Capital Raising: Reminder of FMCA Exclusions

David Smillie

This article appeared in the Otago Daily Times, August 2016.

It has been around 3 years since the Financial Markets Conduct Act 2013 (FMCA) was passed and it has been welcomed by the business community. This is the first of two articles designed to give a brief reminder of the main exclusions available for businesses seeking to raise money from investors.

The FMCA presented a comprehensive overhaul of securities legislation, including a new exclusion regime which determines whether or not full disclosure is required during offers for financial products. The exclusion regime is practically crafted and targeted at small to medium enterprises that cannot bear the burden of more onerous disclosure requirements in the same way large entities can. The exclusion regime is stepped to reflect the stages of typical capital raising strategies that small businesses engage in as they begin to look for outside investment.

There are four main levels of exclusions. These are for offers to relatives and close business associates; offers to employees of the business; offers to wholesale investors; and ‘small offers’. Above small offers sits listing as a public company. This article will be split into two parts, the first concentrating on offers to relatives and close business associates and employees; and the second looking at wholesale investors and small offers.

For many small companies, raising capital begins at a level closely related to the company. The first level of exclusions available to companies is when capital is being raised from close business associates of the business and relatives of the directors of the business. Crucially, this exclusion does not apply to friends and acquaintances of the directors of the business.

To qualify as a “close business associate” the person must be a director or senior manager of the company, or own 5% or more of the shares, be a relative of those persons or else have a close professional or business relationship with a director or senior manager of the business. The nature of the last relationship must be such that the associate is able to assess the merits of the offer in a prudent manner. The offeror must be able to show a professional nexus between themselves and the associate.

In contrast to this more restricted definition of a close business associate, the definition of “relative” is relatively wide. It extends to partners, children, grandchildren, siblings and all of their partners, as well as trustees of trusts of which the offeror or a relative as described above is a beneficiary. These relationships can also be step-relationships. This wide approach to defining a relative for the purpose of exclusion is a sensible approach which reflects that while a business is just starting out it is likely that it will enjoy support from nearly all the family. The danger here is that this wide definition of relative in the context of large families may see less connected relatives in large family situations be included under this exclusion when they may otherwise be considered ordinary investors and would require more comprehensive disclosure to assess the merits of an offer.

The next method of capital raising sometimes used by businesses are employee share schemes. The Act recognises the larger degree of separation between the company and its employees compared to close business associates and relatives. As such, some limited disclosure is required to be presented along with the offer. This includes documentation detailing the scheme along with the financial statements of the company, a copy of the company’s latest annual report and an auditor’s report. The employee must also be given a prescribed warning statement which outlines that as employee investors they will rank behind creditors and preferential shareholders in the event of a liquidation of the company and that they have fewer legal protections and have been afforded less disclosure than other investors.

To take advantage of the exemption for employee share schemes under the FMCA the investment offer has to be made as part of the employee’s remuneration arrangements, raising funds cannot be the “primary purpose” of the offer and the total number of shares issued to employees in any 12-month period cannot exceed 10% of the total number of shares in the company.

The next article will focus on the FMCA’s exemptions for offers to wholesale investors and small offers.