Tax Effective Fundraising

27 November 2024
News

It’s not easy raising funds; it’s high risk for the investor given the majority of start-ups don’t work out. Investors have different options available to them to protect against this risk, with some start-ups and some investors able to take advantage of various tax incentive schemes that are in place which assist with de-risking investments. This article takes a look at those schemes.

Whilst start ups often need external investment in order to grow and scale, investors will want a return on their capital: either reliable dividend income or long-term capital growth or, ideally, both. However, typically start-ups simply do not envisage profits for many years, and when they do start to generate profits, paying out dividends is unlikely to be a priority (for them or investors); often, they will need to plough the profits back into the business instead to scale it. Coupled with higher risks of failure (and so capital losses for investors), the tax system recognises that investors need to be enticed into investing into start-ups and other early-stage businesses.

Investment schemes

To give start up companies a level playing field there are a number of investment schemes that give investors enhanced tax breaks when they introduce new capital into the business by subscribing for shares. The Seed Enterprise Investment Scheme (SEIS), Enterprise Investment Scheme (EIS), and Venture Capital Trust Scheme (VCT) each encourage investors to finance smaller companies.

Both SEIS and EIS are regularly used by start-ups, though thought should be given to raising capital this way and then later receiving institutional investment from investors that may want liquidation preferences that sit above the ordinary shares held by your early investors.
VCT was designed to spread investment risk over a number of companies; investors invest in the venture capital trust, which will then buy shares in a number of qualifying companies.

Tax breaks

Traditional investing by a UK tax resident in the shares of a UK company comes with an income tax charge on any dividend for investors, along with a capital gains tax (CGT) charge on the gain they make when they come to sell. Shares are generally acquired out of post-tax income and any capital losses may typically only be set against capital gains.

The schemes give investors a varying number of tax breaks, which can include:

Deferral of capital gains on assets sold to finance an acquisition of qualifying shares – meaning more money can be spent acquiring more shares and a tax bill delayed
Income tax deduction on a percentage of the value of the investment in the year that it is made
CGT relief on the gain made in the qualifying shares
Ability to set any losses against income

This makes investing in eligible companies much more attractive, as investors can benefit significantly if values rise, but also have valuable tax benefits if the companies fail. This attempts to make higher risk start up companies that need funding to grow, succeed and thrive a more enticing prospect compared to safer, more reliable, established companies.

Investee company conditions

Following perceived abuse of the schemes, new rules were introduced in 2018. These put in place a two-part condition, which requires the investee company to:

Intend to grow and develop over the long-term (e.g have plans in place to increase revenue, customer base and number of employees (i.e. an SPV for a specific project would not meet this test)); and
Have a significant risk of loss of capital to the investor greater than the net return (risk here means the commercial risk of the company failing in the market), i.e. the company must be highly likely not to deliver a return to the investor, including the benefit of tax relief).

In addition, there are a number of other conditions which the investee company must meet to enable investors to benefit:

	SEIS	EIS	VCT
Type of company	Unquoted (can be listed on AIM)	Unquoted (can be listed on AIM)	London Stock Exchange or on any other EU regulated Market, i.e. not on AIM. At least 70% of the VCT’s investments must be in unquoted companies (can be listed on AIM)
Ownership / subsidiaries	The company must not be controlled by another company and must not have any subsidiaries that are not 51% or more subsidiaries	The company must not be a 51% or more subsidiary of any other company and must not have any subsidiaries that are not 51% or more subsidiaries	The VCT itself must not be a close company. Broadly this means that the VCT company must not be controlled by five or fewer shareholders or any number of directors
Assets	The company must have no more than £350,000 in gross assets	The company must have gross assets of less than £15 million before the EIS share issue and less than £16 million afterwards	The companies that the VCT invests in must have gross assets of less than £15 million before the VCT share issue and less than £16 million afterwards
Employees	The company must have less than 25 employees	The company must have less than 250 employees (500 if the company is “knowledge intensive”)	Each company that the VCT invests in must have less than 250 employees (500 if the company is “knowledge intensive”)
Time limits / restrictions	No previous EIS or VCT investments can have been made. The company must be less than three years old	EIS cannot apply if it has been more than seven years since the company’s first commercial sale (ten years if the company is “knowledge intensive”)	Subject to some exceptions for “follow up investments”, VCTs cannot invest if it has been more than seven years since the target company’s first commercial sale (ten years if the company is “knowledge intensive”)
Trade	The company must be trading, not have previously carried out another trade and must not carry out an excluded trade*	The company must be a trading company but must not carry out an excluded trade*	The VCT’s income must derive wholly or mainly from shares or securities. The VCT must distribute by way of dividend at least 85% of its income from shares. No more than 15% of the value of a VCT’s total investments can be in any one company. At least 70% of the companies invested in must be trading companies but must not carry out an excluded trade*
Limits	No more than £250,000 per group can be raised in any three-year period (for SEIS to apply as mentioned above the company must not have any subsidiaries that it owns less than 51% of the shares in – this is the group for these purposes)	No more than £5 million per year can be raised from any combination of SEIS, EIS and VCT. No more than a total of £12 million (£20 million if the company is “knowledge intensive”) per group can be raised from any combination of EIS, SEIS and VCT	No more than £5 million per year can be raised from any combination of SEIS, EIS and VCT. No more than a total of £12 million (£20 million if the company is “knowledge intensive”) per group ca be raised from any combination of EIS, SEIS and VCT
Location	Must be a UK resident company carrying on a trade in the UK or an overseas company with a UK permanent establishment carrying on a trade	Must be a UK resident company carrying on a trade in the UK or an overseas company with a UK permanent establishment carrying on a trade

