An overview of the risk to capital condition and what both companies and investors need to do to meet it.
When applying for SEIS or EIS advance assurance, you’ll see the phrases ‘grow and develop’ and ‘risk to capital’ appear throughout.
They tie into the ‘risk to capital’ condition that HMRC introduced in 2018 to ensure that investment under SEIS/EIS is true to the spirit of the schemes: to encourage investment in early stage and small businesses, and help them grow and develop (rather than as a tool for capital preservation through tax planning).
There are two parts to the risk to capital condition, both of which you must meet:
- The company in which the investment is made must have objectives to grow and develop over the long term.
- The investment must carry a significant risk that the investor will lose more capital than they gain as a return (including any tax relief).
Growth and development will be measured by how you will use the investment to grow your revenue, customer base and number of employees. This should be permanent and not rely on the investor’s continued support.
The good news is that HMRC takes a ‘reasonable’ approach to the condition, with a ‘non-exhaustive list of factors’ and ‘no bright lines’ between a qualifying and non-qualifying company. Also, if one or more indicators of capital preservation are present in the application, that doesn’t necessarily mean the company won’t meet the condition, and vice-versa.
In other words, HMRC will view your application, supporting documents and relation to the investor as a whole to determine whether you have genuine intent to grow and develop your business, and the level of risk posed to the investors’ capital.
As you work your way through the application and write your business plan, ensure that everything is consistent with one another and that you clearly highlight:
- Your intentions to grow and develop
- What you will spend the investment on
- How the investment will fuel your growth and development
It’s also important that the amount of money you intend to raise is consistent with the amount of money you will spend to grow and develop.
For example, if you say you want to raise £1 million but plan to spend the money on a new piece of equipment that costs £20,000, HMRC will see the inconsistencies and may flag it as failing to meet the condition.
There are no hard and fast rules to what you can actually spend the investment on, so long as it presents a risk of loss of capital to the investor.
For example, increasing your marketing budget, hiring new employees, purchasing new equipment or expanding your facility will all satisfy the condition, as it’s not guaranteed that spending more and expanding will result in success.
However, purchasing another business is prohibited and will be seen as capital preservation. Other risk-reducing arrangements include:
- Giving investors priority over other investors
- Allowing investors to withdraw their money as soon as possible
- Protecting an investor’s money so that other investors' money is used first
For full details on the risk to capital condition, read HMRC’s guidance here.
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