Is your company looking for investors?
If your company is planning to expand its business operations, one option is to look for investors who will provide additional funding in return for the issue of shares in the company.
Fundraising of this type is subject to a complex and rigorous regulatory regime – designed to protect investors – and any company which is planning to raise third party funds must obtain the proper legal advice before proceeding.
We have set out below a summary of just some of the issues which must be considered before embarking on a fundraising exercise.
What you can and cannot do
In order to encourage potential investors to invest in your company, you will need to provide them with information about your business, its trading activities and its assets and liabilities. To do this, you will probably need to prepare some form of business plan or investment memorandum. At the very least, you will need to explain your business to them by telephone or in a face-to-face meeting.
These activities are likely to constitute “financial promotion” under the UK Financial Services and Markets Act 2000 (“FSMA”). The term “financial promotion” is usually taken to mean an invitation or inducement to engage in investment activity.
By giving the business plan to various people, you will almost certainly commit an offence under FSMA unless the company itself is an “authorised person”, as defined in FSMA (usually an investment bank, broker or financial adviser) or the content of the business plan has been formally approved by an authorised person, or the investor is exempt from the restrictions on financial promotions (see below).
This rule applies not only to the statements made in the business plan itself, but also to verbal statements (i.e. by telephone or in meetings) which are likely to lead to the recipient investing in the company. Indeed, stricter rules apply to these so-called “real-time” communications unless the recipient is an investment professional or can reasonably be expected to understand the risks – or has requested the verbal or other communication. To be on the safe side, unless the company is confident that the recipient is an investment professional, it would be best to write to the recipient and suggest a telephone call or meeting, rather than cold-calling them.
The prohibition on financial promotion is subject to various exemptions, which are discussed below.
If the company contravenes FSMA, the company and its directors could be fined and the company may be unable to enforce any agreement to invest in the company which results from the financial promotion – or worse still, the investor can claim back their money and any losses after they have invested. This applies regardless of whether or not you have done anything ‘wrong’ in the sense of misleading the investor.
Who can receive your business plan?
First, you should only give your business plan to recipients in the UK. If you are planning to extend a fundraising offer to non-UK recipients, you will have to comply with the applicable overseas regulations and we can arrange foreign legal advice through our international associate firms.
Secondly, if the company is an authorised person or the business plan or other communication has been approved by an authorised person then the communication can be issued to a wide variety of potential investors, subject to various other guidelines.
Assuming that the company is not an authorised person, there are various exemptions to the prohibition on financial promotion contained in FSMA. For example, the business plan will not require approval by an authorised person if the only recipients are either:
(a) investment professionals;
(b) high net-worth individuals or companies; or
(c) sophisticated investors.
An “investment professional” is usually taken to mean a person or organisation who or which is specifically authorised or exempted under FSMA or whose business routinely involves dealing in, or advising on, investments. This would include stockbrokers, banks, corporate finance houses and, in many cases, accountants.
High net-worth individuals, companies and unincorporated associations
High net-worth individuals or companies are those with assets of a value above certain thresholds which, in effect, enable them to face the risks involved in making a proposed investment.
To qualify as a high net-worth individual, a potential investor must supply a certificate signed by him within the previous 12 months, stating that he is a high net-worth individual and accepts that he will lose his protection under FSMA if he signs the statement, and confirming that he (a) had, during the financial year immediately preceding the date of the certificate, an annual income to the value of £100,000 or more; or (b) held, throughout the financial year immediately preceding the date of the certificate, net assets to the value of £250,000 or more.
Many people may automatically assume that they qualify as a certified high net worth individual on the basis of the value of their home. However, FSMA provides that an individual’s net assets do not include their main residence, pension or life insurance. The exemption for high net-worth individuals is also limited to certain types of investment, including shares and debentures in unlisted companies, and futures and collective investment schemes in respect of such securities and cannot be used for investments under which the Investor could incur liability above the amount invested.
The communication to the high net-worth individual cannot be made in person, by telephone or other interactive dialogue ("real time") unless the meeting, conversation or other communication is in response to an express request from the recipient ("solicited"). This effectively precludes cold-calling. The communication must also indicate (a) that it is exempt on the ground that it is made to a high net-worth individual; (b) the requirements for qualifying as a high net-worth individual; (c) that the content has not been approved by an authorised person – and will not therefore have been subject to the tests and controls which would have been imposed if it had been approved; (d) that the investment may expose the individual to significant risk of losing their investment; and (e) that if in doubt, the individual should contact an authorised person.
