The cost of fundraising
- Helen Curtis
- Updated: Mon, 7th Nov 2016
Raising finance and choosing the best means of doing so remains a challenge for businesses. Low key fund raising 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 some of which are highlighted below.
Hidden costs can arise under the Financial Services and Markets Act 2000 (FSMA) which seeks to regulate the raising of finance. The regulation comes via the compulsory due diligence by independent third parties often referred to as brokers or sponsors who are regulated to review and verify the content of all materials issued relating to the fund raising. The FSMA obligations are not preserved for the realms of large companies, banks and financial institutions – FSMA requirements can apply to any company potentially unless they can bring themselves within an exemption as we go onto explain.
Why is this area important?
Failure to comply with the FSMA and the Financial Conduct Authority (FCA) Prospectus Rules is a criminal offence so knowing and understanding the relevant rules is important. The financial penalties – fines or compensation – that can be imposed are not limited in any way by FSMA and there are cases of fines of tens of thousands pounds being imposed by the Financial Conduct Authority. The decisions of the Financial Conduct Authority are public 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 which is policed by the Financial Conduct Authority (FCA).
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.
Situations where you will not require a vetted Prospectus – You will not require a prospectus if you satisfy one of the following exemptions:
- Any one person has to invest at least EUR 100,000.
- The total amount of securities offered for investment is no more than EUR 1,500,000 (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 click here.
We work with investors and businesses seeking investment via crowd funding and have come across many horror stories. Hence, we feel a quick run through on what crowdfunding is along with the benefits and traps will help you navigate this growth area.
What is crowd funding and what do you need to know about it?
For existing business owners and entrepreneurs who have a great business idea worth pursuing, finding early stage funding has always been tricky. Small business owners that are being rejected by banks now have the chance to ask investors for funds directly. Crowd funding is a business asking a large number of people for a small amount of capital, rather than the traditional model of a small number of people and a large amount of capital.
Downsides of crowd funding as a means of raising investment
As with most small, privately owned companies, the shares are illiquid. Whether you can sell the shares to receive back some/all of your investment depends on whether there is a willing buyer, rather than shares in stock market traded companies, where the funds can be returned relatively quickly. Most investors will seek to include provisions in the shareholders’ agreement that prevent founders from selling their shares within a certain time period following equity investment. That is sought to protect the value in the business.
The business will also have to attempt to keep a large number of shareholders onside. An intermediary can handle this process, but the investors will be keen to ensure that the directors are promoting the success of the company for their benefit as a whole.
Helen Curtis is a corporate lawyer 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.