How To Comply With The Financial Health Requirement When Raising Funds Through SEIS and EIS

George Harrison October 22, 2024

Raising money through the Seed Enterprise Investment Scheme (“SEIS”) and the Enterprise Investment Scheme (“EIS”) can be a useful way for companies to attract investment. These government-backed schemes offer significant tax benefits to investors, making it easier for early-stage and growing companies to secure funding. However, to qualify, companies must meet specific requirements, including the Financial Health Requirement, to protect investors from unnecessary risks.

What are SEIS and EIS?

SEIS and EIS are investment schemes introduced by the UK government to encourage private investment in small, early-stage, and growing businesses. These schemes give investors attractive tax incentives in exchange for taking on the higher risk associated with investing in young companies.

SEIS targets very early-stage companies, typically startups.
EIS is designed for slightly more established businesses, though it is still focused on small to medium-sized businesses.

Both schemes help companies raise much-needed capital, but to qualify, companies must meet strict requirements.

What is the Financial Health Requirement?

One of the key criteria companies must meet to raise funds through SEIS or EIS is the Financial Health Requirement. This rule ensures that financially unstable or insolvent companies can’t raise money through these schemes, safeguarding investors from higher risks.

The Financial Health Requirement requires companies to meet two conditions:

The company must not be “in difficulty” at the time the shares are issued; and
The company must not meet the insolvency criteria laid out in the Insolvency Act 1986, in other words it must be able to pay its debts and have a positive balance sheet.

What does “in difficulty” mean?

A company is considered “in difficulty” if:

It cannot pay its debts as they fall due; and/or
The value of its assets is less than its liabilities, including future liabilities (this is known as the ‘balance sheet test’).

If a company meets these insolvency criteria, it will likely be rejected for SEIS or EIS funding.

Raising funds after seven years of trading: Additional Rules

If your company has been trading for more than seven years, you will face additional hurdles to raise funds under EIS. HMRC applies a “basic age condition,” which usually prevents companies from accessing EIS investment after their seventh year of trading.

However, exceptions exist. Companies that meet certain criteria can still raise EIS-qualifying investments beyond this age, but they must satisfy an extra limb of the Financial Health Requirement:

if more than half of the company’s subscribed share capital has been lost due to accumulated losses, the company will likely fail the Financial Health Requirement test.

The Problem with this Additional Rule

This extra rule has historically caused confusion because:

Young, innovative companies often carry losses due to heavy investments in research and development (“R&D”).
These losses don’t necessarily reflect a company’s long-term viability, as many startups take time to become profitable.
Companies that rely on SEIS/EIS funding often need multiple rounds of investment and may not have other funding sources after seven years of trading.

HMRC’s Additional Guidance

On 18 August 2023, HMRC updated its guidance to clarify how it assesses companies raising EIS funds after the basic age condition. The key change is that HMRC will now allow companies to make reasonable adjustments to their accounts when assessing whether they meet the Financial Health Requirement.

For example:

R&D expenses that were recorded as costs on the income statement can now be considered as capitalised assets, reflecting the long-term value of the investment.
Future investments that are non-tax incentivised and irrevocably committed may also be factored into the assessment.

HMRC go on to state “ultimately, whether it is reasonable to assume a company should be regarded as in difficulty will require an assessment of the company’s particular financial circumstances including the ability of the company to maintain its activity in the short or medium term.”

This change means that companies are no longer penalised for accounting decisions that don’t fully reflect their financial health. Instead, HMRC now focuses more on the company’s ability to operate sustainably in the short or medium term.

Practical steps to comply with the Financial Health Requirement

Here’s how companies can make sure they comply with the Financial Health Requirement when raising money through SEIS or EIS:

Assess your financial position: Ensure your company is not “in difficulty” by evaluating whether you can meet your debts and maintain a positive balance sheet.
Check your accounts for accumulated losses: If your company has been trading for over seven years, verify that more than half of your subscribed share capital hasn’t been eroded by losses. If it has, consider how you can adjust your financials (e.g., capitalising R&D expenses).
Make sure your accounts and any adjustments are well-documented to present a clear financial picture to HMRC.
Seek Advance Assurance from HMRC: This optional step allows you to get early confirmation from HMRC that your company qualifies for SEIS or EIS funding, giving you peace of mind and helping attract investors.
Work with advisors: SEIS and EIS rules can be complex, and it’s a good idea to consult with legal and financial professionals who have experience with these schemes.

How we can help

If you are a company seeking advice in relation to SEIS or EIS, or have any questions about the financial health requirement in general, we would be more than happy to advise and guide you. As always, we will ensure that your matter is dealt with efficiently, diligently and effectively.

It is important to seek legal advice in relation to the SEIS and EIS schemes, especially given that it is easy to make mistakes and get caught by various pitfalls, as explained by our helpful blog article here.

This article is intended for general information only, applies to the law at the time of publication, is not specific to the facts of your case and is not intended to be a replacement for legal advice. It is recommended that specific professional advice is sought before relying on any of the information given. © Jonathan Lea Limited.