How to protect EIS eligibility when using Growth Shares
Some of our competitors are telling startup founders that Growth Shares and EIS funding cannot co-exist.
But that’s a whole bunch of nonsense - with properly drafted articles they can happily exist alongside each other. Allow me to explain why.
First, just so we’re all on the same page:
- The Enterprise Investment Scheme (EIS) is a UK government scheme that offers tax relief to investors to help small high-risk trading companies get the funds they need. For eligible companies, it’s a no brainer.
- Growth Shares, on the other hand, are real shares, issued upfront, at a hurdle rate. Commonly used by high growth companies to attract talent and reward key players with a slice of the pie.
Eligible companies can benefit from both EIS funding and the use of Growth Shares. What seems to have ‘confused’ our competitors is the preferential nature of the waterfall structure.
One of the requirements for EIS is that EIS Shares must not carry any preferential rights which, among other things, means that they must come last in a waterfall.
A waterfall structure outlines how everyone financially involved in the venture will be compensated in the event of the sale of the company, or a liquidation.
Because of that, EIS Shares are generally issued as Ordinary Shares.
Long story short, Growth Shares are perfectly fine to be issued alongside Ordinary Shares that are issued for EIS… but they can affect EIS eligibility if the waterfall isn’t structured properly.
And that’s precisely what happened in the Abingdon Health Limited v HMRC (2016) case. The waterfall in Abingdon Health Limited’s articles was designed so that:
(i) firstly, payment of the hurdle amount was made to the EIS Shares, then;
(ii) secondly, the Growth Shares received their relevant payment, and;
(iii) finally any remaining funds were split on a pro-rata basis.
This caused issues because the proposed EIS Shares were receiving the first payment, giving them preference over the Growth Shares.
But if the waterfall is structured properly, incidents like this can be totally avoided.
How to structure the waterfall to preserve EIS eligibility
The Vestd Articles of Association are designed in such a way that EIS eligibility should not be affected by the waterfall when Growth Shares are issued. To avoid this problem, the waterfall is structured as follows:
- Firstly, the Deferred Shares get £0.01 between the class;
- Secondly, the Growth Shares receive their relevant payment;
- Finally, any remaining funds are awarded pro-rata among the A Shares (which will include the EIS Share classes).
The Articles also stipulate that EIS eligible shares do not get a preference in regards to dividends.
Hopefully, that’s cleared a few things up. We cover this topic in more detail on our Help site. Needless to say, Growth Shares and EIS can coexist when articles are drafted with this in mind.
To learn more about Growth Shares and how sharing equity could transform your business, book a free consultation with one of our equity consultants. They’ll be happy to answer any specific questions you may have.