EIS/SEIS - is there any protection against loss

It is easy to get swept away by the generous tax reliefs and invest funds. We explain below that there are some protections to take but they are fairly limited for investors.

It is a difficult balance between ensuring your investment:

• Grows in value as the company grows; and
• Is not foolishly, or worse, fraudulently frittered away.

Based on past experience, we have explained common concerns.   Protections should be reflected in the investment agreement, shareholders agreement or the company’s articles of association.

Legal safeguards for EIS/SEIS investors

Often the founder(s) desire a “no-strings” investment.  So there is a risk the founders might pay themselves an excessive salary, which ruins the business, or take their newly acquired knowledge and expertise and set up a rival company of which they own 100%. Hence SEIS and EIS investors should require:

• Veto rights on director salary increases and other types of expenditure;
• Leaver provisions that force the founder(s) to offer their shares to the remaining shareholders if they stop working for the company;
• Restrictive covenants that impose protective periods during which founder(s) cannot poach staff, approach customers or set up in competition;
• Confirmation that intellectual property has been adequately registered and protected;
• Review of the business plan; and
• Control to prevent the business failing to satisfy the qualifying trade requirement which is the same for SEIS and EIS.

Is there a minimum investment requirement for EIS and SEIS?

There is no minimum subscription level required for an investment to qualify for SEIS or EIS relief.

What rights should minority shareholders look for with EIS or SEIS?

Minority shareholders do have rights if the directors act in breach of their fiduciary duties.  However, enforcing those rights will be much easier if the investment agreement contains the provisions they may need to rely upon if disputes arise. Things to consider include:-

• Tag-along & drag-along rights - SEIS and EIS investors  should ensure they won’t end up holding the company with a total stranger following a sale of the business.  So investors should have tag along rights which give minority shareholders a right to piggy back (tag along) on any sale of shares to a third party and  drag along rights which enables SEIS and EIS shareholder to require that any forced sale of their own shares, as part of a company sale, cannot happen unless the purchase price at least equals the original purchase price.
• Prospect of future dilution  -  SEIS and EIS investors are not afforded special anti dilution rights.  That means that need to due their due diligence to take calculated risks.
• A pre-emption right: this is essentially a right of first refusal. For instance, an EIS investor holding 5% of the shares, who wants to maintain a 5% stake, gets first refusal to invest additional funds to maintain their 5% shareholding.

What veto rights do EIS/SEIS investors need?

The directors usually determine the day-to-day management issues. However, SEIS and EIS investors may decide that certain matters require their approval. This “wish-list” requires consideration. A lengthy “wish-list” of matters requiring investor approval might hamstring the company. Nevertheless, such matters could include:

• Corporate structuring protections:  e.g. no shares are subdivided or re-designated without investor approval;
• Loans or capital expenditure: greater than a threshold, say £5,000, which would be a fairly low level of micro-management;
• Information rights: the investors may well demand the right to request information.

Warranty as to satisfaction of EIS/SEIS conditions

Investors can request a warranty that the conditions for EIS/SEIS are satisfied. However, post investment events can happen during the life of the investment which cause the investment to fail for EIS/SEIS purposes.  Often a company will refuse to provide any warranty - it is a matter of doing your due diligence.