Startups and scale-ups looking to raise capital must be conscious of their disclosure obligations.
Disclosure is often considered a public or listed-company issue, and may easily be overlooked by private companies who do not think disclosure obligations under corporations law applies to them.
However, this is not always the case, and it’s important for private companies raising capital to understand the regulatory landscape.
Private companies must comply with any disclosure obligations to potential investors, and must also comply with the relevant exemption requirements under the Corporations Act 2001 (Cth).
When do public companies need to issue a formal disclosure document under the Corporations Act?
Chapter 6D of the Corporations Act governs the disclosure regime for the offer, sale and issue of various securities.
Assuming you don’t qualify for an exemption, several regulated disclosure document options may be used by public companies.
- Prospectus. The ‘full-blown’ disclosure document for companies, which must comply with both the general and specific content requirements set out in the Corporations Act, and various ASIC guidance.
- Short–form prospectus. A short-form prospectus refers to key information set out in the prospectus. A company can take this approach where the prescribed information regarding the documents is summarised in the short-form prospectus. Investors may then request the prospectus for more information.
- Transaction–specific prospectus. Technically a form of prospectus applying to ‘continuously quoted’ securities. For example, securities from listed entities which meet certain other requirements. This may exempt a company from having to include information which has already been disclosed to a relevant stock exchange in a prospectus; the market should have sufficient information to reach an informed view where a company has complied with its continuous disclosure obligations.
- Offer information statement. An alternative to a prospectus where the amount to be raised is no more than $10 million.
What about private companies?
The Corporations Act prohibits private companies from activities requiring disclosure to investors under Chapter 6D, except for offers of shares to existing shareholders or employees — but this clearly doesn’t impose a blanket prohibition on private companies raising capital or issuing securities.
Instead, companies must ensure they qualify for a disclosure exemption before raising capital from new investors.
Relevant disclosure exemptions
Disclosure exemptions commonly used by both public and private companies include the following.
1. Sophisticated and professional investors
Sophisticated investors are persons who meet certain income or assets requirements evidenced by an accountant’s certificate (currently set at gross annual income of $250,000 or more in each of the previous two years or net assets of at least $2.5 million), or who invest at least $500,000 in the offer or previous offers of those securities.
A person can qualify as a professional investor in several ways, including by being an Australian Financial Services Licensee, a listed entity, a body corporate who carries on a business of investing in certain assets, or a person who ‘controls’ assets of at least $10 million.
Companies must ensure they have relevant documentation as evidence of a person’s status as an exempt investor (for example, an accountant’s certificate for a sophisticated investor relying on the income or assets requirements).
Companies new to raising capital often take their incoming investors’ identities for granted, which is risky, as aspects of the sophisticated investor test depend on the company obtaining certain documentation.
2. 20/12 ‘small scale offerings’ exemption
An offer of securities does not need disclosure under Chapter 6D where, in any 12-month period, the offer results in:
- Less than 20 people issued securities; and
- Less than $2 million raised by the company issuing securities.
Importantly, calculating the amount raised excludes any issue or sale made with an alternative disclosure exemption (or for public companies, under a disclosure document).
3. Employees and existing shareholders
Disclosure exemptions for issuing securities to employees and existing shareholders are available to public and private companies. Requirements depend on the offer’s scale and nature. Companies should ensure when issuing securities to employees (whether under a share option plan or otherwise) or existing investors (such as under a rights issue), they comply with the applicable exemption requirements.
It’s common for an offer to employees or existing investors to also fall within one of the other exemptions set out above (for example, it may constitute a small-scale offering).
Falling within each of these exemptions requires the company and the offer (and in some cases, the incoming investors) to meet certain requirements under the Corporations Act.
So you’re exempt from issuing a disclosure document, are you off the hook?
Not exactly. Your disclosure obligations don’t end with meeting the Corporations Act requirements.
There are general law and statutory prohibitions on companies and their personnel engaging in ‘misleading or deceptive conduct’, relating to disclosure in capital raising.
The Corporations Act and the Australian Securities and Investments Commission Act 2001 (Cth) contain prohibitions on engaging in conduct which is or is likely to be misleading or deceptive in relation to a financial product or a financial service.
The prohibitions depend on various factors, but should not be disregarded in the current environment of increased shareholder activism and scrutiny of corporate behaviour.
Even silence can constitute misleading or deceptive conduct at general law or under statute. Companies must ensure they do not withhold information such that it could mislead or deceive.
Capital raising companies will find the Corporations Act’s general prospectus disclosure test a good starting point. This test covers all the information investors and their professional advisors would reasonably require to assess the rights attaching to the securities, including the assets, liabilities, financial position and performance, profits, losses and prospects of the company.
This doesn’t mean private companies need to issue a prospectus-style document (which would undermine the benefit of the exemptions), but they must consider the potential investor’s understanding to ensure that they have an informed and accurate understanding of their investment.
So what if you don’t disclose?
Criminal and civil legal penalties may apply for inadequate disclosure to investors, or for misleading or deceptive conduct.
But the ramifications can extend much further: reputational damage associated with negative publicity may cause potential and existing investors to lose confidence, and sour relationships with customers and suppliers.
Increased regulatory focus on investor protection and consumer rights provide extra incentive for companies to meet their disclosure obligations, particularly private companies which may overlook these issues.
This article was updated on March 13, 2020.