If a client company asks how to raise funds where debt is not suitable, there is a new answer to add to the mix available since 1 April.
Perhaps an entrepreneurial company has an innovative product which still needs some development and the potential market looks attractive. Perhaps the company is relatively mature and very profitable and the owner wishes to sell some shares to realise the asset for personal purposes. Do the provisions of the Financial Markets Conduct Act 2013 [FMCA] provide any new avenue for raising funds?
For the entrepreneur, for many years, the angel investment process has become well developed to provide funding for innovations. The angel process was necessary because the Securities Act 1978 prohibits public offers unless accompanied by a Prospectus and Investment Statement [P&IS] Disclosure. Costs made this route prohibitive for smaller amounts.
The unintended effect was that entrepreneurial activity, wealth creation, job creation, and economic development were all hindered to a large degree for 35 years while the Securities Act has been in force.
The FMCA has provided a faster and more convenient one-step process which is likely to compete strongly with the angel process if not replace it completely. The new process is actually an old process. It is an Initial Public Offer. These new IPOs are authorised under FMCA Schedule 1 Clause 6 which succinctly excludes offers to the public from P&IS Disclosure requirements but only if the offer is through the licenced intermediary.
The licencee acts as a guardian gateway to prevent irresponsible promoters presenting inappropriate offers to the public. This device has to be praised as an excellent development allowing public fund-raising up to $2 million in any 12 months which should satisfy most SME and entrepreneurial companies [FMC Phase 1 Regs 2014 Schedule 1 Clause 4].
A rigorous FMA licensing process ensures the licencees are up to the task. Entrepreneural companies can now approach an intended licencee such as IceHouse associate company The Snowball Effect Ltd.
The only requirement for the fund-raising company is completion of a public offer document. A template guide is provided for what investors typically want to know. The flexibility is important for start-up entrepreneurial companies which may need to emphasise different strengths in different areas. Anything which sells and everything that discloses should be included succinctly and accurately. [See FMCA Part 2 ss 19 to 23.]
There are new protections for investors. One significant element about the crowd funding process is that investors are able to pose questions to companies. That will operate rather like buyers’ questions on the Trade Me auction site. The company IPO statement is therefore open to public scrutiny. That could well prove a demanding process.
Under clause 27 of the FMCA Phase 1 Regs 2014 Schedule 1, a condition for the crowd funding licence is to make a warning statement available so investors must read it.
The warning statement includes:
- Equity crowd funding is risky. You may lose your entire investment, and must be in a position to bear this risk without undue hardship.
- Issuers using this facility include new or rapidly growing ventures. Investment in these types of businesses is very speculative and carries high risks.
Omit these two sentences if the facility is confined to issuers for whom the sentences would be inapplicable (like a mature profitable SMEs). The older shorter version was “caveat emptor”.
This warning must be seen in the light of the amount which an investor can invest. Consideration was given to limiting investors to, for example, $25,000 but picking any figure created demarcation problems. So no limit is given other than the $2 million which the company can raise.
Financial literacy demands that education be the method for New Zealanders to grow wealth rather than the “prohibition” demand that people be protected from themselves. Licencees are free to add a warning that investors should limit investment to no more than 5% of their net worth. Such a warning would help protect licencees and applicant companies.
The licencee will be wanting to ensure that only projects which have a significant chance of being funded are presented to the public.
During this early stage of crowd funded IPOs, it is relevant that there is 35 years of pent-up public frustration at being denied access to such ventures. Public interest may be high. The new equity crowd funding system provides much more succinct disclosure and is much more transparent and accountable. It is culture changing legislation.
A rare example of one prospect for crowd funding in the financial services sector is a system for comparing the performance of investment advisers.
For 80 years in the United States and 30 years in New Zealand, consumer investors have asked how they can compare investment advisers. The industry has never had an incentive to supply an answer. A proposal by Investment Advisers Performance Measures [IAPM] is before licencee Snowball Effect to raise funds to provide just such a service. Lawyers and chartered accountants may be interested to find out just how that new service can help their referral process and risk management especially if also a trustee.
It should firstly be noted that the previous prohibitions about secondary market selling, typically undertaken by owners, has been substantially tightened. Owners who are “controllers” may not sell their shares without full P&IS disclosure. This is seemingly in contradiction to the liberalisation contained in the FMCA to encourage business. However the owner no longer needs to attempt to sell shares though back street methods.
Owner “controllers” are now controlled by a new provision in FMCA Sch 1 Clause 33 which regulates sales made by controllers of the company which are not quoted / listed. Full P&IS disclosure is required.
Clause 34 now regulates the work-around where a sale by a controller is made to an exempt co-conspirator party who then on-sells. If the second sale is within 12 months and if that second sale was the intent, full P&IS disclosure is required. There is now very little point in looking for a work around. It is simpler and easier to get IPO funding.
FMCA Phase 1 Regs 2014 Regulation 16  defines the crowd funding service as having a “principal” purpose of matching companies raising funds with investors seeking to invest relatively small amounts. Reg. 16 goes on to specify that the service also includes any “broking service” and operating a “trading facility” for companies that have raised funds on that platform.
This is a secondary market trading platform. It is a major advance for business everywhere in New Zealand which should be considered in advice to client companies. This is an SME / start-up stock exchange.
This most important addition to the IPO process means that such companies have an immediate liquidity for all shareholders. It is possible that many SME companies could seek to obtain that liquidity advantage.
It will be interesting to see how this new market develops and how it leads to more SMEs going on to the NZAX or NZX. For example, at this stage, the intent of the applicant start up IAPM is to move to a full listing.
It should also be noted that NZX has announced that is it is developing a new growth exchange operating in the greater than $10 million market capitalisation replacing NZAX. After five years, start-ups should have achieved that level. It seems that there will shortly be a full stock exchange continuum from start-up to genesis. All investors who enjoy stock markets should be highly supportive of this development.
Commercial lawyers and chartered accountants should acquaint themselves with the new rules in order to help clients participate in the new evolution of growth capital markets. The first tranche of IPOs is expected to start this month when FMA will have completed the first licencing processes. Registering for updates is easy and available now at www.snowballeffect.co.nz.
For the FMA and industry educators, the IPO investor warning includes the statement to “seek independent financial advice”.
The problem is that no one is authorised in New Zealand to provide financial advice on start-up ventures. AFAs must pass exams or provide proof of experience. Those exams do not include start-up venture assessment. [Standard Set D Course 25648 Element 5]. Some unknown AFAs may claim their experience is enough but no such claim has been found. This topic requires further exploration by parties interested in the investment adviser industry and growth companies versus managed funds.
A solution is needed for those angel investors who may be feeling the cold winds of change. Perhaps they could approach the powerfully developing licencees with the idea that the angels become mentors for the applicant companies.
An agreement would be needed to protect applicants and the licencee. Angel availability and potential investment participation at the front end on day one or as underwriting of the IPO in the event of a shortfall or both and announced before the public round could greatly enhance the prospects for all. Co-operation is better than competition in many circumstances, especially when the law has gone against you. Angels will need to adapt.
Miles Hayward-Ryan is an in-house corporate lawyer and founder director of IAPM which is applying for IPO funding. Any lawyer interested in further material about the issues raised in this article may contact Miles at (09) 413 5355, email email@example.com or see www.iapm.co.nz.