Breaking down the regulatory barriers

A simplification of the regulatory regime for financial promotions will remove obstacles that, some argue, inhibited investment in small and growing firms by private investors.

The changes, which came into force in March, should make it easier for high-growth firms to attract the funding they need to invest and succeed, and in turn contribute to the UK’s economic prosperity.

Under the previous system, companies wishing to raise finance from private investors had to get their promotional material approved by a person authorised by the Financial Services Authority, unless the firm was specifically targeting people certified as ‘high net worth’ individuals by their accountant or employer, or as ‘sophisticated’ investors by an authorised intermediary.

‘High net worth’ individuals are defined by the FSA as those who earn at least £100,000 per annum or have net assets of at least £250,000, excluding their primary residence. A ‘sophisticated’ investor is defined as a person who has made investments in unlisted companies before, is currently or has been in the previous two years a company director, or someone who works or has worked in a professional capacity in private equity or SME fundraising.

But this certification regime was failing. Would-be investors found it time consuming, costly and inconvenient. At the same time, there was a reluctance on the part of FSA-authorised individuals to certify investors for fear of being sued.

To overcome these problems, the government has decided to make two main changes to the regulations.

Firstly, investors are now to be allowed to self-certify themselves as high net worth individuals or sophisticated investors without having to go through an authorised intermediary.

Secondly, companies are now allowed to promote to individuals that they ‘reasonably believe’ self certifieds are high net worth or sophisticated investors, without the cost of going through an authorised intermediary to protect themselves.

There are some concerns that shares in unlisted companies could be marketed to unsuitable investors, even if the promotion is accompanied by an appropriate ‘health warning’. And by receiving unapproved promotions, investors give up certain protections and channels of redress.

If you are planning to market your shares to investors directly, you will need to make sure that the ‘health warning’ is sufficient, which will probably mean taking advice from an authorised intermediary.

Apart from the regulatory issues, private company directors must be aware of the practicalities of raising capital from private investors. It can be a long and arduous process, which may involve kissing a lot of frogs. The process can also divert directors’ attentions away from the day-to-day running of the business.

Single significant investors may want a board seat and the ability to manage their investment closely. But this is not necessarily a negative, and many businesses find that investors can add significant value to the business in an executive or non-executive capacity.

Companies do, however, need to be aware of any overly restrictive conditions attached to investment that may restrict growth, impede future funding rounds or affect exit timings and strategies.

If you raise capital from a syndicate of investors, you need to be ready to manage each investor individually and be prepared for the practicalities of managing a large, diverse shareholder base that may have different views on issues such as the sale of the company.

Your shareholder base will also expect regular reporting and updates on company trading. Some may contact you monthly to get this information; others may do so more frequently. If the investment in your company qualifies for the enterprise investment scheme (EIS) , the administrative burden becomes even more cumbersome with investors requiring EIS certificates and annual confirmation that the company has done nothing to jeopardise its EIS status.

The recent regulatory changes undoubtedly make it easier to promote investment in unlisted company shares to private investors. But unless there is a dedicated resource in-house to manage the pre and post-investment process, using an authorised intermediary may still be the best way forward.

Claire Madden is a director of private investor network Hotbed Ltd

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