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Envestors: 50 shades of grey – taking off the blindfold when it comes to FCA regulation

Why incubators, accelerators and networks matching investors and startups need to be regulated

By Oliver Woolley, CEO of Envestors

While few among us find the idea of getting a firm grip on financial services regulation a titillating one, it is necessary. Those that don’t, leave themselves at the mercy of the regulatory body, the Financial Conduct Authority (FCA), which has a well-earned reputation for cracking the whip.

Considering rules, guidelines, exclusions and exemptions, the financial services regulation is notoriously complicated. The handbook written to help distill the regulation itself makes the three-part Fifty Shades series look like a short story, with the glossary alone accounting for 583 pages.

This complexity has created a spectrum of grey areas and led to widespread issues in the early-stage investment space with many unauthorised organisations conducting regulated activities, either unaware they are doing so or under the belief that they are somehow exempt.

And while it’s easy to get tied up trying to decipher the definitions, rules, exemptions and exclusions, we are here to ease the pain, take off the blindfold and help you dominate when it comes to financial services regulation.

So, here we expose the naked truth when it comes to the most common grey areas surrounding financial services regulation in early-stage investing.

Grey area #1: I am not regulated, so I don’t need to worry about it.

This is a bit like saying, ‘I don’t have a license to drive, so the highway code doesn’t apply to me,’ and yet it is a real misconception in the market.

If you are an unregulated network or introducer you can be reported to the FCA.  If you are found to be undertaking regulatory activity, e.g. “arranging”  deals in investments, without the required FCA permissions, it is a criminal offence and the individuals responsible for operating the unregulated network won’t just get a gentle slap on the wrist, they might just find themselves in handcuffs.  If that isn’t bad enough, any transactions could also be unwound, and you could have to pay damages.

Grey area #2: I am not giving advice to investors, so I don’t’ need to be regulated.

This is a common interpretation we hear from angel networks and other organisations who help match start-ups and investors. The grey area here is around the word ‘advice’ and how you’re actually interacting with both investors and start-up companies.

Let’s have a look at some key terms and what they mean from a regulatory perspective:

Advising: When we’re talking about equity investment, ‘advising’ falls into two categories: (1) Advising companies about raising investment i.e. providing corporate finance advice to startups with regards to matters such as valuation and deal structuring and (2) Advising investors about investing i.e. providing recommendations in respect of making investments.

The definition of investment advice is quite broad, so if you’re running an investment network and you’re not saying to investors, ‘put your money in this deal’ you’re in the clear, right?

Wrong.

While you may not be carrying on the regulated activity of providing investment advice to investors, you may be carrying on a different regulated activity: arranging deals in investments.

Arranging is defined by the FCA as bringing about deals in investments, making arrangements with a view to transactions in investments or agreeing to carry on either of those regulated activities.

Here you can see an organisation that brings together investors and startups for the purposes of showcasing or discussing investment opportunities that will lead to transaction, is very likely carrying on the regulated activity of ‘arranging’.  However, again there are certain exclusion and exemptions which could apply, so you should obtain advice to confirm your exact regulatory position.

Grey area #3: Anyone can run a pitching event to help start-ups

Yes, anyone can arrange a pitching event. But. But. But. . .

There are several caveats here that you need to be aware of before you start sending out invites.

You must ensure that the investors you invite are at the right kind of investors. The right kind of investors are the kind with money, right?

Not exactly, because any marketing which is capable of having an effect in the UK, which involves an invitation or inducement to engage in investment activity, would fall within the scope of the UK financial promotion regime.  Similar to regulated activities, breach of the financial promotion regulation is a criminal offence, transactions could be unwound, and you could have to pay damages.

To avoid getting yourself into a bind, ensure any financial promotions are issued or approved by an FCA-authorised person, unless you are absolutely sure it falls within an exemption from the financial promotion regime.

Grey Area #4: I am only targeting high net worth individuals and sophisticated investors, so I don’t need to be regulated

There are exemptions that apply to certain classifications of investors and rules around how you can market and interact with each.

Two such classes of investors are called ‘Certified High Net Worth Individuals (HNWI)’ and ‘Sophisticated Investors’ who have signed statements confirming their status within the last 12 months. If you request a copy of these statements for each person, then you know that your audience fall within this exemption.  However, you still have to be extremely cautious not to cross over from the financial promotion, before or after your event into the regulated activity of arranging. The exemptions that apply to the financial promotion regime do not generally apply to regulated arranging.

