The principals test, also know as the innovation test is available to anyone wishing to access ESIC concessions. The test should be applied after passing the Early Stage Test and is one of 2 methods to confirm ESIC status.
The simplest way to learn more about the test is to add a listing and complete our ESIC questionnaire, or alternately use the ESIC calculator. However you may wish to learn more about the 5 requirements before getting started;
1. Is the company developing a new or significantly improved innovation?
2. Does the company have potential for high growth?
3. Is the company business model scalable?
4. Will the company address a national, international or global market
5. Is there potential for a clear competitive advantage?
Note: To some, these may seem to be quite onerous conditions, which is true, ESIC's are not meant to be any average startup or SME, they should be aiming to become a huge success!
The tests seem straightforward, though they are not and there are a number of sub tests / considerations to overcome.
Test 1a Is the company 'developing for commercilisation'
- this sub-test deals with companies that are either too early or too late in the commercialisation process.
Tip; A company solely focused on R&D should not be considered ESIC
A company that has completed its commercialisation would have lost any ESIC status it may have had
Test 1b Is the development 'new or significantly improved'
- this subtest establishes a high threshold for ESIC companies
Tip; If someone else has a website/app/technology showing the same business model in the same addressable market the company is unlikely to be ESIC
If the innovation is a minor improvement or part of the business, when considered from the customer perspective, the company is unlikely to be ESIC
Just because something is new and innovative to the company, does not make in ESIC worthy, it must be genuinely innovative in a broadly addressable markets.
Test 2 Does the company have 'High' Growth Potential
What is High Growth and what do I need to show this, is it sales?
High growth potential is distinct from typical small to medium enterprises such as cafes, local retail, local service providers. An ESIC needs to show it has the potential for high growth in a broad addresable market, for example a mobile application that plans on trialling in Melbourne, though after this beta test, it can rapidly expand to include all national cities and beyond.
An ESIC does not need to have sales already*, its early stage, though it must have a documented plan showing the potential for high growth.
Note* sales of >$200,000 in the prior year will cause the company to fail the early stage test.
Test 3 Scalability
Will the company be able to increase its share of the market or enter into new markets due to its operating leverage?
Tip Operating leverage is where the existing revenues can be multiplied through incurring a reduced or minimal increase in operating costs
Typical examples involve the use of technology platforms that scale naturally, though companies that sell product(s) can show this by demonstrating that the cost of production decreases with an increase in sales, for example by leveraging the existing operating costs of its manufacturing equipment and suppliers.
Test 4 Broader Market
The company must demonstrate that it has potential to address market that is broader than a local city, area or region. the company does not need to have a national or multi national market at the time of investment
Tips: A broader market could be as little as Sydney and Melbourne
Demonstrating this will involve leads, tenders, bids, channel partners, or sales
Test 5 competitive advantage
The company must demonstrate that it has the potential to create a sustainable competitive advantage over its competitors
Tips: Competitive advantage can be shown through the level of value for customers, rarity, imitability and sustainablity of the advantage.
The ESIC test must be supported by evidence for each of the 5 tests, which at times can be a burden to time-poor hyper growth companies. The law refers to the following documents;
- A business plan
- Commercialisation strategy
- Competition Analysis
- Demonstrated Evidence
Typicial startups using a 'pitch dec' and rapid commercialisation techniques tend to find this confronting and dreary, though the ATO have adapted to accept modern documentation provided this captures the necessary information. For further guidance see our ESIC record keeping guide.
Other factors to consider
By now you may have noticed that the details you collate to support your principals claim include some highly classified documentation. Now we love our investors, though not perhaps enough to entrust them with the 'special sauce'. This is one reason you may wish to consider applying to the Australian Tax Office for a Private Binding Ruling (PBR). The ATO have become skilled in assessing ESIC companies and are typically fair if not thorough.
Conditions for failure
- customising an existing product - a minor extension, such as an update to existing equipment or software - changes to pricing strategies - changes to goods resulting from cyclical or seasonal change - trading of new products for a wholesaler, retail outlet or distribution business where the activities are similar to the approach of competitors - ceasing to utilise a process or method.