There is a great scene in the Simpson’s, parodying the dot.com bubble. Bart sells his cartoon idea to a tech start-up and they pay him in endless rolls of stock. Why I mention this episode (called ‘I Am Furious (Yellow)’) is because sometimes, start-ups have a bad habit of giving away shares without thinking about the implications and those in receipt, assume that a value is guaranteed.
- So never take the issuing of shares lightly.
Especially as a sudden parting due to a severe clash of opinions, is like a mini-divorce. Costly and some very dirty laundry can end up in the public domain.
So before you start to exchange part of your company for investment or to pay employees in lieu of bonus/salaries- remember:
- If you have an investor through an SEIS or EIS scheme they have to stay for a minimum of 3 years to avail of their tax benefits
- You need to make sure you can work with the investor and that they will agree to a term of work that you are comfortable with, e.g. set out how to deal with conflict, decision making etc
- For employee share option schemes there are HRMC implications for both the employer and employee and lock-in periods
- For Company Share Option Plans (CSOP) employees have to get voting right and the shares must be in the holding company
- How do you value their shares if they have to leave?
- How are you going to fund their payout? Find another investor, take from retained earnings, or issue a debenture or another form of debt?
- Make sure members of staff know that any breach in a contract can impact on their share options
SEIS/EIS – (Seed) Enterprise Investment Scheme
Both of these schemes are set out by HRMC:
Both give external investors (not connected) tax relief as long as the HRMC deem the shares qualify. SEIS is the entry-level scheme with a maximum investment of £150,000 and EIS allows for up a total investment £5,000,000 into a company. The value per investor is capped at £100k and £1m respectively per tax year.
A start-up must be an unquoted company and be either trading for at least 4 months or if not trading, spent 70% of existing funding. Existing funding tends to be the owner's original investment.
Note- applying for EIS does require more paperwork, which is only fair considering the value of the tax breaks involved. However, SEIS is relatively straightforward. Do not be tricked into paying for an expensive business plan.
So while a full business plan is not required for SEIS, do make sure the pitch deck you submit is clear about how you will spend the investment and the benefits for your company. HRMC is validating that you are a going concern, not checking for typos or fancy graphics!
There are 3 key forms associated with these schemes:
1. Advanced assurance – Not mandatory, but by having approval this makes you more attractive to investors. Also, this form gives you a chance to check any issues before applying formally and saves any embarrassing moments with investors. Covers both SEIS and EIS can take up to 6 weeks for approval.
Form SEIS1 – When an investor is ready to invest and want to apply for SEIS, you complete this form per investor to get the allotment officially approved, up to the £150k cap. Once approved, a form SEIS3 is sent to the investor for them to apply for their tax relief.
Form EIS1 – As with SEIS this form is used for any investment up to the cap of £5m and an EIS3 form issued for the investor to complete.
Employee Share schemes
There are actually a few schemes but all of them need to be approved by HRMC. Again a common issue is founders handing out 10% of ownership to a member of the team without realising there are tax implications for the receiver.
Also note- HRMC have to approve the valuations you assign to shares.
These schemes cover full time and part time staff. As a rule of thumb, set aside 10-25% of share capital for employee shares.
The official guidelines are found on HRMC website:
So to offer shares in a tax efficient manner there are 4 schemes:
- Share incentive plans (SIPs)
- Save as you earn (SAYE)
- Company share option plans (CSOPs)
- Enterprise Management Incentives (EMIs)
For early-stage start-ups, SIP’s may be the most practical as employers can award free shares as opposed to CSOP’s which require employees to buy in. Also, shares while ordinary, can be issued without voting rights under a SIP’s scheme, unlike a CSOP scheme.
You can design a policy which suits your business, e.g. impose a probationary period before becoming eligible, set number of years served, performance scores, bonus levels etc. However, you cannot discriminate, so if two people have fulfilled 2 years service and met certain targets they are both allowed to take part.
Alternatively, if you want to share the benefits with employees but you do not want to give away a part of your company, also consider bonus plans as part of employment contracts. Or deferred bonuses based on loyalty, e.g. award £10,000 bonus for staying 3 years or a % bonus. However, any additional income will be taxed.
Anything that involves HRMC is designed to help grow business, but the rules are subject to change. Also, fraud can carry severe penalties. Therefore, it is extremely important to consult with an independent tax expert before embarking on any share option schemes or making investments into your company.
You should not have to incur huge costs for advanced assurance, as this is in effect a background check to give you comfort before formally applying for SEIS or EIS investment. Make sure you can evidence the purpose of your business, who the team are and what the money is being used for.
Follow the format of the form and just provide what they ask for.
Remember- giving any part of your company away ties you to people that you have to work with professionally. Respect and trust have to be in place.