From angel money to institutional money

Angels rarely ask. They are backing you, they know roughly what the company has done, and their own relief either worked or it did not. A fund is different. It is buying into a structure that has to survive a decade, several more rounds and eventually a sale. So it looks at how that structure was built, and it finds whatever was done quickly in year one.

By then almost none of it can be changed.

What angels leave behind

The early rounds are where the permanent decisions get made, usually by people with no reason to think they are permanent.

A founder raises fifty thousand pounds from three people who believe in them. The lawyer issues the shares, everyone signs, the money lands. Nobody asks whether the company has spent its SEIS allowance, because at that point SEIS feels like a detail to sort out later.

It is not a detail. The SEIS allowance is two hundred and fifty thousand pounds, and the company gets it once. Not once a year. Once, for its entire life. Spend it on a friends and family round at a valuation nobody thought about, and it is gone before the round where it would have made a difference.

The same applies to the order in which shares are issued. SEIS shares have to come before EIS shares. Issue both on the same day, which is what happens when a round completes in one sitting, and the SEIS relief fails for everyone in it. The register of members shows a single date and there is nothing to argue with.

Neither of these is a judgement call. They are arithmetic and sequence, and they are decided at the moment of issue.

Instruments that look like investment but are not

Advance subscription agreements and convertible loan notes both solve the same problem. The company needs money now and nobody wants to fix a valuation yet.

They are treated very differently.

An advance subscription agreement can work for SEIS and EIS if it is drafted properly. It has to be non refundable, carry no interest, and convert within a reasonably short longstop period. Get any of those wrong and the investor loses the relief on money they have already handed over.

A convertible loan note generally does not work at all. Shares have to be paid up in cash at the point of issue, and converting debt is not paying cash. Founders who raised on loan notes because it was quicker often discover this when an investor asks for their certificate.

The instruments are not interchangeable. They are chosen at the point of greatest time pressure, which is exactly why they go wrong.

Where a term sheet breaks the relief

Institutional terms and SEIS or EIS terms pull against each other.

A fund wants a liquidation preference, and it is entitled to. It is not claiming relief, so the preference costs it nothing. But if the round is mixed, and some investors are claiming SEIS or EIS on the same class of shares, that preference removes the relief for all of them. The shares have to be ordinary, with no preferential right to dividends and no preferential right to assets on a winding up.

This surfaces late. The term sheet is agreed, the long form documents arrive, and someone notices in week three that half the round no longer qualifies. Renegotiating a preference at that stage is not a conversation any founder wants.

The fix is to raise it before the term sheet, not after. Funds are usually relaxed about a separate ordinary class for the relief investors, provided somebody asks early.

Options, and the three year window you did not notice

Most companies grant options before they raise institutionally. Most do it badly.

An EMI option has to be notified to HMRC within ninety two days of grant. Miss it and the option is not an EMI option, whatever the paperwork says. The employee pays income tax on exercise instead of capital gains tax on sale, and the company loses its deduction. A fund's lawyers will check the notification dates for every grant, and finding a gap is a routine part of diligence.

The exercise price matters just as much. Agree the market value with HMRC on form VAL231 before you grant, and you have a figure you can rely on. Skip it and you are arguing about valuation years later, at exit, with money on the table.

There is also something that happens to existing options when the round completes. If an investor takes control of the company, and control here means another company rather than a fund, existing EMI options face a disqualifying event. From that point the holder has ninety days to exercise or the favourable treatment is lost. Corporate venture arms and strategic investors are where this bites. It is not a reason to refuse the money. It is a reason to know in advance and tell the option holders.

The valuation you set with angels follows you

A high angel valuation feels like a win. It is less dilution and a better headline.

It also sets the floor for everything afterwards. Options granted at that price are worth nothing until the company grows past it. Growth shares issued to a founder who has been diluted have to clear the same hurdle. And if the market has moved down since, the next round prices against where the market is now, not where it was when you agreed the number.

That is a commercial problem before it is a tax one. But it becomes a tax problem the moment you try to fix it, because reorganising share classes inside the three year holding period can count as a disposal for investors claiming relief. The instinct to tidy the cap table before a fund sees it is a good one. Doing it without checking the clock is not.

What to sort out before you start

Not all of this is fixable. Some of it is.

Pull the compliance file first. Advance assurance letters, SEIS1 and EIS1 submissions, the certificates that went out to investors, and the dates on all of it. If something is missing, you want to know before a fund tells you.

Check every option grant against its notification date. Ninety two days from grant, and the clock does not care that the paperwork was signed.

Look at what your SEIS allowance actually has left in it. Grant funding often counts as state aid and eats into the same ceiling, which catches companies that never thought of themselves as having received state aid at all.

And work out, before the term sheet, which investors in the round are claiming relief and what that means for the share class they take.

None of this is difficult. It is only difficult once it is late.

The real shift

Moving from angels to institutional money is usually described as a step up in scale. It is more useful to think of it as the point at which everything you did quickly gets read carefully.

Angels back a person. Funds buy a structure. The structure was built by a founder who had a fortnight to close a round and other things to worry about, and it contains decisions nobody flagged at the time because nobody was looking.

The founders who raise well are not the ones who avoided every mistake. They are the ones who knew what was in the file before somebody else opened it.

This article sets out the general position and is not advice on any particular set of facts. Thresholds and rates are those applying at the date of publication. A version of this article first appeared on LinkedIn.