A high net-worth company is one with at least 20 members plus share capital or net assets of at least £500,000 or, alternatively, with less than 20 members but with share capital or net assets of at least £5 million. A high net-worth unincorporated association is one with net assets of not less than £5million.
To qualify as a sophisticated investor, a person must have supplied either (a) a certificate, signed by an authorised person within the previous three years, confirming that the individual is sufficiently knowledgeable to understand the risks associated with the type of investment which is being offered, together with a statement signed by the individual in the last 12 months, confirming that he qualifies as a sophisticated investor and accepts that he will lose his protection under FSMA if he signs the statement, and listing the types of investment in relation to which he qualifies as sophisticated; or (b) a statement signed by the individual in the last 12 months, confirming that he qualifies as a sophisticated investor and accepts that he will lose his protection under FSMA if he signs the statement, listing the types of investment in relation to which he qualifies as sophisticated and confirming that at least one of the following applies: (i) the person is a member of a network or syndicate of business angels and has been so for six months before the date of the statement; (ii) he has made more than one investment in an unlisted company in the two years prior to the date of the statement; (iii) he is working, or has worked in the two years before the date of the statement, in a professional capacity in the private equity sector, or in the provision of finance for small and medium enterprises; or (iv) he is currently, or has been in the two years before the date of the statement, a director of a company with an annual turnover of at least £1 million.
The communication to the sophisticated investor must indicate (a) that it is exempt on the ground that it is made to a sophisticated investor; (b) the requirements for qualifying as a sophisticated investor; (c) that the content has not been approved by an authorised person; (d) that the investment may expose the investor to significant risk of losing their investment or incurring additional liability; and (e) that if in doubt, the investor should contact an authorised person.
Unlike the exemption for high net-worth individuals, the exemption for sophisticated investors who have been certified by an authorised person is available for all types of investment. The exemption for self-certified sophisticated investors, however, is limited to certain types of investment, including shares and debentures in unlisted companies, and futures and collective investment schemes in respect of such securities.
How do you find high net-worth individuals or sophisticated investors?
The above exemptions are helpful, but any company seeking funding is still presented with the practical issue of how to find potential investors. There is no central register of investors who are exempt from FSMA. However, a number of authorised persons, including brokers, corporate finance houses and some accountants, have created networks of people to whom prospective investments may be offered without breaching the restrictions in FSMA. Indeed, the FSMA regime includes a specific exemption to permit the promotion of investment opportunities to networks of these so called “business angels”.
What if your business plan falls into the wrong hands?
When sending an “unapproved” business plan (i.e. one which has not been approved by an authorised person) to an exempt person described above, the company must ask the recipient to keep it confidential, and not to pass it on to any other person. Otherwise, if the recipient passes it on to another person who is not in the same category, the company could be treated as having caused the business plan to be issued to that other person and thereby itself commit an offence under FSMA, for example if the recipient is not an exempt person.
Any financial promotion must also include a statement that it is only communicated to a specific class of exempt recipient, and that other types of recipient are not permitted to take up the investment and should return any document to the company. The company must also take other measures to ensure that the recipients of any financial promotion fall within the relevant class.
Using the Internet
Many companies seeking investors will want to put their business plan on the company’s website. The Financial Conduct Authority ("FCA"), which took over from the Financial Services Authority in April 2013, has advised that, if a website, operated in the course of a business, invites or induces a person to engage in investment activity, this will constitute financial promotion. There is therefore a risk that the website will be accessed by a potential investor who does not fall into one of the categories of exempt persons described above and that the website will breach the FSMA prohibition against financial promotion. In addition, the internet can be accessed world-wide so, in theory, to be absolutely safe, the company would need to ensure that any communication on its website complied with the regulatory regimes applicable in every country in the world.
- include a prominent disclaimer on the website making it clear that (a) the communications are “directed” to certain types of persons; (b) such persons must be resident in the UK only; (c) the investment is only available to such persons; and (c) that persons who do not fall within that category should not rely on the communication.
- establish proper systems and procedures to prevent other recipients from engaging in the investment activity – for example, only allowing access to the website to persons who have provided the certificates referred to above, together with appropriate information confirming their UK residency.
The guidance issued both before and after FSMA suggests that this approach would reduce the likelihood of the FCA taking action for breach of the legislation. Ultimately, however, there is no guarantee that any disclaimer or other measure will be effective, so the safest course would be to avoid using the internet to promote a fundraising exercise.
Can a private company offer its securities to the public?
