VCM8160 - Venture Capital Schemes: companies receiving risk finance investments: follow-on funding: business plans supporting condition A and condition C

As explained in VCM8154, the need for follow-on funding must have been foreseen in the company’s business plan at the time of the original risk finance investment. While the need for a business plan is not specified in the domestic legislation, it is an underlying requirement of the State aid rules.

The company is not expected to anticipate the exact amounts or dates it will need for follow-on funding.

For example, follow on funding may be needed only once the company has reached a certain stage. The date of that next step may not be known at the time of the initial funding except that it is likely to occur in, for example, a particular year. Similarly, the exact cost may not be known although a broad outline of the activities to be funded would be.

However, where the stages, amounts and timings are significantly different from the original business plan the company should include an explanation of the discrepancies either in the business plan accompanying the application for follow-on funding or in a covering letter.

Where the initial investment was made before 18 November 2015 the company must demonstrate that it would have met either condition A or condition B if those rules had applied at the time of the initial investment. Companies that received their initial relevant investment before 18 November 2015 and would not have met either condition A or B will not be eligible to receive follow-on investments.

HMRC takes a pragmatic view where a company did not include the need for follow-on funding in its business plan before 18 November 2015. The company will need to show the follow-on funding will support the same activities as those supported by the initial investment.

Example 38

Company D was set up in 2015 to develop new drugs to alleviate respiratory conditions. It receives its first relevant investment on 6 April 2016, when it issues £150,000 of shares to two SEIS investors to carry out a feasibility study. The company’s business plan specifies three further rounds of funding will be needed to develop a new drug if the feasibility study is successful.

The feasibility study is successful and the company goes on to raise the additional investments through a combination of EIS and VCT funding, broadly in line with the initial business plan expectations.

The company meets condition A for follow-on funding.

Example 39

Company E was set up in 1998 to develop a new type of waterproof coat. It received total relevant investments under EIS and VCT of £1 million to carry out the work and made its first commercial sale of the product in 2004. The company raised further EIS and VCT investments of £1 million in 2013 to develop new walking boots. In 2016 it now needs to raise £1 million in follow-on funding to get the new product to market.

The investments received in 2013 would not have met condition A because:

• the first commercial sale of the company was more than 7 years before the date of the investment in 2013 and
• the boot development is not the same activity as that for which the initial investment was received.

However the 2013 investment may have met condition B, if the company’s average annual turnover for the previous 5 years was less than £2 million, because by selling new walking boots the company was entering a new product market.

If condition B would have been met in 2013 the latest £1 million investment will meet the age condition for follow-on funding under condition C.

Example 40

Company F was set up in 1970 to manufacture and sell precision tools to the car industry. Its first commercial sale was made in 1972. In 2014 the company received its first relevant investment to develop new products for the oil industry. The 2014 investment would have met condition B (entering a new product market or geographical market).

Unfortunately one of the new products was unsuccessful before it was brought to market but work continued on the other products. Even though some of the company’s activities which were being funded had ceased, the company would be eligible for follow-on funding under condition C for the remaining activities.

Example 41

Company G is set up in 2017 to develop and sell apps for mobile devices. No external investment is needed but the directors are keen that the company should be eligible to receive relevant investments in the future. They persuade a friend to invest £1,000 in the company under the EIS. The money is to be used to help fund the purchase of software needed to develop a specific app.

In 2025, more than 7 years after the company’s first commercial sale, the company wants to raise £1 million from a mixed group of EIS investors and VCTs to fund the development of an augmented reality programme.

The company would not qualify for EIS or VCT funding on the £1 million investments. This is because the money would not be used for the same relevant business activity as the initial relevant investment (the development of the app).

Also, follow-on funding that is eligible under condition A or condition B must be specified at the time the initial relevant investment is received.

A company cannot use a relevant investment within the basic age limit to ‘bookmark’ future, unspecified and unrelated, potential investments.