Funding the gap – SEIS and EIS

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It is widely acknowledged that the success and growth of SMEs is integral for the UK's return to a stable growth economy. Despite this, in a recent report, the Department for Business, Innovation and Skills (BIS) estimated that the total funding gap facing SMEs in Britain for the period 2012-2017 will be between £26 billion and £59 billion. Simply put, UK's SMEs do not have access to enough sources of capital.

This funding gap is particularly visible at the start-up/early stage end of the SME spectrum within the technology sector, with many commentators stating the lack of access to capital at the start-up/early stage level as one of the biggest hurdles that needs to be overcome if we are to create the tech start-up/early stage ecosystem that our Government strives to create.

As a result Government and policy makers have introduced numerous policies and schemes to try and fill the "funding gap". Two such existing schemes are SEIS and EIS. This article gives a brief overview of the attractiveness of SEIS and EIS to the investor, their benefits for SMEs and their use as a valuable tool for addressing the funding gap.

What is SEIS and EIS?

SEIS (Seed Enterprise Investment Scheme)

The Seed Enterprise Investment Scheme is designed to encourage individuals to invest into start-up and early stage trading companies. In return for investing into SEIS eligible shares, an investor will be able to take advantage of the following generous tax advantages:

  • the investor's income tax liability is reduced by 50% of the sums invested, up to the annual investment limit of £100,000;
  • exemption from capital gains tax on the disposal of any SEIS shares provided they have been held for 3 years or more and no disqualifying event has occurred within that 3 year period; and
  • chargeable gains on the disposal of any asset in the tax year 2012-13 and 2013-14 will be wholly or partially exempt from capital gains tax (up to the maximum SEIS annual investment limit of £100,000) if a qualifying investment in SEIS eligible shares is made within the same tax year or the following year.

SEIS – The investor

The eligibility requirements and conditions relating to the investor including that he/she can not be an employee of the investee company (although they can be appointed a non executive director), their investment must be in return for no more than 30% of the issued share capital of the company and the subscription must be made for genuine commercial reasons. Further to this, in order for the investor to fully benefit from the tax reliefs he/she will need to have a net taxable income of at least £142,185 and hold the shares for at least three years.

SEIS – The investee company

There are also numerous eligibility requirements conditions relating to the SEIS investee company, including that (note that these are not exhaustive):

  • its gross assets must not exceed £200,000 immediately before the shares are issued;
  • it must exist for the purpose of carrying on a new qualifying trade; § it must have fewer than 25 full-time employees;
  • it can only raise a maximum of £150,000 through SEIS investments or other investments that constitute state aid;
  • must be independent and have a UK permanent establishment; § it must not be in financial difficulties; and
  • the money raised must be used within three years of the relevant share issue and must be used for a qualifying business activity.

EIS (Enterprise Investment Scheme)

The Enterprise Investment Scheme is broadly similar to the SEIS scheme and is more recognised and established, having being in existence since 1994. Investments in EIS eligible shares have a slightly less generous tax relief than SEIS eligible shares in recognition of the fact that it is aimed at more established companies than those eligible for SEIS. However, the tax advantages are still very generous in that the investor will benefit from:

  • the investor's income tax liability is reduced by 30% of the sums invested up to the current annual investment limit of £1,000,000 provided the shares are held for three years;
  • exemption from capital gains tax on the disposal of any EIS shares provided they have been held for 3 years or more and no disqualifying event has occurred within that 3 year period; and 
  • deferral of any chargeable capital gain reinvested in EIS shares.

EIS – The investor

The eligibility requirements and conditions for an investor in EIS shares are broadly similar to those of an investor in SEIS shares.

EIS – The investee company

The eligibility requirements and conditions relating to the EIS investee company include that (note that these are not exhaustive):

  • its gross assets must not exceed £15,000,000 prior to the investment;
  • it must exist for the purpose of carrying on a qualifying trade;
  • it must not have raised more than £5,000,000 in total during the 12 months preceding the investment under EIS, SEIS, or from a VCT and any other scheme which qualifies as state aid;
  • must be independent and have a UK permanent establishment;
  • it must not be in financial difficulties; and
  • the money raised must be used within two years of the relevant share issue and must be used for a qualifying business activity.

Is it funding the gap?

As at 31 December 2012, EIS alone has raised over £8.6 billion for SMEs since its inception in 1994 and over £650 million has been raised in the last year alone. This figure is also likely to be an undervalue as companies have 4 years to file for EIS with HMRC and there may be further fundraising yet to be filed with HMRC.

Despite the eligibility requirements and conditions for both investor and investee being quite complex for both SEIS and EIS, there is still undoubtedly a huge incentive for an investor to invest through either SEIS or EIS, especially when that investor has made a substantial capital gain on the disposal of another asset.

SEIS and EIS are aimed at start-up/early stage companies (in the case of SEIS) and more established SMEs (in the case of EIS). Between 2008 and 2011 approximately 49% of investments (by number) were for amounts below £100,000 and approximately 10% of investments (by number) were for over £1,000,000, with investments for over £1,000,000 accounting for approximately 50% of investments by value.

The size of these investments do not meet the investment criteria of most managed funds meaning that SEIS and EIS are providing an incentive to invest in companies which institutional investors do not generally target, which in concept starts to address the funding gap by providing an incentive for private investors to invest in such companies directly.

The ability to benefit from generous combined income and capital gains tax reliefs in such investments means that an investor can hedge his capital invested against the tax relief he will receive on the investment, with the possibility of making a good return if the company succeeds (which will be exempt from capital gains tax). This provides further incentive to invest in such companies, especially high-growth potential technology companies, who often struggle to attract early-stage capital due to their risk.

SEIS and EIS have certain suitability to high-risk/high-growth potential companies, especially for those within the technology sector. This is a sector being heavily promoted and supported by the Government and those in business as playing a large part in the future of the UK economy. Creation and support for technology start-up clusters such as Tech City and Level 39 in London and the creation of many other clusters throughout the UK, all of which have the aim of enhancing the technology start-up ecosystem within the UK and creating more technology companies who would no doubt be suitable for SEIS and EIS investment.

SEIS and EIS's suitability to the high-growth potential sectors such as the technology sector, is supported by the fact that nearly a quarter of all EIS investments have been made in the hi-tech sector since 1994. All of this furthers the case that SEIS and EIS address the funding gap from a conceptual point of view in that it creates an incentive to invest in the types of companies that our country is trying to encourage and support, as well as still being suitable for any type of SME.

To conclude, combining the generous tax reliefs both schemes offer and their obvious suitability to the technology high-growth potential sector which the Government is actively trying to promote within the UK as the future of the UK economy, SEIS and EIS are undoubtedly a very important part of the toolkit for funding the gap in years to come by providing an incentive for individual investors to invest directly into companies which may otherwise struggle to secure the capital they need to succeed.

It will be interesting to see whether greater awareness of SEIS and EIS and continued support from the Government results in investors, who would have previously invested their capital in a managed fund, investing more capital directly into SMEs through SEIS or EIS on the basis that the added risk of such direct investment in an early stage company is off-set by the generous tax reliefs they will receive for doing so. If this occurs, SEIS and EIS will truly become a valuable tool in funding the gap.

In the next article we will be looking at Venture Capital Trusts and their ability to fund the gap between SEIS/EIS and mid-market private equity.