- Advance approval of EIS/SEIS plummets
- New risk rules mean many start-ups failing to secure venture capital
The tightening of the rules on venture capital investing is driving up the cost of capital for start-ups and small businesses, according to Price Bailey, the Top 30 accountancy firm.
According to Price Bailey, the new ‘risk to capital ’ rules, which mean that entrepreneurs must demonstrate to HMRC and investors that there is a “significant risk” of a capital loss on their shares exceeding the “net investment return”, is leading to a surge in the number of applications for Enterprise Investment Schemes (EIS) and Seed Enterprise Investment Schemes (SEIS) being rejected. This is pushing up the cost of accessing venture capital.
Figures obtained by Price Bailey, show that the percentage of EIS advance assurance applications receiving approval has fallen to 62% in 2018/19, from 81% in 2015/16. The percentage of SEIS advance assurance applications being approved has fallen by a greater amount, to 60% in 2018/19 from 86% in 2015/16.
Advance assurance is the process by which entrepreneurs seek clearance from HMRC before issuing EIS/SEIS-compliant shares to investors.
Price Bailey says that the added complexity of the application process, and the increased likelihood of applications being rejected, has pushed up the cost of raising venture capital via EIS/SEIS by well over half. The cost of professional fees for the process has risen significantly, which a start-up business can ill afford.
Jay Sanghrajka, Tax Partner at Price Bailey, comments: “Clearance from HMRC used to be quite forthcoming but the new risk to capital rules, have introduced greater uncertainty and subjectivity into the process.”
“HMRC designated 20 sectors which do not qualify for venture capital investment, but there is still a lack of clarity about what ‘significant risk’ to capital in the ‘long-term’ actually means. This imprecise language means that entrepreneurs and investors are spending more time and money on applications than previously without the certainty of whether they will qualify for EIS or SEIS relief or not.”
He adds: “There are a host of minor rules, which make it much easier to make mistakes in the process of applying and retaining EIS and SEIS status and this can prove very costly to investors who have invested money in the expectation of received EIS or SEIS relief. Simplification of the rules is needed to avoid investors looking at these valuable reliefs as unattainable.”
Impact on investors
Price Bailey says that the recent rule changes have marked a very clear shift towards growth, and away from capital preservation strategies. This means that in many cases, businesses using EIS/SEIS to raise money represent higher risk investments.
Sanghrajka went on to say “The changes mean that investments should carry a real risk that investors will lose more capital than they are likely to gain. HMRC decides whether investors’ capital is at risk by looking at a businesses’ financial position. The problem is that the “risk to capital” rules are opaque and too subjective, which makes it hard for investors and entrepreneurs to make informed decisions.”
“While the risk profile of qualifying businesses has been stepped up, so have the potential returns. Investment is being focused into younger businesses at an earlier stage of their development. Investors, therefore, have fewer choices than they did under the old rules, and the potential for extreme outcomes in either direction has been greatly increased.”
“Investors will need to consider how much they are prepared to lose. One way to manage the increased risk is by investing across a number of different businesses or EIS funds.”
“There is now a much greater onus on investors to learn about the fund managers and their track records, and seek to understand the investee companies that will sit within any given portfolio. Given the heightened risk posed by EIS and SEIS investments, investors may want to revise their diversification strategies accordingly.”
NOTES TO EDITORS
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About Price Bailey
Price Bailey is a top 30 accountancy practice specialising in providing accountancy and business advice to enable the growth of regional, national and international businesses. In addition to traditional accounting services, the firm has a range of specialists in many areas, which combine to provide a complete, integrated business offering. These include tax consultancy, corporate finance, strategic planning, insolvency & recovery and employment law.
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