Business Angel Investing FSMA _Published_ by linzhengnd


Introduction                               extends to investments in private
                                           companies, and the purpose of this
The main provisions of the Financial       note is to highlight some of the
Services & Markets Act 2000 (the           principal issues affecting investment in
“FSMA”) and its derivative regulations     such companies by private individuals
are a vast body of legislation whose       (often referred to as „business
primary aim is the regulation of the       angels‟).
financial services industry.      The
definition of investments includes the     General Prohibition
shares in any company (public or
private) and investors in private          It is an offence to carry on a “regulated
companies therefore need to be aware       activity” in the United Kingdom unless
of the extent to which the FSMA            you are an “authorised person” or an
applies to them.                           “exempt person”. Under the FSMA,
                                           authorised       persons     must      be
The principal regulatory objectives        authorised by the FSA and exempt
are:-                                      persons are as defined in Exemption
                                           Orders published by the Treasury.
   Maintaining confidence      in   the
    financial system;                      Regulated activities include:-

   Promoting public understanding of         Dealing in investments;
    the financial system;
                                              Arranging deals in investments;
   Securing the appropriate degree
    of protection for consumers; and          Managing investments; and

   Reducing the extent to which it is        Giving investment advice.
    possible for a business to be used
    for a purpose connected with           Investments include shares or stock in
    financial crime.                       the share capital of a company which
                                           includes any body corporate wherever
While the main thrust of the legislation   incorporated.      Investments also
is directed at financial institutions      include debentures, debenture stock,
listed companies, the public markets,      loan stock and any other instruments
listed securities, Collective Investment   creating or acknowledging a present
Schemes and the banking, insurance         or    future   indebtedness,    share
and pensions industries, the legislation   warrants, options and loans secured
over land.      These definitions are           angels; or
widely drafted to include investments
(and loans) in all private companies.
                                               There may be no formal structure
Business Angel Syndicates                       in place at all with a syndicate
                                                operating on a completely ad hoc
The Government now recognises the               basis. While it is up to the gate-
important role played by business               keeper to co-ordinate the activities
angels both individually and in                 of the syndicate, he must be
syndicates in the creation and                  careful not to carry out a
development of small companies, and             “regulated” activity on behalf of
it is widely recognised that the advice         the syndicate or of any of its
and assistance which they are able to           members.
offer is often as important as the cash
investment.                                 This means that:-

While the vast majority of business            The gate-keeper must not “deal in
angels are not authorised persons, it is        investments”. However, as long
now quite common for syndicates of              as individual members of the
business angels to appoint a “gate-             syndicate    make    their  own
keeper” who is responsible for co-              investment decisions this should
ordinating their activities and who is          not be a problem.
frequently the first point of contact for
prospective investors.                         The gate-keeper should not
                                                “arrange deals in investments”.
Business angel syndicates may be                This issue is resolved by the key
organised in a number of ways but               members      of    the   syndicate
typically:-                                     “arranging the deal” themselves.
                                                While the gatekeeper has an
   The investors may subscribe for             important role to play in carrying
    shares in a company of which the            out the due diligence and the
    gate-keeper is a Director and the           discussions leading up to a deal,
    company       makes     its    own          the deal itself is arranged by the
    investments. While such an                  key investors who distribute the
    arrangement is likely to resolve            “financial promotion” to other
    many of the regulatory issues as            members of the syndicate.
    the company is investing its own
    money, it is not tax efficient and         While the gate-keeper may accept
    therefore unattractive to the vast          some responsibility for gathering
    majority of business angels (who            information     about      investee
    will want to secure „EIS‟ tax relief        companies and passing relevant
    on their investment);                       information on to investors, he will
                                                not undertake any form of
   The     angels   may      become            discretionary           investment
    members of a company limited by             management activity and the
    guarantee which is run by the               investors would typically appoint
    gate-keeper.    The gate-keeper             one of their number or some third
    may be paid by the company to               party to act as a non-executive
    co-ordinate the activities of the           director with responsibility for
    syndicate but the company itself            monitoring the investment.
    must be run on a not for profit
    basis with the control of                  While the gate-keeper may
    investment decisions left in the            become involved in discussions
    hands of individual business                about the purchase or sale of
    investments, he will not be              Business Plan presentation) which:
    involved     in the giving        of
    investment      advice.         The      (i) is made to an association, or to a
    gatekeeper would also consult            member of an association, the
    with the investors before agreeing       membership of which the person
    to any matter which requires the         making such communication believes
    consent of the investors and the         on reasonable grounds comprises
    investors would always be closely        wholly or predominantly persons who
    involved in the ultimate realisation     are:
    of their investment and make their
    own decision.                               certified high net worth individuals;

