Running out of money is one of the main reasons startups fail and raising capital can be difficult, so here’s a top tip for how to make your startup attractive to investors.
If it’s not already on your Trello board, becoming recognised as an Early Stage Innovation Company (ESIC) should be.
Why are ESICs attractive to investors?
There are generous tax incentives available for people who invest in an ESIC. They’re explained here by the ATO but to summarise, investors can claim a tax offset of 20% of their investment and if there’s an exit in the next one to 10 years, their investment is capital gains tax free.
If you’re involved in capital raising discussions, this can give you an edge. You’ll be able to confidently present your company as an ESIC and demonstrate high growth potential.
As with all things tax, it can get technical. The offset is capped at $200,000 per year for sophisticated investors. Non-sophisticated investors are able to invest up to $50,000 per year, on which they can claim the 20% offset.
How do you become an ESIC?
As with all things tax related in Australia, directors can self-determine their ESIC status but you need to have clear grounds for it.
However, investors typically prefer an outside view and ask companies to apply to the ATO for a formal ESIC ruling. So if you’re wanting to make your startup attractive to investors, then the onus usually falls on you to do it.
You can start by completing a self-assessment, which comprises two tests:
- Early stage test
- Innovation test
The early stage test is straightforward – you’ll basically need to satisfy the rules that you’re an early stage emerging company.
The next step is the innovation test and there are two options for this:
The 100 point test includes an analysis of any R&D tax incentives claimed, participation in an accelerator program, any capital raised to date, and any enforceable rights you have such as a patent.
If you can’t meet this test, that’s okay. An increasing number of startups are relying on the second option – the principles based test. But this is harder to confidently assess yourself. You need to demonstrate your potential for high growth, your competitive advantage and how you can scale, among other requirements. In an increasingly competitive startup environment, this can be difficult.
Where can I get help to become an ESIC?
Becoming an ESIC is not guaranteed, and it’s also not a free ride to investment. Crossing your i’s and dotting your t’s is important for investors’ peace of mind, and also for your own.
There are ‘ESIC certification’ companies around that hold the line that you *must* be ESIC certified (by them, for a fee of course). This is not correct. You can self-determine, however investors usually prefer an ATO ruling.
There are also consulting companies that charge many thousands of dollars to prepare ATO ESIC filing lodgements.
But most of the information needed comes from the startups themselves, which is why we provide a different approach to guide you in preparing the submission. This makes it more cost-effective too, so chat to us if we can assist.
Before you go
As with all our articles, please don’t take them as personal tax advice. Speak to our tax expert, Mike, for that.
And if you’re in the market for capital raising, don’t forget to download our free startup founders guide to funding ebook for everything you need to know about funding including more tips on how to make your startup attractive to investors.
Thanks to rawpixel.com on pexels.com for the image.