How companies can benefit from both EIS funding and the use of growth shares.
EIS eligibility is vital for many companies and investors. It encourages investment in small businesses by offering tax advantages for eligible investors. For a company to be eligible for EIS and in turn be able to offer EIS Shares, it must meet certain criteria.
One of these criteria is that the shares being issued as EIS eligible shares (the “EIS Shares”) must not carry any preferential rights. This means, amongst other things, that the EIS Shares must come last in a waterfall, which dictates how the funds from a liquidation or sale of the company will be split among the share classes. As a result, EIS Shares are generally ordinary shares.
Growth Shares can cause problems for EIS eligibility if the waterfall is not structured properly. In Abingdon Health Limited v HMRC  TC 05525, EIS relief was denied due to the proposed EIS Shares receiving a preference. This was found due to the fact that the waterfall in Abingdon Health Limited’s articles was designed so (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 which gave them a preference over the Growth Shares.
The Vestd articles of association have been designed in such a way that EIS eligibility is not affected by the waterfall when Growth Shares are issued. This problem is avoided by structuring the waterfall 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).
Since the EIS Shares are paid last in the waterfall, it does not have a negative impact on their EIS eligibility. It should be noted that there are various additional criteria that a company must meet in order to be able to issue EIS eligible shares.
Similarly, the Vestd articles of association are designed so that any EIS eligible shares do not get a preference in regards to dividends. The articles allow for differential dividends with the caveat that any class of shares which has previously received EIS advance assurance from HMRC, or has been granted EIS relief, shall not receive any dividend greater than another class of shares. The only exception to this is the deferred shares, which are not eligible for dividends.
HMRC provided some clarity around the fact that EIS Shares may have a preference over deferred shares in certain circumstances and still be EIS eligible, stating:
“The rights carried by ordinary shares may in some cases be preferential as compared with the rights of deferred shares, but this is not necessarily so. In particular, where deferred shares carry a purely theoretical right to a residue of assets in a winding up (for example where, in the case of a very small company, after the first £20million has been distributed to ordinary shareholders the deferred shareholders are entitled to 1p per share) we do not regard the ordinary shares as carrying a preferential right.
Where a company has two classes of issued share capital, and dividends are declared on one class but not on the other, the right of the former class is not a preferential right."
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