Taking on equity investment – selling or issuing shares in your company to outside investors – is a milestone for any businesses. It brings a host of opportunities as well as challenges, and it comes in many different forms. This section of the guide will cover the most common forms as well as the all-important SEIS and EIS tax reliefs.
Before we dive into the detail, it is worth bearing a few overarching points in mind when seeking equity investment.
The Seed Enterprise Investment Scheme (SEIS) and the Enterprise Investment Scheme (EIS) are government approved schemes which provide significant tax reliefs to UK tax-paying individuals who invest in early stage UK companies by subscribing for shares.
In a nutshell, investors are able to claim back a material portion of their investment into an SEIS / EIS qualifying company against their income tax bill. EIS investors benefit from a 30% tax deduction – this means that an investment of £10,000 would in fact cost them just £7,000. They can also benefit from 0% capital gains tax, if certain conditions are satisfied.
It can therefore be important (or even critical) for individual investors, such as angels, to be able to claim SEIS/EIS tax relief on their investment. Institutional investors (e.g. venture capital funds and trade investors) will not be able to benefit from these reliefs, although some venture capital funds have EIS funds (effectively pools of individuals) that can benefit.
SEIS and EIS each have a similar objective – to encourage investment in high-risk, early stage UK companies – and a similar outcome – tax relief for the investor – but differ in the companies they cover and the scale of the tax relief on offer. In general, SEIS is targeted at very early stage companies whereas EIS is targeted more at medium sized start-ups. They can, however, be used together as part of the same investment into the same company.
Although it is the individual investor that directly benefits from these tax reliefs, the company raising the investment will also benefit. This is because the tax reliefs reduce the cost for the investors to invest (as they effectively get a material portion of their investment back from HMRC), which makes the investment more attractive. This means, if your company qualifies for SEIS / EIS, you may find it easier to attract the investment in the first place and demand better terms from the investors.
More information on qualifying criteria is below.
For any young business in the games sector, SEIS and EIS are important to understand, as the reliefs they offer will often be a key incentive for a potential investor to provide early stage equity investment into your studio. Many investors will treat SEIS / EIS qualification as a condition of their investment.
If you plan to raise equity investment from individuals, it is therefore critical to have considered whether the reliefs will be available and possibly (if not ideally) received advance assurance from HMRC (see below).
Studios will often set up a special purpose company for each new game project, in particular due to the need to optimise the video games tax relief that may be available. As a practical point, it is important to consider whether the SEIS/EIS investor is investing in a special purpose company that you have established solely to develop and exploit one game, or a company that intends to develop numerous games. This is likely to have a material impact on the availability of tax relief and, accordingly, the deal that you reach with the investor.
If you are seeking SEIS or EIS finance for a special purpose company established to develop and exploit a single game then you should take specialist advice because there are some restrictions on the use of SEIS and EIS finance in this context.
As from 15 March 2018, the Seed Enterprise Investment Scheme (SEIS) and the Enterprise Investment Scheme (EIS) were subject to a new ‘risk to capital’ condition.
The ‘risk to capital’ condition has two limbs:
HMRC has published guidance (which includes various worked examples) to help companies and investors answer this question. The guidance is available here: https://www.gov.uk/hmrc-internal-manuals/venture-capital-schemes-manual/vcm8500, and the answers to the questions below summarise the key elements of it.
The general theme from the guidance is that HMRC is seeking to ensure that SEIS and EIS are only used to raise capital that is truly at risk (and not protected or secured by the investee company in any way). HMRC has said that it will take an holistic and (according to the guidance) “reasonable” view (taking into account sector/industry standard practice) in assessing whether the condition has been met.
The guidance makes clear that companies established for the sole purpose of developing and producing one specific project which will be completed within a fixed timeframe are unlikely to qualify. Instead, it expects a qualifying company to re-invest capital with a view to expanding its business (such as by increasing revenues, expanding its employee or customer base or building a brand) over a period beyond the EIS and SEIS minimum holding periods of 3 years.
For a games studio, this requirement is likely to translate into a development company that is raising money either for a slate of projects (and which does not intend to return funds to investors based on the performance of a game in a single format but re-invests any profits from a successful game into the development of sequels or new formats or other new projects) or a ‘game as a service’ where the studio’s intention is to continually develop and evolve a single game over the long-term with a view to expanding its appeal and growing its revenue generation. We are not aware that the ‘game as a service’ model has been tested with HMRC following the introduction of the risk to capital condition, but applying HMRC’s guidance provides sound arguments that such a model should not fall foul of the condition merely because it involves the development and exploitation of a single game, provided that profit from the game is re-invested in the continued development and improvement of the game. It is likely, however, that any business plan submitted to HMRC (as part of a submission for advance assurance that the studio will qualify for SEIS and/or EIS relief) would need to provide a contingency plan for any ‘game as a service’ that was not commercially successful and which did not therefore merit further investment. In such a case, the studio’s business plan would need to contemplate investment in new projects (rather than winding up the company and distributing assets (after payment of any liabilities) to shareholders).
A summary of the key points is as follows:
Main rules that apply to both SEIS and EIS
The shares in the fundraising company that are subscribed for by the investor must be:
or the reliefs will be not apply.
Main rules that apply specifically to SEIS
Rules that apply specifically to EIS
HMRC operates an “Advance Assurance” process for companies seeking SEIS and EIS eligibility through which it will assess a company and business for SEIS or EIS eligibility and, if successful, provide an initial, non-binding, indicative certificate to the company. Although the certificate is of limited legal force, it is frequently requested by more sophisticated angel investors as a condition of their investment.
As part of this process, applicant companies typically submit their articles of association and, if relevant, shareholders’ agreement to HMRC and so it is important that companies take legal and tax advice in connection with these documents to ensure that they comply with the SEIS or EIS rules (as applicable).
