Does 'financial health' matter?

📘 Overview

This article explains when a company is treated as in financial difficulty for the purposes of the Enterprise Investment Scheme (EIS). It covers the formal definition, how HMRC interpret the rules, and the adjustments companies can make when assessing their financial position.

📊 What does “not in financial difficulty” mean for EIS?

To qualify for the EIS, a company must not be in financial difficulty at the time it issues EIS shares. This assessment is made at the beginning of Period B: the date the shares are issued.

A company will not meet the financial health requirement if it is reasonable to assume it would be regarded as a company in difficulty.

🔍 How “company in difficulty” is defined

The definition comes from the EU State Aid Guidelines. These guidelines state that a company is considered to be in difficulty when, without State intervention, it is almost certain to go out of business in the short or medium term.

The rules provide specific circumstances in which this is considered to be the case.

When HMRC normally regard a company as being in difficulty

HMRC generally apply the criteria used in the Insolvency Act 1986, including:

Unable to pay debts as they fall due (the cash flow test)
Liabilities exceed assets, taking into account contingent and prospective liabilities (the balance sheet test)

If either of these applies, HMRC will normally treat the company as in difficulty for EIS purposes.

📊 Additional rules for companies outside their initial investing period

If a company is raising funds outside its initial investing period (seven years from first commercial sale, or ten years for a knowledge-intensive company) a further test applies:

📘 Capital-loss test

A company will also be regarded as in difficulty if more than half of its subscribed share capital has disappeared due to accumulated losses.

This occurs when accumulated losses reduce reserves (and other components of the company’s own funds) to a negative cumulative amount that exceeds half of the subscribed share capital.

💡 Reasonable adjustments that may affect the assessment

A company’s latest accounts are the starting point for assessing financial health. However, HMRC allow reasonable adjustments to reflect the financial position at the date of share issue.

Examples include:

Irrevocable future investments (non-tax incentivised) that strengthen the balance sheet
R&D expenditure expensed in the accounts that could have been capitalised
Other adjustments that fairly reflect the company’s financial position at the relevant date

These adjustments may make a material difference, especially for early-stage, R&D-heavy, or scaling companies.

🔍 Practical assessment: short and medium-term viability

Ultimately, the question is whether it is reasonable to assume the company cannot maintain its activity in the short or medium term without external support.

This involves a holistic review of the company’s circumstances, including:

its cash position and forecast
its ability to meet liabilities
the strength of committed investment
whether the business is sustainable without State intervention

✅ Key Points

A company must not be in financial difficulty at the date EIS shares are issued.
Insolvency Act criteria (inability to pay debts, liabilities exceeding assets) are central to HMRC’s assessment.
Companies outside their initial investing period must also consider the capital-loss test.
Reasonable adjustments to the accounts may be allowed, particularly for future investment or R&D-heavy businesses.
The assessment ultimately depends on whether the company can continue to operate in the short or medium term.