What is the EIS?

The Enterprise Investment Scheme ("EIS") is a government scheme that provides a range of tax reliefs for investors who subscribe for qualifying shares in qualifying companies. There are five current separate EIS tax reliefs:

• Income tax relief -  Provided an EIS qualifying investment is held for no less than three years from the date of issue, or  until three years from commencement of trade, if later, an individual with no more than a 30% interest in the company can reduce their income tax liability by an amount equal to 20% of the amount invested. The minimum subscription is £500 per company and the maximum in respect of which a subscriber may obtain income tax relief  in any year is £500,000.  Individuals may elect to treat their subscription for EIS shares, up to their maximum annual allowance, as if made in the previous tax year, thereby carrying income tax relief back one year.  Working example
• CGT Deferral Relief - Tax on  gains realised on a different asset can be deferred indefinitely, where disposal of that asset was less than 36 months before the EIS investment or less than 12 months after it.  Deferral relief is unlimited, in other words, this relief is not limited to investments of £500,000 per annum and can also be claimed by investors (individuals or trustees) whose interest in the company exceeds 30%. This can be done on a sequential or serial basis. Working example
• CGT Freedom - No Capital Gains Tax payable on disposal of shares after three years, or three years after commencement of trade, if later,  provided the EIS initial income tax relief was given and not withdrawn on those shares. Working example
• Loss Relief - If EIS shares are disposed of at any time at a loss (after taking into account income tax relief), such loss can be set against the investor's capital gains or his income in the year of disposal or the previous year.  For gains offset against income tax,  the net effect is to limit the investment exposure to 48p in the £1 for a 40% tax payer or to 40p in the £1 for a 50% tax payer, if the shares become totally worthless.  Alternatively the losses can  be offset against Capital Gains Tax at the prevailing rate - 18% from tax year 2008/09. Working example
• Inheritance Tax Exemption - EIS Investments are generally exempt from Inheritance Tax after two years of holding such investment. Working example

 EIS is appropriate for those investors who wish to include in their portfolio some high risk companies.

The rules governing the EIS are complex and interrelated with other legislation so it is nearly always essential to consult a professional who is experienced in this area.  It is a very specialised area and you should check the credentials of the firm to make sure that it is sufficiently expert in the subject of EIS to be able to provide worthwhile advice.   Many firms do not have this expertise and accordingly they may put you off investing, or seeking investment, via the EIS route.  If in any doubt, please do consult a professionally qualified adviser.

HMRC publish relevant information on their website at http://www.hmrc.gov.uk/eis.  A PDF of HMRC's guidance of the EIS can be downloaded here.  An Introduction to the Enterprise Investment Scheme (EIS).

Found this quite interesting from an article on the site of some London solicitors - a list of do-s and don't-s for people selling businesses. 

Food for thought is seems to me, but perhaps a bit over done. At least in my view. Some of the don't-s I've never seen at all and I don't see most of the other don't-s very often either.  So mostly theoretical risks, rather than ones one sees in practice.

On the other hand some of the do-s look a big and rather unrealistic ask for buyers - how about sellers giving only very limited warranties? Not something most buyers and their solicitors are going to accept lightly, I think, and with good reason.

The same goes for several liablity rather than joint and several.  Several liablity is better for sellers, but as a buyer you'd always want joint and several and argue that the sellers themselves should have a contribution agreement.

It's also worth saying that warranty claims are pretty rare - though disputes over earnouts and deferred consideration less so - and in practice the principal purpose of the warranties is at least as much about eliciting disclosures - ie information - as about clawing money back from the sellers later on.

The legal risks for sellers when selling a business are very real and potentially devastating if they come home to roost. 

So here are a few basic DOs and DON’Ts by way of some impromptu legal advice on selling a business that will hopefully minimise these risks or at least establish a fair balance of risk between buyer and seller.

	DON’T be too eager to swap the benefits of limited liability for unlimited personal liability under personal warranties and indemnities to the buyer following a sale of the business.
	DON’T give personal warranties in respect of matters that are clearly impossible to predict, such as warranting the forward profit of the business after completion, or warranting the accuracy of cash-flow forecasts or business plans.
	DON’T accept a paper-only deal if at all possible (for example, shares or options in the buyer, but no cash).
	DON’T accept personal cash liability for future claims in excess of the cash you have actually received from the buyer for the business at the time the claim arises.
	DON’T automatically expect deferred payments to be met.
	DON’T accept an ‘earn-out’ based on future profits without retaining close involvement in the business going forward.
	DON’T allow the price payable for the business to be based on post-completion accounts prepared by the buyer using different accounting principles or treatment that have been applied to the business prior to the sale.
	DON’T accept ‘joint and several’ liability amongst several sellers for the full price when the price is being split between those sellers. Ensure that liability is several, not joint, and is limited in each case to the amount of cash actually received.
	DON’T allow buyers to set-off potential or threatened claims against deferred payments.

