What Legal Documents Do You Need for an SEIS or EIS Round?

A guest article by Steven Mather, solicitor

What legal documents do you need for an SEIS or EIS round? Usually new articles of association, a shareholders' or investment agreement and the board and shareholder resolutions to issue the shares, plus an advance subscription agreement if investors are paying before the shares can be issued. Each of them has to stay within the scheme rules and reflect the investment as it was described to HMRC when it gave advance assurance, and that second point is where relief tends to come unstuck.

Most founders, quite reasonably, think of SEIS and EIS as a tax exercise, and the tax side is properly technical: whether the company and its trade qualify, how the round is structured, the advance assurance application and, later, the compliance statements. ASWATAX deal with all of that, including checking the articles and investor documents against the scheme rules. I draft those documents and get the shares issued, and although that sounds like the administrative end of the job, HMRC's advance assurance only covers the investment as it was described in the application. If the articles that are finally adopted give investors rights the application didn't mention, or the shares are issued in the wrong way or the wrong order, the relief can fail even though the tax planning was right. ASWATAX's EIS and SEIS page sets out the current limits and conditions, so I won't repeat them here.

The share rights

The schemes are strict about the kind of share that qualifies. For EIS, section 173 of the Income Tax Act 2007 requires ordinary shares which, during the relevant period, carry no present or future right to be redeemed and no present or future preferential right to the company's assets on a winding up. A preferential dividend is allowed only in narrow circumstances (broadly, where it isn't cumulative and neither the amount nor the timing depends on a decision of the company or the shareholder), and SEIS has equivalent rules in Part 5A of the same Act.

Several common investment terms fall foul of those rules, the obvious one being a liquidation preference, which gives investors their money back before anyone else on a sale or winding up. It's standard in venture capital deals but will stop SEIS and EIS relief, and so will a right to have the company buy the shares back at a fixed price. They usually turn up because the documents started life as a template from a larger funding round, or because the investor asked for them (which is understandable), and nobody checked them against the scheme.

The articles of association

Most small companies run on the model articles, or on a bespoke set adopted years ago that nobody has looked at since. An investment round is usually when new articles are needed, as the rights attached to the shares sit in the articles along with pre-emption rights on new issues and transfers, drag and tag along rights and leaver provisions for founders.

Most of that is fine under SEIS and EIS, but the articles still need checking against the scheme rules clause by clause, as that is where a stray preference or redemption right will usually be found. The documents are usually drafted after advance assurance has been given, so the share rights in them need to match the ones described in the application. Articles also tend to change during negotiation with investors, and if they do, the changes should go back to ASWATAX before anything is signed.

Most small companies run on the model articles, or on a bespoke set adopted years ago that nobody has looked at since.

The shareholders' agreement or investment agreement

This is where investors put their protections: consent rights over major decisions, regular financial information, sometimes a seat on the board, and warranties from the founders about the business, and generally speaking those are fine.

The trouble comes with anything that protects the investor from the risk of losing their money. Both schemes have a risk to capital condition, and HMRC looks closely at arrangements that amount to downside protection or a guaranteed way out, such as a put option, a promise by the founders to buy the investor's shares at a set price, or an understanding that the company will be sold to a particular buyer. Anti-dilution provisions need care too, depending on how they work.

Warranties are worth thinking about as well. A payment to an investor can count as the investor receiving value, which can reduce or withdraw their relief, so who gives the warranties and how a claim would be paid should be settled with the tax position in mind. It's much easier to deal with that at draft stage than after a claim has been made.

Advance subscription agreements

Sometimes the company needs the money before it's ready to agree a valuation and issue shares. A convertible loan won't work for SEIS or EIS, because a loan isn't a subscription for shares, so the usual alternative is an advance subscription agreement, under which the investor pays now and receives shares later.

HMRC has published guidance on when it will accept these for EIS (VCM12025) and SEIS (VCM33025). In short, the money mustn't be refundable, the agreement mustn't carry interest or be capable of being varied, cancelled or assigned, and the longstop date for issuing the shares should be no more than six months away. Relief only runs from the date the shares are actually issued, and if you want advance assurance you should get it before the agreement is signed. It's guidance rather than law, but in practice it is what HMRC applies.

