starting a tech business - a legal guide

Starting a tech businessA legal guide

2nd edition

IntroductionWhen starting any business there are many matters that need to be dealt with. Most important is a good idea which can be turned into a product or service which can then be sold.

However, to develop a business, it is often necessary to raise finance and, if it is a technology business, it will be necessary to protect the ideas being developed and to incentivise employees.

This booklet summarises the legal issues that those starting a technology business must consider. It is intended for general guidance only and does not represent legal advice.

Further information can be found on the TW Tech Focus microsite at www.taylorwessing.com/twtechfocus. The microsite also includes a suite of free seed investment documents which are available on an open-source basis. We have also recently added a document builder facility for the term sheets that are on the site.

For further information please contact your usual Taylor Wessing adviser or one of our specialists, whose details are provided at the back of this booklet.

Editors

Adrian Rainey Partner +44 (0)20 7300 4154 [email protected]

Angus Miln Partner +44(0)20 7300 4988 [email protected]

Setting up a company 03

Seed investment 13

Key issues and terms of seed investment

Key terms of the articles of association

Intellectual property 29

Employment issues 37

Immigration 47

Share options 55

Tax 63

Enterprise Investment Scheme (EIS)

Seed Enterprise Investment Scheme (SEIS)

Contacts 71

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Setting up a company

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Overview

u A company is a legal entity with a separate identity from those who own it or run it.

u Businesses can also be run as a sole trader or as a partnership. Those approaches do not allow the business to be owned by a separate legal entity or provide limitation of exposure to the debts and other liabilities of the business in the way that a limited liability company does.

u Other possibilities include a limited liability partnership (LLP) which is similar to a limited company in providing limitation of liability and a separate legal entity. An LLP is not viewed as an entity in its own right in the same way as a company for tax purposes.

u Getting the legal formalities right at the outset and getting into good habits of administration can prevent difficult questions arising later on, for example on fund raising, bringing in new partners or realising value.

Who forms the company?

u A company is registered by filing the necessary documents (including Form IN01) and paying the required fee at Companies House. The company is brought into existence when the Registrar of Companies issues a certificate of incorporation.

u A company can either be registered with documents that are specifically tailored to the requirements of the owners, or a company can be bought that has already been incorporated but not yet traded (a shelf company) and its constitutional documents

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amended to suit the owner’s needs. Law firms, law stationers and company formation agents register shelf companies with standard provisions in their constitution for this purpose.

Shares and shareholders

u A fundamental question is who will own the company. Related to this is working out if the company should have different types of shares in addition to an initial class of ordinary shares, for example additional classes of ordinary share or preference shares. This means considering economic rights (income and capital), voting rights and other matters such as transferability and ability to convert into other classes of shares at particular times. Questions may also arise as to the issue of options and warrants to subscribe for shares.

u Often it will make sense to set out rights of shareholders in an investment agreement or shareholders’ agreement, to supplement what is in the company’s articles of association – see next section.

Directors

u An early decision to make is who will be the initial director(s) of the company. The board of directors is responsible for the day to day running of the business. A private company needs to have at least one director. At least one director must be an individual and all directors must be at least 16 years old.

u Each director must consent to act as a director and that consent must be provided to Companies House either in written form or electronically, together with certain other details.

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Secretary

u A private company does not need to have a secretary (unless the company’s articles of association require it). It can be useful to appoint a company secretary, to have one person who takes care of the legal administrative requirements, such as ensuring that the required filings are made at Companies House and dealing with shareholders.

u As with directors, the secretary must consent to act.

Name of the company

u The company’s name must end with “limited” or “Ltd”.

u Before finalising a company name, checks should be run by searching at Companies House (using their WebCheck service) for names the same as an existing name on the index of company names. The Trade Marks Register of the UK Intellectual Property Office should also be checked. This is because:

› no two English companies can have the same name;

› if the name includes the registered trade mark of a third party, the use of that name will automatically breach the registered mark if the intended use is in the same class; and

› if there is confusion in the market place between the corporate names and both companies are in a similar trade, a “passing off” action may be brought by the first company which has built up goodwill in the name, against the second.

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u There are further restrictions under the Companies Act 2006 in relation to:

› names that suggest a connection with Her Majesty’s Government, a devolved government or administration or a specified public authority;

› names that include “sensitive” words and expressions included in regulations;

› names that include words that would constitute an offence; and

› offensive names.

u Even after incorporation a company can be required to change its name in the first year if:

› the name is “too like” an existing name on the index;

› misleading information was provided at the time of registration;

› the company’s activities are misleading; or

› the name is too similar to a name in which someone else has goodwill.

u In general a name is “too like” an existing name if the differences are so trivial that the public are likely to be confused by the simultaneous appearance of both names on the index; and/or the names look and sound the same.

u In addition to the basic searches referred to above, to start off on a sound footing other searches can be performed in relation to trading names and trade marks in the UK and abroad and on such other matters as URLs and patents.

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Articles of association

u The company must have articles of association. The articles are a contract between each shareholder and the company and govern the company’s internal workings and will set out a range of procedures to deal with various matters including rights attaching to shares, directors’ powers, proceedings at director and shareholder meetings and voting rights.

u Usually the articles are not contentious; however, in the event of an investment by an independent third party, the articles will often be one of the main focuses for negotiation – see next section.

u The articles need to be registered at Companies House unless the company relies on the “Model Articles”, which apply by default if no others are registered by the company. The Model Articles may not be suitable for every company and will generally require alteration to meet the needs of the company.

Registered office

u A company is required at all times to have a registered office to which all communications and notices may be addressed. Service of a document on a company is effective if it is sent to the company’s registered office.

u A company may change its registered office by giving notice to Companies House. The change takes effect when the notice is registered. There is a 14-day period after the date of registration of the notice where a person may validly serve documents at the company’s previous registered office.

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Statements of initial shareholdings and capital

u The statement of initial shareholdings in the application to form a company (Form IN01) must state the total shares taken by the subscribers on formation including the number, class and the aggregate nominal value of those shares of the subscriber’s shares.

u Whenever possible, all of the founders should subscribe for shares on incorporation and should subscribe for more than one share each.

u An individual subscribing for shares who is a director / employee or about to become one should sign a Section 431 election within 14 days of subscription.

Documentation for incorporation

u To incorporate the company the following documents must be filed with Companies House:

› application to register a company (Form IN01) and the fee;

› articles of association (unless Model Articles are adopted in their entirety); and

› additional information if the application includes a sensitive word or expression (see Name of company).

u These items can be filed in paper form by sending them to Companies House in Cardiff (for companies to be incorporated in England and Wales). Hand delivery is also possible during office hours, for which the branch of Companies House in London may also be used. Registration normally takes seven days if the application for registration is made using the normal service for which the fee is £40. An expedited service of incorporation within 24 hours is available and costs £100.

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u They can also be filed electronically if an electronic filing service account is set up. The fee is £13 (£30 for the same day).

u Alternatively, the Companies House web incorporation service can be used. This allows people to set up a simple private limited company, using Model Articles, for a fee of £15. Customers access the service via the Companies House website (www.gov.uk/limited-company-formation).

Stationery, websites, emails and signage

u Every company must display its registered name at its registered office and at any location, other than the registered office, at which it keeps company records available for inspection as required under the Companies Act. The registered name must also be displayed at any other location at which it carries on business, unless this is a location which is primarily used for living accommodation.

u The registered name must also be disclosed in legible characters on all websites of the company and on all (whether in hard copy, electronic form or any other form) other forms of its business correspondence and documentation.

u In addition to the registered name, all business letters, order forms and all of a company’s websites must clearly state details of the registered number, the part of the United Kingdom in which the company is registered and the address of the registered office.

