The hidden trap and cost – Raising finance and choosing the best means of doing so remains a challenge for businesses. Low key and low value from friends and family does not usually create any additional compliance costs. However, in practice most businesses will have to cast their nets much wider when seeking to raise finance and it is at this stage that issues can arise which you may not be expecting relating to a regime implemented in the Financial Services and Markets Act 2000 (FMSA) which seeks to regulate the raising of finance via the compulsory due diligence by third parties of materials issued relating to the fund raising – the regime is not preserved for the realms of large companies, banks and financial institutions – it can apply to any company potentially unless they can bring themselves within an exemption as explained below.
Why is this area important? Failure to comply with the FMSA and the Financial Conduct Authority’s Prospectus Rules is a criminal offence so knowing and understanding the relevant rules is extremely important. The financial penalties – fines or compensation – that can be imposed are not limited in any way by FMSA and there are cases of fines of tens of thousands pounds being imposed by the Financial Conduct Authority. The decisions of the FCA are reported publically with resultant bad publicity for the company and its directors.
The Prospectus Rules – The high profile investment scandals of recent years have served to impose regulation designed to protect potential investors. This includes, perhaps most importantly, the need to issue a prospectus. The prospectus requires accountants, solicitors and brokers to sign off on matters relating to the company which will include but is not limited to the accounts and financial reporting, payment of taxes, compliance with legislation and details of the company’s business and key customers and clients which usually requires disclosure of the pipeline of business. In order to determine whether a prospectus will be required, it is necessary to consider whether the offer of securities falls within the scope of the EU Prospectus Directive (2003/71/EC) (as amended) and Prospectus Regulation (809/2004) (as amended) and is supported the Financial Conduct Authority (FCA) and FMSA.
If a fund raising is caught by the Prospectus Rules, the costs of complying with them will mean a significant increase in the overall cost of raising finance. Costs will be incurred in preparing a detailed prospectus on the company and its need for finance which has to be approved and signed off by an accredited person under the FCA guidelines – usually a broker who charges a fee. If you are not within an exemption as outlined below you will need a prospectus if there is an “offer of securities to the public” – this is defined very widely and covers a communication to any person which presents sufficient information on the transferable securities to be offered and the terms on which they are to be offered to enable an investor to decide to buy or subscribe for the securities in question.
How can you avoid the Prospectus Rules? There are some exceptions to the Prospectus Rules and the need for a prospectus which you need to check to see if you fall within, as life will be much easier if you do.
Situations where you will not require a prospectus – You will not require a prospectus if:
Any one person has to invest at least EUR 100,000.
The total amount offered for investment is no more than EUR 100,000 (it will be necessary to take into account any offers over the past 12 months to calculate this).
The shares are offered in connection with a merger or demerger or takeover.
The total amount offered in the EEA states is no more than EUR 5 million.
The offer is made or directed at fewer than 150 persons per EEA state.
The significance of this is that any business intending to offer securities should take advice on whether such an offer would be deemed “an offer of transferable securities to the public”. If the offer does fall within this category, whether or not the offer falls within any of the exemptions should be considered or, if this is not the case, one should look at whether the offer could be adapted so that it does fall within an exemption without negatively impacting on the likely success of the offer. There are alternatives to financing a business and we have outlined some ideas on finance for business at http://www.gannons.co.uk/expertise/business-law/finance-for-business/
Marc Mediratta is a corporate partner in our London commercial law team and regularly advises businesses and investors on how to raise finance and structure equity for a return on investment. He can be contacted on 0207 438 1060.