Issuing the shares

The directors need authority to allot the shares. In a private company with only one class of shares they may already have it under section 550 of the Companies Act 2006, but if a new class is being created, or the articles restrict the directors, a shareholder resolution under section 551 will be needed. The statutory pre-emption rights in section 561, which would otherwise mean offering the new shares to the existing shareholders first, usually have to be disapplied. After that there is a board meeting to approve the allotment, an update to the register of members, a return of allotment (form SH01) at Companies House within one month under section 555, and share certificates within two months.

For the schemes, the shares have to be paid for in cash and fully paid up when they're issued. Small companies sometimes issue the shares and chase the money afterwards, and that doesn't work here.

Where a round uses both SEIS and EIS, the EIS shares have to be issued at least a day after the SEIS shares. The safest way to handle that is two separate allotments, each with its own board approval, on dates agreed with ASWATAX in advance, because getting the order wrong can cost the investors their SEIS relief.

After the shares are issued

ASWATAX deal with the compliance statement and the certificates investors use to claim, but relief can still be lost later if the company does something during the qualifying period that breaks the rules, for example buying back shares from investors, issuing new shares that rank ahead of theirs, or making payments to investors beyond normal commercial terms.

A covenant in the shareholders' agreement that the company won't do anything to put relief at risk without investor consent gives investors some comfort, and it also puts the point in front of the directors before they act, which is useful two or three years in when the people running the company are busy and the scheme conditions are no longer front of mind.

Working with your tax adviser

Tax advice and legal drafting are often done by different people who don't speak to each other, and over the course of a negotiation the documents can drift away from what HMRC was told. The simplest way to avoid that is for the solicitor to see the advance assurance application and HMRC's response before drafting, and for any later change to the documents to go back to the tax adviser before signing.

If you're planning a round, start with the structuring and advance assurance with ASWATAX. When you're ready to put the articles, the shareholders' agreement, any advance subscription agreements and the share issue paperwork in place, that's where I come in.

FAQs

Do I need a solicitor for an SEIS or EIS round?

Not for the tax side, but most rounds need new articles and an investment or shareholders' agreement, and those have to be drafted within the scheme rules. A small round with a single investor may need less, although the share issue paperwork still has to be right.

Can investors have a liquidation preference on SEIS or EIS shares?

Not during the qualifying period, because a preferential right to the company's assets on a winding up is not allowed, so the usual venture capital liquidation preference has to come out.

Can I use a convertible loan note for SEIS or EIS?

Not if the investor wants relief, because a loan isn't a subscription for shares. An advance subscription agreement that follows HMRC's guidance is the usual alternative.

What happens if the deal changes after advance assurance?

Advance assurance only covers the investment as it was described to HMRC, so changes should be checked with your tax adviser before signing and reported to HMRC where they affect the position.

Sources

• Income Tax Act 2007, section 173 (EIS shares requirement): https://www.legislation.gov.uk/ukpga/2007/3/section/173
• Income Tax Act 2007, Part 5A (SEIS): https://www.legislation.gov.uk/ukpga/2007/3/part/5A
• HMRC Venture Capital Schemes Manual, advance subscription agreements: VCM12025 ; VCM33025
• Companies Act 2006, sections 550, 555 and 561: s550 ; s555 ; s561

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About the author

I'm Steven Mather, a business solicitor. Most of my work is company sales and purchases for owner-managed businesses, and I also draft shareholders' agreements, articles and share issue documents, including for SEIS and EIS rounds, on fixed fees agreed before I start. You can find out more at stevenmather.co.uk, and do get in touch if you need some help.

Written by Steven Mather, a business solicitor acting on company sales and purchases. This is general information about the law, not legal or tax advice on your situation. Steven's legal work is carried out through Nexa Law Limited, which is authorised and regulated by the Solicitors Regulation Authority (SRA number 633024).