights on winding-up, they will be 'connected' and therefore not eligible for relief under the scheme. 'Associates' are any partner or relative of the investor and, in certain circumstances, trustees and personal representatives of trusts/estates in which the investor was either settler or had an interest
- irrespective of the 30% test, an individual is connected with the issuing company if they, or any associate, is an employee or partner of the issuing company or any of its subsidiaries at the time of issue
- an individual is also connected with the issuing company if they are a director (unless unpaid) of that company or of a subsidiary or partner of that company. Business angels, who have had no previous connection with the EIS company, may receive a 'reasonable remuneration' for their services as a director.
The rules start to get really complicated when looking at the requirements for a qualifying company. The main rules are outlined below are an 'in-a-nutshell' version of the rules, which run to many pages of legislation.
For shares to be eligible for EIS relief, the company must:
- be unquoted at the time of issue, with no arrangements in place for the company to become quoted
- not be under the control of another company, nor must there be arrangements in place at the time of the share issue
- meet certain conditions in respect of subsidiaries that it may have
- be a 'small' company. The definition of small for these purposes does not follow the Companies Act definition of a small company. To qualify as small for EIS purposes, gross asset value of the company (or group, if there are subsidiaries) must not exceed £15,000,000 before the issue of the EIS shares and £16,000,000 afterwards
- carry on a qualifying trade either itself or through a qualifying subsidiary
- raise no more than £10,000,000 per annum by way of EIS and venture capital trust subscriptions combined
- apply the funds for qualifying trading purposes within two years of the share issue
- have fewer than 250 employees.
Most trades will qualify as a 'qualifying trade'. However, certain trades are excluded by legislation. This will need to be checked with your adviser.
There is no requirement that the qualifying company is resident in the UK, but for shares issued on or after 6 April 2011, the company must have a ‘permanent establishment’ in the UK.
The EIS scheme facilitates a business raising long-term equity capital with attractive incentives for the investor.
The right finance for your business section of this website gives examples of financial structures that are suitable for different trading types and sizes of business.
Loans are a common form of finance, like trade credit and overdraft facilities. There are different types of loans available including mortgage and offset facilities. A loan can be used alongside a hedge or an interest swap, for example, to ensure that the cost of the loan is suitable for the business needs. For short-term problems, such as managing your cashflow, an overdraft or business credit card may be more suitable options.
Where loans are used to finance assets, hire purchase or leasing should also be considered.