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Companies House filings

u All statutory forms are available, free of charge from Companies House. They can be obtained from their website or by telephoning 0303 1234 500.

u Forms can be filed electronically using WebFiling or Software Filing (for which suitable software needs to be installed). They can also be filed in hard copy.

u A company using WebFiling can register for the PROOF (PROtected On-line Filing) Scheme. This provides additional security relating to the delivery of directors’ details and registered office address for documents delivered electronically. It prevents unauthenticated paper filings.

u Directors have a responsibility to prepare and deliver documents, on behalf of the company, to Companies House when required by the Companies Act. Common filings include:

› the annual return;

› the annual accounts;

› notification of any change in the company’s officers or in their personal details;

› notification of a change to the company’s registered office;

› allotment of shares; and

› registration of charges.

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Seed investment

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Seed investment

Equity

Equity is a term which covers all types of shareholding investments in a company. Equity has the following characteristics.

u It gives the equity holder ownership of a stake in the business.

u It is unprotected so on a liquidation or winding-up the shareholders will not recover their funds until all creditors and other costs of winding up the company have been paid in full.

u When a company is limited by shares the liability of those shareholders can never be more than the amount which they invested.

u A shareholder has rights in the company; these are set out under statute and common law and can be varied by agreement between shareholders through the articles of association and/or a shareholders’ agreement.

Debt

Debt is a term which covers all types of borrowings by companies and has the following characteristics:

u Debt ranks ahead of equity on an insolvency of a company. Secured debt ranks ahead of unsecured debt.

u If it is secured this means that the company has charged or pledged certain of its assets to the lender in order to obtain funds.

u From the company’s point of view a secured loan will restrict its ability to deal with the assets which have been charged.

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Seed investment

u Many lenders will not risk funds in companies with little trading history and/or tangible assets without taking some form of personal security from the shareholders or directors.

u The advantage to the shareholders and the company of borrowing money is that it allows shareholders to retain their shareholdings without dilution.

Loan notes

u Loan notes can be a halfway house between equity and debt and be a flexible alternative.

u A third party will lend money to a company and the loan will be convertible into shares at a prescribed price at a future date or on certain events happening.

u There would usually be interest payable on the capital amount of the loan notes. That capital sum may be secured against assets of the company. Loan notes may also be repayable within a certain period or on certain events happening.

Statutory restrictions to raising funds

u Companies seeking finance from investors are, in effect, promoting investments and must therefore ensure that in doing so, they comply with the relevant legal and regulatory requirements which have been put in place to protect the investor.

u Financial promotion communications in the UK are prohibited unless they are made or approved by an ‘authorised person’ or unless there is an available exemption. There are exemptions available where the target audience is restricted to institutional investors such as venture capital funds, existing shareholders or

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Seed investment

creditors and certain high net worth and sophisticated individuals such as business angels (or groups of them).

u Private companies are prohibited from offering shares or other types of securities to the public (including any section of the public). However, private limited companies can offer their shares by private placement in certain circumstances.

Key issues and terms of seed investment

Key documentation

u At the initial stages, quite often heads of terms will be put in place between the investor and the founders to set out the key terms of the investment and reflect a non-binding indicative offer from the investor. An important element will be setting out the agreed valuation of the company which then determines the price of the shares being issued, amount of investment and percentage of the company the investor will obtain. An investor may require that it has exclusivity for a limited period to complete the investment. A detailed heads of terms will make the negotiation of the binding legal documentation an easier process.

u As part of this process, the investor will be carrying out due diligence on the company (and typically issue a due diligence questionnaire) and making financial and commercial investigations and the parties will enter into a confidentiality agreement. The investors will be examining the business plan and financial budget in detail.

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Seed investment

u The two principal binding documents are the investment agreement (also called the subscription and shareholders’ agreement) which sets out the contractual terms of the investment and the articles of association which sets out the rights of the classes of shares.

u If the funding is a seed investment, one would not expect all of the rights of an investor (set out on the following page) to be required, but the rights are explained in full so a founder can understand the typical terms that can be asked of them.

Key terms of the Investment Agreement

u Parties

› Existing shareholders and the company

All the existing shareholders (and in particular the founders) and the company should be a party to the agreement, although it may not be practical for all minority shareholders to be a party if there are a large number of them.

› Investors

As the investment agreement deals with the subscription for shares by the investors in return for the investment monies, the investment agreement should bind all investors participating, including any separate funds that are investing.

› Future shareholders

It is usual to have a provision requiring any transferee or new allottee of shares to enter into a deed of adherence which has the effect of treating the new shareholder as if he were an original party to the investment agreement and therefore bound by the provisions of the agreement.

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Seed investment

u Completion conditions

The investor will stipulate that certain conditions must be satisfied before the investment can proceed to completion. These conditions may include the following:

› completion of any necessary due diligence in respect of the company;

› the delivery of a satisfactory business plan and management accounts;

› obtaining any required tax clearances, for example for VCT or EIS purposes;

› having the necessary authorities (board and shareholder) in place to issue the new shares to investors and adopt the new articles of association;

› the founders and key management having been issued shares or options. See the ’Share Options’ section for discussion of tax issues for share and options and ’Setting up a Company’ for details of the initial stages of incorporation;

› the necessary intellectual property rights being owned by the company; and

› appropriate insurance such as keyman and directors’ and officers’ liability insurance being put in place.

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Seed investment

u Completion mechanics

These are actions that need to be taken on the completion of the investment:

› Approval of the investment agreement and if applicable, disclosure letter.

› Issue of subscription shares to the investor.

› Appointment of the investor director(s) to the board of directors.

› An obligation on the investor to pay the subscription monies to the company’s bank account.

› Approval and execution of service agreements if the founders are to become executive directors of the company.

› Adoption of or commitment to adopt a share option plan.

u Tranche payments

Many investors, particularly in the context of start-up companies, may not want to provide all the funds at the beginning of their investment. There may be negotiation as to the timing of instalments and whether any future instalments should be subject to performance milestones. If so then care should be taken to ensure the milestones are as unambiguous as possible.

u Warranties

› Warranties are assurances made by the warrantors, who are usually the founders and the company, that certain statements relating to the company are true and accurate at the completion date.

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Seed investment

› If any of the warranties are untrue as at completion, any investor can sue the warrantors for breach of contract.

› The warrantors can qualify the warranties by way of a disclosure letter and agree limitations to the warranties (for example, time limitation, materiality threshold and financial limitation (which for the founder is usually linked to a multiple of his salary)).

u Investor consent regime

› The investor will usually have a minority interest, i.e. it will be holding less than 50% of shares in the company. Under English company law, many shareholder matters can be passed by either the holders of over 50% or at least 75% of the shares.

› The investor will want a contractual right to prevent shareholders taking key decisions without their consent. This applies to management decisions as well as shareholder decisions.

› The level of consent is very much dependent on how many investors are investing in the target. If there is only one investor, then it is usual to state that none of the matters listed above can be done without the prior approval of the investor. However, where there is a consortium of investors it is impracticable and time consuming to require the consent of every single investor before any shareholder matter or board matter is undertaken. In these circumstances it is much more usual to require the consent of the holders of a certain percentage of the investor shares.

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Seed investment

u Financial information

› It is often a requirement that the company produces management accounts, audited accounts and financial models and budgets for the upcoming financial years. This can be burdensome for management to produce.

