The Enterprise Investment Scheme (EIS) is one of the UK government’s key initiatives to encourage investment in early-stage companies. It provides generous tax reliefs to individuals who invest in qualifying businesses, making it more attractive to back start-ups that might otherwise struggle to raise funds. For growing companies, EIS can be an excellent source of capital to support their development.
This article explains how the scheme works, the benefits it offers to both investors and businesses, and the main conditions that apply under the law of England and Wales.
Please note: At JPP Law, we do not advise on the tax aspects of the EIS scheme. If you need help with the accounting side, we can refer you to a specialist accountant. What we do handle is the legal framework around funding rounds, including shareholder agreements, articles of association, directors’ duties, and the commercial contracts that support the investment.
How the Enterprise Investment Scheme Works
The Enterprise Investment Scheme was introduced in 1994. Its purpose is to reduce the financial risk for individuals who choose to invest in smaller, higher-risk trading companies. To encourage private investment in start-ups and scale-ups, the government provides a package of tax reliefs designed to reduce risk and promote growth.
When an investor buys new shares in an EIS-qualifying company, they may be eligible for tax reliefs on their investment. However, the company must meet certain conditions relating to its size, the type of trade it carries out, and how it uses the money raised.
Tax Reliefs Available to Investors
Investors can benefit from a number of tax reliefs through EIS, provided they meet the qualifying conditions. These include:
- Income tax relief: Investors can claim relief at 30% of the cost of shares, up to a maximum annual investment of £1 million. If the company qualifies as a “knowledge-intensive company,” the limit increases to £2 million.
- Capital gains tax (CGT) exemption: If EIS shares are held for at least three years and the company continues to qualify, any gain on disposal of the shares is free from CGT.
- Loss relief: If the shares are sold at a loss, investors can set that loss against income tax or capital gains tax, reducing the financial impact of a failed investment.
- Capital gains deferral relief: Investors can defer a capital gains tax liability by reinvesting the gain into EIS shares. The deferred gain becomes chargeable only when the EIS shares are sold or cease to qualify.
These reliefs can significantly reduce the overall risk for investors and make EIS shares an attractive option for those looking to diversify their portfolio.
Conditions for Investors
Not every individual can automatically benefit from the scheme. Investors must meet certain conditions:
- They must not be connected with the company, which generally means they cannot be an employee or hold more than 30% of the company’s shares, voting rights, or loan capital.
- They must buy full-risk ordinary shares that carry no preferential rights to dividends or assets on winding up.
- They must hold the shares for a minimum of three years to retain the tax reliefs.
These rules are designed to ensure that EIS genuinely supports new growth capital, rather than being used for tax planning in less risky scenarios.
Conditions for Companies
For a company to raise money under EIS, it must meet strict eligibility requirements. Some of the key conditions include:
- The company must have gross assets of less than £15 million before the investment and no more than £16 million after the investment.
- It must employ fewer than 250 full-time equivalent staff, or fewer than 500 if it qualifies as a knowledge-intensive company.
- The money raised must be used for the growth and development of the business within two years of the share issue. It cannot be used simply to acquire another business or to fund certain excluded trades.
- The company must carry out a qualifying trade. Certain sectors, such as dealing in land or commodities, financial services, and energy generation, are excluded.
Companies can raise up to £5 million each year under EIS, with a lifetime limit of £12 million. For knowledge-intensive companies, the lifetime limit increases to £20 million.
Benefits for Investors
The main advantage for investors is the reduction in financial risk. The income tax relief provides an immediate saving, while the CGT exemption and loss relief help protect against future downside. The ability to defer capital gains can also be valuable for individuals with large gains from other investments.
EIS is often used by high-net-worth individuals who are comfortable with the risks associated with investing in early-stage companies. However, it can also appeal to smaller investors who want to support innovative businesses while benefitting from tax advantages.
Benefits for Businesses
From the perspective of a start-up or growing business, EIS provides access to a pool of private investors who may otherwise be reluctant to commit funds. Because the scheme makes investment more attractive to individuals, businesses can raise capital to fund product development, expansion, or entry into new markets.
EIS funding is particularly important for companies that are too early in their development to secure bank loans or institutional investment. The scheme can therefore play a vital role in supporting innovation and entrepreneurship across the UK.
Practical Considerations
Although the scheme offers generous incentives, both investors and companies need to take care in ensuring compliance. HM Revenue & Customs (HMRC) must be satisfied that the investment meets the conditions of the scheme.
Companies can apply for advance assurance from HMRC before issuing shares, which gives potential investors confidence that the shares should qualify. Investors, meanwhile, must claim the reliefs on their tax return and keep sufficient records to prove eligibility.
Given the detailed conditions and the risk of losing relief if they are not met, legal and tax advice is strongly recommended before proceeding with an EIS investment.
How JPP Law Can Help
At JPP Law, our solicitors regularly support both companies and investors with the legal aspects of Enterprise Investment Scheme funding.
We assist businesses in preparing the necessary legal documentation. If you need assistance with ensuring your business meets the eligibility requirements and making applications to HMRC for advance assurance, we work with a several highly recommended accountancy firms. If you need tax advice please email [email protected] and we will happily introduce you to one of our preferred accountants.
For investors, we can explain the legal conditions attached to EIS investments and review agreements to help safeguard their position.
If you are considering using the Enterprise Investment Scheme, whether as an investor or as a business seeking funding, contact JPP Law today to discuss how we can help with the legal process.
