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How to Finance a Start Up- Help for potential investors
There are different forms of relief regarding seed capital and investors
In the past funding for startups came from savings, friends and family or, quite simply, by just doing it. Much has been written by Richard Branson and others about taking a risk when young and with nothing to lose, but many of us who are a little ol er find it harder to take the plunge. Having said that, and much like in past recessions, an increasing number of people are deciding to start their own businesses.
From experience and recent Internet searches it appears that there is little in the way of advertised seed capital providers in the UK and that the established business angel networks appear to be interested only in businesses which already have “traction”. Is this an untapped market, I ask myself, or is it simply too risky a prospect to contemplate? So assuming I might have some seed capital to invest, how do I access any available tax reliefs, and what can I do – if anything – to reduce my risk? There are three readily available reliefs available to a seed capital investor:
1. Entrepreneur’s Relief; future capital gains up to £10m taxed at 10%.
2. Enterprise Investment Scheme Relief, EIS. Income tax relief at 30% based on initial investment, ability to hold over capital gains, saving up to 28%, and future capital gains taxed at 0%.
3. Interest Relief on loans taken out to acquire shares in a close company or for making loans to a close company (unfortunately if you get EIS relief then you get no interest relief); up to 50% tax relief on qualifying interest payments made in a tax year.
So taking Entrepreneurs Relief to start with you will need at least 5% of a qualifying company’s share capital and be an officer or employee of that company. Having achieved qualifying status, what could you look forward to? Making a fortune, suffering capital gains taxed at 10%, losing all your money and realizing a capital loss, being diluted below 5% in subsequent fund raising rounds and losing the relief, being removed as a director and losing your relief! The list goes on. To be a qualifying company in broad terms it needs to be a trading company or the holding company of a trading group.
EIS moves one step forward, as on making a qualifying investment a claim for a repayment of income tax can be made amounting to 30% of the amount invested and capital gains can be deferred on making the investment, saving a further 28% potentially. In addition, provided shares are held for at least three years and the company remains a qualifying company, future capital gains will be tax free although it should be noted that any deferred gains will now crystallize. The flip side to all this is that should the company cease to be a qualifying company or the shares are sold within the three-year time limit, then all the reliefs are clawed back. This is generally outside the EIS investor’s control and can give rise to some unexpected cash flow problems.
From next April the restrictive limits on the number of employees a qualifying company can have and the amount of money that can be raised are set to increase, subject to clearance from the EU. Currently the limits are 50 employees and £2m raised in any 12 month period, which will increase to 250 and £10m respectively. Finally if Entrepreneur’s Relief or EIS Relief is not available, then tax relief is available for interest on loans taken out to invest in a close company. This relief may not be as advantageous as EIS, but for a 50% tax payer it is better than nothing.
Fundamental to all three methods of obtaining relief is getting good advice and understanding how the tax rules work. This is important both when you make the investment and over the life of the investment. Accessing the potential tax reliefs is generally good news for investors, but having them withdrawn and the resultant changes to your budgeted cash flows can be devastating.
It is a common truth that if an investment is only going to be worthwhile because of the tax reliefs then you need to question very carefully whether it is a good investment at all.
For the lucky few making such an investment, it will be a stressfree route to making a good return at a super low tax rate.
However, everyone else needs to think about protecting your interests from day one and to take good advice from your accountant, tax and legal advisor. The best advice here is to make sure there is a comprehensive shareholders’ agreement, that the company’s articles include suitable share transfer and share issue clauses and that Key-Man/shareholder protection/critical illness insurance is taken out to ensure some return of capital should the key or one of the key founders of the business die or become ill or otherwise become debilitated and unable to run the business. Lastly there is no substitute for good due diligence. Your best chance of being successful will be investing in business sectors you understand, people you trust and whom you believe to have the right skills to succeed as well as good luck and an improving economy.
To conclude, as a friend or family member who is going to invest, whatever the facts are do not miss out on the reliefs that are available but be prepared to wave goodbye to your cash. If you treat your investment as a lottery you won’t be disappointed. If you are investing as a business angel then be prepared to take specialist advice, undertake due diligence and only invest what you can afford to lose. The relevant tax reliefs reflect the inherent risk, so buyers beware. Happy hunting!
Author: Peter Owen, email@example.com
ECOVIS Wingrave Yeats, London, United Kingdom
ECOVIS AG Steuerberatungsgesellschaft
The particular strength of Ecovis is the combination of personal advice at a local level with the general expertise of an international and interdisciplinary network of professionals. Every Ecovis office can rely on qualified specialists in the back offices as well as on the specific industrial or national know-how of all the Ecovis experts worldwide. This diversified expertise provides clients with effective support, especially in the fields of international transactions and investments - from preparation in the client's home country to support in the target country.
In its consulting work Ecovis concentrates mainly on mid-sized firms. Both nationally and internationally, its one-stop-shop concept ensures all-round support in legal, fiscal, managerial and administrative issues.
The name Ecovis, a combination of the terms economy and vision, expresses both its international character and its focus on the future and growth.
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