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A traditional route for companies to raise investment in the start-up and early stage has been to offer investors shares in the business in return for their funding.
In the United Kingdom, this can usually be underpinned by the Seed Enterprise Investment Scheme (SEIS) and Enterprise Investment Scheme (EIS) which offer the investor some hugely attractive tax breaks.
The downside of this approach is that, by offering a number of shares for the investment, the company is explicitly attributing a value to the business.
Whilst friends and family are likely to base their judgement on the people, proposition and plan, for private investors this business valuation is pivotal.
However, for start-ups and early stage businesses, quantifying this value is notoriously subjective. For instance, you have a great idea and have developed a prototype. You have worked out that you need £1m of investment to get to market and are prepared to offer a 25% equity stake in return. In essence, you have given your business at pre-money value of £4m even though you have not generated any revenue.
Until recently, the common alternative has been the use of Convertible Loan Notes. Here the investment is initially in the form of debt with the option to convert into to shares or for the loan to be repaid. The conversion is usually triggered by a future event such as the next funding round or an exit and the conversion price determined at that point. For example, the price per share at the next funding round discounted by 20%.
The beauty of Convertible Loan Notes is that this postpones the contentious issue of valuation plus it gives the investor some protection as the debt ranks above the shareholders in the event of an insolvency.
The problem is Convertible Loan Notes do not allow the investor to claim the tax reliefs under SEIS or EIS.
An Advance Subscription Agreement is a funding mechanism aimed to resolve this. In essence, the funds provided to the company at the date of the agreement convert to shares upon a future event.
However, the investment is not a loan with the right of repayment. Neither is there the right to earn interest. Essentially, it is a prepayment for share capital that must convert at some point. Should there be no next funding round nor exit, this would be on a defined date or on insolvency.
As the investment no longer has the downside protection of a convertible loan, if structured correctly, it could become eligible for SEIS or EIS relief.
An Advanced Subscription Agreement usually is underpinned with the following clauses:
The combination of the SEIS and/or EIS tax reliefs and safeguards plus a defined future share price is an extremely attractive option for the investor.
However, the structure of the Advanced Subscription Agreement is critical to ensure SEIS and EIS eligibility and HMRC look at this on a case-by-case basis. For instance, if the terms stipulate a conversion to anything other than Ordinary shares, the investment would automatically be outside the scope.
At CooperFaure, we have vast experience of helping business start-ups to secure funding and, in particular, benefit from government schemes. So far this year, we have supported clients in raising over £3m in investment finance through numerous channels.
If you would like an initial call or meeting to discuss your circumstances, please email us at startup@cooperfaure.co.uk to arrange a time. It is absolutely free and there is no obligation.
To read the latest regarding MTD, as of October 2021, read our blog post here.
Following intense lobbying from the Treasury Committees, business, software developers and the accountancy profession, including CooperFaure, the government have announced a delay and a reboot of Making Tax Digital.
In the Budget before the election, the intention was for it to be mandatory all businesses to report quarterly and keep records digitally starting in April 2018 with the self-employed and landlords with a revenue over the VAT threshold, currently £85,000.
Now the government has announced that:
Mel Stride, the Financial Secretary to the Treasury responsible for Making Tax Digital stated “Businesses agree that digitising the tax system is the right direction of travel. However, many have been worried about the scope and pace of reforms. We have listened very carefully to their concerns and are making changes so that we can bring the tax system into the digital age in a way that is right for all businesses.”
This deferral will allow much-needed additional time for software development and systems testing. CooperFaure is part of the HMRC pilot programme for this and will be keeping our clients updated in the run up to April 2019.
Making Tax Digital will be offered on a voluntary basis for the small businesses and landlords with a turnover below the VAT threshold but there is a clear pledge that this will not become mandatory until ‘at least’ 2020.
The Treasury also confirmed that a Finance Bill will be introduced as soon as possible after the summer recess to legislate for the policies that were dropped from the Finance Act before the sudden General Election in June.
As part of this, policies originally announced to start from April 2017 will be effective from that date such as the changes to non-domicile rules and loss relief reform.
If you have any questions or concerns over either Making Tax Digital or the measures in the Finance Bill, please email us at tax@cooperfaure.co.uk.