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The real reason why EIS and SEIS applications are falling

Launched in 1994 and 2012, EIS and SEIS have encouraged investors to back riskier businesses by providing access to income tax and capital gains tax relief, but now the much heralded funding method is on the decline.
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Ask a sample of entrepreneurs and investors from other countries what they’d like to borrow from the UK and chances are a few will mention EIS and SEIS – the Enterprise Investment Scheme and Seed Enterprise Investment Scheme.

Knowing that capital is hard to access for not just young companies, but also those looking to disrupt with an unproven idea, successive governments have backed the funding mechanisms and seen the number of applications steadily grow.

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Now, however, recent statistics from HMRC reveal that EIS applications have witnessed a near 20 per cent decline year-on-year – a worrying trend that needs some closer examination. While some may suggest the dip can be put down to the increasing variety of funding options out there today, evidence suggests it might be complex administration putting some off.

For Neil Pearson, partner and tax and investment specialist at law firm Mills & Reeve, we are now seeing the real impacts of changes made by the Treasury to EIS and SEIS rules in the 2015 Summer Budget from former chancellor George Osborne.

Back then, the chancellor announced alterations to the framework as part of the Finance Act, adding new layers of complexity and confusion to EIS.

“While the revisions to the eligibly and limitations largely effect EIS and not SEIS, the increasingly complicated nature of the tax relief system is confusing the investor and business communities,” Pearson noted.

“This ambiguity is turning them off and deterring vital deals needed to drive growth through both scheme, leading to this fall in applications.”

Another new law put in place meant restrictions on investors. It is now a requirement that if an investor already holds shares in the invested company, those shares must be either founder or risk capital shares – those which are EIS qualifying. This means that a large number of investors cannot make new EIS investments as they already hold minatory shareholdings in the invested company which were not made under EIS.

Statistics show that around 3,285 companies raised a total of £1.65bn of funds under the EIS scheme in 2015-16, down from the £1.88bn from 3,330 companies in 2014-15. Furthermore, data revealed 210 fewer companies raised funds through EIS for the first time, banking £293m less – evidence that changes are putting off first-time users. Interested readers can see the statistics in full on the Treasury website.

EIS and SEIS applications

Toby Ryland, corporate tax partner at HW Fisher & Company, believes the application process for both EIS and SEIS has got steadily harder and more complicated over the years – with the real catalyst being the 2015 restrictions on number of eligible companies.

“The new rules included a time limit stipulating that most companies can only apply for EIS or SEIS funding in the first seven years [of operation], whereas before 2015 any company could apply. The schemes are now limited to younger companies and this has significantly reduced the volume of applications,” he told Real Business.

So, what could be done to arrest the slide and help boost EIS and SEIS applications to pre-2015 levels? Bruce Macfarlane, managing partner at venture capital firm MMC Ventures, suggests adopting industry standard documents or wording of key clauses, speeding up the negotiating documents and reducing the number of companies seeking clearance.

He’s also an advocate of fast-tracking repeat clearances. “HMRC believes that 70 per cent of all applications are cleared at the first stage; no further information is needed by the inspector,” Macfarlane explained. “We would like a fast-track for clearance on applications which are on the same terms as a previously cleared round. This would free up more experienced inspectors to deal with new or more difficult cases.”

Pearson, meanwhile, wants the government to take another look at the rules and invest in more internal resources to improve dialogue with industry. “New legislation introduced means that businesses that have been trading for seven years or more, or ten for ‘knowledge intensive companies’, no longer qualify for the EIS. This is an unnecessary measure that excludes a number of viable businesses from significant investment opportunities and it should be removed,” he added.

Mark Palethorpe, CFO Cox Powertrain, has used EIS to raise money for his business. He said:  “We’d like to see the terms of the EIS extended to allow innovative companies to raise more vital funding and for individuals to have freedom to invest more.

“We’d like to see the existing caps removed – at the moment an investor can only invest £20m and then a total of £5m per year. Also, non-doms are not eligible to invest through EIS which feels like a wasted opportunity.”

Charles Good, chairman of Cox Powertrain, had interesting comments regarding the parameters currently in place. Having invested in Cox Powertrain through EIS, Good said: “The cap is set too low for companies like Cox that are big game changers and require substantial high risk capital before getting into production.

“It is not right that a major corporate can incubate new technologies and get corporation tax relief ad infinitum with no cap, but companies backed by entrepreneurs are capped out. In the case of Cox, it will take us £60m before we get into revenue and create a £1bn company which is our target. A higher cap is needed if ‘UK plc’ is genuinely going to turn itself into a thriving new enterprise economy, based on a revival of genuine risk taking to create long-term wealth.”

As a vital source of finance for many British companies, HW Fisher & Company’s Ryland went one step further by saying it is the only practical way of securing financial support for some growing young businesses.

“One of the main pitfalls of EIS is its lack of accessibility. To counter this, the government should be investing in higher-quality automated assistance for companies checking whether they qualify,” he suggested. “Implementing a simple but comprehensive online checklist that people can fill in to help them through the mass of qualifying conditions would be a beneficial step.”

A startup these days, he told Real Business, is also excluded if it intends to enter, or has, any kind of joint venture with a third party through a new company – meaning potentially lucrative and game-changing partnerships are conflicting.

If Britain and its business community is to hold onto its coveted position as a friendly, supportive and tax efficient place to start a disruptive company, the government will have to make sure the 20 per cent dip experienced in the last year is not repeated.

If it fails to do this, leaving EIS and SEIS applications unnecessarily time-consuming and complicated, international entrepreneurs and investors might be a little stumped if that “what do you want from Britain?” question crops up again.

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About Author

Hunter Ruthven

Hunter Ruthven is the editor of Real Business. He is also the editor of Business Advice, a title focused solely on a section of the business community currently underserved – micro companies. Alongside this, he is part of the team that hosts the Growing Business Awards, First Women Awards and Future 50 initiative.

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