Raising investment is a key milestone for most start-ups and early-stage businesses. Founders often look to funding rounds as a way to secure growth capital, bring in strategic investors and increase their company’s profile. Alongside the commercial aspects, there are important legal requirements to consider, particularly around financial promotions. In this article, we explain how the law regulates investment communications and explain how you can help avoid mistakes that could delay or even prevent a deal.
The Stages of Funding Rounds
Funding rounds usually happen in stages as the company grows. Here is how the stages are normally divided:
- Seed funding is typically the first formal investment, often from angel investors or seed funds.
- Series A, B, C and beyond involve progressively larger sums from venture capital firms and other institutional investors.
At each stage, the legal and regulatory environment becomes more complex. Agreements with investors need to be clear, compliant and tailored to the company’s future plans.
Preparing for a Funding Round
Founders should take the lead in preparing their own legal framework before approaching investors. If you do not set the terms, investors may step in and do it for you. A well-prepared structure makes it easier to attract the right backers and keep control of your business. Here are some key steps to consider:
- Take charge of the documentation: Draft your own shareholders’ agreement and subscription agreement so you maintain maximum control rather than leaving these to investors.
- Put in place the right framework: Having clear agreements in place from the outset makes it easier and quicker for investors to sign up.
- Consider individual agreements: Using separate subscription agreements for each investor, instead of one single agreement for the whole round, can provide flexibility and allow multiple closings.
- Check eligibility for tax reliefs: Investors often look for SEIS or EIS status, so it is useful to confirm whether your company qualifies.
- Plan your investor communications: Make sure any promotional material is compliant with financial promotion rules, and that exemptions or approvals are in place.
Being proactive at this stage helps avoid delays later, reduces the chance of disputes, and demonstrates professionalism to potential investors.
The Role of Founders
In most start-ups, founders wear several hats at once. Understanding the legal responsibilities attached to each role is important before entering a funding round:
- Director: As registered at Companies House, directors are responsible for running the company and making decisions on its behalf. They may also be shareholders, but they carry distinct legal duties to act in the best interests of the company.
- Shareholder: Holding shares gives founders ownership rights, including the ability to vote on certain matters under the Companies Act 2006. However, being a shareholder does not by itself give authority to run the business day-to-day.
- Lender: Founders sometimes lend money to their company, for example by paying for expenses personally. In this situation, they are acting as creditors of the business.
- Borrower: If a founder withdraws money from the company without it being recorded as salary or dividend, they are effectively borrowing funds until the withdrawal is properly accounted for.
During a funding round, these overlapping roles can create complexity. Founders are not only promoting the company as shareholders but also taking on legal responsibility as directors. If misleading statements are made to investors, it is usually the directors who will be held accountable.
What are Financial Promotions?
Under the Financial Services and Markets Act 2000 (FSMA), a financial promotion is any invitation or inducement to engage in investment activity. In practice, this means almost any communication that could persuade someone to buy shares or invest in a business.
The definition is very wide. It can cover:
- Written material such as pitch decks, emails or information memoranda.
- Verbal discussions, for example in a meeting or investor call.
- Online content, including website pages or social media posts that promote an investment opportunity.
Because the test is broad, most communications about investing will count as financial promotions unless a specific exemption applies. This is why founders need to be cautious and treat even informal investor approaches as potentially regulated activity.
How are Financial Promotions Regulated?
In England and Wales, the regulation of financial promotions is set out in the Financial Services and Markets Act 2000 (FSMA). The rules are designed to protect investors by ensuring that communications about investment opportunities are fair, clear and not misleading.
The starting point is that no one may make a financial promotion unless they are properly authorised or the promotion has been approved. In practice, this means:
- Authorised firms: Only those who hold permission from the Financial Conduct Authority (FCA) can freely communicate financial promotions.
- Approval by an authorised person: If a company is not authorised, it must arrange for an FCA-authorised firm to check and approve the promotion before it is circulated. The authorised firm takes regulatory responsibility for the content.
The effect of this regime is that founders must treat almost all communications with potential investors as falling under FSMA. Even informal discussions or early-stage pitch materials could be caught, so compliance should be built into the fundraising process from the beginning.
Exemptions to the Financial Promotions Rules
There are exemptions that allow businesses to make investment communications without FCA authorisation. Common examples include promotions directed at:
- High net worth individuals who meet certain income or asset thresholds.
- Sophisticated investors, such as those who have experience in angel investing or are members of an accredited network.
- Investment professionals, including institutional investors and authorised firms.
These exemptions are tightly defined, and businesses must make sure they fall within the criteria before relying on them. Misuse of an exemption could expose founders to criminal or civil liability.
Consequences of Breaching Financial Promotion Rules
Breaching the rules on financial promotions can have serious consequences. Agreements made as a result of an unlawful promotion may be unenforceable, leaving the business unable to rely on the investment. The FCA also has powers to investigate and take action against businesses and individuals who breach the regime. In serious cases, there may be criminal penalties.
For founders, the reputational impact can be just as damaging. Investors are unlikely to proceed if they believe the company has taken shortcuts with regulatory compliance.
Precautions You Should Take
When preparing for or conducting a funding round, it is important to handle communications carefully. The following practical steps can help reduce the risk of breaching the financial promotion rules:
- Face-to-face conversations are usually acceptable, as long as they are one-to-one and not part of a wider, public communication.
- Responding to an investor’s request for information may fall outside the restrictions if it is a genuine one-off response, but you should still keep the content accurate and limited to what was asked.
- Verify investor status if you are relying on exemptions such as “high net worth individual” or “sophisticated investor”. Always ask to see their signed certificate before proceeding.
- Business angel clubs can be covered by exemptions, but confirm with the organisers that their membership meets the relevant criteria before presenting.
- Disclaimers should be included on all written materials, making it clear that the content is for specific types of investors and should not be treated as a general invitation to the public.
Taking these steps will not only help ensure compliance with the financial promotion rules but also build trust with potential investors.
Speak to JPP Law
At JPP Law, we advise founders and growing companies on all aspects of funding rounds, from structuring share issues to ensuring compliance with financial promotion rules. Our solicitors have experience guiding start-ups and established businesses through the investment process, helping them raise capital while staying within the law.
If you are preparing for a funding round and want clear, practical advice, please contact JPP Law to speak with one of our solicitors.
