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HMRC internal manual

Venture Capital Schemes Manual

New product or geographic market

The money raised under the 50% test must be used for entering a new product market or new geographic market.

A product market is all those products and / or services which are regarded as interchangeable or substitutable by the customer, by reason of the products’ characteristics, their prices and their intended use.

A geographic market is the area in which the company is involved in the supply and demand of products or services, in which the conditions of competition are sufficiently similar and which can be distinguished from neighbouring areas because the conditions of competition are appreciably different in those areas.

Whether a company is entering a new product or geographic market will depend on the precise circumstances of the company:  what it has done in the past and what it is intending to do. The company will need to explain in detail what it has been doing (and where), what it will be doing (and where) and why the new activity means it is entering a new product or geographic market.

The investment must be made before the company embarks on the new business activities. The test is the extent to which the company has already started activities for the purposes of entering a new product or geographic market or not. This is different from the approach taken to determine a company’s initial investing period which relies on the date a company has made its first commercial sale. A first commercial sale may take place after a test sale.

By contrast, if a company has already taken definite steps to enter a new product or geographical market, for example by carrying out widespread test sales, the company will have begun to develop enough of a track record in that activity for commercial lenders to evaluate whether the activity would be viable, bearing in mind the company’s business track record.

Ultimately it will be a matter of fact as to whether a company’s previous activities in a new market are materially significant. Factors to consider may include:

  • the amount of activity already carried out by the company in the new market: the more activity carried out, the less likely the company is to be preparing to enter a new market
  • the length of time those activities have been carried out for: the longer the company has been investigating the market, the less likely the market is to be new to the company
  • the amount of money already expended in the new market as a proportion of the amount of the investment sought: the more money and resource expended before the relevant investment is received, compared with the amount of the proposed investment the less likely the market is to be new.

The factors above are for illustrative purposes only. Other factors may also come into play depending on the exact circumstances of the company, its history and its past and future activities.

Example 33

A company that started trading in 1990 to supply unbranded parts for a large car manufacturer wants to start making and marketing bespoke, branded, parts directly to enthusiasts restoring vintage cars.

Is there a new product market?

  • If the company’s business has always been to supply the large car manufacturer, the vintage car restoration market may well be a new product market because the vintage car enthusiasts would never have heard of the company let alone consider it could provide parts for their cars.
  • However if the company has been operating from premises and supplying bespoke parts for a range of customers, it is likely that the company is already known among the customer base as a source of bespoke parts. In that case there may not be a new product market.
  • If the company were to sell the parts through the large car manufacturer for onward sale to the vintage car enthusiasts there would not be a new product market.

Is there a new geographic market?

  • What are the company’s current and proposed geographic markets? If the company has been operating in a geographic area, perhaps with its sole customer being a nearby car manufacturer, and if the vintage car enthusiasts are spread across the country, it is possible that the company may now be entering a new geographic market.
  • However if the company was supplying several manufacturers across the country (and has always been open to take on new orders) it would be less likely to be entering a new geographic market with its vintage car enthusiasts.
  • Companies that are already providing goods and services through internet sales are less likely to be entering a new geographic market.

Example 34

A company has been trading since 2000. It develops and manufactures specialist medical products which it sells to hospitals across the UK and Europe. The company has realised that it can use one of its products for monitoring air pollution but it needs extra investment to fund the development of the product. It will also need money to market the new product.

The company will be entering a new product market. It has been operating exclusively in the specialist medical industry and is proposing to enter a completely different industry. The air pollution industry would never have considered the company as a potential supplier.

Example 35

A company started trading as a teashop in 2005. The company operated from a single site in Devon and sold its own speciality Devonshire cakes and products to its customers. Over time the company’s products started to win a reputation and the company started to sell its products packaged for take away to customers who called into the teashop.

The company now wants to market its products to a wider customer base. To do that it will need to set up a new large scale manufacturing and distribution process, including marketing, packing and customer service staff, on new premises.

The company is not intending to increase its range of products and so the only question is whether it is entering a new geographic market.

The company has been operating solely from its Devon teashop premises. If the company is looking to market its products across a wider area, centred on the teashop, for example by supplying local shops and restaurants, it is unlikely to be entering a new geographic area because it carrying out a natural expansion of its business. Extending the customer base to neighbouring towns is an incremental development that any developing company would consider especially if it has established products with good customer recognition of its brand.

However if the company is looking to, say, set up an internet site to supply customers across the UK, it may well be entering a new geographic market. The company would need money to pay for website development as well as the marketing, packing and customer services staff.

If the company is entering a new geographic market it must spend all the money raised on the new activities intended to enter the new geographic market. In this example this could include the costs of setting up production facilities specifically to cater for the new geographic market as such facilities would be completely new to the business and not simply an extension of the existing capabilities.

The company cannot, for example, use the money to develop new products for the teashop or engage new staff to promote the teashop or any other part of the existing business. If money is needed to develop the existing business this cannot be provided through the EIS or by VCTs and must instead be provided through the market.

If the company uses the money to develop the new premises and equipment but does not enter the new geographic market or pulls out of it early, the relevant investments will no longer be qualifying investments for the EIS or qualifying holdings for VCTs.