There is a plethora of online guides and resources relating to SEIS and EIS. We suggest looking at the HMRC advice as a starting point, which is available here and here.
The rules are complex so we suggest that you seek specialist advice if you wish to establish an EIS or SEIS.
Feel free to contact Mark Phillips or Edward Lane for further information about EIS or SEIS.
The terms “business angels” or “angel investors” are normally used to describe high-net worth individuals who invest in early stage businesses. Over the past decade, encouraged by the significant tax reliefs available through SEIS and EIS, it has become increasingly common for early stage companies to seek their initial rounds of finance from business angels as well as from the well-trodden ‘family and friends’ route.
The benefits for a company seeking finance from a business angel rather than a larger institutional investor such as a venture capital fund are several:
The biggest issue with business angels is finding them! Traditionally business angels have invested in sectors other than games (such as technology and online services companies). For games companies therefore, a continuing challenge is to find angel investors who are active in the sector – especially when they rarely advertise themselves in public. The most effective way of finding business angels is to simply broaden your network as much as possible by attending industry-focussed events or conferences and seeking referrals from more seasoned players in the industry who may just refer you to the right contact.
Some business angels operate in “clubs” or “syndicates”, e.g. the interactive entertainment-focused TGF (The Games Fund) and The Games Angels. The angels in these groups act together so a company is likely to be able to raise a larger amount in a single process. The downside however is that these groups can sometimes act as a mini-institution and therefore lose the speed, flexibility and ‘softer’ approach of a more typical angel. Your lawyer may be able to direct you to clubs or syndicates of angels.
With the recent boom in angel investment in the UK, investors have become much more sophisticated and therefore more discerning of potential companies looking to fundraise. This has had several knock-on consequences:
Feel free to contact Mark Phillips or Edward Lane for further information about business angels.
In its broadest sense, the term “venture capital” can mean any source of finance from investors seeking a return on their investment (including even angel investors). However, most people would understand the term to refer to institutional funds whose main business it is to invest money in a portfolio of early stage businesses with a view to realising an exit after a certain period (typically between three to six years) to achieve a return.
Bringing on a venture capital fund as an investor in your business has many risks and challenges, as well as opportunities. Here are some of the key things to think about.
‘Private equity’ is another term with many different meanings, however, in the investment context, the term is usually used to refer to ‘private equity funds’. These funds differ from venture capital funds in that they normally buy established companies outright (or at least a majority shareholding) rather than investing in minority shareholdings. Growing games companies are therefore unlikely to cross paths with ‘private equity funds’ until they are much more established.
Private equity funds will tend to hold investments for a period of 3 – 5 years and so, like venture capital funds, be very focused on their exit. This may mean that a condition of their investment is that they can require you to sell at the same time as them.
Like venture capital funds, they will expect certain protections and control over key decisions (such as incurring high levels of debt or issuing more shares). However, they will not usually request oversight over day-to-day management of your business. Whilst they will usually seek to have a representative on the board of your company, they are there to monitor and generally not to instigate operational changes. However, the approach of each fund is different.
Feel free to contact Mark Phillips or Edward Lane for further information about Venture Capital and Private Equity.
Accelerators are organisations that provide various forms of both financial and non-financial support to early stage businesses, with the aim of helping to “accelerate” the business and improve its chances of attracting investment at a later stage.
Accelerators sometimes provide equity funding (i.e. funding for shares) or grant funding and, often more importantly, non-financial assistance to companies. The main types of non-financial assistance that an accelerator can provide include: (1) the provision of subsidised office space; (2) software or hardware for the development of technology or IP; (3) marketing and advertising services; (4) introductions to other investors and people who may help further grow the business; and (5) mentoring support.
An accelerator can help a studio or other business that is at the early stage of its development and needs advice on its future plans and any or all of the forms of support outlined above.
Accelerators that are known to have funded games businesses in the past include Techstars London, Seedcamp, Founders Factory, Entrepreneur First, Microsoft Ventures and Y Combinator. In addition, Creative England, Indie Lab and UKIE (partnered with Barclays) provides accelerator programmes for games companies with advice from experts and opportunities to pitch to investors on offer.
Please contact Mark Phillips or Edward Lane for more details.
Most accelerators operate rounds of scheduled events and support activities that run for a fixed duration (typically around three months) and so applicants will need to apply for their services in these set windows. Studios interested in applying to an accelerator should note that the terms of any cash injections are usually non-negotiable. A studio chosen to participate by an accelerator will usually work onsite at the accelerator’s premises for the duration of the programme. This allows the entity to get the most benefit from the mentoring, support, introductions, lectures, and the other benefits the accelerator provides. Finally, normally the key factor in the selection process is down to the willingness of the founders to receive advice and adapt the business accordingly.
Although the terms “accelerators” and “incubators” are often used interchangeably there are a few differences in how they operate and their aims. The main difference is that incubators may be run as non-profits designed to help start-ups find their footing through shared space and costs to help boost the local economy. Accelerators are run for profit by taking an equity stake in each company they host (although this can apply to some “incubators”). As well as this, accelerators are usually time limited programs, while incubators sometimes do not have any time limit on how long a company can continue to use the services.
As accelerators are generally and incubators can be profit-seeking businesses (and/or businesses looking to recoup their investment and make a return on their investment), care should be taken when reviewing and accepting a place on an accelerator to ensure that you are comfortable giving away the amount of equity the accelerator or incubator is asking for. It may be a good idea, depending on your budget, to seek legal advice to make sure you are protecting yourself properly.
Feel free to contact Mark Phillips or Edward Lane if you need any further information on Accelerators.