› The investor is also likely to require that they can access to the accounts of the company for inspection.

u Board representation

› In most cases where a minority stake is being taken, the investor is likely to require that it is able to have an entrenched right to appoint a director and that any such director must be present in order for there to be quorum of any meeting of the board to allow business to proceed. Founders may also have an entrenched right to appoint a director. These rights are often subject to maintaining a minimum shareholding.

› In some cases, the investor may look for ’observer rights’ so that it has the right to send non-directors to sit in and observe board meetings and to receive board papers, but not to vote.

u Restrictive covenants

› The purpose of restrictive covenants or non-competes is to prevent the founders from competing with the business of the target company whilst, and when they cease to be, involved with the company.

› Typically, restrictive covenants will be found in the service agreement as well as the investment agreement. However, restrictive covenants in the investment agreement are generally more enforceable than those in the service agreement, as the founders are giving the covenants as shareholders (not employees) in part consideration for the investment.

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Seed investment

Key terms of the articles of association

Classes of shares

u All companies will be incorporated with ordinary shares. If there is only one class of shares they will be ordinary. These have full voting rights, dividend rights and capital rights (to receive funds on any winding up or other return of the company’s assets to its shareholders).

u A company can have any number of types of shares. Some investors will require to be issued with preferred shares.

u Once a company has more than one class of shares, separate class consent may be required if the rights of a class of share are being varied or abrogated.

Liquidation and sale preference

u If the articles of association are silent, on a distribution of net proceeds of a company on a liquidation or sale, such proceeds are distributed to shareholders pro rata to their shareholding in the company. The investor may require a ‘liquidation preference’, i.e. the right to be paid a sum equal to (or in some cases though less common these days a multiple of) the subscription amount paid by it before any of the other shareholders are paid. This may also apply on a listing. If an investor wants EIS or Seed EIS relief he will be restricted from certain preferences.

u The investor can seek a non-participating or a participating preference depending on the commercial circumstances. A non-participating preference means that the investor receives

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Seed investment

its subscription amount paid in priority and the remaining proceeds are distributed to the other shareholders pro rata to their shareholding. Alternatively, after the investor receives its priority payment the remaining proceeds are distributed to all shareholders including the investors pro rata to their shareholding.

Dividends

The holder of preferred shares may receive a dividend ahead of the ordinary shareholders. However, dividends cannot be paid to shareholders unless the company has distributable profits so there is no guarantee that the investor will receive the dividend. The dividend may become payable on a quarterly or annual basis, at the time of an exit or conversion and can be cumulative or non-cumulative.

Voting

It is typical for the holders of ordinary and preferred shares to have one vote for each share held although in some circumstances a preference share will be non-voting.

Conversion

It is usual that the holders of preferred shares have the right to convert their preferred shares into ordinary shares at any time. However, on certain events it is usual to see a provision made for the automatic conversion of the preferred shares into ordinary shares, for example on the listing of a company. An investor may insist that an automatic conversion on a listing of the company only happens if the shares are listed at a price which is at least the same price per share as the subscription price paid by the investor.

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Seed investment

Anti-dilution

u Should the business and accordingly values decline, the company may need to issue further equity at a lower price. An investor (particularly an institutional investor) may look to protect its stake by having the right to have further shares issued, at no cost, but credited as fully paid, to bring its cost per share in line with the lower issue price. Such adjustment could be based solely on the new issue price (full ratchet) or could take account of the amount of new monies being raised and shares in issue (weighted average).

u The articles of association can contain “pay to play” provisions so that if the investor does not participate in the future issue, it loses its right to such anti-dilution protection.

Founder shares

u The investor may insist that the ordinary shares issued to the founders may be subject to a ’vesting schedule’. This means that, although the shares are issued to the founders from the outset, the holding of such shares is conditional on the founders continuing to be employed by the company for a certain period of time.

u If the principle of vesting is accepted, typically the articles of association will include provisions so that the founder shares vest on a monthly or quarterly basis over a defined period. The circumstances of departure (e.g. misconduct or poor health) may vary the vesting or whether such vesting applies and if so at what price the shares must be offered for sale.

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Seed investment

u In respect of unvested shares of a departing founder, it is not unusual for such shares to become converted into deferred shares with minimal rights.

u Alternatively, the unvested shares may be purchased by the company (but the company must have distributable profits for a buy back), offered to incoming employees, employee benefit trust or the other shareholders of the company pro rata to their shareholding (the price of such shares being determined by the circumstances under which the founder departs) or the shares become non-voting until the time of a transfer or listing.

Pre-emption rights on new issue of shares

u When a company issues new shares, the articles of association typically stipulate (unless dis-applied by special resolution) that the company is required to offer such shares first to the existing shareholders pro-rata to their shareholdings (or a particular class of shares).

u The main purpose of the pre-emption rights is to give existing shareholders a right to maintain their percentage interest in the company.

u There are typically carve-outs including the grant of options under the share option plan and shares issued for an acquisition.

Pre-emption rights on transfers of shares

u Unless the transfer falls within the list of permitted transfers, the transfer must comply with the pre-emption rights and the shares be offered to the other shareholders. The selling shareholder should be required to give notice to the company of

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its intention to sell. The priority in which sale shares are offered to the existing shareholders must then be determined. The investor may insist that it has a first right of refusal over any shares proposed to be sold irrespective of class.

u Permitted transfers are exemptions to the pre-emption rights and may include transfers to family members and trusts as well as intra-group transfers amongst group companies or members of an investment fund.

u The investor may require that its prior consent is required before a founder can transfer his shares, in particular unvested shares.

Compulsory transfers

u On the occurrence of certain circumstances a shareholder is compelled to sell his shares. These typically include bankruptcy or insolvency events, change of control of a company that is a shareholder.

u If a shareholder is an employee he may be compelled to sell his shares depending on whether he is a good (ill health) or bad (misconduct) leaver. The circumstances of departure will also determine whether he sells at market value or nominal value.

Drag along rights

u “Drag along” is another situation where a shareholder may be compelled to sell his shares. The drag-along provision compels minority shareholders to sell if a specified percentage of shareholders decide to sell the company (for example 75%).

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Seed investment

u This mechanism enables the sale of the entire company to a purchaser although a purchaser may be reluctant to rely on such provision to effect the share transfers. It is important that the drag along also applies to existing options that are exercised at the time of a sale.

Tag along rights

u Shareholders may want to negotiate “tag along” rights so that if an offer for shares in the company is received by a number of shareholders holding a specified number of shares (so that for example the purchaser will acquire a controlling interest in the company), and those shareholders wish to accept the offer, that offer cannot proceed unless it is made available to other (or perhaps all other) shareholders at the same price. This protects minority shareholders so that they can participate in any offer.

u Additionally, “tag along” rights or “co-sale” rights can be put in place to ensure that, if the founders receive an acceptable offer from a third party, they are obliged to procure that the third party also makes an offer to the investors or the other shareholders on the same terms for the requisite percentage of their shares.

Additional issues

The articles of association will also deal with the following issues: director appointments and conduct of board meetings, conduct of shareholder meetings, conflicts of interest of directors and insurance and indemnity of officers of the company.

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Intellectual property

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Understanding intellectual property rights is vital for any tech start-up. What makes any digital business stand out from others is its intellectual property and its continued business success depends in part on how well it protects its IP. This short guide is intended to give an overview of the types of intellectual property right which might be relevant to a digital business and how you should go about protecting them.