*Carrying out an excluded trade means that more than 20% of the company’s business and excluded trades include:

dealing in land, commodities, futures, shares, securities or other financial instruments
dealing in goods other than in the course of an ordinary wholesale or retail distribution trade
financial activities, such as banking or insurance
leasing assets for hire
receiving royalties or licence fees (save for intangible assets)
legal or accountancy services
farming / woodlands and timber production
property development
nursing home or hotel management or operation
producing coal or steel
shipbuilding
energy generation or supplying or creating fuel
providing services to a connected person conducting an above trade

Investor conditions

There are also conditions for the investor themselves to meet:

	SEIS	EIS	VCT
Type of shares acquired	Newly issued ordinary shares	Newly issued ordinary shares	Shares in the VCT can be bought on the open market, however second-hand shares will not entitle you to up front income tax relief
Payment for shares	Cash only	Cash only	Cash only
Tax avoidance	The subscription for the shares of the company must not form part of a scheme or arrangement the main purpose, or one of the main purposes, of which is the avoidance of tax	The subscription for the shares of the company must not form part of a scheme or arrangement the main purpose, or one of the main purposes, of which is the avoidance of tax
Period of ownership to qualify for CGT relief on sale	Three years minimum	Three years minimum	Five years minimum
Connection	The investor cannot be an employee of the company or any qualifying subsidiary during the period of three years commencing with the date the shares are issued (a director position is acceptable but compensation must not be excessive). The investor must not have a substantial interest in the company	The investor must not be connected to the company (i.e. either alone or with associates owning or entitled to acquire more than 30% of the share capital, voting power or assets or any subsidiary on a winding up OR being an employee of the company or its group (can be a director but must not receive excessive compensation))	VCT cannot have more than 15% of its total investments in any one company

Investor benefits

Provided that these conditions are met, the investor can receive the following benefits:

	SEIS	EIS	VCT
Annual investment upon which investor can obtain tax relief	£200,000	£1 million (£2 million if at least £1 million is invested in knowledge intensive companies)	£200,000
Percentage of investment on which income tax relief can be claimed	50%	30%	30%
Income tax relief on dividends?	No	No	Yes
CGT relief on initial investment	50% capped at £100,000	100%	N/A
Type of CGT relief on initial investment	Deferral	Deferral	N/A
Gains exempt from capital gains when investment sold?	Yes, if income tax relief was received	Yes, if income tax relief was received	Yes. The VCT itself is also exempt from corporation tax on chargeable gains
Relief for capital losses against income	Yes	Yes	No
Inheritance tax (IHT)	Any investment made in a SEIS-qualifying company held at the time of death is exempt from IHT after it has been held for two years	Any investment made in an EIS-qualifying company held at the time of death is exempt from IHT after it has been held for two years	No relief from IHT as holding shares in an investment company

The capital gains deferral for EIS and SEIS allows an investor to defer their gain from the sale of any asset by spending the proceeds on EIS or SEIS shares. You must make the investment between one calendar year before and three calendar years after you sell the asset.

A bit of maths

An investor sells an unrelated capital asset for £140,000, making £100,000 of profit. Usually, this £100,000 would be subject to CGT. However, they invest the full £100,000 of profit into a company that qualifies for EIS. Their CGT on the £100,000 is therefore deferred.

