EIS – Importance to UK Angel Investments

The Enterprise Investment Scheme (EIS) is one of those rare Government incentives that actually works.  It is very important that any UK based start-up trying to raise funds from Angel Investors understands EIS as it is a key requirement for many Angels, myself included.

What is EIS?  Details are on the HMRC website, but in summary it provides tax relief for an investor investing in an EIS qualified company, subject to a certain number of rules.  In practice what this means is that for each £100 I invest in an EIS qualified company I get £20 back off my income tax bill, a significant return.  Furthermore, provided I hold the shares for 3 years, then, should the company be successful and I later sell my shares, any gain I make will be free of Capital Gains Tax (CGT) – today that saves me 40% on exit!  Finally, in summary terms, should the investment not be successful and the company fails I can write the loss off against income tax (not just against Capital Gains).

If you’re running a start-up business I hope you can see why understanding EIS is so essential when asking an Angel to invest – the EIS scheme is a real incentive for investment.  There are rules associated with EIS and it is important that you understand them; for example in the standard Shareholder’s Agreement I use for investments it is a condition that the company does nothing to prejudice its EIS status.

Is everything about EIS good?  Inevitably not; there are plenty of changes that would make it even better in terms of encouraging greater investment in UK businesses.  Before the last election in May I wrote a guest blog for startups.co.uk with my 3 Angel wishes for a new Government, included in which was a request for greater EIS incentives.  This subject was also discussed at length at the recent Seedsummit event sponsored by Seedcamp on 26th January at Techhub.  Some of the changes suggested include:

  1. Allowing convertible loans (which include conversion discounts and interest) to be allowed for EIS
  2. Similarly enabling preference shares to be allowable
  3. (and my main gripe) allow a greater percentage holding to qualify for EIS (currently limited to 30%)

It’ll be interesting to see whether there is any movement on this or other aspects of EIS in the forthcoming budget on March 23rd.

About Julian Ranger

Please see http://www.jranger.com/

Posted on February 28, 2011, in Angel Investing, Entrepreneurship, Start-Ups and tagged , , , , . Bookmark the permalink. 7 Comments.

  1. EIS certainly has its place, and you’re right to assert that every startup should know about it. Understanding the requirements and process are essential before you go anywhere near angel networks, but it’s a topic that I’ve never seen discussed or raised at any startup event.

    Moreover, there’s a strong argument that the existence of EIS actually does more long-term structural damage than it does short-term good. Firstly, the skills required for, and the outcomes of, a successful EIS raise are not necessarily aligned with that of the successful enterprise. There are heavy transactional costs, particularly so if you are forced to use IFAs to find investors.

    More significantly, the scheme runs the danger of becoming about the tax break itself, rather than about the quality of the investment. This reached it apogee a few years ago (before the Revenue clamped down) in the UK film industry, where a few Bialystock-and-Bloom companies specialised in producing hours and hours of unwatchable crap that would never see light of day. This crap was, however, ideal for its main purpose of reducing wealthy individuals’ tax liabilities. It may well have been beneficial in keeping people in work (and enriching others), but it led to the structural issue where investors were generally unable to understand the process and equation of risk and reward intrinsic to investing. When the Revenue pulled the plug, risk capital vanished overnight, because outside the tax break, there was no culture of understanding risk.

    Similarly, the rigid restriction mentioned above (ie Ordinary Shares only!) means that financial innovation has been stifled in the UK. Take a look at the US for inventive structures combining options, preference shares and various version of debt / equity convertibility. Plump for EIS and all these options are gone. I would argue that the poor investment culture and the lack of sophisticated tools for managing risk are the biggest reason the UK lags so far behind the United States.

    • Peter – good points, especially re the rigid restrictions.

      Regarding transactional costs of EIS, that is dependent on whether the angels you are working with and/or your legal/accountant support has been through the process before. If they have then the extra admin and knowing the rules is not that onerous and should amount to a few £K at most.

      Regarding, the investment being about the tax break, rather than the quality of the investment, that could indeed be a danger – it certainly was with VCTs I think when the tax break on those was at 40% . I haven’t seen any situations where it has been an issue, but then I invest with other serious angels and am a member of angel groups where there is a real angel investment intent. Something to watch for certainly.

  2. I’m not sure angel investors should look for more than 30% equity in any startup – so having a cap is good in my opinion.

    • Paul – my reason for this is less for Angel investors, and more to encourage successful entrepreneurs to have another go and create their own new businesses funded by themselves. At the moment, it makes more financial sense for me to invest in other businesses with EIS than to start up and invest in my own new business without EIS – I do not think that makes sense as my experience as a previously successful entrepreneur should be valuable (but no guarantee!) in a new startup that I create.
      (As it happens I have started several new businesses in which I have invested without EIS (e.g. http://www.dadapp.com, http://www.socislsafe.net), but that’s because I believe in them strongly, rather than from any sound financial planning.)

  3. Good point Julian – I’ll point you in the direction of a cool startup in that case 😉

  1. Pingback: UK Enterprise Investment Scheme (EIS) – budget changes |

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