In the UK, intellectual property is protected by several different sorts of rights. Usually, you need to rely on several of these because no single right usually protects everything that is valuable about your business. (While there are some national variations to exactly how each type of IP right works, generally speaking the same approach is adopted by countries worldwide.) In looking at IPR’s it can help to consider four distinct areas of value:

u Innovation

u Design and appearance

u Brand

u Data

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Innovation

Confidential information and patents

Tech businesses reinvent products, services and business models. The most important way to protect such innovation, at least initially, is to keep it confidential. As soon as you have revealed what your idea is to the world (and that includes anyone who has not agreed to keep it confidential) then your options for protecting it are significantly reduced. So keep ideas confidential and try only to reveal them to people whom you trust to keep them confidential. Nowadays, it is much more difficult to get partners or investors to sign NDAs so you need to make a decision whether to reveal the idea or not.

At some point you will almost certainly have to reveal your innovation more publicly. At that stage you may still enjoy some protection for your innovation if it is something which you have applied for a patent over.

Depending what sort of idea it is (and, in particular, there needs to be a technical effect of some sort – and so business models can be challenging to protect), it may be possible to patent the inventive aspects of it. To acquire a patent you need to go through a government registration process. You work with experts (patent agents) who are skilled at analysing what is inventive about your idea and can help you satisfy the requirements that it is both new (“novelty”) and wouldn’t simply have occurred to anyone expert in that area (that it is “not obvious”). If you can satisfy these criteria and it is the right kind of invention then you may eventually be granted a patent. It is not a quick or cheap process. But a granted patent gives you a potentially strong monopoly over that particular invention.

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If you can at least apply for a patent before having to reveal your idea to investors etc. then you are likely to be taken more seriously and will have better protection for the concept. Owning patents and showing you are serious about IP protection can, of itself, add to the value of your business.

Design

Copyright, design rights and trade marks

You are likely to spend a great deal of time and effort on how your website or app looks and works. Because of the functional nature of many aspects of websites and apps, it can be difficult to protect how it works but there will be copyright protection potentially for the overall look and feel of the website and design elements within it. In addition, the content you create, whether it is images, videos, music, text, will all be protectable by copyright. Copyright also applies to

some aspects of computer software.

Copyright gives the copyright owner (often the creator) the right to prevent other people from copying, using or exploiting their original works without their consent. It is the most pervasive of IPRs, subsisting in anything from menial pieces of text to great works of art, literature and music. It will apply to the visuals and graphics you use, text and blog posts, clips and music. While it does apply to software code (because that’s a form of writing), as it does not usually protect how things work, and so for example it is only of limited use in protecting the functionality of a website. Copyright comes into existence automatically when the relevant work is created. This makes it a powerful right because no formal steps are needed before it can be relied on and it lasts for many years after the death of the creator.

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You may also be able to protect icons and logos used in your product as designs and trade marks, which are discussed below.

Brands

Registered trade marks and passing off

In terms of “bang for your buck”, brand protection can be one of the better investments that a start up company can make. The primary form of brand protection is a trade mark registration. It’s possible to obtain a registered trade mark for just about any mark which is distinctive (in other words which is not descriptive) of the chosen goods or services. These can be words, slogans, logos and even colours and sounds. There is a formal registration process but once that is passed (which takes a few months) the registration lasts for 10 years before any additional fees are due. The costs are fairly low, and the right can cover most countries worldwide, with a mark covering the whole of the EU costing only about triple what a UK only mark costs. In general terms, a trade mark registration permits its owner to complain about other companies using the same or a similar mark on similar goods or services.

Registered trade marks are fairly cost-effective to enforce against infringers. If you don’t have a registration, you may still be able to take action against someone using a similar name or get-up under a right called “passing off”. For this you will need to be able to prove that you have used your mark (etc) enough for it to have acquired some reputation, in the sense that customers associate it with you. If you can also show that it is likely that customers will be confused between the two marks then you may well have all the ingredients necessary for a passing off claim.

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Domain names in the UK

u Domain name jurisdiction, unlike other forms of intellectual property, is determined not by where the business or creator seeking protection is based, but by the top level domain. There are currently 22 top level domain names available in addition to country names such as .fr and there will soon be many more as organisations have, from the beginning of January 2012, been able to apply for a bespoke top level domain name.

u Domain names originate in the US where they are issued and administered under the aegis of ICANN (the Internet Corporation for Assigned Names and Numbers). However .uk domains are overseen by a company based in Oxfordshire called Nominet (www.nominet.uk/).

Data

Copyright and database right

Data is often the most valuable asset of a digital business, whether in terms of the services you offer being data-rich or data-enabled, or the value you enjoy from the data your customers are prepared to share with you. Despite this, IP protection around data is a complex topic because data itself is often not protectible.

The main type of IP right around data is actually a form of protection of the database itself, rather than of the underlying data. This can seem an artificial distinction. What is protected by the right is the investment which is made in obtaining or verifying the data and presenting it.

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Copyright may also apply to the underlying data and the way it has been compiled. But to take advantage of this you will need to be able to prove that enough skill and effort has gone into the data.

When talking about data, it’s important to keep in mind that here we are talking about data as a form of intellectual property. “Data protection” is an entirely different topic relating to rights to personal data.

Data Protection

u Any data which can be used to identify an individual is “personal data”. All businesses will process (use) personal data e.g. in customer and supplier databases and employee records and, therefore, may need to make a notification to the Information Commissioner about their data processing activities as a data controller.

u A Data Controller has responsibility for the way in which data is processed and is defined as any organisation or individual who is responsible for determining how and why personal data is processed. A Data Controller has a number of legal obligations including to keep the data secure and up to date.

u Where a Data Controller appoints an agent to carry out processing and the agent does nothing with the data on its own initiative, the agent will be a Data Processor rather than Data Controller. A Data Processor has no direct obligations under the legislation but is likely to be contractually obliged to comply with instructions of the Data Controller.

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u Transfer of personal data outside the EEA is subject to certain exceptions, prohibited unless the data subject has consented and therefore Data Controllers should be mindful of where they host the personal data and how it is processed.

u EU data protection law is changing, with a new General Data Protection Regulation due to come into force in 2018. Businesses which comply with current data protection law will find it easier to deal with incoming changes. While many elements of the new law will be familiar, it also introduces an increased compliance burden, new rights for individuals and significant penalties for non-compliance.

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Employment issues

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Employment issues

Hiring staff

Hiring members of staff will be an important step in growing your business. In doing so, however, it is important to be aware of your rights as an employer but also the rights of your employees. Many questions arise, such as is a written contract needed, what will the employee’s holiday entitlement be, are work permits required, will the employee be entitled to sick pay and what happens if you want to let the employee go? You will find below a brief consideration of some of the main issues when hiring staff, although these are a general guide and specific advice will always be needed.

Contracts of employment

Often one of the first issues that a new or early stage business will face is deciding how to engage its staff and in particular whether this should be as a contractor or employee.

Engaging staff as independent contractors is often seen an attractive option as it can mean saving costs. For example, unlike employees, contractors do not have any right to be paid the national minimum wage, holidays or sick leave and there is no requirement for your business to pay employer’s national insurance contributions of 13.8% on any payments for services. However, it is essential that this arrangement properly reflects a contractor-customer arrangement in practice, not just on paper, otherwise there is risk to your business of having unexpected employment and tax liabilities.

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Employment issues

As a guide, a contractor should generally have control over where, when and how the work is done, can turn down work or provide a substitute to do the work, is not integrated into your business and does not receive a salary or benefits. A contractor would also usually be engaged on a short term or project basis.

In contrast, an employee-employer arrangement would usually be the opposite of these circumstances.

Often, early stage businesses in the tech sector wish to engage certain individuals as an “Intern”. An Intern is usually considered to be a job title of an employee entitled to at least the national minimum wage or national living wage (see below) rather than its own independent employment status, except in limited circumstances where the individual is working short term as part of an agreed educational work scheme.

