Employee shares headaches for early stage companies

Cash is often tight for early stage start-ups.

So often, as well as the founders taking little or no cash out of the business as salary in its early days, the first (brave!) employees also end up having to share this pain.

To help ease this, it is common for employees to be offered shares in the company in lieu of salary (in full or in part). This seems like a sensible option, as the first employees they are treated like sort of quasi-founders, and by taking a small slice of the equity they have the potential to share in the upside of equity ownership if all goes well in exiting further down the line.

This can therefore work well commercially, however, it can cause a headache from a tax perspective….

The UK tax rules related to shares issued or transferred to employees are unfortunately tightly drawn. This results in shares passed to employees being treated for tax as if they were received at full market value – even if no cash changed hands – and therefore as ‘earnings’.

So, say I reward you with 500 ordinary shares in my early stage start up company for the hard work and dedication you’ve put in so far and for accepting a reduced salary, HM Revenue & Customs (HMRC) would treat these shares as employee related income subject to income tax (and possibly even National Insurance). Any employment related tax would be due on the market value of the shares at the date of issue or transfer less any amount paid (if any). The logic behind this is that had the company had cash and paid a salary instead then this would have been subject to tax via PAYE in the normal way so there should be no difference…

But so many start up and early stage companies do not think of this – why should they?

In very early stage companies this may be less of an issue but in situations where there has been external investment or where there is valuable proprietary intellectual property (IP) or even where the founders have a track record of success and there is significant ‘hope value’ or likelihood of success (and therefore value) then extreme care is required.

Complex rules like these, quite frankly, should not be inflicted on new and emerging companies, however, they can and do bite so it’s better to be forewarned (and armed) than to risk stumbling into this headache later down the line which could ultimately disrupt investment or exit opportunities – or at least result in a distracting tax investigation!

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How to get to grips with your business finances

It is easy to get caught up in ‘doing’ rather than ‘running’ your business.

So many business owners find themselves running simply to stand still – finding new customers, taking and fulfilling orders and addressing (hopefully not too many) customer complaints.

Sometimes its difficult to see the wood for the trees:

I’m really busy so I must be making money – right…?

Not necessarily.

Understanding your business finances

It is understandable that, at the end of a busy day working in your business, you would prefer not to review your business finances. But if you don’t understand the numbers that your business is producing then how will you know which bits are working (and profitable) and which bits of your daily work are simply a waste of time and effort?

I frequently recommend that owners of new businesses sit down (at least weekly) with a pencil and journal (yes, that technical!) and write out the week’s sales figures and costs by hand. I find that there is something more insightful about using a pencil and paper compared to an excel or similar spreadsheet – perhaps its the exercise of writing by hand that makes you think more deeply about the figures and how they connect (or not…).

At its most basic, to write out your sales income (ideally split across services or products) and associated costs, will give you a much clearer view of what is profitable work and what is unprofitable – the figures rarely lie. You would be astounded how few entrepreneurs do this simple exercise – and by the number of business owners whose jaws hit the desk when they realise why (or even that!) they are losing money you can tell they wish they’d done this far earlier!

Moving on from pencil and paper to the day-t0-day, I’m a big fan of online cloud accounting packages like Xero as they provide a live dashboard view of the health and performance of your business. Now with live feeds across the majority of UK banks, entrepreneurs can get a realtime view of the health (or otherwise!) of their business. The bank balance is clearly there to see plus debts receivable as are costs payable. Cashflow is absolutely king for all businesses so the ability to see how much cash is in the bank, how much is due in and how much is due out at any one time is crucially important if you are to be in the driving seat in running your business.

Don’t get put off by accountancy mumbo-jumbo, simply by taking the steps set out above on a daily or at least weekly basis, you will be streets ahead of many of your competitors who are ‘busy being busy’ with no clear focus or direction on what works for the future of their business. Try it. Let me know how you get on.

If you are a digital, tech or creative business and you would like some assistance in getting a better grip on your business finances then please drop me a line.

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Why do most companies have a 31 December financial year end?

Most companies have 31 December financial year ends.

Yet you have a choice as to when your company accounting period runs to in the UK – unlike in some other countries – so there is no obligation to follow the crowd. Actually, there are some quite compelling reasons why you should opt NOT to have a 31 December year end:

  • the company tax year runs to 31 March so tax changes are often enforced with effect from 1 April. Companies with 31 December year ends therefore have to tackle complicated in-year hybrid tax rates and calculations compared to say 31 March year end companies;
  • the personal tax year runs to 5 April. Easier to plan your tax affairs for your owner managed business if your company tax year is more closely aligned with the personal tax year end;
  • the end of the calendar year falls into the Christmas and New Year holidays – do you really need the stress of closing your company books for the year end on top of the end of year festivities?
  • your compliance costs. Basic laws of supply and demand apply. If most businesses have year ends around the same time, most accountancy firms will be rushed off their feet between November to March so how much scope do you think they might have to share some cost savings with you…?

