cover of How to Fund Your Business: The Essential Guide to Raising Finance to Start and Grow Your BusinessHow to Fund Your Business: The Essential Guide to Raising Finance to Start and Grow Your Business
author: Steve Parks
asin: 0273706241

Over the last couple of days some further details have been emerging about the small print behind the budget.

One change that has caught my eye is a new restriction on two key sources of finance for fast-growth companies - Venture Capital Trusts (VCT's) and the Enterprise Investment Scheme (EIS) - two key sources of funding I write about in How to Fund Your Business.

From the new tax year (6th April, 2007) only companies with less than 50 employees will be able to seek finance from these sorces, and they will be allowed to raise a maximum of £2m in any one year.

At first sight this looks like bad news - and to companies with more than 50 employees or looking to raise more than £2m it is! - but on giving it more thought this might actually be good for UK entrepreneurs as a whole.

In general if you're raising more than £2m and you've got a mid sized company then you can attract the interests of Venture Capital investors - but raising amounts of less than £2m, and raising investment for earlier stage companies can be more difficult.

These measures will encourage (or force) VCT's and EIS investors to direct their investments at these earlier stage companies, rather than at the 'safer bets' in larger companies, and perhaps go some way to solving some of the 'funding gap' that has been identified in the UK.

What is the Enterprise Investment Scheme?

The EIS is a scheme offered to small companies and their investors by HM Revenue and Customs (HMRC). It offers a package of benefits to investors to encourage them to provide funding over a period of three years or more to companies that would otherwise be seen as too risky.

These benefits include:

  • An immediate tax relief of 20% of their investment. So if they invest £100k in you now under the EIS, they can reduce their current year's tax bill by £20k!
  • Any gains they make on their investment in you are exempt from Capital Gains Tax (CGT) - which otherwise would take away 40% of their profit.
  • If they were about to incur Capital Gains Tax on the money they are investing in your business (perhaps they sold some shares and are then using that money) they can defer the CGT for as long as the investment remains in your business.
  • No inheritance tax is incurred on investments made under the EIS scheme (that have been held for at least two years prior to death).
  • If something goes wrong and the investor makes a loss on their shares in your business, they can claim loss relief, reducing their tax bill in compensation.

These benefits provide a significant counterweight to the risks of investing in smaller companies, and make it much easier for entrepreneurs to raise funding from Business Angels.

What are Venture Capital Trusts?

VCT's are another scheme offered by HM Revenue and Customs to encourage investment in enterprise, this time by allowing tax relief to investors in stock-market listed vehicles that invest in a portfolio of small companies.

The benefits investors in VCT's receive are:

  • Income tax relief of 30% of the amount invested (this used to be 40% but was reduced in the last budget).
  • Exemption from Income Taxon the dividends from teh shares in the VCT.
  • No Capital Gains Tax when they sell the shares in the VCT.

There are restrictions on what companies VCT's are able to make investments in, including certain restrictions on trading activities, value of assets etc, but most small companies will be eligible.

Of course, with VCT's the investment in the trading company is made by professional fund managers so there'll be a lot more due diligence than investments made by business angels under the EIS.

But both of these schemes offer small companies good opportunities to raise investment, and that may just have got easier following Gordon Brown's latest budget.