Section II of 8
Test 4: Risk-to-capital, the substance test
Test four · high leverage. Whether your company has a long-term growth and development objective, and whether the investor's capital is meaningfully at risk of being lost in pursuit of it.
What the test is for
The risk-to-capital condition was introduced in 2018 to close the gap between the technical eligibility tests (which a clever lawyer can satisfy) and the policy intent of the schemes (which is to fund genuinely risky, growth-oriented small companies). It is a two-limb test: the company must have, at the time of investment, a long-term growth-and-development objective; and there must be a significant risk that the investor's capital will be lost in pursuit of that objective.
Unlike most of the other tests, this one is not satisfied by ticking a box. HMRC has explicit guidance that risk-to-capital is to be read as a substance test, not a formal one. Applications that meet every other condition can still fail on risk-to-capital if the overall picture is one of low risk or short-term return.
How HMRC reads for it
HMRC reads the application, the business plan, the financial forecast, and the pitch deck as a single document. They are asking: does this look like a genuine growth-stage business taking real risk? Or does it look like a structure that has been arranged to qualify for tax relief while minimising actual downside?
The signals that read as low risk: heavy reliance on tangible assets (especially property) that hold value if the trade fails; recurring revenue streams that look more like rental or licence income than trading; capital-protected structures, indemnities, or insurance that reduce investor downside; short payback periods modelled into the financials; or a strategy whose primary commercial proposition is the tax relief itself.
The signals that read as genuine risk: an early-stage trade that is not yet profitable; meaningful R&D or product investment ahead of revenue; expansion into markets that are uncertain; a financial model that shows a credible path to a much larger business but with realistic possibility of failure along the way.
What good looks like
A risk-to-capital statement that is specific to your company. It names the growth objective in concrete terms (the target market, the scale you are trying to reach, the time horizon), explains why your model requires this round to pursue that objective, and acknowledges the principal risks that could cause the investor to lose money. Generic statements about market risk, competition, or execution risk read as boilerplate. Specific risks – "the v2 platform may fail to achieve commercial traction in the German market within eighteen months" – read as substance.
The other half of risk-to-capital is the growth-and-development objective. If your business plan shows a steady-state small business with modest growth, you have a problem on this test even if the risk side is strong. HMRC is looking for ambition: a plan to be meaningfully bigger in three to five years than today.
Common failure modes
The boilerplate statement.
A paragraph that could appear in any application, on any business, and that recites the words of the test without grounding them in the company's specifics. HMRC reads boilerplate as evidence that the test has not been thought about.
The asset-heavy model.
A balance sheet dominated by tangible assets the investor could recover even on failure – a property portfolio, equipment, inventory – reads as low risk. The same business with a software-and-services model reads differently. Where the model is genuinely asset-heavy, the application must explain why the assets are operational rather than protective.
The SWOT that is mostly Strengths and Opportunities.
Pitch deck SWOT analyses tend to be optimistic by design. HMRC reads them with the weights inverted: the Weaknesses and Threats sections are where they look for evidence of risk. A SWOT with three lines under each negative quadrant and ten under each positive quadrant reads as concealment.
The funding-gap mismatch.
A raise sized at £150,000 against a business plan showing a 24-month deployment is straightforward. A raise sized at £750,000 against a business plan that needs perhaps £200,000 to reach its stated milestones reads as an attempt to maximise tax relief rather than fund the trade. The amount raised should match the funding gap the plan demonstrates.
The seven-plus-year EIS story without ambition.
EIS allows companies to raise within a longer trading window if they qualify as KICs or meet certain conditions. Older companies applying for first EIS use sometimes describe their trade as established and stable. That is the wrong framing. The EIS test is about future growth ambition, not past stability. Older companies need to make the growth case more clearly, not less.
The "we cannot lose" tone.
Pitches that emphasise downside protection, contracted revenue, or guaranteed contracts often read very well to a risk-averse investor and very badly to HMRC. The schemes are explicit that the investor's money must be at risk. A pitch that suggests it is not, defeats the test. The reframe that works: rather than "we have de-risked the model through contracted revenue", write "we have identified the principal downside risks – slower-than-projected uptake, longer enterprise sales cycles, possible regulatory delay – and are managing each through specific actions". The same business, the same plan, the same investor protections. The difference is whether the reader is left thinking the money cannot be lost, or thinking it might be but the management of the risks is credible.
The investor wants to know what could go right. HMRC wants to know what could go wrong. The strongest applications answer both, honestly.