Anthony Rose
News of the big tech valuation reductions in the U.S. might have you holding your breath as a startup founder. The change in narrative may suggest a slow summer ahead, and speculative investment will prove unpopular.
That said, KPMG’s latest venture capital report reveals a rich environment for British startups to succeed. Scaleups raised over £6.9 billion between January and March alone. Competition will be hot.
In response to this new environment, founders should do everything they can to make investment decisions easier for VCs and angels. In the U.K., the HMRC’s Enterprise Investment and Seed Enterprise Investment Schemes (SEIS and EIS) present one of the best ways to do this, as they offer tax-relief benefits to early-stage investors, which could give them the nudge to take the plunge.
That said, EIS and SEIS applications are no simple business. In fact, about 23% fail (in some years, it has been about 40%.) Because the funding comes from taxpayers’ money, HMRC is very careful about who it allows to use the schemes.
There’s no tricking a system only meant for those classified as “high-risk” businesses. As a result, you’ll need to prove your business is real, and as many forget, you’ll also need to present a strategy for success.
Your business plan will be the first place HMRC looks for this proof. Here’s how to prepare it ahead of an application.
Clarity is key
The first step to HMRC-proof your business plan is to present everything with perfect clarity. You should demonstrate an unerring ability to showcase market gaps and the potential solutions that might fill them. This is of especial importance in the current market.
As the application demands, founders must provide “details of all trading or other activities to be carried on by the company.” There’s no space to tip-toe around the fine details. HMRC will not be fooled. Avoid jargon, demonstrate how your business provides the solution to a problem in a clear and calculated way, and show how you plan to make money. Use evidence.
One of the most common reasons we see applications disqualified is “continuation of trade.” This refers to attempts to bypass SEIS eligibility, which involves a two-year age gap.
One group of Swedish founders we met wanted to scale their operation in the U.K. using SEIS. Their application failed (despite our 99% success rate) because HMRC discovered the company had operated for over two years, just under a different IP address. It’s for this exact reason HMRC demands such rigorous business plans from its EIS and SEIS applicants.
Certain other activities could also exempt you from the schemes — banking, insurance, money-lending, debt-factoring and hire-purchase financing, to name a few. Make sure you cover all bases. Only clear descriptions of your revenue streams will assure the people who assess your application.
Protect your property
There’s a good chance your business might be developing its own intellectual property (IP) rights, which might involve patents, trademarks or copyright. Defining your existing IP rights and describing your plans to license such rights in the future will help HMRC better understand your business and in turn approve your application. It also helps to prove your ambition to innovate, which is an important factor for high-risk investments.
The other edge to this is that some IP licensing is exempted in the SEIS rules. If you plan to license your IP and want to receive royalties in return, details about your plan to do so should be included in your business plan as an assurance.
Use specific wording
As described, your business plan will help HMRC understand your aspirations for growth. The prolific use of third-party contractors by early-stage businesses presents one challenge to proving this. HMRC understands third-party partnerships are part of the startup lifecycle, but it also wants to know that your business plans to bring some outsourced services in-house at some point.
To avoid confusion, specify every service you subcontract and each activity you perform in-house. Use specific wording. I’ve often seen founders refer to investors as “partners” in their business plans, which isn’t true. Investors will never be partners; they’re investors.
Getting this wrong can result in your application being rejected. As pedantic as it might sound, the semantics are important here.
Make ambitious but reasonable plans
HMRC will ask you to submit a chart of your three-year projected profit and losses as part of the EIS or SEIS application. The market’s current caution gives this chart especial importance. The chart will indicate the future financial health of your business and also reveal the type of speculative entrepreneurship that investors, and HMRC, will be trying to avoid.
Your chart should prove your ambition to outlast the current market uncertainty. It should outline your plans to reach every stage of growth, such as entering new geographical markets and releasing new product features.
It should also be realistic. HMRC’s team understands that your company will lose money over the first few years (that’s why you seek funding, after all). Just make it clear and make it honest.
Present your weaknesses
As part of the application, HMRC will require you to address the capital your business will put at risk. This might make you panic — after all, most founders aim to convince people that their businesses are very low risk. But you can relax, as HMRC actually looks for high-risk applicants for its EIS and SEIS schemes. It’s designed with them in mind.
Your business plan for HMRC should, for this reason, be different from the pitch you present to investors. The latter might rely on rhetoric, but EIS and SEIS applications should go straight down the line.
That said, remain cautious. Hard facts should remain consistent across the business. I’ve seen founders with delightful pitch decks and SEIS applications, but their websites present a different set of information, which reveals inconsistency. Don’t get carried away.
Demonstrate your plans for the funding
Investors will try to avoid unprofitable businesses at all costs. That means HMRC will scrutinize cash flow and future profitability with rigor. Your business plan should make it very clear where and how you plan to spend your investment.
We encourage founders to use pie charts to present this information. The charts tend to make it easier for everyone to see your plans and may also help you examine areas for improvement.
If your plan involves high spending on capital investment, this might reduce the “risk” aspect of your business, which invalidates your application for the SEIS scheme. On the other hand, activities that promote growth — new hires, marketing and R&D — will all support your claim.
No exit
Exit strategies might attract investors. In fact, many founders include them in the business plans they present in pitch decks. When presenting a plan to HMRC, however, you’ll want to avoid this.
An exit strategy might show an investor that you’re committed to make them money (what they care about), but it might give the people at HMRC the impression that you’re uncommitted to your business and therefore its long-term growth. Remove anything related to exit strategies, buyouts or acquisitions in your SEIS business plan.
Succeeding in your EIS or SEIS application could make or break your business in the current market. But all too often, founders fail to take the applications as seriously as they should. You need to take a specific, targeted approach when you complete yours.
Remain honest and clear. As long as your business is eligible, you should pass without a problem.
Comment