Consultation on changing the rules which apply when companies raise money from angel investors

Companies often look to high-net-worth individuals (HNW) and sophisticated investors to provide funds in return for new shares. This is particularly common for small and medium sized enterprises (SMEs).

There are various legal rules in place to protect potential individual investors. These legal rules include the UK financial promotions regime which provides two key safeguards for potential investors. (A financial promotion is a communication that contains an invitation or inducement to engage in a financial product or service, and this includes the offer to buy new shares in a company).

The first key safeguard is that a company seeking investment in return for new shares (equity investment) cannot communicate the equity investment opportunity unless either:

• the content of the investment opportunity has been approved by a firm authorised by a relevant financial services regulator (the Financial Conduct Authority (FCA) or Prudential Regulation Authority (PRA)) to carry on regulated financial services activity; or
• the individual business communicating the equity investment opportunity holds such an authorisation itself.

(This is called the financial promotion restriction).

The second is that the FCA sets binding rules that authorised firms must comply with when communicating or approving financial promotions, for example the requirement that financial promotions must be fair, clear and not misleading.

There are a number of exemptions to the financial promotions regime which enable unauthorised individuals or companies to communicate financial promotions (like an equity investment opportunity) without requiring the need for approval from an authorised firm (and without incurring the associated costs). These exemptions include three exemptions commonly used by SMEs being those for:

• certified HNW individuals;
• sophisticated investors; and
• self-certified sophisticated investors,

(which for the purposes of this article we shall call the Business Angel Exemptions).

The use of each exemption requires careful compliance with all the conditions for such exemption to apply. Unfortunately, many companies are not aware of, and/or overlook or fail to carefully comply with, the relevant legal rules around offers for new shares and the conditions which apply to any given exemption being relied upon, which can be a criminal offence and lead to an agreed share subscription being unenforceable and potentially having to be unwound.

The Business Angel Exemptions have not been reviewed for 15 years during which time there have been significant economic, social and technological changes which change the context in which these exemptions must be viewed. These include the development of the online investment market which has allowed more investment decisions to be taken online without the involvement of a financial intermediary, changes to rules around pension fund withdrawal, price inflation (some exemptions refer to financial limits such as income or assets) and the historic misuse of certain exemptions. As a result, the government is consulting on various changes to the Business Angel Exemptions. The aim of the consultation is to ensure that:

• thresholds for exempt investors are calibrated to reflect investors’ experience and their ability to absorb losses;
• to reduce the risk that investors receiving financial promotions under the exemptions do not meet relevant conditions; and
• to ensure that where exemptions are used, investors clearly understand the regulatory protections they are losing and are able to take responsibility for their investment decisions.

This adjustment of the exemptions must be balanced to ensure that it does not have a significant negative effect on the ability of companies and firms to raise money using the Business Angel Exemptions, whilst at the same time ensuring that investors in SMEs are appropriately protected.

We do not have the space in this article to go through all the detail of this consultation but have set out some examples of matters being consulted on.

The certified HNW individual’s exemption refers to the individual having an income of £100,000 or more in the last year, or net assets (as defined) of £250,000 or more. The consultation proposes to adjust the annual income level up to between £150,000 and £175,000. It also considers increasing the net asset amount to between £385,000 and £900,000. The lower updated amounts in each case would reflect the increase in inflation since the thresholds were first introduced. The higher amounts would catch the top 1% of earners and asset owners (which was the original intent of the earnings threshold).

The self-certified sophisticated investors exemption requires the individual to self-certify if they meet one of a number of qualifying criteria. One of these is that the individual has made more than one investment in an unlisted company in the last two years. In light of the ease with which individuals can invest in private companies, the government is consulting on removing this qualifying criteria. A separate qualifying criteria states that the individual has been in the last two years or is currently a director of a company with an annual turnover of at least £1 million. It is proposed to increase this financial threshold to £1.4 million to take account of inflation.

At present, companies that offer shares under the HNW individual and self-certificated investors exemptions must ‘believe on reasonable grounds’ that the individual they are communicating to has signed the relevant HNW or self-certified sophisticated investor statement. However, there is currently no obligation on the company to check the relevant individual meets the necessary criteria. The government therefore proposes that the company communicating the offer must have a reasonable belief that the individual meets the relevant exemption criteria (rather than a belief that the individual has signed the relevant statement). It would be for the company in question to determine how it comes to this conclusion and to document this. The individual investor would still need to sign the relevant statement, so there would be a responsibility on both the investor and the company to ensure the relevant conditions have been met at the appropriate point in time.

The government proposes making three substantive changes to the statements for HNW individuals and self-certified sophisticated investors. These aim to avoid situations where investors wrongly certify themselves and / or fail to understand the regulatory protections they are giving up when receiving promotions subject to exemptions.

The government consultation was launched on 15 December 2021 and closes on 9 March 2022.