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Recent figures from HMRC have shown that a record number of companies have raised funds via the Enterprise Investment Scheme (EIS). In 2021-22, this grew by 19% on the previous year to 4,480 – with total funding rising to £2,305m (up by 39%).
These are encouraging signs for investors and startup founders, particularly following the difficult COVID-19 pandemic years. Below, we explore why the figures are up and some implications for early-stage investor portfolios going forwards.
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The rise in EIS investing
In 2020-21, 3,755 companies raised a total of £1,658 million of funds under the EIS scheme. This was at the peak of Britain’s “lockdown era” and it represented a notable fall from the previous year. In 2019-20, 4,215 companies raised a total of £1,905 million in funds.
The Institute for Government (IFG) provides an interesting timeline of COVID-19 events to “map” over these EIS figures. In the most recent EIS figures mentioned above (for 2021-22), this was the period when “non-essential retail” started to reopen.
Outdoor venues such as pubs, restaurants, zoos and theme parks started to open their doors again. Steadily, the prohibition on household mixing was relaxed slightly to the “rule of 6”. By July, legal limits on social contact were removed in England.
This gradual re-opening of the UK economy correlates with growing EIS fundraising. Not only were investors starting to regain confidence that “normality” was starting to return, but a year had passed since the COVID-19 outbreak – giving businesses time to adapt to a new way of operating (remote and online-based working).
In 2020, 726,000 new businesses were created in the UK compared to 636,000 in 2019. Online retail businesses comprised a significant portion of this entrepreneurial wave. Moreover, McKinsey noted that COVID-19 had pushed many businesses “Over the technology tipping point and transformed [them] forever”.
Naturally, this created a more “ripe” startup landscape for EIS investors. As BDO tax partner, David Brookes, says: “The latest figures show an encouraging rebound … both [EIS and SEIS] offer valuable funding opportunities for new and growing businesses, particularly in the tech space, which are so crucial in helping to drive economic growth.”
Looking ahead – EIS in 2023
EIS remains an attractive option for founders and investors in 2023-24. One issue currently highlighted by BDO is that there is a rise in rejections of advance assurance applications for SEIS in EIS. In their efforts to clamp down on unjustified tax relief claims, many investors feel that officials are being a bit excessive in their interpretation and implementation of the rules.
To guard against this, it can help investors to work within a dedicated investor network (like ours at Bure Valley Group!) to help navigate the complexities of both schemes and increase chances of application success.
As noted in previous articles, EIS is likely to become increasingly popular with investors from 2023 as other tax allowances shrink – e.g. the Annual Exempt Amount for tax-free capital gains. However, the fundraising climate in the 2022-23 tax year may prove harder than the prior year.
The cost of living rose sharply in 2022 and inflation continues to rise high today, in August 2023. Rising input costs have affected many UK businesses, including startups, and pressured their margins. Higher interest rates have also made it harder to raise money from lenders.
71% of startups saw inflation as their “top concern” in 2022. Whilst inflation figures are more encouraging in August 2023 (7.9%), demand for many raw materials remains high and is continuing to put financial strain on business owners.
Yet the appetite for funding remains strong. In August 2022, reports showed that 66% of businesses were seeking investment despite the economic climate. With lenders more reluctant to offer finance, this created more space for EIS investors to approach founders.
Indeed, 40% of businesses reported that they had “missed a business opportunity in the past 12 months” due to a lack of finance. EIS investors can help startups avoid further opportunity costs moving forwards – giving founders another option apart from debt.
One of the best defences against inflation for startups is investing in infrastructure – anything that improves productivity and efficiency-enhancing processes.
As such, EIS investors may wish to look out for startups which are focused on enhancing their overall competitiveness and output (instead of those with a determination to grow short-term profit without an eye on the long term).
More than before, startups need to demonstrate to EIS investors that they are paying close attention to financial modelling and forecasting, re-forecasting targets and budgets, cash-flow analysis and the subsequent impact of expenditure changes.
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