My love hate relationship with UK (S)EIS reliefs
TLDR; We're using tax policy to mandate inferior and restrictive capital structures at precisely the moment when companies need maximum flexibility.
Quick intro
For those who don't know: (S)EIS provides income tax relief to investors based on the amount they invest, plus capital gains exemption and inheritance tax benefits. For the most generous SEIS investments, when all reliefs can be claimed, only 15.5% of the investment is truly 'at risk'. This is why HMRC spends considerable effort checking these are 'legitimate' risky businesses - the type the government quite rightly wants to encourage. Not just because successful businesses grow UK PLC, but because building them upskills our capability to implement global innovations. The relief looks generous because it is, but also because most of these companies end up returning 0.0% - nothing, zilch.
For me, with my investor hat on, it's great - I get some money back from the government when I invest in companies where I expect to lose all my money. In the very unlikely case that something does go well, I don't have to pay as much tax on the gains.
But... I see every month that these reliefs are distorting and directly harming the funding environment for startups in the UK at the very early stage. The fatal flaw is simple: (S)EIS forces the earliest stage businesses to set a price in their business - right at the point of formation when there is maximum uncertainty about how much it might be worth.
The fatal flaw: (S)EIS forces the earliest stage businesses to set a price
Y Combinator solved this years ago by creating the SAFE - a ludicrously elegant mechanism that is an unsecured investment that converts at a subsequent funding round at a market-determined price, usually with a 'cap' or a 'discount'. It solves the biggest problem in early-stage investment: how to price a company before it's established. It's the best instrument yet devised for early-stage high-tech funding.
EIS has been designed around managing downside risk of both investment and 'gaming' by rogue investors - very British - but this actually makes failure more likely. The system provides upfront income tax relief for downside protection, then capital gains relief on the backend if things work out. But to ensure the generous reliefs aren't abused, it forces premature pricing and rigid structures. The UK is optimising for "what happens if this goes wrong" rather than "how do we maximise the chance this goes right."
In the UK, because we're conservative (and have limited capital to deploy), we're forcing ourselves to set premature prices. We therefore set prices that are too low - because why would you set them high? - creating a real early-stage problem for high-tech companies: either go to the US, or accept artificially low valuations that tether you to slower investment cycles and depressed valuation expectations from the start.
The US SAFE does the opposite: it gives the best results (especially to investors) when things go well, because that's what actually delivers returns. SAFEs convert at favourable prices when companies are succeeding and raising proper rounds. The economic incentives align everyone around success rather than failure management.
This is impacting UK competitiveness at the earliest stage
I'm working with three companies right now that could raise hundreds of thousands of pounds and accelerate their growth, but they can't - because doing so would make them ineligible for the UK tax reliefs that exist to encourage exactly this investment! These are in time-sensitive industries like AI where speed matters enormously.
Back when EIS was 20%, I was involved with companies that used Convertible Loan Notes (CLNs) - instruments that worked somewhat like SAFEs. You'd get a loan, convert it to equity after 12-24 months, and claim EIS relief. This was abused, so HMRC cracked down. Now the only available instrument is the ASA (Advance Subscription Agreement) which, to maintain EIS eligibility, must convert within 6 months at a pre-set price.
Because there's a mandatory conversion price, it gets set at the minimum acceptable to investors if things go wrong (if they can't raise further funding). SAFEs convert when things go right - at market prices with proper information. With funding rounds now taking twice as long as in 2022, the 6-month ASA window is essentially a death sentence.
Funds that gather investor investments into single entities can take advantage of early-stage companies. They can afford to 'spray and pray' - invest in lots of companies and aggregate the risk of the individual business whilst still getting their SEIS - but if they're doing that, they are able to aggregate away the risk SEIS was designed to fix, ending up subsidising a gamed market.
We've built a system that's more concerned with limiting how badly things can go wrong than maximising how well they can go right. That's exactly backwards for innovation policy.
The heart of the problem with EIS
To be really specific about the problems I have with EIS:
1. Forced Pricing at Maximum Uncertainty
Early-stage companies have the least information but are forced into the most rigid structures
Modern finance has developed instruments (SAFEs, convertibles) specifically to handle uncertainty
(S)EIS rules out these instruments for UK investors, forcing premature price discovery to the detriment of investors (best go to US) and companies
2. Misaligned Risk Management
System optimises for downside protection rather than upside maximisation
Creates artificial pricing floors that become psychological anchors
Incentivises conservative behaviour when companies need maximum ambition
3. Systematic Gaming by Sophisticated Actors
Large VCs exploit tax arbitrage through diversified portfolios
Small individual investments get government subsidies whilst VCs diversify away risk
Crowds out genuine angel investors who provide expertise and networks
4. International Competitiveness Damage
UK companies become structurally unattractive to global capital
Forces companies to choose between UK tax benefits OR modern funding structures
Drives brain drain as companies relocate for better funding frameworks
5. Market Structure Distortion
Creates two-tier system: tax-motivated vs return-motivated capital
Fragments investor base and creates artificial constraints
Policy-induced market failure where regulation prevents efficient capital allocation
6. Early Induced Regulatory Burden
Legal costs of priced rounds are much higher than alternatives as they require a full set of documents
ASA investments require pre-approval from HMRC causing delays and burden
Complex tax issues combined with lack of understanding creates opportunities to mess up company on day 1
A potential fix I've been mulling for months
The simplest way to fix this issue is to allow SAFE-like investments to qualify for (S)EIS. Allow investors to invest in a SAFE to get a company going at the earliest stage, and then allow the investment to qualify for tax reliefs when it converts into equity at a subsequent funding round.
Proposed Structure:
Instrument: SAFE (Simple Agreement for Future Equity)
Characteristics: Unsecured, unpriced, converts into equity at future qualifying round
Tax Treatment: No upfront relief; (S)EIS benefits apply when SAFE converts into qualifying shares
Qualifying Conditions: SAFE converts in an (S)EIS qualifying round where total round size exceeds SAFE amount
Size Limit: Individual SAFE capped at current (S)EIS limits
Anti-Gaming: Converting round must itself be EIS eligible and have investors investing on EIS terms that in aggregate exceed the SAFE amount
Investors: Investors are incentivised to pressure the business to conduct a funding round at a proper price in order to claim their reliefs - realigned with founders!