Powers of Attorney                              high    net    worth    companies,
                                                 unincorporated associations or
It is common practice for the gate-              trustees of a high value trust;
keeper or a “lead” business angel to
act as attorney for a group of                  certified      or      self-certified
investors. If the gate-keeper accepts            sophisticated investors; and
a Power of Attorney from an investor
either he or the person drawing up the       (ii) relates only to an investment under
Power of Attorney should make it clear       the terms of which a person cannot
to the investor that he should take          incur a liability or obligation to pay or
advice from the authorised person in         contribute more than he commits by
relation to the matters which are            way of investment.
covered by the Power of Attorney.
This is often dealt with in the              The above exemption makes the job
membership form for a business angel         of a “gate-keeper” much easier than
syndicate that the granter of the            under previous legislation.
Power of Attorney would need to sign.
The Power of Attorney should be used         Certified High Net Worth Individual
for administrative and procedural
matters only (eg the completion of an        A “Certified High Net Worth Individual”
investment) and never to make                is an individual who has signed a
discretionary investment decisions.          declaration       stating      that      he
                                             understands the risks involved in
Financial Promotion                          accepting promotions which are not
                                             authorised by the FSA and that, during
In terms of the FSMA unauthorised            the     financial    year     immediately
financial promotion is a criminal            preceding the date in which the
offence which carries a custodial            certificate is signed, the individual had
sentence of up to seven years. The           either (i) an income of not less than
simple act of giving a Business Plan to      £100,000 or (ii) net assets to the value
somebody who is not entitled to              of not less than £250,000 (excluding
receive       it     could      constitute   principal residence and pension
unauthorised      financial    promotion.    provision).         This     self-certified
There       are     however       detailed   declaration must be renewed on an
regulations      which      enable     the   annual basis and must be in the
distribution of unauthorised Business        prescribed      statutory    form     (see
Plans to certain categories of investor.     separate Briefing Note).

The financial     promotion restriction      Certified Sophisticated Investors
does not apply    to any „non-real time
communication‟    or „solicited real time    A “sophisticated investor” may be
communication‟    (ie Business Plan or       either self-certified or certified by an
authorised person.                           does not apply to associations of
                                             certified high net worth individuals or
For self-certification, the individual       certified sophisticated investors (i.e.
must sign an annual declaration              business angel syndicates) the
stating that he understands the risks        members of which are duly certified.
involved in accepting promotions
which are not authorised by the FSA          High    Net    Worth     Companies,
and that the individual:-                    Unincorporated Associations etc