Contracts

Regardless of how you engage your staff, it is essential that you have a written contract agreed prior to the commencement of work to ensure expectations are clear, you have flexibility in the relationship and your business interests are properly protected. Employment or contractor agreements may seem like an extra expense but these will be the first documents that are reviewed if there is a difficulty or breakdown in the relationship and without an

agreement you have minimal protection in law.

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Employment issues

Every employee must be given a written statement of certain minimum terms and conditions of their employment within two months of their start date. They are also entitled to receive an itemised statement of pay and deductions for tax, etc. It is worth remembering that after a month of working for you an employee will be entitled to a minimum of one week’s notice and this will increase by one for every year of service up to a maximum of 12

weeks with twelve or more years’ service.

There is no requirement to provide a contractor with a written agreement. However, without a written agreement, the terms of the provision of services to your business may be unclear and open to dispute and your business has very little protection. Importantly, if your contractor is creating intellectual property as a design or software, any rights in such intellectual property will belong to the contractor unless otherwise agreed.

Investors will often want the founders and important members of staff to sign up to appropriate employment contracts containing, among other things, IP and confidentiality protection for the company and post-termination restrictions to lesson the risk of competition for a period of time after the employee has left the company. Investors will also want to establish who owns any IP in the business and ensure that this belongs or is transferred to your company.

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Employment issues

Employee working hours and holiday

Any employees working for you are entitled to work up to a maximum of an average of 48 hours per working week unless they sign an agreement explicitly revoking this protection. In addition, all full-time employees are entitled to a minimum of 28 days’ paid holiday per year (which can include the eight public holidays in the UK), with a pro-rated equivalent for part-timers. The amount each employee will be paid for a holiday taken is usually based on the average pay of the 12 week period prior to the holiday starting.

National Minimum Wage

All workers benefit from either the National Minimum Wage or the National Living Wage (together the “NMW”). The living wage rate for workers aged 25 and over, known as the national living wage which is £7.50 and the standard basic rate for payment of the NMW for workers aged 21-24 inclusive is £7.05 per hour. Young workers aged between 18 and 20 are entitled to the NMW at the lower rate of £5.60 (Development rate) and those aged 16 and 17 are entitled to a rate of £4.05 (Young Workers rate) and apprentices aged under 19, or aged 19 or over and in the first year of their apprenticeship, to £3.50 (Apprentice rate). Employers are under a duty to keep full records of payment to their employees and it is important to ensure that you have these right from the start.

An employee cannot be paid in shares or share options instead of national minimum wage and the provision of any share rights must be treated as a separate benefit.

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Employment issues

Income Tax and National Insurance

An employer is primarily responsible for the deduction of an employee’s income tax and national insurance contributions from the employee’s salary and for the payment of these sums to HM Revenue & Customs on a regular basis. This system is known as Pay As You Earn, or PAYE. The employer must register with the appropriate authorities for PAYE.

If the employer does not make these deductions from salaries and payments to the relevant authorities, the employer may be subject to liability for the sums which ought to have been deducted in respect of the amounts paid and for penalties and interest on the unpaid sums.

The rates of income tax for the year 2016/2017 are as follows:

£0 – £33,500 20% £33,500 – £150,000 40% Over £150,000 45%

Most individuals will have a standard personal income allowance each year which is tax free and income tax is charged only on amounts earned above this amount. The standard personal allowance is currently this is £11,500.

In addition, an employer will be obliged to pay the employer’s national insurance contributions (NICs) at a flat rate of 13.8% of the salary (above a minimum limit and the first £7,000 of employees NICs costs is exempt). There is also a liability for the employer to deduct the employee’s NICs from the employee’s salary. Broadly the employee’s NICs are at a rate of 12% for salary between £157 and £866 per week and at a flat rate of 2% above £866 per week.

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Employment issues

An employer is not responsible for the deduction of income tax or national insurance contributions for independent contractors and those individuals must pay tax on their own behalf. If your business incorrectly categorises an individual as an independent contractor when they are in fact an employee, HM Revenue & Customs would look to your business to pay any unpaid tax in the first instance. Therefore, it is normal to agree as part of a contractor agreement that the contractor will indemnify your business for any and all income tax and national insurance contributions which are due on payments for services.

Family friendly laws

All female employees are entitled to 52 weeks’ maternity leave, regardless of how long they have been with the business, and during this period the contract of employment will continue except for those parts relating to pay. For any employees who have 26 weeks’ continuous service, statutory maternity pay must be provided.

All pregnant women are entitled to reasonable time off in order to attend ante-natal appointments. On a woman’s return to work after maternity leave she must be reinstated in her former position unless this is after 26 weeks of leave and it is not reasonably practicable to do so. Any dismissal on the grounds of pregnancy is automatically unfair and would also amount to sex discrimination.

The partners of women who have become mothers are entitled to up to two weeks paid paternity leave on the birth of the child. The woman and partner can now share up to 50 weeks of the woman’s leave as shared parental leave, subject to certain requirements.

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Employment issues

There are similar provisions in relation to adoption leave which cover the same period.

All employees with at least 26 weeks’ of continuous service are able to make an application to the employer to work flexibly in terms of the number of hours they work a week or the times that they are required to work. They are also able to make a request to work from home. Although employers do not have to agree to such requests, they do have to take them seriously and it is important to demonstrate that as an employer you have considered whether or not it is possible to agree the request.

Health and safety

An employer is under a general direct duty to have regard to the safety of all employees. The employer is also liable for accidents caused by acts of employees where the employees were acting in the course of their employment.

There may be civil liability and criminal liability for failure to observe health and safety responsibilities. The officers of a company in breach of the legislation may be personally liable, in addition to the company itself.

An employer is obliged to maintain insurance, under one or more approved policies with an authorised insurer, against liability for bodily injury or disease sustained by employees and arising out of

and in the course of their employment.

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Employment issues

Once your business has five or more employees, it is required to have a written health and safety policy which includes accident management and reporting procedures.

Dismissal

All employees have the right not to be unfairly dismissed once they have worked for a company for two years. Dismissals are only fair if they relate to:

u Capability

u Conduct

u Redundancy

u Illegality of continuing to employ someone (e.g. their visa has expired)

u Some other substantial reason

A dismissal for any other reason will be unfair. In addition to only dismissing someone for a fair reason, the employer must follow a fair procedure in reaching the decision to dismiss. If employees are found to have been unfairly dismissed they may be compensated by a basic award and an additional compensatory award. The basic award is calculated on the same basis as a redundancy payment. The current maximum compensatory award for unfair dismissal is the lessor of 12 months pay or £80,541.

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Employment issues

Redundancy

In the event that an employee is redundant (i.e. where the business has closed down or else the type of work that the employee is doing is no longer being done by the business) any employee who has two years’ continuous service has a right to compensation in addition to their notice period. Redundancy payments are calculated on a sliding scale depending on age and the length of service with the company. The maximum award is £14,670 but most employees do not have the necessary service for this amount of money (20 years). It is nevertheless an additional cost to the business which should be factored in.

Pensions

Legal requirements have been introduced requiring employers of UK workers to automatically enrol those workers into a pension scheme. When this applies generally depends on how many workers the employer had on its PAYE payroll on 1 April 2012, or, if it had none on that date, when it started to do so. When it does apply, all workers who earn over a minimum amount and are aged at least 22 and under state pension age will need to be automatically put into a pension scheme. Employers using defined contribution pension arrangements will need to make contributions of at least 1% (rising to 3% from 6 April 2019 onwards) of qualifying earnings (which include salary and other items such as bonuses), and, where applicable, deduct employee contributions as well. It is wise to prepare several months in advance, carefully choosing the scheme and pension arrangements to be used, setting up the payroll process and communicating with employees, taking into account the legal requirements on this also.

