FAQs for startups

A convertible loan allows an investor to convert a loan it is making into equity (shares) in that company in the future. This arrangement is on pre-agreed terms and usually, but not always, at a discount to a benchmark price per share (e.g. the price per share in the company’s next funding round).

An ASA is very similar to a convertible loan, except that the amount invested cannot be repaid in any circumstances and no interest will accrue.

Subject to meeting the various criteria, it is possible for ASAs to attract tax relief under the Seed Enterprise Investment Scheme (SEIS) or under the Enterprise Investment Scheme (EIS) (whereas those reliefs are not available to investors under a convertible loan).

We are often asked about SAFEs (simple agreements for future equity). These documents are more common in the US and in our experience don’t work so well for UK companies under English and Welsh law. ASAs have become the local adaptation of US SAFEs and we find that clients interested in SAFEs are generally happy to use ASAs (or convertible loans) instead.

Startup investments are, in the majority of cases, inherently risky and the main attraction of using ASAs or convertible loans is often the flexibility and speed with which they can be put into place. This means they can often be used for bridging finance prior to a funding round.

Another of the main advantages is that you don't get into valuation issues up front when your investor puts the money in. Those valuation discussions are in effect deferred until the point of conversion and will be driven by the price of the next round or another pricing event.

Convertible loans can be perceived as a lower risk investment to investors than equity. That's because, as a loan holder, an investor would be a creditor in the event that things don't go to plan with the growth of the company. This is especially the case if the loan is secured although most commonly in a startup, loans will be unsecured.

The types of convertible instruments we see are advanced subscription agreements (ASAs) and convertible loans.

Not in all cases but, particularly if investors are involved, it's a useful thing to have. Some companies with simple shareholder arrangements will sometimes just have articles of association and no shareholders’ agreement.

Because it regulates how the company is run and sets out the relationship between all of the shareholders. It is also a private document, that does not need to be filed at Companies House (unlike a company’s articles of association).

In order to keep your startup costs to a minimum, the most cost effective time to put in place a shareholders’ agreement would usually be at the point investors become involved. This is because they are likely to demand their own protections and if you already have your own shareholders’ agreement you might find that you have to start again from scratch!

However, startups with multiple co-founders who are not anticipating raising external investment in the short to medium term should also consider entering into a shareholders’ agreement.

The content of your shareholders’ agreement will depend on the number of shareholders and the level of shareholding. However, key things to include are:

• rules on issuing and transferring shares, including how to prevent/control them being acquired by third parties.
• how the company will run, including appointing, removing and paying directors, rules of business, finance arrangements etc.
• how dividends will be paid.
• dispute resolution procedures.
• investor/shareholder consent requirements, if applicable.

These are matters that the board of a company cannot undertake without the consent of the company’s investors and are a common inclusion in shareholders’ agreements where investors are involved. The consent can usually be given by investors holding an agreed percentage of shares held by investors.

Copyright protects your work and stops others from using it without your permission. It is a non-registered right that arises automatically on the creation of, say, your company name, logo or strapline. You get copyright protection automatically as it arises at the point of creation.

You automatically get copyright protection when you create:

• original literary, dramatic, musical and artistic work, including illustration and photography
• original non-literary written work, such as software, web content and databases
• sound and music recordings
• film and television recordings
• broadcasts
• the layout of published editions of written, dramatic and musical works.

• literary, dramatic, musical or artistic works - the life of the author who created it, plus 70 years 
• sound and music recordings - 70 years from when the recording is published
• films - 70 years from the last to die of the director, screenplay author or composer  
• broadcasts - 50 years from the first broadcast
• the layout of published editions of written, dramatic and musical works - 25 years from the first publication.

This generally depends on nationality; what activity the individual will be doing in the UK; and how long they intend to stay for.

Some overseas nationals from certain countries (e.g US, Australia, Canada, EU countries) can come to the UK under a visitor status without the need to obtain a formal permission. They should only undertake certain permitted activities and stay in the UK for less than six months. There are specific rules applying to certain types of permitted activities and the visitors’ rules should be carefully considered by employers before bringing staff to the UK under a visitor status.