   is a member of a network or              The person making the financial
    syndicate of business angels for at      promotion must reasonably believe
    least six months prior to the date       that     the     relevant   company,
    of signing; or                           unincorporated association or other
                                             entity falls into one of the following
   has made more than one                   categories:-
    investment in an unlisted company
    in the two years prior to the date of       Any body corporate which has, or
    signing; or                                  which is a member of the same
                                                 group as an undertaking which
   is working (or has worked in the             has, a called up share capital or
    two years prior to the date of               net assets of:-
    signing) in a professional capacity
    in the private equity sector, or in          o not less than £0.5m, in the
    the provision of finance for small             case of a body corporate which
    and medium enterprises; or                     has more than 20 members or
                                                   which     is   a    subsidiary
   is (or has been in the two years               undertaking   of   a parent
    prior to the date of signing) a                undertaking which has more
    director of a company with an                  than 20 members; and
    annual turnover of more than £1m.
                                                 o not less than £5m, in the case
This self-certified declaration must               of any other body corporate; or
also be in the prescribed statutory
form (see separate Briefing Note).              Any unincorporated association or
                                                 partnership which has net assets
If an individual is unable or unwilling to       of not less than £5m; or
be self-certified, he may nevertheless
be certified by an authorised person to         A „high value trust‟, which has
the effect that he is “sufficiently              gross assets of not less than
knowledgeable to understand the risks            £10m.
associated with that description of
investment”. This certificate is valid for   Business Plan Disclaimers
three years and must be accompanied
by a further annual declaration signed       While some investors may find the
by the investor stating that he              certification scheme cumbersome, it is
understands the risks involved in non-       clear that Parliament has taken
FSA authorised investments. The              account of the many concerns which
wording of this declaration should           have been expressed over the
follow the prescribed form (see              distribution of Business Plans which
separate Briefing Note).                     may constitute unauthorised financial
Associations of High Net Worth
Individuals or Sophisticated Investors       Since 3 March 2005 it has been a legal
The financial promotion restriction          requirement that Business Plans must
have a prominent warning as follows:
                                                 Dishonestly conceals any material
      Warning: The content of                     facts whether in connection with a
      this promotion has not                      statement, promise or forecast
      been approved by an                         made by him or otherwise; or
      authorised person within                   Recklessly makes (dishonestly or
      the meaning of the                          otherwise) a statement, promise
      Financial Services and                      or forecast which is misleading,
      Markets      Act      2000.                 false or deceptive in a material
      Reliance       on      this                 particular;
      promotion       for     the
      purpose of engaging in                  is guilty of an offence with a maximum
                                              custodial sentence of 7 years.
      any investment activity
      may       expose         an
                                              In this context it is important for those
      individual to a significant
                                              preparing     Business        Plans    to
      risk of losing all of the
                                              understand clearly the difference
      property or other assets                between financial projections and
      invested.                               financial forecasts.     In either case
                                              these should be reasonably based on
There       are     various       statutory   appropriate assumptions which can be
requirements regarding this warning           verified by prospective investors but
(see separate Briefing Note). The             projections are merely illustrative
Business      Plan    must       also    be   whereas forecasts represent the
accompanied by an indication - (a) that       directors view of the likely outcome.
it is exempt from the general restriction
(in section 21 of the FSMA) on the            The Prospectus Regulations 2005
communication of          invitations or      In     terms    of    the   Prospectus
inducements to engage in investment           Regulations it is an offence to
activity on the grounds that it is made       distribute a financial promotion to 100
to either a certified high net worth          people or more unless it meets the
individual or sophisticated investor; (b)     requirements of the Regulations (ie it
of the requirements that must be met          is a Prospectus) or:-
for an individual to qualify as a certified
high     net    worth      individual    or      The minimum investment is at
sophisticated investor (see separate              least 50,000 euros;
Briefing Note); and (c) that any
individual who is in any doubt about             The investment is denominated in
the investment to which the Business              amounts of not less than 50,000
Plan relates should consult an                    euros; or
authorised person specialising in
advising on investments of the kind in           The total amount being raised is
question.                                         less than 100,000 euros.
Misleading        Statements          and     It is important that this restriction
Practices                                     should be borne in mind when
                                              distributing  financial   promotion
In terms of section 397 of the FSMA           material.
any person who:-
   Makes a statement, promise or
    forecast which he knows to be             The FSMA and its subordinate
    misleading, false or deceptive in         legislation are even more complex and
    any material particular;                  wide reaching than the legislation
which they replace. However, the
Government has attempted, through
subordinate legislation (in particular
with the Financial Services and
Markets      Act     2000    (Financial
Promotion Order) 2005), to take on
board the concerns of informal
investors. It is now much easier for
business angel syndicates to comply
with the FSMA but a further relaxation
of the rules could help with the
administrative burden that many
business     angel    syndicates   are
currently faced with.

While all reasonable care has been
taken in the preparation of this guide,
no responsibility is accepted by MBM
Commercial LLP for any errors it may
contain,      whether    caused      by
negligence or otherwise, or for any
loss, howsoever caused, occasioned
to any person by reliance on it.
Individual advice should be sought
before considering any of the matters
detailed in this guide.

For further details, please contact:

Sandy Finlayson
Stuart Hendry
Kenny Mumford

Tel:    0131 226 8200
Fax:    0131 226 8240


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