This week we are looking at the ways that companies can qualify for EIS despite being outside of the ‘initial investing period’. There are a few ways to do this, but there are also a number of areas to watch out for where mistakes that prevent EIS qualification can be made.
What is the initial investing period?
Broadly, the initial investing period is the seven years following a company’s first commercial sale. (Knowledge Intensive Companies (“KICs”) have more generous rules which allow them a longer initial investing period and several other relaxations.
The first commercial sale can sometimes be tricky to pin down. It’s defined in the European Commission’s Guidelines on State Aid as “the first sale by an undertaking on a product or service market, excluding limited sales to test the market”. The key point to bear in mind is the “limited sales to test the market” point, as the first time a company makes a sale (for example of a prototype) does not necessarily mean that the seven year clock to receive EIS will immediately start ticking after this.
Receiving EIS investment after the initial investing period
There are three conditions that allow companies to access EIS investments after the initial investing period – conditions A, B and C. Your company only has to meet one of these.
Condition A – past S/EIS received
Funding under condition A is available if a company has already received past S/EIS investment before the end of the initial investing period and:
- the new EIS funding is used for the same qualifying business activities as the first S/EIS funding was; and
- the company’s business plan at the time of the initial funding foresaw the need for follow-on funding.
It is the second condition that is a frequent issue. Where companies suspect that they will require further funding, this should always be specified in the business plan – even if the quantum of future funding required is not specifically known at that time.
(NB: where the initial S/EIS was received before 18 November 2015, the business plan does not have to show the need for follow-on funding.)
Condition B – new product or geographic market
Condition B allows companies to receive EIS funding where:
- the amount of the EIS funding, together with any other EIS, SEIS, VCT, SITR or other Notified State Aid funding (e.g. Innovate UK or SMART Grant) within a 30-day period, is at least 50% of the company’s average annual turnover (calculated by averaging the company’s turnover for the past five years); and
- the money raised by the EIS funding must be used for entering a new product market or geographic market).
The first test is often overlooked as companies focus on the second. It is important to note that non-EIS investment does not qualify. Scottish Investment Bank match equity funding, for example, is not a Notified State Aid and does not qualify.
As the EIS funding needs to be spent entirely on the new product or geographic activity (and companies need to show how the money will be spent), companies should not try to raise more money than they need for the new activity, as spending money on other business activities would cause them to fail the condition. On the other hand, the first part of the test may mean that companies need to raise a large investment if they have succeeded in generating significant turnover over the past few years – so it is important that companies carefully consider exactly how much EIS funding they require.
To be considered to be entering a new product market, a company must show that it is targeting a new customer base, and not just releasing a new product which its existing customers would use.
In terms of entering a new geographic market, companies need to show that the conditions of competition are appreciably different in this new area. Expanding to a new city is not likely to meet this test, but expanding to a new continent likely is.
The key point for a company to prove with relation to condition B is that it would not be possible to use its previous track record to assess the potential of success for its new activity. Companies should aim to demonstrate to HMRC that they are effectively setting up a new business, not just slowly expanding.
Condition C – past EIS funding under condition B
Condition C is, luckily, a lot simpler, and is simply for companies that have raised EIS funding under condition B and now wish to raise follow-on funding. The rules are the same as for condition A – remember the importance of specifying the need for follow-on funding in the business plan!
Securing EIS investment after the initial investing period of 7 years may look like a daunting process, so if you think that this might apply to your company it’s best to start thinking about it sooner rather than later. That way, parts of the tests are less likely to catch you out in the future.
If you would like further advice regarding the availability of EIS relief, please get in touch with us. You can also check out our other blog on EIS for companies that innovate here.