Immigration

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Immigration

Overview

One of the most common complaints from UK technology businesses is their difficulty in finding suitably skilled staff. Despite the fact that UK employers can freely hire any citizen of the European Economic Area (EEA) or Switzerland without any visa issue, there is an ongoing shortage of skilled developers and specialist technology staff in the UK. Digital economy firms are increasingly looking abroad or to non-EEA staff already in the UK to plug the skills gap. You will find below an overview of the main UK visa options available to non-European exceptional talent, entrepreneurs and start – up tech businesses (this is a summary of the core routes rather than a comprehensive review of all visas).

In each case, the spouse/unmarried cohabiting partner and children (under 18) of the main visa applicant may be eligible for dependant visas too, enabling those family members to work and/or be educated in the UK.

Entrepreneur visas, sole representative visas, exceptional talent visas and sponsored Tier 2 General visas lead to permanent residency after five years continuous stay in the UK. Permanent residency is a mandatory stepping stone to getting a British passport.

Entrepreneurs

Non-European entrepreneurs looking to start-up or join a business venture in the UK should consider the Tier 1 Entrepreneur visa if no other work visa routes summarised in this section are suitable (for example if the entrepreneur will be the sole owner of a UK start-up). The main conditions and things to consider for this investment based personal visa are:

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Immigration

u To get and hold the visa, the entrepreneur must invest the minimum level of funds into a new or existing UK business. If the seed money comes from a reputable source, the minimum investment is £50,000. A qualifying source of funding will be any of:

(a) a VC firm regulated by the FCA,

(b) a UK entrepreneurial seed funding competition endorsed by UK Trade & Investment (UKTI) or

(c a UK government department making funds available for the purpose of setting up or expanding a UK business.

u In most other cases, the entrepreneur will need to invest at least £200,000 of their own unrestricted personal funds, but this can include money from third party contributors in certain circumstances (although in practice it can be difficult to obtain the required supporting evidence). If the entrepreneur is applying for the visa in the UK, the funds must be held in the UK.

u There are also additional English Language and maintenance (funds) requirements.

u The visa will be granted for 40 months initially and can be extended for a further two year period. To extend the visa the entrepreneur must prove that

(a) the required minimum investment was made into a trading UK business,

(b) he/she has registered as a UK director or as self-employed within 6 months, and

(c) he/she created at least two full-time equivalent jobs for settled workers (usually meaning European citizens or non-EEA citizens with UK permanent residency) lasting at least 12 months each. Permanent residency can be accelerated in certain circumstances.

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Immigration

u In all Tier 1 Entrepreneur visa applications – whether initial applications, extension or permanent residency applications – UK Visas & Immigration (UKVI) will use a “genuine entrepreneur” test. This subjective test is designed to tackle previous abuse of this visa route and allows the case worker to assess the credibility, source of funds, profile, entrepreneurial and business track record, and the investment history of the entrepreneur. It will require the applicant to disclose extensive documentary evidence to prove the “genuineness” of the application.

u Non-EEA graduates may be eligible for a different entrepreneur category – a Tier 1 Graduate Entrepreneur visa – for up to 2 years, but this requires the entrepreneur to have been officially endorsed as having a genuine and credible business idea. Endorsement must be by either UKTI as part of its elite global graduate entrepreneur programme (Sirius) or by an approved UK higher education institution.

Exceptional talent

The Tier 1 Exceptional Talent visa (the “Tech Nation” Visa Scheme) is designed for non-EEA citizens that have been endorsed as an internationally recognised leader or that can demonstrate the potential to become a world leader in the digital technology field. It is also available for internationally recognised skilled professionals within the digital technology sector. This route provides a long-term work visa leading to permanent residency after 5 years that is personal to the individual – it is not tied to a sponsoring employer. Each applicant needs prior endorsement from Tech City UK as the official designated body for the technology sector. Tech City UK can endorse up to 200 candidates each year.

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Immigration

Overseas businesses

u Overseas tech businesses sending one senior and established employee to the UK to set up a UK office for the first time should use a “sole representative” visa. This will enable one employee of the parent business to run the UK operation on a full-time basis. After arrival in the UK, the sole representative can oversee a sponsor licence process to enable subsequent staff transfers to the UK from overseas offices (see below).

u The employee must not be a majority shareholder in the overseas business (any ownership up to 50% is acceptable) and the new UK operation must be either a registered establishment (branch) or wholly owned subsidiary of the parent company. The UK operation should be incorporated within one month or so of the sole representative’s arrival in the UK and must also carry out the same type of business as the overseas business.

Work visas for technology businesses – Tier 2 visas

Due to the previous closure of various personal visa routes (such as Tier 1 General and Tier 1 Post Study Work for UK graduates), UK employers will often need to use Tier 2 work permits to hire skilled non-EEA staff. Tier 2 is a sponsored visa route for skilled non-EEA employees with a job offer from a UK employer holding a sponsor licence. There are two categories for tech employers:

u Tier 2 Intra Company Transfers – if the UK operation has linked overseas offices

u Tier 2 General – for all other non-EEA hires, or where the employee wants eligibility for permanent residency.

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Immigration

u To get a sponsor licence, the UK office needs to be trading (with at least one employee) and show that it can meet certain HR and compliance requirements. The processing time for a sponsor licence application from a start-up trading business with a UK bank account and other registrations already in place is typically less than one month from submission, if the company is not selected for a routine visit /audit from UKVI. For a recently incorporated UK entity, a UK bank account often is a mandatory supporting document for a sponsor licence application, but with the extensive anti – money laundering checks that banks are required to perform, opening an account takes a number of weeks.

u Once a licence is in place it can be used to recruit skilled non-EEA staff, either already in the UK or from overseas, although with the exception of high-earners, recruitment from abroad using the Tier 2 General route will usually result in additional process and delay because the UK’s immigration cap will apply.

u For all Tier 2 visas, there are minimum salary and skill levels for the UK job, and unfortunately there are no concessions for start-ups. Minimum salaries are often job specific and rise with inflation each year. From April 2016 the absolute minimum annual salary for all Tier 2 visas is:

› Tier 2 General – £20,800 (or the minimum market rate for the role, if higher). For experienced workers, this threshold will increase to £25,000 in Autumn 2016 and to £30,000 in April 2017.

› Tier 2 ICT visa of at least 12 months’ duration – £41,500 (or the minimum market rate for the role, if higher). This threshold will apply to all ICTs regardless of visa duration (except for Graduate Trainees) from April 2017.

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Immigration

u Often the UK employer must advertise the role to the resident workforce for at least 28 days before a Tier 2 General visa can be issued to a non-EEA hire, because the UK employer must show that there are no suitably qualified “settled” applicants that could do the job. UK sponsors hiring to fill specified “shortage occupation” roles or hiring non-EEA graduates from UK universities are exempt from advertising in some cases.

u Several occupations in the digital technology sector were added to the Shortage Occupation List (SOL) at the end of 2015, although the roles on the SOL are changed regularly. Roles on this list are exempt from the usual Tier 2 General advertising requirements and also get priority in the monthly allocations against the UK’s immigration cap. IT Product Managers, Data Scientists, Senior Developers and Cyber Security Specialists were all added to the SOL, but the concessions only apply to a “qualifying company” and to roles requiring that the individual has a minimum level of relevant experience. A qualifying company must have less than 250 employees in the UK and meet some other conditions.

u If the UK office is part of an international corporate structure, Tier 2 Intra-Company Transfer visas can be used to move employees with at least 12 months’ service with an overseas office to the UK operation on assignment, in which case the UK sponsor will be exempt from the UK’s immigration cap and from advertising. From April 2017, the one year experience requirement will be removed for ICT applications where the applicant is earning more than £73,900 per year.

