Section II of 8
Test 3: Investor terms, share rights and arrangements
Test three · high leverage. Whether the shares being issued, and any arrangements that surround them, leave the investor's capital genuinely at risk in the way the schemes require.
What the test is for
SEIS and EIS shares must be ordinary shares, fully paid up in cash on issue, and they must carry no preferential rights to assets on winding-up, no preferential rights to dividends that are cumulative or that can be varied at the company's discretion, and no rights to redemption. There must also be no arrangements at the time of issue under which the shares may be repurchased, the investor may be bought out, or the company may be sold on terms already agreed.
The intent is straightforward. SEIS and EIS investors get a generous tax treatment because they take genuine risk. If the shares come with downside protection, guaranteed returns, or a pre-arranged exit, they are not at risk in the way the schemes require, and the tax relief is not warranted.
How HMRC reads for it
HMRC reads the articles of association, the shareholders' agreement (or equivalent investor agreement), and the subscription documents. They are looking for any clause that gives the investor a preference, a guarantee, a redemption right, or an exit on terms set at the time of issue. They are also reading the pitch deck and any term sheet that has been shared with prospective investors, because pre-issue arrangements count even if they don't appear in the final constitutional documents.
The clauses that most often trip applications: liquidation preferences (where the SEIS or EIS investor recovers their investment first on a winding-up or sale); cumulative or fixed dividends; redemption rights or put options that allow the investor to require the company to buy them out; investor-specific exit arrangements that operate as a pre-arranged or guaranteed sale (ordinary drag-along rights at agreed thresholds are generally not the problem; the issue is structures that effectively guarantee an exit on agreed terms to the SEIS or EIS investor specifically); anti-dilution protections that operate as a guaranteed return; and side letters that promise the investor anything not on offer to other shareholders.
What good looks like
Articles that define one class of ordinary shares, fully paid in cash on issue, ranking equally with all other ordinary shares as to dividends, voting, and return of capital on winding-up. A shareholders' agreement that contains standard investor protections (information rights, pre-emption, tag-along) but no preferences, no guaranteed returns, no put options, no pre-arranged exit. If the round includes multiple classes (perhaps a non-SEIS class for some investors and a SEIS class for others), the SEIS class must be the plain ordinary share, and the application must say so.
What is still allowed
Removing preferences from the SEIS or EIS class does not mean stripping investor protections from the round entirely. The standard UK venture protections – information rights, pre-emption on future issues, tag-along on founder sales, anti-dilution by adjustment, board observer rights – are all compatible with SEIS and EIS shares being plain ordinary, because they operate at the shareholders'-agreement level rather than as preferences attaching to the shares themselves.
The pattern that experienced UK venture lawyers use: two share classes in the same round. A SEIS or EIS class of plain ordinary shares for the investors taking the relief, and a non-SEIS/EIS preferred class for investors who require preferences and are not claiming the relief. The two classes co-exist in the cap table. The SEIS or EIS class stays clean. The protections that some investors need sit on the other class.
Common failure modes
The liquidation preference brought in from a US template.
Standard US seed terms include a 1x preference as a matter of course. UK SEIS and EIS investors cannot have one. If a template has been adapted from a US Y Combinator SAFE or similar document, the preference language often survives the conversion unnoticed.
Convertible loan notes or SAFEs converting on SEIS/EIS terms.
Convertible instruments can be SEIS or EIS eligible at conversion, but only if the conversion terms produce ordinary shares with no preferences. A SAFE or note that converts into preferred shares – even nominally "ordinary preferred" – fails.
Discretionary dividend rights treated as ordinary.
Some articles include a discretionary preferred dividend for the new class, on the reasoning that "the company can choose not to declare it." HMRC reads the existence of the right itself as a preference, not the exercise of it.
Redemption rights as "investor protection".
Articles or shareholders' agreements that allow the investor to require redemption on a future trigger (failure to raise a Series A by year three, change of control, founder departure) constitute a redemption right. Whether it is ever exercised is irrelevant.
Pre-arranged exits in side letters.
A side agreement with one investor promising a buy-back, a guaranteed exit path, or an undertaking that the company will be sold by a given date – even if commercially soft and never enforced – is treated as a pre-arrangement and defeats the test.
Anti-dilution that operates as a return guarantee.
Standard weighted-average anti-dilution is generally fine for ordinary shares because it operates by adjusting conversion ratios rather than guaranteeing returns. Full-ratchet anti-dilution, or any clause that issues compensating shares specifically to top up an investor whose stake has been diluted by a down-round, can read as a guarantee.
The investor protections that make a deal closeable are often the protections that make it ineligible. Pick one.