Navigating SEIS and EIS: Risk-to-capital decoded

Navigating the world of SEIS/EIS is challenging, and predicting approval can be especially difficult with stipulations such as ‘risk-to-capital’. For both businesses and investors, this condition is pivotal, as it is one of the first things HMRC will consider. 

Let’s break down what this term means for founders looking to fundraise, and investors looking to take advantage of these tax-efficient schemes.

A quick refresher: what are SEIS and EIS?

The Seed Enterprise Investment Scheme (SEIS) and the Enterprise Investment Scheme (EIS) are government-backed schemes to incentivise investment into small and scaling businesses. 

They do this by offering significant tax advantages to those raising and investing through the schemes. Here’s how they work: 

• SEIS: Investors can claim 50% tax relief on investments of up to £200,000 per tax year.
• EIS: Investors receive 30% tax relief on investments of up to £1 million (or £2 million for knowledge-intensive companies).

Whilst these schemes are a great way to make the funding journey easier for businesses, they come with their own qualifying criteria, which can be hard to navigate.

What is SEIS/EIS risk-to-capital?

The risk-to-capital condition is a principles-based test introduced by HMRC to evaluate whether a business is genuinely using SEIS/EIS funding for growth, or whether they are using it for a low-risk, tax-advantaged investment. 

Essentially, it is to ensure that the scheme is only available to growing businesses who need the investment to scale, rather than stable businesses who are using the government schemes for the primary purpose of mitigating the tax burden for themselves and their investors.

To meet this condition, businesses must satisfy two criteria: 

• Evidence of clear growth potential: The company must display a clear plan for long-term growth and development.
• Prove to be a genuine risk to investors: The investment must carry a clear financial risk for investors, even after accounting for the tax reliefs.

Failing to meet either of these criteria could disqualify a business from securing SEIS/EIS funding.

Breaking down the two conditions

1. Evidence of clear growth potential

Businesses must demonstrate that the SEIS/EIS funding will drive measurable growth for the business. It should be clear that without securing the funding raised through SEIS or EIS, the business will struggle to meet the targets it outlines.

HMRC considers factors such as: 

• Projected increases in revenue
• Growth in customer numbers and market reach
• Development of company infrastructure
• Expansion of product or service offering

Companies should show how the money will be used to directly support scaling efforts, such as those listed above. 

2. Genuine risk to investors

Perhaps the more nuanced of the two conditions, this one stipulates that the investment should not be structured to guarantee returns or prioritise tax relief. 

Key areas HMRC evaluates include: 

• The business model’s viability
• Originality of product or service
• Financial projections and potential ROI
• Assets and expenditure
• Cap table and ownership splits between founders and investors

It is key to note that there is a balance between your representation of your company to investors and to HMRC. You want the prospect to be attractive to investors, but if the picture you paint is too rosy, this may flag up as problematic with HMRC. 

A useful way to assess potential success is to consider whether your business depends on SEIS/EIS incentives to attract investors. 

If your investment opportunity remains appealing even without the tax reliefs these schemes offer, it’s a strong indicator that the risk-to-capital conditions may not be satisfied.

Risk-to-capital and SPVs

Setting up a special purpose vehicle can make securing SEIS/EIS Advance Assurance more challenging, and complicate the risk-to-capital assessment process. Here’s why:

• Increased complexity: SPVs introduce additional layers to the company structure, potentially complicating HMRC's evaluation of investment eligibility.
• Control and ownership: HMRC closely examines the company's ownership and control. If an SPV obscures these details, it may trigger concerns.
• Substance over form: HMRC prioritises the transaction's substance over its structure. Using an SPV without a clear commercial purpose could be viewed negatively.

Tips to meet the SEIS/EIS risk-to-capital conditions

• Create a compelling growth plan
  Develop a business plan that outlines your growth strategy and financial forecasts. Be specific about how the SEIS/EIS funding will enable your goals.
• Be honest about risks
  Whilst you want to remain attractive to investors, transparency about risks is crucial. Demonstrating commercial uncertainty shows HMRC that the investment carries genuine risk-to-capital.
• Seek expert guidance
  At Vestd, we understand that navigating SEIS/EIS applications can be difficult, and so we are here to provide end-to-end support with your application. We can screen your applications so you can ensure your submission has the best possible chance of success.

Summary

HMRC have introduced their risk-to-capital conditions to ensure that SEIS/EIS funding primarily supports genuine entrepreneurial ventures that could not exist without the support of the schemes. 

For founders, this means presenting a clear and honest business case that is focussed on growth. For investors, it’s about identifying businesses with commercial promise, not just tax-saving potential. 

With InVestd Raise, you are able to streamline your fundraising journey, so you can grow, without the admin headaches.

With our Customer Success team by your side, navigating your SEIS/EIS journey becomes seamless and stress-free, eliminating any complexities along the way. Ready to get started? Let’s talk.