New investment practices for start-ups

Jonathan Lea, solicitor with law firm Bargate Murray, looks at how new government schemes could aid start-up development and the legal considerations that need to be addressed.

The new Seed Enterprise Investment Scheme (SEIS) that will come into existence on 6 April this year will offer unprecedented tax breaks to investors willing to back start-ups.

It should therefore hopefully fuel the trend for those with capital to invest directly in companies themselves, rather than only put their money in property and expensively managed funds that only invest in established public companies with increasingly weak or negative growth prospects.

SEIS investors can commit up to £150,000 in a single company, and in return receive tax relief of 50 per cent on their income tax for the year the investment is made. Additionally investors also gain exemption from capital gains tax on the proceeds of sale of an investment and, for the 2012-2013 tax year only, roll over relief on any chargeable gain made on other capital assets to the extent the money is reinvested in the SEIS company.

Appetite for tech

There is increasing interest in investing in internet and software companies as such businesses have increasingly low overheads, can grow internationally easily and have an ability to dominate industries through information and networks. In short, the economy is experiencing a digital riptide that is turning traditional business models on their head and producing a wave of innovative and game changing start-ups that investors are increasingly clamouring to be part of.

Investors need to ensure that business founders are of the right entrepreneurial character and have a good skill set. It’s of increasing importance that founders possess a good understanding of web development, as well as being advanced users of social media. This will ensure that they have access to top information and ideas, understand rapidly evolving trends and also have sufficiently large networks that they can leverage to grow the business.

Angel investors should work with the right experts to help them carry out focused, legal, commercial and financial due diligence on the target business in proportion to the value of the deal.  Investors should check that a company has been properly incorporated and owns all business assets, and that relevant contracts are in place and effective. The precise ownership details and intricacies of the company’s intellectual property as well as the impact of existing financing and security arrangements, and whether any disputes exist or are threatened, should also be investigated.

A recent survey by the National Endowment for Science, Technology and Arts shows that those investors who perform even limited due diligence will experience far fewer failed investments.

Documenting the deal

The main legal document that will govern an investment is the subscription and shareholders agreement, which contains a number of provisions that need to be carefully negotiated.  This will include a set of warranties to be given by the founder(s), restrictive covenants, indemnities, share dilution clauses, veto’s of key decisions, performance ratchets, permitted transfers and other exit terms.

Parties will also want to agree the extent of an investor’s actual involvement with the start-up, while an angel will often be appointed to the company’s board.

Jonathan Lea is a solicitor with law firm Bargate Murray. He focuses on angel investments and also advises London’s Silicon Roundabout start-ups.

Further reading:

Hunter Ruthven

Hunter Ruthven

Hunter was the Editor for from 2012 to 2014, before moving on to Caspian Media Ltd to be Editor of Real Business.

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