The cost of fundraising
- Helen Curtis
- Updated: Thu, 16th Mar 2017
The cost of fundraising and means of doing so remains a challenge for businesses. To scale up, most businesses will have to cast their nets widely to raise finance and there will be a cost of fundraising which goes beyond merely commission. You may not be aware of the issues can arise. We highlight key costs of fundraising below.
Hidden costs can arise under the Financial Services and Markets Act 2000 (FSMA). FSMA seeks to regulate the raising of finance. 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 unless they can bring themselves within an exemption. We explain the FSMA exemptions for you.
The hidden cost of fundraising
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 which adds to the cost of fund raising. The decisions of the Financial Conduct Authority are public with resultant bad publicity for the company and its directors.
FSMA implications – 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. A 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.
Will the cost of your fundraising include a Prospectus?
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 fundraising. Costs will be incurred in preparing a detailed prospectus on the company. and its need for finance. The Prospectus will have to be approved and signed off by an accredited person under the FCA guidelines – usually a broker who charges a fee.
Outside the exemptions
If you are not within an exemption you will need a prospectus if there is an “offer of securities to the public” – this is defined very widely. An offer of securities to the public covers a communication to any person designed to enable an investor to decide to buy or subscribe for shares (or other securities).
Exemptions which will reduce the cost of fundraising
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; or
- 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; or
- The shares are offered in connection with a merger or demerger or takeover; or
- The total amount offered in the EEA states is no more than EUR 5 million; or
- 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 shares or other 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 an exemption, you can 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. If that does not work there are alternatives for financing a business.
Cost of fundraising using crowd funding
We work with investors and businesses seeking investment via crowd funding. There are 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.
Large number of shareholders
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.