Does 'financial health' matter?

For a company to qualify for the Enterprise Investment Scheme (EIS) it must not be in financial difficulty at the time of issuing shares. A company is considered in difficulty if it can't pay debts or its liabilities exceed assets. Additional criteria apply, such as if more than half of its share capital has been lost due to accumulated losses. Special adjustments can be made based on factors like future investments or R&D expenses.

The issuing company must meet the financial health requirement at the beginning of 'Period B' - that is, at the date the shares are issued, and it will not meet the financial health requirement if it would be reasonable to assume that it would be regarded as a company ‘in difficulty’.

The definition of a company in difficulty is given by EU guidelines. The guidelines set out that an company is considered to be in difficulty when, without intervention by the State, it will almost certainly be condemned to going out of business in the short or medium term and define the circumstances where this is considered to be the case.

Applying these definitions, HMRC will in general regard any company as being ‘in difficulty’ when it meets the criteria for insolvency under the Insolvency Act 1986, such as:

• the company is unable to pay its debts as they fall due
• the value of the company’s assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities (the “balance sheet test”).

Additionally, where a company is raising funds outside of its initial investing period (seven years since first commercial sale, or ten years if knowledge intensive) it will also be regarded as being in difficulty if more than half of its subscribed share capital has disappeared as a result of accumulated losses. This is the case when deduction of accumulated losses from reserves (and all other elements generally considered as part of the own funds of the company) leads to a negative cumulative amount that exceeds half of the subscribed share capital.

Whilst a company’s most recent accounts will be the starting point in determining this position, due consideration will also be given to any reasonable adjustments that could be made to the accounts figure reflecting the particular circumstances of the company at the date of the relevant share issue. For example, where a company can show irrevocable future investments (non-tax incentivised), or any R&D costs expensed in the accounts which could have been capitalised.

Ultimately, whether it is reasonable to assume a company should be regarded as in difficulty will require an assessment of the company’s particular financial circumstances including the ability of the company to maintain its activity in the short or medium term.