On 11 June 2024 Gravita ran a workshop as part of London Tech Week, aimed at helping ambitious UK tech companies set up the most beneficial financial and tax structures for growth.
The session was led by Caroline Plumb, Gravita CEO, alongside Kate Greenhough, Gravita Tax Partner, and Ben Chernoff, Gravita Accounts Partner. Kate and Ben are both experts in supporting the technology sector, with many years’ experience of advising tech companies from startup all the way through to scale-up and beyond.
If you missed the workshop, don’t worry. We’ve gathered together the most common questions around scaling up, funding your growth, due diligence and making the most tax-efficient choices when it comes to company structure and tax planning.
Here’s our short summary of the session, with our advice on the most productive ways to fund and invest in the future of your new or established tech business.
The importance of choosing the right financial and tax structures
We get it. At the early stages of getting your tech business off the ground, you’ll be hyper-focused on getting to the minimum viable product (MVP) stage and taking the first tentative steps towards growing the business. At this point, tax and financial structures are probably not front of mind in your current thinking.
But making the right decisions around the financial structuring of the business can be crucial to your success further along the business journey. When it comes to raising funds or an exit event, you’ll wish you had thought about these structures sooner.
With this need for an awareness of financial and tax structures in mind, let’s take a look at some of the themes and questions that came out of our London Tech Week workshop.
Q1: How can we avoid the most common pitfalls when exploring share options?
Going through the business idea stage, seed funding, MVP and bringing in your first customers is a whirlwind ride. But legal potholes can slow you down, if you’re not paying attention, especially when you’re exploring share options and ways to bring investment into the business.
Here are some key areas to watch out for when considering share options:
- Compliance: Don’t trip up when it comes to the paperwork! Schemes like Enterprise Management Incentives (EMI) require you to notify HM Revenue & Customs (HMRC) and to use the correct forms. Incorrect submissions can lead to delays and penalties, both of which can put the brakes on your scale-up growth.
- Limits: EMI options have restrictions in place that you should be fully aware of before going down this route. The company must be independent and shouldn’t have arrangements leading to a potential takeover. Similarly, for the Seed Enterprise Investment Scheme (SEIS) or Enterprise Investment Scheme (EIS) options, changes in share capital or terms can impact eligibility.
- Share Types: Choose your share types wisely! Issuing the wrong type of share can have significant tax implications, either for the business or for the shareholder. It’s important to understand the differences between ordinary shares and preference shares before assigning any options.
Q2: How can R&D Tax Credits help to extend our cash runway and liquidity?
Cashflow is the lifeblood of any tech startup. Having a workable cash runway doesn’t just help you keep the lights on in the business. A sensible runway also gives the financial flexibility to look at different growth plans and your options for funding the next stage of the business.
A significant way to extend your runway is to make use of the R&D tax credit framework that’s available to UK tech businesses. If your research and development is delivering innovation to the sector, you may well be eligible for tax relief against your corporation tax bill.
To make an R&D tax claim you need to explain how a project:
- looked for an advance in the field
- had to overcome the scientific or technological uncertainty
- tried to overcome the scientific or technological uncertainty
- could not be easily worked out by a professional in the field.
If your business meets the eligibility criteria, there are a number of other factors to consider, so you maximise the potential impact of the R&D tax credit for the business.
For example:
- Keep detailed records: Having records of all your R&D activities will be crucial to the claim. Make sure you document how your project advances scientific or technological knowledge. This advance could be a new invention, a process improvement or overcoming a technical hurdle that will help to advance development within your niche.
- Paperwork matters: The Research and Development Expenditure Credit (RDEC) form, or AIF (Advance Information Form) for small companies, is crucial. This is where you must meticulously record all your project costs – staff salaries, materials, software licences etc. – categorised by each R&D project. Maintaining separate nominal ledgers for R&D spending will also strengthen your claim.
- Pre-notifying HMRC: If you’re a pre-revenue company, pre-notification with HMRC can be a sensible move. This clarifies your eligibility for R&D tax credits before you make any significant expenditure, helping you to speed up the process of a claim once you start experiencing R&D costs on your innovation project.
Q3: What financial or tax red flags can kill a transaction at the due diligence stage?
Funding and investment is what keeps your tech startup evolving. But securing investment and setting up the most beneficial transactions hinges on having a robust due diligence process.
Due diligence exists to put the most meaningful checks in place prior to a transaction. If your investor spots any red flags as part of this process, it can reduce confidence, affect the agreed investment amount and may even derail the transaction completely.
Here are a few of the more common red flags to be aware of, so you can ensure your tech business is the most attractive proposition for potential investors:
- Contractual shortcomings: The absence of key contracts with partners or vendors can raise concerns about your operational stability as a business. Investors will be looking for robust contracts and strong relationships with your existing partners.
- Equity scheme errors: Incorrectly structured share schemes, incomplete paperwork, and non-compliance with tax regulations (e.g. EMI options) can pose significant risks and can be seen as a sign of poor governance of the business.
- Tax issues: Outstanding HMRC enquiries for VAT or corporation tax, or improper claims for tax reliefs, can signal potential liabilities. A laissez-faire attitude to your tax management is a bad sign for investors and shows the importance of considering your financial structures and tax planning with great care.
- Employee benefit omissions: Failure to adhere to regulations regarding employee benefits or freelancer taxation (IR35) can lead to penalties and financial burdens for the business. An investor won’t want to take on significant burdens or legal entanglements, so sticking closely to the current rules around employee benefits is critical.
It’s also worth thinking about potential weaknesses in your financial management, that could be seen as potential warning signs by investors.
These financial red flags can include:
- Inadequate provisions: a lack of provisions for potential liabilities can go a long way to hindering investor confidence.
- Cashflow concerns: Inconsistent or dwindling cashflow raises questions about your financial viability and your potential to fund the next stage of growth.
- Debt burdens: High debt levels in the business can limit your financial flexibility as a company and may well hamper future investment opportunities.
- Accounting discrepancies: If your finance team has inaccurate accounting practices in place, this can impede a clear understanding of the company’s financial health.
Addressing these red flags through internal due diligence can minimise the risks and set the foundations for a smoother and more successful fundraising process.
Gravita: expert advisers to the technology sector
Our Technology team gives forward-thinking advice to innovative and ambitious tech companies at all phases of their lives. We’ll support your tech business through growth, funding, raising, mergers and acquisitions, listing and beyond.
If you want to scale your tech business with the most appropriate financial structures and tax planning in place, we’re here to help you thrive and achieve the best possible financial results.
Contact the Gravita team today.
