"The Treasury sought to focus EIS towards sectors that it truly wanted risk capital to focus on, such as our primary sectors of innovative technology and life sciences."
Thankfully we were able to focus on the positives that we expected as the Treasury sought to focus EIS towards sectors that it truly wanted risk capital to focus on, such as our primary sectors of innovative technology and life sciences.
So, when the Chancellor did step up to the dispatch box and outlined a new environment for the EIS sector, one which returned it to its original conception focusing on investment in risk-based ventures and setting the scene for a movement away from capital preservation schemes, that was music to our ears. Perhaps the one thing that nobody was expecting was the use of common sense in introducing a principles-based approach.
As the recent guide from our trade body, EISA, outlines this was a new landscape but also a new opportunity, because the benefits that come with EIS/SEIS investment were not just being maintained but enhanced. For instance, the amount that individuals could invest through an EIS has doubled from £1m to £2m as long as at least £1m of that is invested in ‘knowledge intensive’ companies, while the total amount per tax year that can be invested in these ‘knowledge intensive’ businesses has been increased from £5m to £10m.
Those words, ‘knowledge intensive’, are particularly important. Back in 2015 the Government announced a number of changes to EIS and Venture Capital Trust schemes including the creation of special eligibility terms for ‘knowledge intensive’ companies. From this definition we know that an investee company is deemed a knowledge-intensive company if, at the time of the share issue, it meets an operating costs condition and either the innovation condition or the skilled employee condition:
To clarify, the operating costs conditions are:
• In at least one of the ‘relevant three preceding years’, at least 15% of operating costs must have consisted of research and development or innovation expenditure. Operating costs are, broadly, expenses recorded in the profit and loss account or income statement other than those incurred intra-group; or
• In each of the three ‘relevant three preceding years’, at least 10% of operating costs consisted of R&D expenditure.
The innovation condition is:
• At the time the shares are issued, the issuing EIS company has created or is creating (or is preparing to create) intellectual property and it is reasonable to assume that within 10 years of the share issue, the exploitation or use of that intellectual property will form the greater part of the issuing company’s business.
The skilled employee condition is:
• At least 20% of the investee company’s workforce has a higher education qualification and is engaged directly in R&D carried on by the issuing EIS company (or in groups, the issuing/investee company and any qualifying subsidiary).
For the above purposes, the last of the ‘relevant three preceding years’ ends on the later of either:
• Immediately before the beginning of the company’s last accounts filing period that ends before the share issue; or
• Twelve months before the date on which the relevant shares are issued.
These might form the baseline for the definition of ‘knowledge intensive’ but, given the changes announced in last year’s Budget and the increased focus on EIS/SEIS thereafter, we expect this definition to be fleshed out further over time. Indeed, it will be interesting to see how the characterisation of ‘knowledge intensive’ evolves.
With regards to the research and development aspect, it’s important to recognise that although a company must be undergoing R&D this does not preclude them from being revenue generating. For example, at EIS level, Deepbridge looks for companies that are revenue-generating or can prove they have a commercial market yet are continuing to undertake R&D and further product development. This investment criteria of being revenue generating, provides a degree of reassurance as it demonstrates that the investee company is not ‘just a good idea’ whilst the continuing product development is likely to allow for potential significant growth.
Managers need to look carefully at their investees ‘knowledge intensive’ capabilities, and rather importantly, the type of sectors where such businesses are likely to be proliferating. Having that experience to find these firms will be crucial because it’s quite clear that not all businesses can meet the ‘knowledge intensive’ grade in order to benefit from the sizeable opportunities that the Budget has thrown out.
Working with sector-focused managers will help reassure advisers and investors that the manager understands how to work with knowledge intensive companies. This term is not new and those managers that have specific experience of investing in the innovative sectors, such as technology and life sciences, are likely to be best placed to make the most of the generous expansion of the EIS for knowledge intensive companies.