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Immigration

Visa Minimum UK annual salary Permanent residency after 5 years

Sole representative

O P

Tier 2 ICT P(salary can be paid in overseas currency or GBP)

O(visa usually capped at five years, with 12 month cooling off period in most cases. There are exceptions for high-earning employees)

Tier 2 General P P(otherwise visa usually capped at six years, with 12 month cooling period unless employee is a high-earner)

Tier 1 Entrepreneur

O P(can be accelerated)

u From Autumn 2016 all Tier 2 applicants for visas of more than 6 months will have to pay an Immigration Health Surcharge of £200 per applicant per year of the visa, as an up-front contribution to the NHS (until Autumn 2016 ICT applicants are exempt). From April 2017, all Tier 2 sponsors will also have to pay an additional Immigration Skills Charge of £1,000 per year of the visa (£364 for small businesses), although there will be an exception for PhD level jobs and for graduates switching from Tier 4 to Tier 2 General.

u A high level overview of the sole representative and Tier 2 routes is set out below.

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Share options

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Share options

Methods of incentivising employees / directors / consultants / freelancers

Main methods are (1) issuing shares directly or (2) granting options over shares.

Comparison of advantages and disadvantages:

Shares advantages

Shares disadvantages

Options advantages

Options disadvantages

f Individuals feel more involved

fTax charge on acquisition where full value not paid

fSimple

fNo initial cost to individual

f Initial set up costs

f Individuals can have voting shares

fMore complicated to get shares back from individual

fVesting/performance conditions more complicated to deal with

f Flexible: e.g.

› leavers – easily dealt with;

› vesting and performance conditions easily dealt with;

› can have options exercisable only on an exit

fUnapproved options tax inefficient

fWhere value is low, can be preferable from tax perspective

fNeed provisions in Articles if you want leaver provisions / restrict voting rights

fEMI options are tax efficient

fAdministrative burden – e.g. requirement to notify online within 92 days

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Share options

Direct issue of shares

u A company may choose to incentivise employees / directors / consultants / freelancers by issuing shares in the company directly to the individuals.

u Where shares are to be issued directly, consider:

(1) type of share – e.g. voting / non-voting;

(2) good / bad leaver provisions (to be included in Articles of Association);

(3) corporate authorities to allot shares and compliance with EU Prospectus Directive and Financial Services and Markets Act 2000 (FSMA 2000);

(4) reverse vesting (time / performance) – needs to be set out in a separate agreement with individual;

(5) tax implications:

(a) an employee / director will be subject to tax on the value of what they receive where full value not paid – therefore, better to issue shares at an early stage to reduce tax (as value lower);

(b) if individual is an employee / director (or about to become an employee / director) signing a Section 431 election within 14 days of the date of acquisition;

(c) annual company obligation to report to HMRC online.

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Share options

Options over shares

Options are often a preferred method of incentivising individuals to work for a company as they are flexible, simple and can be tax efficient.

Options can either be granted:

u as part of an employee share option plan (for employees and full-time directors); or

u by separate deed (for consultants / non-exec directors / freelancers).

Consider when granting options:

u compliance with FSMA 2000;

u options terms – acceleration / good / bad leaver provisions;

u corporate authority to grant options; and

u tax implications.

Enterprise Management Incentive (EMI) options

u Very flexible method of incentivising employees and full-time directors.

u Shares acquired on exercise of a qualifying EMI option can automatically qualify for Entrepreneurs’ Relief, the 10% rate of tax on lifetime gains up to £10m, where the exercise is more than a year after the date of grant and the holder of the shares is an officer or employee of the company in the year before the disposal (or, where relevant, the disqualifying event), even where the usual 5% Entrepreneurs’ Relief voting and holding requirements are not met.

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Share options

u EMI options can be granted over up to £250,000 worth of shares to each individual (subject to a £3m overall company limit).

u Most UK tech-companies will qualify to grant EMI options (though detailed rules should be checked).

u No advance clearance or approval procedure is required, although advisable to obtain HMRC’s agreement of valuation.

u EMI options must be notified to HMRC online within 92 days from grant (otherwise option will not qualify as EMI).

u Annual online reporting requirement to HMRC.

Unapproved options: Tax

Do not have tax favoured status

u grant: no income (or other) tax charge on grant:

u exercise: income tax charged on difference between the market value of the shares at the date of exercise and option exercise price:

(1) if at exercise shares are “readily convertible assets” (“RCAs”) e.g. exercise is around the time of a sale of the company, NI and PAYE liabilities arise;

(2) employer NI liability may be transferred to employee (employee obtains income tax credit where liability transferred);

(3) the overall rate of tax on exercise is now up to 54.59% for additional rate taxpayers and remains 50.28% for higher rate taxpayers where the employee NI liability is transferred.

(4) note a section 431 election should be signed within 14 days.

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Share options

u sale of underlying shares: charge to capital gains tax on any increase in value of the shares since exercise (subject to application of CGT annual exemption).

u Note also annual online reporting requirement to HMRC.

Employee shareholder status

As from 1 September 2013, employers of any size, including start-ups, have the option to offer new and existing employees shares worth at least £2,000 to become “employee shareholders.”

The employer may issue or allot to employees fully paid up shares of between £2,000 and £50,000 in the company. The employee will not be required to pay for those shares and there will be an exemption from capital gains tax when sold. For ESS shares acquired after 16 March 2016, the capital gains tax exemption is limited to the first £100,000 of gain (and this is a lifetime limit). The first £2,000 worth of shares will be free of income tax and national insurance contributions. In order to benefit from this tax treatment, the employee and connected persons must not have a material interest of broadly 25% of the company.

An employee shareholder will give up certain statutory employment rights in return for the employee shareholder shares, including:

u unfair dismissal rights;

u statutory redundancy payment;

u rights to flexible working and training; and

u stricter maternity and other family rights (16 weeks’ notice of firm date of return from maternity, paternity, additional paternity or adoption leave instead of usual 8).

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Share options

The rights to claim automatically unfair dismissal, unlawful discrimination and flexible working around sex discrimination issues will, however, be unaffected.

The employer must fulfil the following requirements in order for an employee shareholder agreement to come into effect:

u written statement setting out statutory employment rights not available and rights attaching to the “employee shareholder shares” (e.g. voting and dividends);

u independent legal advice for employees. Reasonable costs of advice to be met by the employer and will not be a taxable benefit; and

u employees given a seven day “cooling off” period from the day legal advice is received during which the agreement is not binding.

Employers will need to take advice on tax, valuation, company law and employment law. HMRC has published guidance on valuing employee shareholder shares and a specific form, VAL 232, for companies to request agreement to a valuation from HMRC.

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Tax

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Tax

Enterprise Investment Scheme (EIS)The scheme provides income tax and capital gains tax reliefs for individual investors who subscribe in cash for ordinary shares in qualifying companies.

Tax relief

u Income tax – an investor who qualifies for the relief can claim an income tax reduction equal to 30% of the money subscribed. The relief is subject to an annual subscription limit, currently £1,000,000 (giving a maximum income tax reduction for the relevant tax year of £300,000).

u Capital gains tax – provided the shares have been held for the requisite period of time (see below), any gain made by the investor on a disposal of EIS qualifying shares is exempt from capital gains tax.

u There are also special rules which allow losses incurred on the disposal of EIS qualifying shares to be set against an investor’s income tax liability.