	DO insist on as much of the price as possible being paid in hard cash upfront on completion and not in options, shares, deferred loan stock or other instruments, even if this means accepting a lower price. Certainty bears a premium and deferred payments are often not met if the buyer has cash-flow problems or simply goes bust.
	DO insist on as much cash being paid on completion, even if a proportion of this is paid into a retention account for a short period of time whilst completion accounts are drawn up.
	DO ensure certainty in the calculation of the price and, if there is some uncertainty, insist on a minimum price.
	DO avoid giving extensive personal warranties, personal indemnities and personal guarantees to the buyer.
	DO negotiate limits (in time and amount) to any warranty liabilities and personal guarantees that you cannot avoid having to give.
	DO insist that these limits apply to all future claims against you and not just to claims for breach of warranty.
	DO insist on security for deferred payments by way of charge over property, assets, shares or bank bonds.
	DO request a personal guarantee for future payments from the buyer’s directors, shareholders or some other third party.
	DO insist that the buyer’s obligations are guaranteed by the holding company of the buyer’s group, particularly future price payments or salary obligations under any continuing service contract.
	DO build in a commercial penalty for non-payment of deferred payments by the buyer, such as an option to repurchase on favourable terms.
	DO negotiate payment of deferred payments into a neutral escrow account pending settlement of any future claims.
	DO insist that you can meet any future claims that the buyer may bring by surrendering shares in the buyer at the value attributed to them on completion (they may go down to zero after the deal, so this latter point is crucial).
	DO impose restrictions on the buyer’s ability to deal with the assets after completion when you are depending on an ‘earn-out’.

I found this - below - from an article on earnouts.  It comes from a Glascow firm of solicitors.  I've never been enthusiasitc about earnouts - okay in the right situation, but generally speaking best avoided, has pretty much been my view.

But there's certainly added interest in them, partly because raising money elsewhere is harder I suspect.  If the buyer can't raise sufficient funds, seller financing/owner financing/deferred consideration - call it what you will - can help bridge the gap between what the seller wants (and the buyer may be wiling to pay) on the what the buyer can afford. 

Earnouts are a step on from that - making the amount the seller gets later dependant on how the business doesin the future.  If the business does well, the earnout will mean the seller gets more.  If it does less well, the seller gets less or maybe even nothing more he has been paid already.

A sharing or risk, but not one without its problems.  I'll write something more on earnouts and deferred consideration later.

Earn Outs - the way forward ?

[...]Theoretically both parties in the earn-out benefit - the purchaser makes the vendor put their money where their mouth is, while the vendor can almost always expect a higher price than they would get for an up-front payment. Indeed the multiples that come into play in an earn-out can often make the deal structure preferable to the vendor.

The trade off is the matching of the current value with the potential value that you could achieve through an earn out. There are very significant multiples that a purchaser can expect to achieve through an earn-out and pay the same in cash up-front as they would have seen the earnings being achieved.

But tensions can arise. In an earn out, it is usual for the vendor to remain a part of the target business until the earn-out is complete to drive the company's growth and conflicts can often occur between vendor and purchaser.

The term of an earn-out is a crucial area of negotiation as for the vendor it is vital that they remain masters of their own destiny. Therefore if they're entitled to a payment based on the performance of the business over the next three to five years, they will want to see that they can manage the business in a way that they want, that they will have adequate working capital and that the business won't be pillaged in order to meet other needs of the purchaser group.

From the purchaser's point of view it will need to ensure that the business is being run in a manner that it is happy with, having committed its own capital to the up-front sum. Inevitably there will be a tension.

Most areas of contention centre around the finances of a business. The vendor will want maximum control and the purchaser will generally accept that there should be a degree of ring fencing in control, but want to be able to step in if they think the thing is going off the rails.

But these tensions must be put aside for the deal to work. An earn-out will only run smoothly if each party is able to see the other's point of view and reach a compromise.

An earn-out will work for both sides providing each is prepared to be practical and commercial about the way it is implemented. If the vendor expects to be able to keep the purchaser completely at arms length and uninformed, then the relationship will break down. If that happens the performance of the business will be impaired and the earn-out will not work. [....]

via macdonaldhenderson.co.uk

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