Venture Capital Schemes: companies receiving risk finance investments: exceptions to the basic age condition: investment to enter new product market or geographic market – condition B
In general, a company that has not received a risk finance investment before the end of its initial investing period is not expected to be subject to a market failure within the State aid guidelines as it should have developed a sufficient track record to access finance. It will have had many years to establish itself and have a track record to show to commercial investors who may be interested in investing in the company to support its ongoing growth and development.
However, in certain specific circumstances, some companies may decide to embark on significant new business activities that are so different from their existing business activities, and require disproportionately more investment compared with the company’s normal activities, that potential investors cannot rely upon the company’s existing track record to determine whether the investment is likely to be successful. Potential investors will have to carry out extra due diligence to reassure themselves of the viability of the investment. This situation may also apply when a company that has previously received relevant investments for certain business activities decides to change direction for which follow-on funding is not available.
In these situations an investment may be eligible for relief under the EIS (or be a qualifying holding for a VCT) where a company needs the money for the purpose of entering a new geographic market or a new product market.
This exception to the basic age limit does not apply to companies that are growing and developing by carrying out incremental changes, where each change can be funded through smaller amounts of investments and where investors can continue to rely upon the company’s track record to date when carrying out due diligence.
This condition does not allow companies older than the age limit to access tax-advantaged funding for their existing activities, even if this would contribute to the growth and development of the company. All the money raised under this exception must be spent on the new activities, otherwise none of the investments will qualify for EIS relief or count as qualifying holdings for VCT purposes.
The following conditions must be met if an investment in an old company to support a new and significant activity is to qualify under the EIS and VCT rules:
- the amount of the relevant investment, together with any other relevant investments made within a 30 day period, must be at least 50% of the company’s average annual turnover, averaged over the previous 5 years (the 50% turnover test)
- the money must be used for entering a new product market or geographic market (or a new product market and new geographic market).
Each new business activity must satisfy the 50% turnover test. A number of smaller unconnected initiatives cannot be combined in order to meet the 50% threshold.
All the money raised must be used for the new activity. If the new enterprise fails before the money is spent, the investment or investments will not be eligible for tax relief. The money cannot be recycled for use on other business activities. It follows that companies should be careful not to raise more money than they know they will spend on the new activity.