If your startup is looking to grow and raise capital, you will typically want to issue new shares to do so. In New Zealand, the issue of securities (including shares) to members of the public is subject to extensive disclosure obligations unless your investors (or offer) fall within certain exclusions. Notably, these disclosure obligations and exclusions will impact both whether you can raise capital and how you can do so. This article will discuss the disclosure exclusion framework focusing on the eligible investor exclusion and how your startup can take advantage of it when raising capital.
How Do Disclosure Obligations Affect My Startup?
Many startup founders raise capital to help fund their startup's operations and grow the business. If you are a company issuing shares to raise capital, the general rule is that you must comply with disclosure obligations under New Zealand securities laws. This includes preparing and issuing a disclosure document in relation to your share offer (called a product disclosure statement).
The purpose of the disclosure obligations is to protect unsophisticated investors. It does so by requiring that companies provide sufficient information about the company and its financial position so that unsophisticated investors understand the risk they are taking when investing in the company.
The full disclosure process required is:
- time-consuming;
- expensive; and
- a potential barrier to small companies looking to raise capital.
However, there are several specific exclusions to these disclosure requirements that startups can take advantage of to support their growth. If one or more of these exclusions apply, you may not need to issue a disclosure document.
One commonly used exclusion is the one for "eligible investors," and it casts the widest net in terms of the types of investors it can capture.
What is an Eligible Investor?
An eligible investor is one category of excluded investor which sits within the broader " wholesale investor" exclusion.
The definition of an eligible investor encompasses several factors. In relation to a specific offer, the key qualities are whether the investor has sufficient previous experience in buying and/or selling shares which allows them to assess:
- the merits of the offer (including the value and risks of the shares on offer);
- their own information needs; and
- the adequacy of the information provided.
Reliance on this exclusion requires the investor to self-certify (in a prescribed form) that they are an eligible investor, the grounds for that certification, and that they understand the consequences of certifying themselves as such. This must also be supported by confirmation from an independent advisor (such as a lawyer or accountant).
Finally, as the offeror of the shares, you must be comfortable that the investor does in fact have the experience they are relying on in their self-certification.
What Does This Mean for My Startup?
The assumption is that eligible investors are in a position to understand the nature and risk of their investment without the need for additional disclosures. As a result, there is less need to protect them by requiring a company to prepare a disclosure document. Therefore, if your investor falls within the category of "eligible investor" (meaning they have self-certified themselves as such), your company does not have to issue a disclosure document.
As mentioned above, there are numerous disclosure exclusions available, and your startup can combine exclusions in relation to one offer. In other words, your company can take advantage of different exclusions for different investors in the same capital raise.
For example, eligible investors will not count towards the 20-investor threshold in the small offers exclusion.
An Example Case Study
Your startup is seeking to raise $1.2 million from 12 investors. You have never raised capital before. Currently, you can make use of the small offer exclusion because you are raising less than $2 million from less than 20 investors during a 12-month period. However, the small offer exclusion operates on a 12-month rolling basis. This means that if your startup wanted to raise further capital under this exemption nine months after the first raise, it could not raise more than $800,000 from more than eight investors. This is because $1.2 million has already been raised from four investors, and the rule is $2 million by 12 investors within a 12-month period.
Four of the initial twelve investors are considered eligible investors. Together, these four investors invested $600,000. The company does not have to include these investors (or the $600,000) in the small offer calculation. By excluding these investors, you have now freed up the ability to raise an additional $600,000 from an additional four investors using the small offers exclusion should you need to.
Keeping Track of Your Investors
It is your company's responsibility to keep clear records of its capital raises and the disclosure exclusions it relies on. This includes whether its investors are eligible investors (or another type of wholesale investor). You should also keep track of which exclusions you have relied on so that you can work out which exclusions are available to you going forward.
Is the Eligible Investor Exclusion the Only Way to Avoid My Disclosure Obligations?
No. There are various other exclusions from disclosure obligations under New Zealand securities law, noting that some are very specific in terms of their requirements. In particular, the eligible investor is part of a broader category of exclusions capturing different types of wholesale investors. Outside of these, family and friends, small offers (referred to in the example above), employee share options, and crowd-funding platform exclusions can be helpful in certain circumstances. It is important to bear in mind that the application of the disclosure exclusions can be complex, and you should always seek legal advice.
Key Takeaways
As a startup, you will likely need to raise capital at some stage. Extensive disclosure obligations will apply unless your offer or investors fall within certain prescribed exclusions. One of these exclusions is when your investor has self-certified themselves as an "eligible investor." Provided that each of your investors falls within one of the exclusions, your startup can raise as much capital as it chooses without having to issue a disclosure document. If you have any questions about disclosure obligation exclusions, our experienced startup lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents.