Section 755 of the Companies Act 2006 prohibits a private company from offering its securities (including shares and debentures) to the public. An offer will not be treated as made to the public if (a) it is not calculated to result in shares or other securities of the company becoming available to anyone other than those receiving the offer; or (b) it is otherwise a private concern of the person receiving it and the person making it (section 756). Section 757 entitles members or creditors of the company, or the Secretary of State, to apply to court for an order restraining the company from breaching the prohibition in section 755, and section 758 provides that, where the breach has already occurred, the members or creditors of the company, or the Secretary of State, can apply to court for an order requiring the company to re-register as a public company or (where that is not possible), for the company to be wound up.
These provisions are fairly draconian, and in order to avoid contravening them, care must be taken to ensure that the offer is expressed to be open to acceptance only by those persons receiving it. Another safeguard would be to approach investors in a two-stage process. A summary document or "teaser" could be sent, which states that it is not itself an offer to the public which is open for acceptance, and it should not attach an acceptance form. Any investor who expresses interest could then be sent a separate communication, with an application form, which makes clear that the offer is not open to anyone other than the named recipients.
If a private company is required to re-register as a plc it must have, amongst other things, issued share capital of at least £50,000, of which at least one-quarter is paid up.
When do you need a prospectus?
Subject to certain limited exceptions, the company must publish a prospectus if it offers shares to the public in the UK or seeks the admission of securities to trading on a regulated market in the UK (section 85 FSMA).
A prospectus is a document which describes the company and its business and must contain all the information an investor might reasonably need to make an informed investment decision. Preparing a prospectus is a complex and time-consuming and can be costly. Professional input at an early stage is highly recommended.
You will not need a prospectus if you are making an offer of shares only to A prospectus will not be required if the offer is only made to qualified investors (persons on a list of qualified investors maintained by the FCA) or to less than 150 persons (other than qualified investors). This limit refers to the number of people to whom the investment is offered, not the number who actually take it up. For example if you offer an investment to 200 people, you will be required to issue a prospectus, even if only 25 people take up the investment. Likewise, you will not need to produce a prospectus if the offer is for a minimum total consideration per investor or minimum specified denomination per unit of less than 100,000 euros, or where the total amount being raised in the offer (and any other offer by the same entity within the preceding 12 months) is less than 5,000,000 euros.
What happens if you get your facts wrong?
The directors of the company may be personally liable to anyone who suffers loss as a result of an incorrect or misleading statement in a prospectus.
In addition, under section 397 FSMA, any director will commit a criminal offence if, in connection with inducing a person to acquire shares, he (a) makes a statement, promise or forecast that he knows is misleading, false or deceptive; (b) dishonestly conceals any material facts; or (c) recklessly makes (dishonestly or otherwise) a statement, promise or forecast that is misleading, false or deceptive.
It is also a criminal offence under section 397 FSMA to engage in conduct that creates a false or misleading impression as to the market in, or value of, any shares, if it is done for the purpose of creating that impression and inducing the acquisition of the shares.
The above is a brief summary of a complex set of different statutes and statutory instruments. We recommend that you adopt the following procedure:
1. Consult us at an early stage and keep us informed on an ongoing basis so we can advise you on what you can and cannot do.
2. Before sending a business plan to any prospective investor or intermediary, send that person a confidentiality letter – including a restriction preventing them from passing the business plan on to any third party – and ask them to sign and return the letter to you.
3. When speaking to potential investors or intermediaries about the business plan or any aspect of the company’s business, avoid making any statements which are inaccurate, unsupportable or misleading – either in themselves or in the context of the offer as a whole. Remember that the rules set out above also apply to verbal statements.
4. Check the business plan carefully to ensure that each statement is accurate, supportable and not misleading.
5. Approve the business plan at a full board meeting before sending it to potential investors.
6. Keep a complete record of the persons to whom you send the business plan, and when, and number each copy before you send it out.
Other forms of funding
Alternatively, you may prefer to consider alternative forms of funding, such as bank loans, asset finance and equipment leasing or simply raise the funding from the existing shareholders in the company.
How we can help
RadcliffesLeBrasseur advises on all aspects of company and commercial law, including Banking and Finance, Commercial Contracts, Commercial Litigation, Corporate Finance, Corporate Tax, Data Protection, E-commerce, Employment, IT, Insolvency, Intellectual Property, Joint Ventures, Mergers and Acquisitions, Partnerships, Pensions and Private Equity/Venture Capital.
For more information on any of the matters mentioned in this bulletin, please contact
Peter Coats, a Partner in our Corporate Department
This briefing is for guidance purposes only. RadcliffesLeBrasseur accepts no responsibility or liability whatsoever for any action taken or not taken in relation to this note and recommends that appropriate legal advice be taken having regard to a client's own particular circumstances.