Knowledge Intensive Companies

HM Government have announced a number of changes to the EIS and VCT schemes this year including the creation of special preferential terms for “knowledge intensive companies”.

This note looks at what knowledge intensive companies are and how they are now treated.

In the March 2015 budget, HM Government announced that it was introducing a total limit on the amount of risk capital a company could raise under SEIS, EIS or VCT of £15 million. This cap would be £20 million for a knowledge based company. Additionally, the government announced that it would increase the number of employees allowed to be employed by a knowledge intensive company raising money under EIS to 499 employees.

In the July 2015 budget, HM Government announced a number of changes to be introduced by the Finance (No. 2) Bill 2015 which included a requirement that a company must raise its first EIS or VCT investment within 7 years of its first commercial sale. This limit is 10 years for knowledge intensive companies. The cap on the amount of risk capital funding was reduced to £12 million (£15 million for knowledge intensive companies).

So what is a knowledge intensive company?

A company is a knowledge-intensive company if, at the time of the share issue, it meets an operating costs condition and either the innovation condition or the skilled employee condition.

The operating costs conditions are:

1. In at least one of the “relevant three preceding years” at least 15% of operating costs consisted of research and development or innovation (R&D) expenditure. Operating costs are, broadly, expenses recorded in the profit and loss account or income statement other than those incurred intra-group. Just and reasonable apportionments may be made to the recognised expenses.

2. In each of the three “relevant three preceding years” at least 10% of operating costs consisted of R&D expenditure.

The innovation condition involves illustrating that, at the time the shares are issued, the issuing (EIS) or investee (VCT) company has created or is creating (or is preparing to create) intellectual property and it is reasonable to assume that within ten years of the share issue, the exploitation or use of that intellectual property will form the greater part of the issuing (EIS) or investee (VCT) company’s (or, as the case may be, group’s) business.

The majority of the intellectual property (in terms of value) must be created by the company and the right to exploit it must vest in the company (whether alone or jointly with others).

The skilled employee condition is that at least 20% of the workforce has a higher education qualification and is engaged directly in R&D carried on by the issuing (EIS) or investee (VCT) company (or in groups, the issuing/investee company and any qualifying subsidiary).

For both EIS and VCT, this condition will be required to be met throughout the period commencing with the share issue and ending on the third anniversary of that issue. (For VCT’s this applies only if the innovation condition is not met and does not apply to the total limit during the five-year post-investment period). However, a company in administration or receivership will be treated as meeting the condition provided it is treated as meeting the trading requirement.

The last of the “relevant three preceding years” ends on the later of:

1. immediately before the beginning of the company’s last accounts filing period that ends before the share issue.

2. 12 months before the date on which the relevant shares are issued.

Increasingly companies at the limits of their EIS and VCT fundraising will be seeking to show that they are knowledge intensive companies and so the above conditions will increase in importance and relevance.