48. Watch out for those start-up bear traps

I can safely say that a couple of my clients think I’m a pretty good guy; and for an accountant, that can be a slightly unusual place to be!

The reason is embarrassingly simple.  They are both CEOs of young businesses that have been going full steam for a year or so with the business of making money and then been pulled-up short in their tracks by the nasty realisation that there are certain expectations of the them from the world of regulation, control and oversight that they are in no position to meet.  I simply helped them to fix this stuff.  While I get a kick out that, the cool thing would have been to have avoided it all in the first place.

Spending scarce time and cash resource on the back office can seem pure folly in the early days, but there are a few things you should give serious thought to before you go too far down the start-up road.  So what are the bear traps?

Accounting records – a moderate knowledge of Excel is a very dangerous thing

Both of my start-up clients had been assiduously recording transactions on Excel.  There was some nice formatting, which made one of my spreadsheets look like a Lowry alongside their Matisse.  However, there was no reconciliation to cash, one had submitted VAT returns that were incomplete, one had only just VAT registered but was switched on enough to know he had no way of preparing a VAT return.  Neither was able to prepare anything close to a set of accounts for tax and statutory reporting.

The accounting software landscape has changed a lot in recent years and the on-line monthly subscription market is teeming with competition.  Some of it is seriously good with all sorts of great functionality such as automated bank feeds, integrated sales invoice emailing and document storage capability.  The paperless accounts department is well and truly here and it has been designed for use by ordinary people and does not cost an arm and a leg.  Getting set up can be a bit daunting but with some experienced help you will soon be very much in control of your numbers.

VAT – presents for the Chancellor

While Margaret Hodge (chair of the Public Accounts Committee) may think it your moral duty to under-claim legitimate business purchase VAT, most entrepreneurs could use the cash.  Not knowing what VAT can be claimed, forgetting to get VAT receipts (or even worse losing them) costs many a start-up masses of cash.   There are several on-line expenses management apps that allow you to scan receipts on your smart phone as you get them and then analyses the receipt for upload later using pretty accurate character recognition software.  The receipt can be binned as soon as it is scanned.

Picking an app that integrated with their on-line accounts package saved my two clients a bunch of time on expense claims and recovered more than enough previously lost VAT to pay the monthly subscription.

Remuneration – the tax man taketh away

Being able to take cash out of the business is the first tangible evidence of success.  Be careful though.  With real-time PAYE and NI reporting any salary must be declared to HMRC when it is taken and the tax paid the following month.  Any cash taken out that is not declared as salary is either a loan or a dividend.  Interest bearing loans to directors and shareholders are not a “no-no” but they do have some challenging tax consequences if not managed properly.  Dividends are great but you can’t pay them until the business is in cumulative profit.  Get some advice on your remuneration plan before you hit the first year end and have to crystallise the tax treatment.

Investors – the tax man giveth (if you get it right)

Many start-ups are funded by cash from a plethora of sources.  Credit cards can be really helpful as can parents, previous employers’ redundancy cheques and the odd angel.  In the general excitement of a new venture, discussions are had about equity splits, loan terms and interest which often do not get documented.  Also cash investors for equity may be looking for the generous SEIS and EIS reliefs that are currently available.  Notwithstanding the income tax relief on investment, the CGT free gains on exit can be worth a lot more and so making £100 worth of subscriber shares SEIS qualifying can be a good plan (if the ownership limits are met).

There are lots of things to get wrong here if you don’t carefully plan what you are doing and so a bit of advice early on can go a long way.  If you intend to issue shares, do so at the time and be careful about getting the cash or cheque before issue if you want SEIS or EIS relief.  If an SEIS or EIS shareholder has loans as well, be careful not to repay these loans during the qualifying period.  Also make sure you don’t preclude SEIS or EIS relief by allowing an investor to hold over 30% of the equity at any stage during the funding process (subscriber shares excepted for SEIS).  For what is a very simple idea for encouraging investment in small businesses, HMRC has excelled itself in the bear traps it has littered along the SEIS/EIS way.

In short, start-up land is a potentially nasty place full of bear traps and the odd alligator too.  Getting some good guys and girls alongside you early on could save you a lot of heart-ache and maybe some money too.

This blog has been written by Nick Lawson, Client Finance Director with Tectona.

To find out more about spotting those bear traps and alligators – or if you would like to discuss any of our other blog topics – please contact Mark Nicholls on 07818 407061 or Email.

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