Legal Q&A: What legal restrictions are there when I’m seeking funding?

Answer:

Investment can be tough to find when you first get started. You may well need to engage with a wide range of people to get to a position where you can close out a funding round, potentially ranging from family and friends to business angels to seed funds to institutional VCs to corporate venturers. 

Investing in startups is a high-risk activity and there is a substantial chance that investors will lose some or all of the money they put into the venture. You will therefore need to put together a really persuasive case to potential investors to get them on board.

A word of caution though: on the face of it, both oral and written communications designed to persuade investors to invest in your company will be “financial promotions”, the communication of which is subject to restrictions contained in the UK financial services legislation.

Under the legislation, a person cannot communicate (which includes causing someone else to communicate) a financial promotion, unless:

  • they are an FSA-authorised person;
  • the communication has been approved by an FSA-authorised person; or
  • the communication falls within an exemption.
Breach of this restriction on the communication of financial promotions is a criminal offence, punishable by up to two years imprisonment or a fine or both (which can be imposed on the company’s officers).

Furthermore, any agreements entered into as a result of prohibited communication may be unenforceable and the investor may be entitled to recover any money paid or other property transferred to the company and to compensation for any loss.

So, in the worst case scenario, if the company fails to ensure compliance with the financial promotion rules when fundraising, then the company (and others who have been knowingly concerned in the contravention) could find themselves liable to sanctions including imprisonment, fines and having to repay amounts raised from investors.

In practice, the safest course of action may therefore be to get such communications approved by an FSA-authorised person such as a corporate finance advisor. The exemptions can also help you, but they are quite specific. Commonly used exemptions include communications to persons who are:

  • Investment professionals (including persons who are themselves FSA-authorised);
  • Certified high net worth individuals;
  • High net worth companies, unincorporated associations etc;
  • Self-certified sophisticated investors; and
  • Associations of high net worth or sophisticated investors.
Additionally, generally where offering transferable securities (e.g. shares) to the public, an approved prospectus is required. Again failure to adhere to this requirement can result in two years imprisonment, a fine, or both (which can be imposed on the company’s officers). A relevant exemption to this requirement is where offers are made only to 149 persons or fewer per EEA state. Therefore you should keep track of how many people are approached in relation to the fundraising and ensure that this number does not exceed 149.

Also bear in mind that jurisdictions other than the UK have their own financial promotion and prospectus rules. If you are going to start speaking with overseas investors, you should check out whether any additional compliance requirements apply.

Charles Fletcher is a corporate lawyer at international law firm Taylor Wessing.

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