So how about having a 31 March company financial year end? Or if you want to be really adventurous you could have a 31 July year end? Wild, huh?

Note that there are Companies House documents to file and certain restrictions can apply in changing accounting periods – check with your accountant first or drop me a line in the contact section (tab at top)

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VAT growing pains for virtual UK business

Interesting comments from Ryan Carson of Carsonified in response to questions regarding hidden challenges lurking in global business via the excellent Duct Tape Marketing. He singled out dealing with VAT as one of the single biggest challenges in growing his UK training business to become a global player commenting:

Image representing Carsonified as depicted in ...
Image via CrunchBase

The laws surrounding tax here aren’t written for the Internet age and don’t really make any sense. It was tough getting a straight answer from the tax man about who we needed to charge tax to and how much. Nightmare!

So true. Yet there have been further changes to VAT introduced this year to add to the confusion and administration. ‘Place of supply’ rules for VAT and determining which services are standard-rated, zero-rated, exempt etc are all routine causes for concern for UK businesses – such issues cause much head-scratching for many accountants let alone business-owners.

We need to simplify VAT administration for UK businesses especially when much of it comprises unpaid form-filling for the government e.g. EC Sales List, Intrastat etc let alone unpaid tax collection! And don’t get me started on the ‘reverse charge mechanism’!

Ryan Carson wisely sums up his advice for UK businesses looking to expand beyond UK shores by saying:

Call your accountant and check tax laws. It’s tough, but once you figure it out, it’s a huge new opportunity to grow your business. Just do it.

Expanding overseas is a minefield for the unwary with rules and regulations above and beyond VAT to contend with, however, by following Ryan’s advice in the above order a supportive professional accountant should be able to walk you through the process. Better to invest a little upfront and get it right, rather than have to unpick a series of potentially expensive cock-ups further down the line.

P.S. Get ready for the change in standard rate VAT from 17.5% to 20% from 4 January 2011.

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IPOs for technology companies – Key learning points

Yet another insightful Techcelerate event this evening in Manchester chewed over whether ‘initial public offerings’ (IPOs) or ‘stock market listings’ are the right capital raising vehicle for growing technology businesses and the process required should they choose to go down this route.

Marcus Stuttard (AIM CEO) delivered a concise analysis of the advantages of listing on the markets including scenarios where this might not be so appropriate and then Anish Kapoor (Telecity LSE listing) and Simon Elms (Warthog AIM listing) delivered warts and all accounts of the IPO process as entrepreneurs who had been through it and managed to live to tell the tale.

Here are my notes:

  1. Choose the right broker or nominated advisor (NOMAD). They hold the key to your long term success in the market.
  2. Your management team will also be key to the success or otherwise of the IPO and beyond. Start making connections with potential non-exec directors etc who can help (sooner rather than later) with strategy and helping build your team in areas like finance and perhaps getting the wheels in motion to appoint a highly regarded chairman.
  3. Have your business model nailed down before you start the IPO process. Markets don’t like unexpected strategic changes.
  4. Be prepared for a long and arduous due diligence process in the run up to listing as lawyers and accountants crawl over your results and forecasts. Your business will be in better shape afterwards!
  5. Costs of listing are significant – both in professional fees and management time. You then have the ongoing regulatory and reporting requirements to comply with. Think through why you are seeking a listing as there could be better alternatives if you are seeking a one-off injection of cash.
  6. The flip-side of point 5 is that once you have been admitted to the markets, raising future cash is easier than seeking private / VC funding.
  7. Institutional investors like to see a track record of management having successful executed IPOs and exits. They are prepared to invest in the management team – even for pre-revenue businesses.
  8. Listings in the US are even trickier than the UK – tighter regulations etc. Proceed with caution.
  9. VCs are increasingly looking to AIM markets to invest capital. Espec VCTs. Another advantage for listing.
  10. Think about the impact on your staff and how the fluctuation of the share price might unnecessarily unsettle them. On the flip side, think of the opportunities to incentivise them with a ready market for the shares.
  11. An IPO can be great for your PR in your sector – speaking of which, consider getting a decent PR agent as part of the IPO process.
  12. For AIM you’re probably looking at a minimum capital investment of £2m+ with the majority currently in the £30m-ish bracket.
  13. As a founder, think about when you can get your cash out post IPO – you will probably find you are severely restricted in cashing out shares due to potential negative sentiment and insider info plus lock-ins. Work this out upfront.
  14. Don’t try to time the markets. You need to take the best deal you can get when presented if you are to continue to build your business and stay one step ahead of the competition.

