Five practical financial solutions available to help grow tech startups
There is no doubt that the setting up of your own tech business is extremely appealing to many people. Who wouldn’t want to be the next Bill Gates, Mark Zuckerberg or Steve Jobs?
The reality is that tech businesses in general abound with problems. The speed of change means that without action a great idea can become obsolete very quickly. The big boys have almost unlimited resources which enable them to throw huge sums of cash and people to resolve issues and create new technology. But should that put you off?
Almost every day we are talking to clients about technological problems and how they are attempting to resolve them. Our world seems to be growing increasingly complex, and with each level of increased complexity comes a new problem for someone to resolve.
This article focuses on some of the financial solutions available that might be of interest:
- Getting the most from R&D
Invariably as a tech startup you will be working on some technological problem which falls within the boundaries of Research & Development. In a previous article, the one minute guide, we highlighted the tax advantages of R&D.
For a startup business, the first point to note is that the tax advantages are only available through a limited company and not as an individual, but DON’T necessarily assumes that the limited company route is best for you.
For example, if you have a great idea but are going to employ staff or contract the work out in order to develop your idea and you were a higher rate taxpayer in the previous three tax years there may be an opportunity to save more tax as an individual than as a limited company.
Let’s assume however that you are the one developing the software which qualifies for R&D and that the only real expense in the short-term is your time, then unfortunately as an individual you can’t pay yourself a salary. A limited company would therefore be preferable for R&D relief as you can pay yourself a salary, which will qualify for the enhanced tax relief. But how much should you pay?
John develops software that qualifies for R&D and decides to pay himself a salary of £24,000 through his limited company. Using the 2019/20 tax rates and assuming a tax code of 1250L his total tax and employee NI (national insurance) liability would be £4,144 and employer NI liability would be £2,121. Total cost for the company is £26,121.
If we assume that the whole cost is entitled to R&D relief then the company has losses of £60,078 (230% x £26,121) which could be cashed in for tax credits at 14.5% – a tax rebate of £8,711.
Overall John is £2,446 up.
Compare this with Tom who develops qualifying software but is told by his advisor to restrict his salary to £8,332. He pays no tax or NI but his losses are just £19,164 which can be cashed in for tax credits at 14.5%- a tax rebate of £2,778!
The examples assume there is only one employee. If there are two employees above the lower earnings threshold then John will receive a £3,000 employer NI allowance and this could make a salary of £24K more beneficial!!! Complex?
Please note however that for accounting periods starting from 1 April 2020 there are new rules to prevent abuse of the payable credit. The measure will cap the credit at three times the claimant’s total PAYE and NICs liability for that year. The measure, however, has no impact in creating enhanced research and development expenditure to offset against profits generated within the company. The measure was introduced following an attempted fraudulent claim for £300m of R&D credits!
If you are entitled to R&D relief then this is free money so getting the right advice is crucial if you want to ensure you maximise the tax-saving opportunity. R&D relief is also regarded by many tech startups as an important cash flow opportunity for the company.
- Enticing investors using the EIS/SEIS scheme
We generally advise business owners not to water down their investment in a business by bringing in outside investors. However, perhaps due to a feeling of insecurity, we frequently see company owners give shares to an employee or relative, often for insignificant amounts of cash. These new shareholders won’t usually have the same passion as the original business owner. The new shareholders quickly become a thorn in their side when the business is profitable, the business owners are looking to extract profits from the business and they have to pay dividends to the investors.
However, there are many occasions where you genuinely have a great idea but lack the resources to develop your software. Time is of the essence, so rather than grind out a solution on the cheap over several years you may need to act now to avoid the possibility of your idea becoming obsolete.
We would recommend you firstly try and get a loan or grant to support your work (call us if you want more help on this) but failing that why not look at the Seed Enterprise Investment Scheme (SEIS) and Enterprise Investment Scheme (EIS). Both are great schemes, which provides tax relief to investors on their investments in qualifying companies. To find out more about the schemes check out our recent blog here.
- Using cloud accounting software solutions to drive your business
As a tech savvy business owner you will love technology and will therefore love cloud accounting software solutions to help drive your business.
We recommend Xero or Quickbooks as a bookkeeping solution to all our clients. Firstly for the ease of use; they are built for business owners not accountants, and are therefore set up to be intuitive. Secondly, they are designed to save you time. Bank feeds ensure that bank transactions are imported automatically into the accounts systems and through AI the software will prepare the transactions for posting to the correct income and expense codes and look to account for the VAT as well. This links up with hundreds of apps such as debt chasing software, quoting systems, invoice scanning and processing systems and helps build an easy to use, a time-saving system which can only enhance your business.
We have a dedicated team within Friend & Grant to focus on providing cloud solutions.
- Using the EMI share option scheme to lock in key employees
As you build your business up you are going to attract key team members such as software developers who are essential to the success of your business. However even early on you may have built considerable value in the business (sale valuations of 15 times EBITDA (earnings before interest, tax, depreciation and amortisation) are easily being met by tech businesses with great subscription income).
Giving shares away can give rise to big tax liabilities under Employment Related Securities legislation, and even then there is no certainty that the team member will be locked in. Share options are a great tool to use and the Enterprise Management Incentive Scheme is a highly affective share option scheme which can be used to tie in key team members. The scheme is highly flexible as the options can be set up to expire when the employee leaves the company or restricted so that they can only be taken up on the sale of the business. You maintain control, but for your team member they are highly tax-efficient and a great incentive to stick with you and help build value in your company. To find out more see our article on EMI here.
- Finding a trusted advisor who will support your growth
You will see from the above that having an advisor who is familiar with tech businesses is highly beneficial. We haven’t even touched on areas such as Patent Box (if you can patent your software then any income which is derived from the patent is taxed at just 10%) or specialist incentive schemes for video gaming businesses, but can provide advice in these areas if required. Identifying opportunities and helping your business to grow is key to the service we offer to our tech clients.
If you have any queries on the above then please call us or contact us here.
The content in this blog is correct as at 05/02/2020. See terms and conditions.