In that year they obtain £30,000 worth of income tax relief. Their net investment cost is therefore, £70,000.

If you have any questions around any of the above or wish to discuss your options further, please contact our Tax team who would be delighted to assist.

Disclaimer

This note reflects the law as at 27 November 2024. The circumstances of each case vary and this note should not be relied upon in place of specific legal advice.

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Elizabeth Small

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Oliver Claridge

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From Start-up to Exit: the Acqui-Hire

24 July 2024
News

As an entrepreneur an exit may seem a long way away when first assembling your team, but if you get that really right, you may find yourself receiving offers from buyers that would like your team for themselves. In a nutshell, that’s an acqui-hire: an acquisition which is aimed at obtaining a team.

It is otherwise a relatively loose term, and it can take different forms such as:

An acquisition of the corporate entity. However, larger acquisitive corporates may well not want to buy an unknown corporate and bring it into their group, particularly if they only want certain assets and don’t want to pick up liabilities.
An asset acquisition, perhaps where some IP that has been created is to be acquired alongside the team.
A simple payment to release the team from terms such as non-competes, and to waive any possible claims the seller may have against the buyer, perhaps with an IP licence to prevent claims in the future that the buyer is misusing the seller’s IP.

Acqui-hires usually happen relatively early in the growth trajectory of a business (possibly during a distressed time too), but they aren’t necessarily straightforward. For example, some of the key points that start-up teams faced with the option should be considering are:

What will happen to the company afterwards (assuming the corporate is not acquired)? Is it to be wound down? And if so, how long will that take? Or will there be a retained and continuing business? Linked with this, careful thought needs to be given as to what the deal means to creditors.
How is the price to be structured? The buyer will want to retain the people it’s acquiring, so may seek to defer some value and link it to retention. You’ll need to think through what happens if the buyer, for example, terminates without cause.
What will the price mean for any investors? For those operating in the digital assets space, this may also include people who invested for tokens.
The employment proposition for those moving over. Again, it’s likely that the buyer will seek to include deferred incentives, such as options, as part of the package. In addition, visa/immigration considerations may need to be considered, depending on the circumstances.
The tax treatment of the proposed deal structure. This will depend on many factors so taking early advice is crucial in order to maximise deal value.

So, if you’re being talked to about an acqui-hire, there’s a fair bit to consider, but at the very least it demonstrates what a great team you have.

Disclaimer

This note reflects the law as at 24 July 2024. The circumstances of each case vary and this note should not be relied upon in place of specific legal advice.

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Daniel Bryan

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Tech Term Sheet Explainer

13 December 2023
News

Your term sheet sets out the fundamental terms of the commercial deal you have struck with your investor(s). Getting it in a shape that everyone is happy with will make for a much smoother execution of your funding round, allowing it to take less time so that you can get back to growing your business.

If you’re bootstrapping your way to an early round of funding, you may think twice about reaching out to an advisor to discuss your term sheet, perhaps wanting to hold off until it’s agreed commercially. I would, however, encourage you to reach out for an initial discussion before signing up to your term sheet, even if just for another perspective on what you’re signing up for.

So, what should a term sheet include?

Valuation

The valuation will set out how much of the equity is being given to the investor(s).

The term sheet may reference the “pre-money” value, being the amount the company is valued at before the funding round closes, and the “post-money” valuation, being the company’s value after (and including) the funding.

Whatever terminology is used, it’s important to understand what you’re agreeing to give to the investor, and whether this is on the basis of the issued share capital or the fully diluted share capital (such that the term sheet may say they’re receiving 10%, but actually, on an issued basis the investor may have more, having factored in the dilutive effects of convertible instruments such as options and warrants).

Option Pool

While the detailed terms of the incentive plan may come later after closing an early round of funding, the term sheet will often set out the percentage option pool to be made available to incentivise key staff. Founders should note how this percentage is calculated (will it dilute everybody or not?).

Investor Shares

The class of shares which investors will receive should have their key rights set out. Is everyone investing for ordinary shares, or will the investors receive preference shares with specific rights?

Preference shares in this context will typically have voting rights and have a priority return over the ordinary shares on a liquidation / exit event. If applicable, the term sheet should set out this priority return (known as a ‘liquidation preference’). It’s customary for investors of preference shares to have a 1* preference, meaning that they receive their investment back first. That said, in recent turbulent markets, there are instances of investors looking for more than this.