If an overseas national will be doing any paid/unpaid work outside of these permitted activities, or if they are coming to the UK for more than 6 months in any 12-month period, then they will most likely first need to apply for a visa.

A careful assessment will need to be carried out before any application is made. There is now a myriad of visa schemes, however, the most common ones are the Skilled Worker visa, the Senior Specialist visa, the Scale-Up visa and the Expansion Worker visa.

Each visa has specific eligibility and suitability requirements.

An employer seeking to employ an overseas national who is not a settled worker or who does not have permission to work in the UK will need to apply to the Home Office for a sponsor licence. EU, EEA and Swiss nationals arriving in the UK after 31 December 2020 should also be sponsored in order to work in the UK.

There are many types of sponsor licence application, and you will need to assess carefully your needs as well as the individual’s circumstances before initiating the application process.

Each licence type has its own specific requirements.

In addition, a worker may sometimes be able to apply for a visa without being sponsored (e.g. Global Talent visa, High Potential Individual).

A specific route also exists for graduates who have just completed an eligible course of study in the UK with a student licensed sponsor.

Employers do not need to sponsor individuals who have obtained permission to work under the Global talent, Graduate or High Potential Individual routes and should be in a position to understand if an individual may benefit from a permission outside the sponsorship system.

Given the end of the free movement of workers, you should consider applying for a Sponsor Licence to obtain permission to recruit the skilled staff you want in the UK. It is a permission granted by UK Visas and Immigration (UKVI) to a UK business to employ workers from outside the UK.

In order to secure a sponsorship licence you will need to identify the type of licence you want to apply for, submit an application to the Home Office, meet the general requirements and the specific route requirements and pay an application fee.

First you will need to establish that you are a genuine organisation operating lawfully in the UK by submitting a selected number of company-related documents depending on the type of organisation and the route you apply for.

The Home Office will assess if you’re a capable of meeting your sponsor duties and evidencing your compliance by checking:

• the backgrounds of the key personnel appointed in your application involved in the running of your business,
• your current human resources and recruitment procedures to make sure that they are robust enough to ensure compliance.

Once the Sponsor Licence is granted, your organisation must meet all of its sponsor’s duties:

• reporting duties, you must report certain information or events to the Home Office using the Sponsor Management System within the appropriate time limits;
• record-keeping duties, you must keep certain documents for each worker you sponsor;
• complying with immigration laws;
• complying with wider UK law;
• not engaging in behaviour or actions that are not conducive to the public good.

You will need to understand and comply with the requirements of the Workers and Temporary Workers: guidance for sponsors part 3: sponsor duties and compliance. Your reporting duties are detailed in Appendix D and you will need to check that your Right to Work Procedures are fully compliant with the Right to work checks: an employer's guide.

You may also want to considering training the key personnel to make sure they understand and implement all your sponsor duties and are prepared for a potential audit visit from UKVI.

If you are a medium or large business (which is defined as one having an annual turnover of more than £10.2m and more than 50 employees), it costs £1,476 for a Tier 2 Licence to Sponsor. If you’re a small or charitable organisation, it costs £536.

Processing times for standard applications are currently eight weeks.

A Licence is valid for four years, after which you can apply to renew it.

Visa fees for all existing applications can be found on this link.

In addition to the cost of the visa, the worker may have to pay a health surcharge which can be reimbursed by the employer. The sponsor has to pay the immigration skills charge, except if you fall in one of the very rare exemptions categories or if the application for a certificate of sponsorship is made under the new Scale Up visa route. These charges vary depending on the particular circumstances, so please let us know if you require specifics on this.

In terms of timescales, it depends where the visa application is being made. The standard processing time is reported to be up to three weeks. However, you can pay an additional fee to access the priority service to speed up the application, if available.

If a member of staff is given shares and doesn't pay the full value for them, the difference between what they pay and what they're worth will be subject to Income Tax and possibly National Insurance Contributions. Considering that Income Tax rates can be as high as 45% for some people, that can be quite a hefty tax bill.

No. There is no tax on granting an EMI option, which can be helpful for employees and companies in a startup phase.

EMIs are designed so that the aforementioned tax benefits are gained as long as the exercise price (when the employee acquires his shares) is at least the market value of the shares when the options were granted. So the employee could pay less than that value, but it means there will be Income Tax (and possibly NI) charges on the shortfall, when the options are exercised.

