What it means
EIS exists because early stage companies are hard to fund. They usually have no assets to secure a loan and no profits to service one, so the government reduces the investor's downside and improves the upside through the tax system rather than by lending money itself.
Figures in this entry are shown in dollars for consistency with the rest of this glossary. The headline relief is income tax relief at 30% of the amount subscribed, claimed against the investor's own income tax bill for the year.
This immediately reduces the effective cost of the investment, so putting in $100,000 costs a taxpayer only $70,000 once the relief is received. Two further reliefs shape the risk profile in ways that matter enormously.
Any gain on the shares is free of capital gains tax provided they are held for at least three years, and if the investment loses money the loss can be set against income at the investor's marginal rate, which cushions the fall considerably. From the company's side, EIS is a fundraising tool with strict conditions.
The business must be relatively small and young, must carry on a qualifying trade rather than an excluded activity such as property development or financial services, and must use the money for growth within a set period. Investors give up things in return for the reliefs.
The shares must be newly issued ordinary shares carrying no preferential rights, the investor must not be connected to the company through significant employment or a large shareholding, and the shares must be held for three years or the income tax relief is clawed back. The reliefs do not make a bad company good, which is the point most often missed.
Early stage failure rates are high, so sensible EIS investors build a portfolio of several holdings and treat the tax relief as a way of improving the odds across the whole set rather than rescuing any single investment.
In practice
Real-world examples.
Example
A software founder raises $600,000 from eight private investors under EIS. The 30% relief means the investors have collectively committed $600,000 but carry an effective cost of $420,000, which made the round far easier to fill than a straight equity raise.
Example
An investor with a large one-off bonus faces a substantial income tax bill. She places $150,000 across five EIS companies, reducing that year's income tax by $45,000 while spreading the underlying business risk across five separate ventures.
Example
A manufacturing start-up applies for advance assurance before approaching investors. The confirmation that its trade qualifies becomes the first slide in its pitch deck, because investors will rarely commit without it.
Formula
Calculation
Income tax relief = amount invested x 30%
Effective cost = amount invested - income tax relief
Net loss after loss relief = effective cost - (effective cost x marginal income tax rate)
Worked example. An investor subscribes $100,000 for new shares in a qualifying EIS company and pays income tax at a marginal rate of 45%.
Income tax relief = $100,000 x 0.30 = $30,000
Effective cost = $100,000 - $30,000 = $70,000
Now consider the worst case, where the company fails completely and the shares become worthless. The investor claims loss relief on the effective cost.
Loss relief = $70,000 x 0.45 = $31,500
Net loss = $70,000 - $31,500 = $38,500
So a total wipeout costs the investor $38,500 out of the original $100,000, which is 38.5% of the amount invested. Now consider the good case, where the shares are sold after four years for $250,000. The gain of $250,000 - $100,000 = $150,000 is free of capital gains tax, so on an effective cost of $70,000 the investor receives $250,000, a return of more than three and a half times the money actually risked.Case study
Seen in the real world.
Thornbury Analytics is an illustrative, entirely fictional data business raising its first outside money. The founders needed $500,000 to hire four engineers and had been turned down by two banks because the company had no trading history and nothing to pledge as security.
Their adviser suggested structuring the round under EIS and obtaining advance assurance first. Ten investors each subscribed $50,000, and because of the 30% relief each was risking an effective $35,000 rather than the full amount. Two of the ten told the founders directly that they would not have participated without the relief, and one calculated that even a total failure would cost him $19,250 after loss relief at 45%, a number he could accept.
Four years later the illustrative company was acquired, and the shares each investor had bought for $50,000 were worth $180,000. Because the holding period exceeded three years, the $130,000 gain per investor was free of capital gains tax. The founders' reflection was that EIS had not changed the quality of their business but had changed who was willing to back it at the moment when nobody else would.
Watch out
Common mistakes.
- Selling EIS shares before the three-year holding period ends, which triggers a clawback of the income tax relief already claimed and turns a modest gain into a poor outcome.
- Assuming any small company qualifies, when excluded trades such as property development, leasing and most financial services are specifically ruled out.
- Treating the tax relief as a reason to skip due diligence, when the relief reduces the loss on a failure but never turns a failing business into a profitable investment.
Questions
People also ask.
What happens if the company is not actually qualifying?
The tax authority can withdraw the reliefs, so investors normally insist the company obtains advance assurance before the shares are issued.
Can I invest in a company where I am a director?
Generally the connected person rules exclude investors with a significant shareholding or a paid employment relationship, although there are narrow allowances for unpaid business angel directors.
How does EIS differ from the Seed Enterprise Investment Scheme?
The seed version targets much younger and smaller companies with lower investment limits and a higher rate of income tax relief, reflecting the greater risk at that stage.
From the founder's library
Take it further with the book.
Build your financial confidence beyond this definition. Shihan's full-length guide, Accounting Fundamentals, takes the same plain-English approach and turns it into a complete, practical playbook for non-finance managers, business owners and students - with chapter-end quiz answers and presentation slides included.
25% off with code MMHQ25, applied at checkout. Priced in USD - checkout may show the equivalent in your local currency.
View the book and save 25%Related