Whether they then participate or not in the balance of any proceeds should also be set out, noting that if they are non-participating (as is common), such that they only receive their liquidation preference, they will likely be convertible or entitled to the amount they’d receive had they been ordinary shares (therefore the preference affords the investor a downside protection).

Anti-Dilution

Investors often seek anti-dilution rights, which may include a ratchet such that, if there is a ‘down round’ in the future, the investors are issued more shares in line with that ratchet. Founders should ensure that the term sheet sets out the applicable type of ratchet, and that they understand what it means.

It’s customary for the ratchet to be what is known as a broad based weighted average ratchet.

Founder Vesting

Investors will expect to see good leaver and bad leaver concepts with a vesting schedule for shares held by founders setting out a founder’s entitlement if the founder leaves the company. We would encourage founders to discuss expectations here with the investors early to ensure alignment.

Board Composition

Including who will have a board seat and against what threshold is common. Boards are typically founder-led in their early stages with more board control given up in follow-on rounds as new investors come in and as independent directors are added.

Veto Rights

Investors will typically expect to have a set of investor veto matters, for which a percentage of the investor pool has to vote in favour for the company to action the matter. There may be shareholder matters and also investor director consent matters.

Founders may also wish to seek founder consent matters, although this is not always acceptable to investors.

Warranties

While the detail of the warranties (contractual promises to investors, e.g. that you’re not currently involved in any litigation) will be in the long form documents, we would encourage founders to consider who will be giving warranties and agree this and the overall liability cap upfront with their investors. Previously, founders often had to give warranties by reference to a salary multiple, however more recently the market has moved to having only the issuing company provide the warranties.

Share Transfers

The term sheet should include reference to certain share transfer matters, to the extent they are to apply. For example, pre-emption rights (and who they are for, e.g. everyone or certain investors), drag along rights and tag along rights (and what threshold triggers these rights) and co-sale rights.

Information Rights

While investors may be represented on the board, they will typically expect to have contractual information rights to enhance the limited information a shareholder in a UK company is typically entitled to see. Setting out what investors will receive, and whether this is for all investors or for those that hold a certain percentage of the equity, will allow you to be aware of the administrative burden of complying with this moving forwards.

SEIS / EIS Tax Reliefs

If the round is going to be raising money from investors looking to obtain SEIS/EIS relief this should be acknowledged, and the founders should take advice on what this is likely to mean in terms of structuring and process for them and what the investors may expect.

For more information about these tax reliefs, see here.

Finally, it’s worth being aware that the majority of the term sheet is typically not legally binding, although it may contain certain parts which are, for example, provisions relating to confidentiality and, if you’ve agreed this with your investor(s), exclusivity for a period of time.

Please get in touch if you would like to talk about your funding round and how we can team up to achieve your objectives.

Disclaimer

This note reflects the law as at 30 November 2023. The circumstances of each case vary and this note should not be relied upon in place of specific legal advice.

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Daniel Bryan

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Ready to Raise Funds?

30 November 2023
News

Being ready to raise funds is a position that every business should seek to be in even where fundraising is not an imminent objective. From a legal point of view, being ready to raise funds really just means knowing where everything is, and being able to demonstrate everything you know about your business to somebody who is taking a look at it. Plus, you want to be able to provide this information as soon as, or possibly before, it’s asked for by any potential investor.

You’re the entrepreneur and I expect that you’re all over your business plan, but, apart from that, here are some of the key things to check are in order:

Your Company Books – starting with a ‘fun’ one, it’s a legal requirement to keep certain statutory registers up to date, such as your register of members. Having ‘up to date’ filings on Companies House is not the same (although potential investors will be taking a look at these too) as it’s the register that shows ownership of legal title to shares. All investors will expect to see these books to check that all is as they expect.
Your Cap Table – your register of members should also be translated to a user friendly cap table that you’ll be able to use to consider pre- and post- money ownership percentages and dilution on a fully diluted basis (i.e. including any option holders or holders of other convertible instruments that will not be on your register of members). Having this ready will help when you negotiate your valuation with investors too. There are online providers of software to help you manage this which may be useful once you have raised funds.
Your Financial Records – what potential investors will want / expect to see will depend on the stage of the business, but any accounting records should be well maintained and available for review.
Your IP – many companies are IP rich and IP should always be considered. For example:
- Have all consultants signed IP assignments?
- Has anyone who has worked on IP for the business (including founders and employees) before the company was incorporated signed IP assignments?
- Have any other IP assets been protected or what is the strategy around that? Is the company name trademarked?
- Has open source been used and can you demonstrate that the terms of the licence don’t require your own IP to be distributed freely?
Your IT
- Do you have a summary of your IT system that you could disclose, with the documentation to support that summary should anyone wish to look at the detail?
- Can you demonstrate that you’ve thought about cyber security? It’s a podium placer for top risks to businesses and demonstrating that you understand the issue, by setting out the approach you take to mitigating the risk, will help put minds at ease.
Their Data – Where is the data you control or process, what is it, and how do you go about making sure you’re dealing with it lawfully? What’s expected of you on this will depend on how data rich your business is and what stage your business is at, but regardless of the answer to those, there will be an expectation that you can show that you’re on top of it.
Your Customers and Suppliers – Are your customer and supplier relationships documented in up to date, unexpired and fully signed contracts? You will likely need to disclose these during the investment process (considering first any particularly sensitive information and whether confidentiality provisions apply).
Your team
- Are the terms of engagement of your employees, workers and consultants all in writing and have they signed up to restrictive covenants, confidentiality undertakings and, where required, IP assignments?
- Are any incentive schemes in place and if so, are all scheme documents available?
An NDA – Before disclosing anything secret, consider agreeing a confidentiality / non-disclosure agreement (NDA) with proposed investors. Having a reasonable NDA ready to sign could help this process (although keep in mind that some institutional investors may require their own paper to be used, not to be difficult, but because it’s been through their own in-house legal review and forms part of their own investment process). Similarly, institutional investors look at so many initial decks that they may not have the time or inclination to be troubled by negotiating an NDA, so think about the ‘when’ of seeking an NDA too.

Having the above in mind will keep you on the front foot when going out to raise funds, whether it’s from angel investors, VCs or otherwise.

When you’re at the point of considering the terms of investment, take a look at our term sheet explainer too.

Disclaimer

This note reflects the law as at 15 November 2023. The circumstances of each case vary and this note should not be relied upon in place of specific legal advice.

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Daniel Bryan

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International Bar Association Tech M&A conference – Key Takeaways

3 April 2023
News

Forsters attended the International Bar Association Tech M&A conference in Berlin on 23 and 24 March. While the Tech sector is being impacted by global macroeconomic conditions, there was a lot of optimism. Here are our key takeaways:

The Tech M&A market has seen exponential growth for two decades, with 7 * growth in deal volumes. This has slowed down recently but the market is by its nature innovative, and so there remains a very positive outlook in the medium to long term. In particular, periods of instability are typically followed by a surge in M&A and investment activity once stakeholders gain confidence that valuations have stabilised, and there is a sense that there is a lot of ‘dry powder’ out there.
Like in the UK, Founders of early stage companies across multiple countries are faced with a market of lower valuations and have been slowing their spend to extend existing cash so far as possible. Investors have been even more selective on where they place their money, with some moving away from the typical 1* preference as a way of balancing risk (though a mention of 8* having been proposed is concerning).
Cybersecurity is a top 3 risk to businesses, with a range of solutions for stakeholders to consider when looking to protect themselves, such as checking that standards and measures have been implemented and monitored, insurance, and technical diligence, alongside legal diligence and warranties on deals. This should be considered on all deals involving data and secret information, not just those with a significant amount of personal data involved. Cybersecurity is a c-suite level conversation for businesses.
Employee incentive schemes remain an important way of rewarding management and employees across the globe, with many taking the form of share/stock plans and phantom share schemes.
Data remains a big topic. Tech businesses with international reach need to be on top of their obligations across various data protection frameworks and need an understanding of how they operate together, considering transfer impact assessments, the UK and EU data frameworks, the US executive order, and more.

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Daniel Bryan

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Aaron Morris

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Forsters advises McLaren Applied Limited on its Asset Based Lending (ABL) facilities.

17 November 2022
News

Forsters has advised McLaren Applied Limited, which is known as a technology first supplier, notably to the motorsport industry in relation to its ABL and cashflow facilities with IGF.

In 2021, McLaren Applied Limited was bought as part of an MBO backed by longstanding Forsters client Greybull Capital who ran the management acquisition of McLaren Applied Limited.

This transaction highlights Forsters’ expertise in advising borrowers on their ABL facilities which are becoming increasingly popular in the UK debt market.

Rowena Marshall and Maximilian Spies-Majewski, from the Forsters Banking & Finance team, alongside PwC’s Debt & Capital Advisory team acted as key advisors to McLaren.

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Rowena Marshall

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