ESIC – Make startups more investible

Running a startup is a tough job where the founders not only develop cutting edge technologies, but also have to look after the financial aspects of their startup. Although I am not a finance or tax expert, I do want to share what I’ve learnt from finance or tax experts we work with. I believe there are things founders can do to make their startup more investible to investors by reducing investment risk.

From 1 July 2016, if your pitch deck includes four magic letters “ESIC” (Early Stage Innovation Company), the investment manager, who reviews dozens of pitch decks full of technical jargons and market analysis every week, will put your pitch deck in a special folder for further review. Why? Because these four letters convey a clear message to the investment manager that even if all the technical jargon and market analysis are wrong, 20% of the investment they make will be tax deductible and on the other hand, if things go well, the Capital Gain Tax (CGT) in ten years will be nil. Sounds like it is worthwhile to spend some time to know more about ESIC, doesn’t it?

You may want to know if it is difficult to qualify as an ESIC company. Well it’s easier than designing an AI algorithm or blockchain architecture. The Australian Tax Office (ATO) provides an education webpage on ESIC qualification. You can gain a quick understanding of the ESIC requirements from the ATO webpage.

Simply put, in order to qualify as an ESIC company, the startup needs to meet the early stage test and either the 100-point innovation test or the principles-based innovation test.

The requirements for the early stage test include:

1. incorporation or registration in Australia;
2. less than $1 million expenses in the previous year;
3. less than $200,000 income in the previous year; and
4. not a public-listed company.

The early stage requirements are quite straightforward and many startups seem to have met these requirements.

The 100-point innovation test is an objective test where you need to have 100 points by meeting different conditions. For example,

• If your R&D expenses account for at least 15% of the total expenses in the previous year, that gives you 50 or 75 points out of 100 points.
• If you hold a standard or innovation patent, you would gain 50 or 25 points.
• If you have completed or are undertaking your business as part of an eligible acceleration program at a startup incubator, this gives you 50 points.
• If you are a startup that has a co-development and commercialisation agreement with one of 42 universities in Australia, then you have another 25 points.
• Of course, you can obtain the 100 points by ticking other boxes listed on the ATO webpage.

If you do not meet the 100-point innovation test, you may want to consider the principles-based innovation test, which requires:

1. genuine innovation for commercialisation;
2. high growth potential;
3. ability to scale up;
4. beyond local market; and
5. competitive advantages.

Although these requirements seem to be subjective to some degree, you can apply for a ruling from the ATO about whether your startup meets the principles-based innovation test before claiming the ESIC status.

Also, it is important to know that the ESIC status is a self-proclaimed status. This means if you get it wrong, the ATO would send a penalty notice to you instead of a cheque to the investors. Therefore, it is wise to consult an ESIC expert to have it done properly and efficiently. If this is something that interests you, just let me know and I would be happy to introduce you to an ESIC expert.