Over the past year companies from all sectors have had to deal with significant financial strain due to the impact of Covid-19. This has lead to many companies considering taking on debt and/or equity finance in order to keep solvent. But what does this mean for companies looking to raise investment under Venture Capital Schemes such as VCT and SEIS/EIS?
Any company intending to raise investment through Venture Capital Schemes (“VCS”) will need to ensure they are not deemed to be in financial difficulty per HMRC guidelines. On the 26th of February 2020, HMRC introduced new guidance concerning how a company is defined as being in financial difficulty.
Financial Difficulty Criteria
HMRC categorises a company as being in financial difficulty if it meets the criteria for insolvency under the Insolvency Act 1986. HMRC will also consider a company to be in financial difficulty if:
- The company cannot pay their debts, as and when they fall due.
- The value of the company's liabilities is greater than its assets, taking into consideration it's contingent and prospective liabilities (the "balance sheet test").
- The company has been trading for more than seven years, and more than half of its subscribed share capital has been wiped out as a result of accumulated losses.
It is worth noting concerning point two, that if the company's liabilities are greater than it's assets due to an isolated event, the company can still be considered financially healthy. For example, a loan that is not due to be paid for several years or a directors loan with no due date or interest. It is worth detailing in the advance assurance cover letter; what the debt is, when it's due, and any interest to be paid, thus illustrating that the company that is financially stable enough to meet its obligations and continue its trade for the foreseeable future.
Any company intending to or has previously raised money under the Venture Capital Schemes should ensure they are operating under a going concern basis. Companies who do not follow the guidance set out by HMRC, risk mis-selling their investment opportunity, which may potentially result in investors not being able to get the tax reliefs offered by the VCS. It is therefore strongly recommended that when submitting VCS applications, companies should be fully transparent and honest about their financial situation when they are embarking on fundraising.
Finally, companies should make note that investment raised under VCS cannot be used to repay company loans whether they are directors loans, commercial loans or government-backed loans (such as the Business Interruption Loan Scheme, The Bounce Back Loan Scheme, etc).
This is a brief summary of the main points relating to areas to consider when companies are under financial difficulty and does not constitute financial advice. You should seek the assistance of financial professionals should you have concerns around this matter for your business.