You might have heard or been told that you are not allowed to ask for investment without having FCA authorisation. Or, that your investment material must be approved by an FCA authorised person before it can be published.
We think startups are entitled to ask for investment without any FCA interference, provided the investment material steers clear of the certain prohibitions and follows certain rules. This article will explain those rules and prohibitions.
What is the rule in the Companies Act?
S755 of the Companies Act 2006 prohibits the offer of shares in a private company to the public. But, an offer is not an offer to the public if it can properly be regarded in all the circumstances as:
- Not being calculated to result directly or indirectly in the shares of the company becoming available to persons other than those receiving the offer; or
- Otherwise being a private matter between the company and the recipient of the offer
Our view, in light of this rule is that posting that you have shares for sale in your startup on your social media channels is acceptable, as your post is only sent out to those who you “follow” and so therefore is not sent to the public at large. To be absolutely sure you do not breach the prohibition in S755 you may want to check your social media settings to ensure that things you post are only sent out to those who you have connected with/follow you/who has “liked” your page etc.
What are the rules in the Financial Services and Markets Act?
Separately, S85 of the FSMA states it is unlawful for a company to offer securities to the public unless a prospectus approved by the FCA has been prepared. Under this legislation, an offer is made “to the public” if there is a communication, to any person where there is 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. The communication can be in any form by any means.
So, unlike the Companies Act, “to the public” under the FSMA is defined not by who the communication was sent to but rather what that communication contained.
Therefore, if you are going to post your pitch deck onto social media, that is probably okay, because without more (say, a term sheet) it would be difficult to argue that any individual had sufficient information to decide whether to buy/subscribe for the securities in question, just by the information contained in the deck or business plan.
Additionally, within this general prohibition are exceptions that a founder could rely on so that he could offer securities to the public without needing an FCA approved prospectus, those exceptions are:
- the total amount being raised from investors in EEA states is less than €5,000,000 (calculated over a period of 12 months);
- the offer is made to or directed at qualified investors only (e.g. venture capitalists and business angels and other persons regulated by the FCA);
- the offer is made to or directed at fewer than 150 natural or legal persons, other than qualified investors, in each EEA state; or
- the minimum consideration payable by any person is €100,000.
Therefore, provided you ensure that you can rely on one of the above exceptions, you can act as though the rule in S85 of the FSMA does not apply.
Generally, what are the rules regarding the publication of financial promotions?
Running alongside the above prohibitions we have just laid out is the S21 FSMA general prohibition on the publication of any form of communication that is deemed to include “an invitation or inducement to engage in financial activity” (otherwise known as a financial promotion).
NB The definition of financial activity includes purchasing/subscribing for shares in a startup.
So, even if you make sure you are not in breach of the Companies Act or S85 of the FSMA, you also need to be wary that nevertheless you are not publishing a financial promotion. So, how do you do that?
What counts as an inducement to engage in financial activity and how can I craft my business plan / pitch deck so that it is not seen as a financial promotion
The first option is to set up your publication so that it could not be described as an “invitation or an inducement” to engage in financial activity, and so fall outside of what a financial promotion is. To do this, you have to know what “an invitation or an inducement to engage in financial activity” looks like.
FCA Perimeter Guidance states that only communications containing a degree of incitement would amount to “inducements” and communications of purely factual information would not. The underlying government policy was “to capture promotional communications only”. Such communications may be distinguished from those which seek merely to inform or educate about the mechanics or risks of investment.
The FCA in their guidance use as an example of an invitation a “prospectus with application forms” to allow to recipient to express a commitment to investing. In our view, we think that what is implied by that example is that if a prospectus does not have a form that allows people to express a commitment to investment with a monetary amount, and if the prospectus instead says “contact us for further information” or something similar, that would not be considered an invitation and would instead be deemed purely informative in nature.
An inducement is softer. An inducement can be described as a link in a chain where the chain is intended to lead ultimately to an agreement to engage in investment activity. But, this does not mean all the links in the chain will be an inducement or that every inducement will be one to engage in investment activity. Only those that are a “significant step” in persuading the recipient will be considered an inducement for the purposes of the regime.
We think the best chance to avoid a pitch deck / BP being seen as an inducement to engage in investment activity is to omit financial information that would indicate a return on investment and instead focus on the product/service you are providing. Doing this gives the communicator a credible argument to suggest that learning more about the company was not a “significant step” in the eventual decision to engage in investment activity, and that it was not until there were further, private discussions between the recipient of the communication and the communicator, discussing the financial implications of a decision to invest, that the recipient was “induced” to engage in any investment activity.
Financial promotions not made ‘in the course of business’
The second option is accepting that you are going to make a “financial promotion”, but relying on the fact you have not made this promotion “in the course of business”.
FCA guidance on this topic explained that a financial promotion must be made ‘in the course of business’ to be within this regime.
The ‘in the course of business’ test requires a commercial interest on the part of the communicator. To demonstrate where the line is, the FCA in their guidance explained that where capital is raised for a small private company and the company is already in operation, it will be ‘acting in the course of business’. However, at the pre-formation stage, individuals who are proposing to run the company may approach friends and relatives to see if they are willing to provide capital and in the FCA’s view this would not be acting ‘in the course of business’, and so are able to make financial promotions
Therefore, we think that if you have not raised capital previously, you would be entitled to make a financial promotion on your social media pages as it would not be seen as being made “in the course of business” at that stage
Financial promotions being made to investment professionals
The third option we propose to ensure you are not breaching the rules around financial promotions is again to accept you are going to make a “financial promotion” as defined by the FSMA, include information about possible returns on investment, but explain using a disclaimer on the front of your promotional material (whether a pitch deck or business plan) that the material is only supposed to be read by investment professionals, high net worth individuals, self-certificated sophisticated investors or business angels, or otherwise the business plan or pitch deck should not be read and should be returned to the publisher.
We suggest this because communications made to these types of people are exempt from the general financial promotion prohibition.
Here is an example of what that disclaimer could look like:
This [insert name of document] is being sent only to investment professionals (as that term is defined in article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (“FPO”)) or to persons to whom it would otherwise be lawful to distribute it. Accordingly, persons who do not have professional experience in matters relating to investments should not rely on this [insert name of document]. The shares in [insert company name] will only be available to an investment professional (as defined above) or a person who has provided written confirmation to the effect that he is an investment professional within the meaning of article 19 of the FPO.
Provided you make sure you navigate the prohibitions introduced by the Companies Act, S85 of the FSMA and rely on one of the three options we have provided to make sure you are not seen as publishing a financial promotion, you are free to advertise your startup on social media in an attempt to generate investment interest.