3 tips for internet, technology and new media start-ups: No2 - Securities Act compliance

POSTED BY Rick Shera
01 September 2010

posted in l@w.geek.nz | Business | Start-Ups



In my previous post I talked about how important it is to make sure that your company actually owns the intellectual property that justifies the investment value. If you don't get that right, then you can find that investors devalue the company, or, worse still, are scared off altogether.

But, if you get Securities Act compliance wrong, then that is potentially far more serious.  Get this wrong and it can lead to legal action against you, your fellow directors and anyone else who is instrumental in promoting the investment and, ultimately, even to criminal prosecution.  This is real black letter law so you'll need to engage a lawyer who knows what they are talking about in terms of the rules around capital raising and investment.

But, here are a few things you need to know though - they are not the only things but they are pretty important:

  • The Securities Act applies whenever you seek investment from members of the public.
  • There are some rules around who are and are not members of the public, which I'll get to in a moment.  But, if you end up having an investor who is a member of the public and who does not fall within an exception, then you must first register a prospectus and issue an investment statement.  Those are complex and expensive documents to prepare, so most start-ups seeking initial growth capital will not want to go there.
  • To avoid that, your investors either need to be people who are not members of the public or they need to be Eligible Persons (as they are called in the Securities Act).
  • It is easy enough to list the categories of people who are not members of the public, from the Securities Act.  The main categories (not the only ones, but the main ones) are:

(i) relatives or close business associates of the issuer or of a director of the issuer:

(ii) persons whose principal business is the investment of money or who, in the course of and for the purposes of their business, habitually invest money:

(iia) persons who are each required to pay a minimum subscription price of at least $500,000 for the securities before the allotment of those securities:

(iib) persons who have each previously paid a minimum subscription price of at least $500,000 for securities (the initial securities) in a single transaction before the allotment of the initial securities, provided that—

(A) the offer of the securities is made by the issuer of the initial securities; and

(B) the offer of the securities is made within 18 months of the date of the first allotment of the initial securities:

(iii) any other person who in all the circumstances can properly be regarded as having been selected otherwise than as a member of the public:

  • Easy enough to list but, at times, very difficult to judge - particularly if you are looking to take advantage of the close business associates exception in (i).
  • Recognising this difficulty however, the Securities Act was changed not so long ago, to provide that certain rules would not apply to specifically defined Eligible Persons.  These exceptions are far clearer. In summary, they cover people who are:
(a) wealthy (net assets of at least NZ$2 million or annual gross income of at least NZ$200,000 for each of the last 2 financial years); or

(b) experienced in investing money; or

(c) experienced in the industry or business to which the security relate.
  • There are various extended definitions and procedures you need to go through to make sure people are in fact Eligible Persons, which I won't go into here. These are all set out in the Securities Act (sections 5(2CA) - 5(2CF)) if you want to take a look.
  • If you can fit your investors within these exceptions, then some of the rules are relaxed and, in particular, you won't need a prospectus or investment statement.
  • A warning though. Cases have gone through every level of our legal system trying to work out the boundaries of some of these exceptions. As I said, it's an area you need expert advice on.
  • One final important point. Just because your investors fall within one of the exceptions and therefore you don't need a prospectus or investment statement, that doesn't mean the Securities Act and the Fair Trading Act won't still apply.  So, whatever you give to an investor or tell them to encourage them to invest needs to be correct and not deceptive or misleading in any way.  Critically, if an investor later alleges the material they were provided was incorrect, then, under the Securities Act, you will have to be able to prove either that it was not or, if it turns out it was, that it was reasonable for you to have believed it was true.  So, you need evidence to back up the claims that you are making to encourage the investment.  Nowhere is that more critical than with things like turnover and profit forecasts, which should also carry suitable risk warnings and disclosure of assumptions.

All of this applies right from the start - as soon as you start talking to a potential investor. If you are at that stage, it pays to take care and to get some good, expert, legal advice.

This is not legal advice in any jurisdiction. For that, you generally have to pay ;-)  Law may have changed since this post was published.

POSTED BY Rick Shera
01 September 2010

posted in l@w.geek.nzBusinessStart-Ups



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