Most investors don’t plan to fail, but with the Seed Enterprise Investment Scheme, if the firm goes down with your money you can still come out as a winner.
That’s the thing about start-up businesses.
The figures show that many fail in the first three years – and that’s the life of a SEIS investment.
So the chances are 25% of firms will fail in their first year, 36% in the second and 44% in the third, according to research by the Federation of Small Businesses.
That means just over half of all start-ups are still around in year four and the attrition rate does not stop there, says the survey, because in year 10, 71% of start-ups have failed.
Incompetence and inexperience
The reasons for failure are mostly put down to bad management – incompetence, inexperience – and fraud.
Investing in a start-up through SEIS comes with some inevitability of failure.
To counter this, HM Revenue & Customs (HMRC) has written in financial compensation to reduce the risk in the form of loss relief.
Inexperienced start-up investors probably regard this as something of no interest, but the statistics show this is probably just as important as the ingoing 50% tax reduction against the value of the initial investment and capital gains tax exemptions on disposing of assets to fund a SEIS investment.
Loss relief works by letting investors recover income tax paid on the 50% of the investment unrelieved from the start.
That translates into loss relief of £50,000 against an initial maximum SEIS investment of £100,000 that picked up a tax reduction of 50% or £50,000 at the start of the SEIS.
The relief is paid at whatever rate of tax the investor pays, so is open to basic and higher rate taxpayers to set off against the tax they pay in the tax year their investment fails.
Loss relief doesn’t mean a SEIS investor can’t lose, because the investment is often more than just the cash but the costs of due diligence which can come to around 10% of the equity stake plus time and effort to help the business fly.
Looking at the reasons for failure, experienced business investors should scrutinise the abilities of management and pore over credit control and financial management to try to eradicate the main reasons for a start-up failure.
Perhaps SEIS investors should consider the tax breaks as spread-betting.
If you are an experienced investor, you are likely to have a number of SEIS interests and hopefully, one or two will pay off big time.
As a less experienced investor, putting a lot of cash into a start-up project knowing the failure rate is not such a good idea.