Any further comments to add?

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A key reason why many start-up businesses fail

Here my short (impromptu) video on why I believe many business start-ups fail.

The old adage that “cash is king” remains as true as ever today, however, there is something else that I am increasingly seeing that can put the future survival of new businesses in jeopardy.

This issue is that: many startups fail to define upfront the market need or problem that their product or service will solve.

Seems obvious right?

You would think so but with so many new businesses looking to innovate into new areas and with technology providing an increasingly affordable platform on which to build new businesses, this consideration sometimes seems to get sidelined – typically until businesses seek funding and / or its too late.

So focus now on that particular market failure or wider need that your future business will plug in the world? What need are we anxiously waiting for you solve by creating your business? What frustrates you (and many others?) that your business will crack?

Be clear on the problem and your business solution and you will be one step ahead in defining future revenues and a potentially profitable business.

7 tips for start-ups seeking VC funding

I’ve been reflecting on the key business learning points emerging from the BVCA’s excellent recent event Financing & funding the digital age held in Manchester on 16 September 2010.

It was a full day of fast moving panel discussions and keynote speeches that kept coming at a relentless pace until almost 6pm – plenty to chew over hence the delay in penning this summary.

There were so many ideas and tips to unpack that I’ve decided to run a series of posts covering different topics. First up is the comments made on VC funding.

BVCA Digital Age 1: 7 tips for start-ups seeking VC funding

  1. Start building relationships with VCs who specialise and invest in your chosen sector NOW – don’t leave it until you need a cash investment.
  2. Better communication is needed between both the VC and entrepreneurial community. There was much talk from tech entrepreneurs of the incredibly frustrating “long….slow…..No” from VCs (which was tacitly admitted by the VC panelists), however, there was sound advice in ensuring that you invest some time upfront to pick the right VC – this means studying each VC’s objectives for investment (does this fit with your business?), timeline for investment or where they are in the fund cycle (have they made any investments yet, and if so, any in businesses like yours?). This should save much time and frustration on both sides.
  3. Business plans are largely a work of fiction (as things rarely pan out the way you planned them) so don’t go crazy building huge singing-all-dancing plans, however, you still need one to set out the investable opportunity for VCs to get an initial idea. The point was made (and reinforced by an excellent post and VC panellist Nic Brisbourne) that the act of sitting down and preparing a business plan helps entrepreneurs hunker down and concentrate on the business model – how is this great idea actually going to make me and my investors money? Sometimes reality strikes home when it comes to calculating the sales v costs etc. See points 6 & 7.
  4. Concentrate on clearly defining the market need that your product or service will solve rather than how sexy your technology is.
  5. Dawning of microfunding? Lower costs of entry for building new tech businesses brings into question how much cash investment entrepreneurs might need and when? Put another way, entrepreneurs might now be able to reach a much more advanced milestone in proving the business concept using just “family, friends and fools’ money” than would have been possible a few years ago – the point of inflexion has shifted along the timescale – so does this represent the dawning of microfunding and a move away from traditional VC seed funding and the timing of subsequent rounds of investment?
  6. Merits of writing a business plan for startups seeking funding is best summed up by the comment: “Execution focuses the mind”.
  7. Best of all, when you do approach VCs, present your business as “strategic opportunity” rather than a request for cash.
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National Insurance Contribution (NIC) Holiday Scheme for businesses – What’s it all about?

Yesterday saw the formal launch of the Regional National Insurance Contribution (NIC) holiday for businesses started between 22 June 2010 and 5 September 2013.

This tax incentive announced in the June 2010 Emergency Budget allows for a 12 month break from paying employer’s national insurance contributions (currently 12.8% going up to 13.8% from 5 April 2011) on the first 10 employees.

The relief is limited to £5,000 per employee (so £50,000 in total) although it is difficult to foresee in practice how the majority of startup businesses will obtain full benefit for this relief given that new recruits would have to be paid approx £45,000 each to trigger a £50,000 employer’s national insurance liability?

