New rules for knowledge-intensive EIS
From 6 April 2018 the EIS allowance has effectively doubled. It is now possible to invest up to £2 million in EIS, provided anything over £1 million is invested in “knowledge-intensive” companies.
In addition, “knowledge-intensive” companies will be able to receive up to £10 million in EIS funding in a year, up from £5 million.
The rules have also been relaxed so in some cases it will be possible to invest in companies which have been trading for more than 10 years (the current requirement for knowledge-intensive companies).
What does ‘knowledge-intensive’ mean?
Broadly speaking, the expression refers to young and innovative businesses. So, for instance, a company which is developing a new drug or treatment would likely fall under the umbrella. A chain of shops opening new sites most likely won’t.
As you would expect, though, HMRC has set specific requirements a company must meet to be categorised as knowledge intensive.
Firstly, there is an ‘operating costs’ condition. When it issues shares the company must have spent:
- at least 15% of its operating costs on research and development or innovation in one or more of the previous three years (or in the three years following investment for a new company); OR
- at least 10% of its operating costs on research and development or innovation in each of the previous three years (or in the three years following investment for a new company).
In addition, the company must meet either an ‘innovation’ or ‘skilled employee’ condition.
The first, the ‘innovation’ condition, requires a company to be creating or have recently created intellectual property, that it will use for its main business activities.
A wide variety of companies could qualify. Scientific companies are probably the first that spring to mind but are not the only ones. A cartoon character created by an animation company could well be that company’s protected intellectual property; so could a piece of software, an app, or a machinery component.
To pass the ‘skilled employee’ test, at least 20% of a company’s employees must hold postgraduate degrees in a subject relevant to their job and must be engaged in research and development.
What other benefits do knowledge-intensive companies enjoy?
The first raft of changes in favour of knowledge-intensive companies was introduced in 2015. Since then, knowledge-intensive companies can:
- receive up to £20 million funding through the venture capital schemes over their lifetime (normally £12 million);
- qualify for EIS if they have up to 499 employees (normally 249);
- qualify for EIS if they have been trading for up to 10 years (normally 7)
The 2017 Autumn Budget relaxed rules further. From 6 April 2018 knowledge-intensive companies will be able to receive up to £10 million of EIS or VCT funding per year (up from £5 million). In addition, whilst before they could receive funding up to 10 years from their first commercial sale, now the 10-year clock could start when their annual turnover first exceeds £200,000.
All these changes mean knowledge-intensive companies will be able to receive more funding over a longer period of time.
Why are the rules changing?
The government wants to support young and innovative companies. It sees particular value in knowledge-intensive companies because of the volume and quality of the jobs they create and the wealth they produce for the country. But it also recognises developing innovation is very costly for companies and takes a long time. It is also riskier for the investor. Therefore, to get more money into these sectors, the government is trying to sweeten the pill for investors by increasing the amount they can invest whilst at the same time softening the rules for the companies looking to raise money.
The EIS changes are welcome. It is basically the government saying, ‘we like EIS and we want to do more to promote it’. In reality, the increased allowance will not make much difference to investors – the vast majority currently invests less than £50,000. What could have a real impact in our view is the fact that the right company can now receive more money over a longer period under EIS. This should give any company with a great idea a better chance to turn it into a commercial success and reward early investors accordingly – although remember these are always high risk investments and capital is at risk.
How to invest in knowledge-intensive companies
The government is currently consulting on introducing HMRC-approved knowledge-intensive EIS funds. However, some EIS funds have been investing in knowledge-intensive companies for some time, so it is already possible for investors to get exposure to the sector.
An example of a knowledge-intensive company is AlgaeCytes, part of the Deepbridge Technology Growth EIS fund. AlgaeCytes has developed a patented process that exploits freshwater algae to produce Omega 3, currently largely produced from a limited and depleting fish population. The company is in negotiations with a number of large corporations involved in food, drink or healthcare product markets. In October 2017 it upscaled its production facilities, allowing it to increase production ten-fold and meet the needs of larger clients.
Indeed, Deepbridge has tested all of its EIS companies against the knowledge-intensive requirements and all qualify.
Another example of a knowledge-intensive company is Ceres Power, a spin-out from Imperial College and part of the Parkwalk Opportunities EIS fund. Ceres Power has developed technology that converts fuel directly into electricity. It uses mains gas, so it can be mass produced at an affordable price. Ceres’ technology has been endorsed through partnerships with global giants, including Japanese groups Honda, Nissan, Fortune 500 engineer Cummins Inc. and the U.S. Department of Energy. Ceres Power was getting close to the lifetime limit for VCT and EIS tax relief investment, so could directly benefit from the new rules.
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