It is not uncommon for networks, post marketing, to help seal the deal by facilitating communication between the start-up and the investor. This is exactly the kind of behaviour that is likely to amount to the regulated activity of arranging and arouse the interest of the FCA.

Grey area #5: “High net worth individuals (HNWI)” and “Sophisticated investors (SI)” are “Professional” investors.

Another common point of confusion we hear in the market in relation to financial promotions is around the classes of investors under these exemptions and what a non-regulated entity may and may not do under exemptions. Let’s take a crash course in what those types are:

Professional:

a) Works in a business that carries on ‘controlled activities’, for example a venture capital firm or a large company that has a corporate treasury function
b) An individual that is authorised or exempt
c) Governments and local authorities

Retail:

a) High Net Worth Individual (HNWI): Has annual income of £100,000 or more and/or net assets worth £250,000 or more. Exemption to net assets includes one’s primary residence, pension and contracts of insurance.
b) Sophisticated Investor: Are deemed sophisticated enough to be aware of the risk of investing into unquoted companies, for example, either a member of a network of business angels or has made more than one investment in an unlisted company in the two years
c) Restricted investor: Does not qualify as a high net worth or sophisticated investor and agrees not to invest more than 10% of their net assets per year. But as a network you can only promote a non-readily realisable security (NRRS) and not a non main-stream pooled investment (NMPI) to this group of investors – let’s not even go there…

So what? The importance of these definitions lies in what you can and cannot do with certain types of investors. Broadly speaking, you can promote and arrange any opportunities to Professional investors as they are deemed to be “professional” enough to fully understand the risks.  But there are heavy restrictions as to how networks engage with Retail investors in terms of marketing and arranging.  And so, assuming that “High net worth individuals (HNWI)” and “sophisticated investors (SI)” are “professional” investors can get networks into hot water.

Another important point is around self-certification. As stated above, to fall within the HNWI or sophisticated investor exemptions from the financial promotion regime a network needs to ensure that investors have self-certified their status within the last 12 months.

Grey area #6: I can promote my equity investment opportunity on social media

Posting your investment opportunity on your website, via your social media or targeting investors via LinkedIn is likely to fall within the financial promotion regime and will leave you open to scrutiny by the FCA.  Breach of the financial promotion is a criminal offence and transactions could be unwound and you could have to pay damages.

As stated above, under Section 21 of Financial Services and Markets Act 2000 (“FSMA” – a tortuous but important bit of legislation protecting investors), any communication which invites someone to buy shares in their company is a financial promotion and, unless you are confident the communication is exempt or has been approved by a FCA registered firm, it is a criminal offence to make such a communication.

If that hasn’t turned you off, section 755 of the Companies Act 2006 prohibits private companies offering shares to the public, unless various conditions are met, such as making the offer to fewer than 150 people or to qualified Professional investors.

To be sure you are not breaching any of these regulations, you may wish to consider two things:

  1. In relation to the financial promotion regime, ensuring any financial promotions falls within an exemption or have been signed off by a FCA authorised firm and
  2. In relation to arranging, ensuring that all investment transactions are arranged through an investment platform which is managed by an FCA authorised firm with permission for arranging, which will also ensure investors go through a proper investor classification and risk awareness process.

These are just a handful of the most common misconceptions that we see. If you feel like you’re groping in the dark when it comes to regulation, there are firms out there that can help. In addition to consulting with a specialist lawyer, regulated firms like Envestors are able to offer Introducer and Appointed Representative status —giving you more than ample cover without having to swallow the cost of becoming regulated in your own right.

It is time for networks working in the exciting world of matching start-ups with investors to take off their blindfolds and submit to regulatory requirements. When this happens and all the players have confidence that investors are fully aware of risks, and importantly that opportunities are ‘clear, fair and not misleading,’ it will mean more money is pumped into start-ups, who desperately need a leg up in these challenging times.

The risks involved in misinterpreting the rules will never outweigh the benefits. When it comes to regulation, the safe word is always compliance.

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Envestors: 50 shades of grey – taking off the blindfold when it comes to FCA regulation

By Envestors20 Oct 2020