How to avoid common Enterprise Investment Scheme pitfalls

Designed to encourage investors to back unquoted companies through generous tax breaks, the Enterprise Investment Scheme (EIS) is said to have become ?increasingly popular? with SMEs struggling to secure funding from banks.?

This is according to recent data from HMRC, which claimed that despite the number of companies raising funds peaking during the dot com boom in 2000 with a record??1,065m, the??1,457m?raised in the tax year 2013/14 surpasses?that number.

In fact, more than?22,900 individual companies having received investment since the scheme?s inception in 1993, with over?? of funds have been raised up to July 2015.

Similarly, during an annual survey of EIS advisers, Intelligent Partnership found that 61 per cent of those surveyed believed their use of the scheme would increase in the next 12 months ? an increase of 15 per cent from the 2014/2015.?

Daniel Kiernan, research director at Intelligent Partnership, said: “It’s no surprise that advisers are expecting to invest more in EIS, as changes to our pension system have strengthened the investment case for tax-efficient investments.”

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However, Adrian Walton, partner at Smith & Williamson, is of the belief that the statistics are ground for?businesses and investors to be aware of the common pitfalls of EIS.

At the top of his list, he suggested that those using EIS needed to avoid shares being issued, for example, today and paid for tomorrow (or later). In this situation, no EIS relief will be available.

Conversion of loans were another factor to be wary of. He said: “There must be a subscription of new funds in order to claim EIS relief. Existing loans in the company can?t be converted to equity, and EIS subscriptions can?t be connected with a loan repayment from the company ? for example the company cannot repay a loan of ?50,000 to an individual who then subscribes ?50,000 for shares.”

Walton?added: “Directorships?is also a complicated area, but as a general rule for active investors, shares should be issued to the relevant individual before they are appointed as a director and prior to the signing of a service agreement. Follow-on EIS investments in the next three years (at a time when the individual is a director) are fine, assuming all other conditions are satisfied, as long as the first EIS share issue was structured correctly.”

Furthermore, EIS shares can?t have anti-dilution rights. Companies need to be careful to ensure that there are no offending clauses in shareholders? agreements or articles, he claimed. As such, he suggested that to avoid dilution, EIS shareholders would have to invest in future funding rounds, normally under standard pre-emption clauses.

Finally, in relation to the 30 per cent equity limits for EIS claimants, the shares held in the relevant company by the individual?s associates? are included.?

“It?s widely known that most family members (spouse, parents, grandparents, children, grandchildren) count as associates but so do fellow partners in a partnership and trustees of associated trusts.

?Interest in government approved schemes such as EIS is expected to increase further, especially given the severe restrictions on pension contributions.”

An interest in SEIS has also spiked since a number of startups applied for the scheme in 2015.

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