Yes. Because EMIs were created by HMRC, there is a process set out by HMRC to follow to get the certainty of knowing what the market value of the shares is at the date of grant, before you go ahead and issue the options.

EMIs are really flexible in terms of when the options can be exercised and the shares can be acquired. Some people, for example, will grant an option because they're aiming for a particular company event when the option will be exercised - maybe the sale of the company, a listing, or a voluntary liquidation. Other people use them so that the options can be exercised on particular dates or in particular periods, so you could use them in that manner. You can also tie performance conditions to them if you so wish.

To use an EMI, there are a number of statutory conditions you must satisfy. Some of the main ones are:

• the company or its group, if relevant, must have less than 250 employees (or full-time equivalents) when the options are granted
• the gross assets of the company or its group, if relevant, must not be more than £30m when the options are granted
• the employee option holder in question must work at least 25 hours a week for the company (or its group, if relevant) or (if less) at least 75% of their working time
• there is a limit of £250,000 worth of option shares per person
• there is also a list of excluded activities which if carried on to a substantial extent by the company (or group) will mean they are not eligible for EMIs. These include among others: banking, insurance, farming, property development, provision of legal or accountancy services and ship building.

It’s recommended that a company checks and takes advice as needed on the various EMI qualifying conditions, including the full range of excluded activities, before setting up an EMI scheme. If there is still doubt as to whether a company may qualify, it’s possible to apply to HMRC for ‘advance assurance’ although time should be allowed for HMRC to consider and respond.

There is a scheme called a Company Share Option Plan (CSOP) which has also been approved by HMRC and works in a similar way to an EMI scheme. However, an employee can only be granted options for shares up to £30,000 in value (proposed to increase to £60,000 from 6 April 2023) and these have to be held for three years before they can be exercised under the terms of a CSOP and obtain the tax advantages. As with EMIs, there are several qualifying conditions which should be checked before setting up a CSOP scheme.

If the company or employee doesn’t qualify for EMI or CSOP options, or for whatever reason they are not considered suitable, you could consider either:

1. granting unapproved share options; or
2. issuing ‘growth’ shares - sometimes known as ‘hurdle’ shares.

You would, however, be moving away from HMRC approved schemes with these.

Unapproved share options

While unapproved share options don’t have any statutory qualifying conditions and so can allow more flexibility, they also don’t have the tax advantages of an EMI or CSOP option and can be tax inefficient for the employee and company.

‘Growth’ shares

A growth or hurdle share arrangement usually involves issuing shares to the employee rather than granting options to acquire shares in the future. So the company would want to consider if that is the desired approach. In this type of arrangement typically shares are issued with particular rights attached to (or stripped out from) them so that their market value on issue is relatively low. If their value at a later point, e.g. an exit event, has increased, the intention would be for that growth in value to be liable to Capital Gains Tax on sale of the shares rather than Income Tax and NI, although advice should be taken on this. It’s also recommended that valuation advice is taken before issuing the shares, as it’s not possible to agree a share valuation with HMRC for these purposes (contrast with EMIs where you can agree a share valuation with HMRC). As they are not an HMRC approved scheme, the general rule would apply that income tax (and possibly NI) would be due on the shortfall between what the employee pays for the shares and their market value on issue.

In the UK, there is a general prohibition on carrying out most of the activities which make up 'financial services' unless the company is authorised or exempt. The general prohibition is set out in section 19 of Financial Services and Markets Act 2000 (FSMA).

You will have to apply to the Financial Conduct Authority (FCA) for authorisation. The permission needed will vary according to the regulated activity being carried out.

It is likely to have a direct effect on your business plan in terms of the cost of the application fee, any potential regulatory capital required and the length of time it might take to gain the authorisation before you can start providing financial services to your customers.

It is very important because a breach section 19 of FSMA is a criminal offence. Also, contracts entered into in unauthorised business are potentially unenforceable.

If you are concerned and think you might be carrying out regulated business which needs to be authorised, you can take a look at the Perimeter Guidance manual from the FCA which gives guidance on the circumstances under which authorisation is required. You can also get in touch with them through their Innovation Hub.