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Raising Money - Good News for Small Companies

February 2005

Quick summary

On 21 February 2005 , following a review of the financial promotion regime, the Government published new regulations which will come into force on 3 March 2005[i] . Many of our clients have found it difficult, under the existing regime, to approach individuals, be they friends, family or business angels, for even small amounts of funding, without fear of falling foul of the law or incurring unwanted expense. These regulations will make it easier for companies to approach potential investors, without fear of making an unlawful financial promotion, by allowing investors to certify themselves as high net worth individuals or sophisticated investors.

Current position

Section 21 of the Financial Services and Markets Act 2000 (“FSMA”) prohibits unauthorised persons communicating an invitation or inducement to engage in investment activity in the course of business (“financial promotion”) unless the content of the communication has been approved or made by an authorised person or the communication otherwise falls within one of the 60 or so exemptions in the current Financial Promotion Order (“FPO”)[ii]. For example, a business plan intended to encourage a potential investor to invest in a company is likely to be a financial promotion which, unless it falls within one of the exemptions, would require approval.

One of the exemptions in the FPO allows a company to make a financial promotion (without approval) to a potential investor who the company knows is certified as a high net worth individual or a sophisticated investor, however:

the certified high net worth individual exemption requires the individual to obtain a certificate signed by either their employer or their accountant stating that they either earn at least £100,000 or have net assets worth at least £250,000; and
the sophisticated investor exemption requires an authorised person to certify that the investor is sufficiently knowledgeable to understand the risks associated with the relevant description of investment.

There has been much criticism of the current certification system (which can be time consuming, costly and inconvenient) and the low levels of certification indicate that the exemptions are not commonly relied upon. Many authorised intermediaries have been reluctant to certify their clients because of fears of potential liability claims, coupled with uncertainty as to what constitutes “sufficiently knowledgeable”, and also because it prevents them from making a financial promotion to those clients moving forward. These problems (added to the lack of clarity as to what constitutes a financial promotion) often deter small companies from raising money from business angels and other individuals, as they do not wish to incur the expense and time of getting a communication authorised. Business angels themselves are prevented from communicating opportunities to other individuals.

Proposed Changes

The new regulations will make two main changes to the current financial promotion regime, namely:

all investors will be entitled to self-certify themselves as either high net worth individuals (same objective tests as above) or sophisticated investors (if they meet one or more criteria set out in the regulations) without having to go through an authorised intermediary; and
companies will be allowed to promote to individuals that they “reasonably believe” are self-certified as high net worth or as sophisticated investors. The Government has stated that reasonable belief merely relates to the existence of a signed statement and may include confirmation (including an oral confirmation) from a potential investor to a company that he or she has a high net worth or is a self-certified sophisticated investor. Ultimately, however, it will be a matter for the courts as to what reasonable belief means in the relevant context.

Promotions to self-certified high net worth or sophisticated investors are to be limited to unlisted equity. There are provisions aimed at ensuring that such investments cannot lead to the investor losing more money than he or she invested. Importantly, the new provisions do not apply to unsolicited real time promotions and will not, therefore, enable a company or a business angel to “cold call” somebody even if such person is reasonably believed to be self-certified.

These changes take into account criticisms made by small companies, investors and the advisors acting for them and benefit all participants: investors will be able to certify themselves and therefore receive information about new investment opportunities and small companies will be able to promote to a greater number of potential investors, confident of acting within the law.

To minimise the risk of incorrect self-certification, the Government has suggested that there should be a requirement for promotional material sent to self-certified high net worth individuals or self-certified sophisticated investors to carry “health warnings”. These warnings, frequently encountered in one form or another in practice already, will consist of a short statement warning that the investment opportunity carries a significant risk of losing all property and other assets invested. The appearance of such warnings will be prescribed so they will appear prominently at the beginning of all promotions.

In addition to the introduction of health warnings, the Government in its response stated that outside the financial promotions regime investors will continue to be protected in relation to communications made to them by the common law and other legislation (for example, the common laws of fraud and negligence and section 397 of FSMA which protects investors from misleading statements).

Comment

The proposed changes are good news for small companies looking to raise money and for individuals who wish to invest in such companies, recognising that investment by individuals who know what they are doing can be adequately protected by the laws outside the financial promotion regime. Our experience is that many small companies are uncertain of the requirements of the financial promotions regime and we believe that the self-certification process, coupled with the “reasonable belief” tests, will make it easier for companies to approach and attract investors without fear of acting outside the law.

Useful web-links to more information:

The Government response to the Consultation. This includes helpful explanatory information and brief guidance for business angels and small companies on key areas of the financial promotions regime (e.g. whether the financial promotions rules apply to them, and when they need not be authorised).

http://www.hm-treasury.gov.uk/media/655/EB/Informal_capital_raising_responopt251104.pdf

The Financial Promotion Order as published on the 21 February 2005 . This includes the rules on self certification and the appropriate wording for ‘health warnings’.

http://www.hmso.gov.uk/si/si2005/20050270.htm

If you have any questions or if you would like to discuss in more detail the contents of this email, please do not hesitate to contact Lucy Vernall ( lucy.vernall@kemplittle.com 020 7710 1602) or Siobhan McElhinney (siobhan.mcelhinney@kemplittle.com 020 7710 1628).

[1] The Financial Services and Markets Act 2000 (Financial Promotion and Promotion of Collective Investments Schemes (Miscellaneous Amendments) Order 2005

[2] The Financial Services and Markets Act 2000 (Financial Promotion) Order 2000 – S.I 2001/1335