How long do the shares have to be held for?

u To benefit from full income tax relief, EIS shares must be (broadly) held for at least three years after the date of their issue. If an investor disposes of EIS shares within three years of their issue, then the EIS income tax relief is withdrawn by reference to the proceeds that the investor receives.

u In addition, if an investor sells their EIS qualifying shares within three years of issue, then any gain ceases to be exempt from capital gains tax.

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Tax

Are there restrictions on who can be a qualifying investor?

u The scheme is not generally available to directors and employees of the company. However, there are some exceptions for existing directors who do not receive salary from the company and new directors (e.g. angel directors) who have not, prior to their investment, been involved in the company’s trade. Complex rules apply to these exceptions.

u EIS relief is not available to investors who hold (directly or indirectly) more than 30% of the company’s ordinary share capital or voting rights.

Which companies qualify for EIS?

u The scheme is only available to companies which meet certain qualifying conditions. The main conditions are:

(a) the company must have a UK permanent establishment;

(b) the company must carry on a qualifying trade on a commercial basis. Companies carrying on certain excluded activities, including (amongst others) dealing in land, property development and banking are not eligible for the scheme;

(c) the company must not be listed on a recognised stock exchange (but an AIM listed company can qualify for the scheme);

(d) the company must not be controlled by another company;

(e) the company must have gross assets of no more than £15 million before the investment and £16 million immediately after the investment; and

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Tax

(f) the company must have fewer than 250 full time employees (500 full time employees if it is a ‘knowledge intensive company’). ‘Knowledge intensive companies’ are, broadly, companies for which R&D spend constitutes a specified proportion or greater of their total operating costs and for which either (i) the majority of their business will involve exploiting IP generated within the business or (ii) 20% or more of their workforce has a higher education qualification and is involved in R&D.

u Companies can only raise a maximum of £5 million in aggregate under the EIS, the Seed Enterprise Investment Scheme (SEIS), the Venture Capital Trust Scheme and certain other State aid investments on a rolling 12 month basis. There is also a £12 million cap on total investment received under the tax-advantaged venture capital schemes (increased to £20 million for ‘knowledge intensive companies’).

u Companies must be less than 7 years old when receiving their first EIS investment (10 years for ‘knowledge intensive companies’), unless the investment will lead to a substantial change in the company’s activity.

u There are a number of other conditions including the following:

› all investments must be made with the intention to grow and develop a business;

› all investors must be ‘independent’ from the company at the time of their first EIS, SEIS or share issue (excluding founder shares). This effectively means that any external investor seeking EIS relief must either have no existing shareholding or have obtained SEIS or EIS relief in relation to any existing holding; and

› EIS funding cannot be used to fund a business acquisition.

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Tax

Seed Enterprise Investment Scheme (SEIS)On 6 April 2012, the Government introduced a new scheme aimed at incentivising investment into ‘seed-stage’ companies. The information below covers the basics of how the scheme works, what tax relief is available and who is eligible for the scheme.

Tax relief

u Income tax – an investor who qualifies for the relief can claim an income tax reduction equal to 50% of the money subscribed, subject to an annual subscription limit of £100,000 (so the maximum income tax saving for a given tax year is £50,000). The relief can only be used to the extent that the individual has an income tax liability (it cannot create a loss or a repayment of tax), but investors can also use the tax reduction against their income tax liability for the previous tax year, or can split the reduction between the two tax years.

u Capital gains tax – where income tax relief is available for an investment in SEIS shares, broadly any capital gain realised on a disposal of the shares will be exempt from tax. In addition, the scheme includes a partial exemption from capital gains tax for proceeds of disposals made in the relevant tax year that are ‘matched’ with investments in SEIS companies during the same period.

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Time limits

u The scheme is only available to small ‘start-up’ companies (companies which have not been actively trading at any time before two years before the shares are issued).

u The shares must generally be held for three years from issue to benefit from the full income tax and capital gains tax reliefs above. If SEIS shares are disposed of within three years of their issue, then there is a potential claw-back of the income tax relief claimed (and no capital gains tax exemptions will be available, either on the disposal or in respect of any earlier disposal of the proceeds which were reinvested in the SEIS shares).

u SEIS relief can only be claimed by an investor (via their self-assessment return) once the company has either spent at least 70% of the SEIS monies invested or been actively trading for at least four months (as opposed to preparing to trade or conducting R&D in advance of trading).

u The previous requirement that 70% of monies raised under SEIS had to be spent before a company could issue shares that qualify for EIS relief has now been withdrawn (so that ‘joint’ SEIS / EIS funding rounds can be implemented (although care must be taken with the timing of such arrangements).

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Are there restrictions on who can be a qualifying investor?

u The investor must not hold (directly or indirectly) more than 30% of the company’s ordinary share capital, issued share capital or voting rights. There are no restrictions on how much loan capital in the company the investor can hold (although care must be taken with regard to convertible loan stock).

u Investors who are employees of the company cannot benefit from SEIS, but existing or new directors in the company will be eligible.

Which companies can qualify for SEIS?

u The scheme is only available to companies which meet certain qualifying conditions. In addition to those mentioned above, the main conditions are:(a) the company must exist wholly for the purpose of carrying

on one or more ‘new’ qualifying trades. Subject to limited exceptions, this condition will not be met where trades or activities that have previously been carried on are in effect transferred to the company. The company need not carry on a trade immediately – it can be engaged in research and development with the intention of trading. In addition, the monies raised under SEIS can be used in such R&D and there is no time limit placed on the company starting an actual trade;

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(b) the company can only raise a maximum of £150,000 under the scheme. Monies raised under SEIS must also be used by the company in its qualifying activity within three years (but, as explained above, this can include R&D work preparatory to the carrying on of an actual trade);

(c) the company must not have had any investment under EIS or the VCT scheme before any shares are issued under SEIS;

(d) the company’s gross assets must not exceed £200,000 immediately before the investment;

(e) the company must have fewer than 25 full time employees;

(f) the company must have a UK permanent establishment;

(g) the company must not be listed on a recognised stock exchange (but an AIM listed company can qualify);

(h) the company must not control, or be controlled by, another company; and

(i) the company must not be a member of a partnership.

Contacts

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Contacts

Adrian Rainey Partner +44 (0)20 7300 4154 [email protected]

Angus Miln Partner +44(0)20 7300 4988 [email protected]

Simon Leslie Senior Associate +44 (0)20 7300 4982 [email protected]

Corporate

Chris Jeffery Partner +44 (0)20 7300 4230 [email protected]

Mark Owen Partner +44 (0)20 7300 4884 [email protected]

Intellectual Property

Sian Skelton Partner +44 (0)20 7300 4769 [email protected]

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Contacts

Ann Casey Partner +44 (0)20 7300 4750 [email protected]

Anna Humphrey Senior Associate +44 (0)20 7300 7095 [email protected]

Share Incentives

Paul Callaghan Partner +44 (0)20 7300 4210 [email protected]

James WatkinsAssociate+44 (0)20 7300 [email protected]

Employment

Rob Young Partner +44 (0)20 7300 4201 [email protected]

James Stewart Senior Associate +44 (0)20 7300 4865 [email protected]

Tax

Charlie Pring Senior Counsel +44 (0)20 7300 4256 [email protected]

Immigration

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© Taylor Wessing LLP 2017 This publication is intended for general public guidance and to highlight issues. It is not intended to apply to specific circumstances or to constitute legal advice. Taylor Wessing’s international offices operate as one firm but are established as distinct legal entities. For further information about our offices and the regulatory regimes that apply to them, please refer to: www.taylorwessing.com/regulatory.html

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