It’s a welcome tax saving all the same to encourage new business start-ups (particularly in the North West), although there are plenty of points to watch – here are just a handful:

NIC holiday points to watch:

  • You must apply for relief under this scheme – it is not an automatic entitlement. You can apply in paper or online.
  • Business start-ups qualify for the first 10 employees recruited during the initial 12 month period. The “initial period” begins on the day the new business commences trading or the date on which the first employee is recruited, whichever is earlier – this cannot be before 22 June 2010.
  • Each qualifying new employee receives a 12 month “holiday” provided this period does not cross the 6 September 2013 end date.
  • ‘Principal place of business’ determines whether your startup qualifies for the relief. Certain geographical areas do not qualify (mainly London and South East) but you can foresee situations where this may not be clear (even though the guidance suggests otherwise) – there is, however, a Region Finder search tool available to assist. For example, those tech businesses that are primarily online or virtual, HMRC will look to where your books, records and equipment are kept. For those that seem to be split fairly evenly between UK locations, then HMRC will look to where the head office is as a key indicator of location.
  • In addition to sole traders, partnerships and companies, property investment businesses and charities are also included as qualifying. Managed service or IR35 income companies do not qualify.
  • Employer’s Class 1 national insurance contributions can only be withheld from the date of official launch i.e. 6 September 2010. Businesses started before this date cannot claim relief from employer’s national insurance until post 5 September 2010.
  • Those new employees paid less than the employer’s national insurance threshold (currently £110 per week) still count toward the 10 employees even if there is no monetary saving for the new business. Similarly, part-time and casual staff individually count for the 10 employees limit – this provides an opportunity for planning with respect to the order of recruits i.e. ideally recruit senior / management team first (the Business Link guidance specifically states that if more than 10 employees join at once then you are free to choose which ones count toward the 10 employee limit).
  • Anti-avoidance legislation is in place to prevent existing businesses from ceasing and restarting substantially the same activities within 6 months to take advantage of the scheme.
  • Class 1A NIC on benefits in kind are unaffected as are the normal monthly employee NIC deductions which must be paid over in the normal way.
  • You must retain the letter or email from HMRC that authorises you to operate the NIC holiday scheme.
  • The NIC holiday scheme is not yet law. The relevant law should be passed around January 2011 so businesses have a choice – either apply now and risk banking the savings (if the law is not passed the employer’s NIC will be due and payable on 19 April 2011) or wait until the law is passed and apply for a refund for the intervening period

HMRC have prepared a flexible form to help calculate and monitor the amount available to withhold under this scheme.

So what appeared to be a straightforward initiative to promote much needed UK startups proves to be a little more tricky in practice although, with a little advance planning, this incentive should provide at least some tax cash savings for new businesses during their tricky first year of trading.

The above information is for educational and entertainment purposes only. It does not constitute professional advice. Please seek advice specific to your circumstances and particular facts. You can contact me if in doubt.

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Getting maximum tax relief on new equipment purchased for your business

When considering purchasing that shiny new MacBook, desk, printer etc (or pretty much any other capital item) for use in your business, you should think about how you can get the best tax result (as well as considering the best model and price).

Purchased computer equipment, furniture and other plant & equipment is not simply deducted from your profits for accounts and tax purposes. Such items are treated as ‘fixed assets’ in your business accounts and depreciated over their useful economic lives e.g. a £600 laptop might be written off against your business profits over say 3 years (at £200 per year). But tax doesn’t necessarily follow this treatment – that would be far too straightforward!

The Capital Allowances tax regime governs the UK tax treatment of fixed assets in order to provide a degree of uniformity given that depreciation policies can differ between different companies.

The good news is that the capital allowances regime has been significantly simplified over the past few years for the majority of UK businesses. Since 2008, the Annual Investment Allowance (AIA) was introduced which allows businesses (except LLPs) to deduct expenditure up to a certain amount each year from taxable profits in Year one ie 100% tax write off immediately against profits.

The AIA originally started at £50,000 per annum, then went up to £100,000 with effect from 1 April 2010 for companies (5 April 2010 for unincorporated businesses) although it has recently been announced that this will decrease to £25,000 from April 2012.

A key tax planning point therefore is to accelerate planned future significant capital expenditure before the capital allowance rates decrease in 2012.

Care needs to be taken in applying these limits in periods where the limit has changed e.g. a business with a 31 December 2010 year end would need to pro-rata the AIA limit given that the allowance changed from £50,000 to £100,000 with effect from 1 April 2010 for companies.  The entitlement is broadly £87,500 AIA for a 31 December 2010 year end, however, some nifty legislative drafting ensures that companies that may have already invested the full £50,000 before the 1 April 2010 (as it otherwise would have been permissible pre the Budget announcement) are not unfairly penalised.

Note that cars are not eligible for the AIA – although there is a some simple tax planning available to fund car purchases with significant tax relief, but I’ll leave that for a future post…

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As always the above information is for guidance and educational purposes only and does not constitute professional advice. Please seek professional advice specific to your facts and circumstances (as tax law can be pretty complex and changes fairly frequently!).

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