2024 dawned with some very important, but often missed, changes to the rules that govern angel investment in UK start-ups. These changes have come in parallel with a disintermediation of early stage (pre-pre-seed) angel investment from professional advisors with many start-ups choosing to raise funds using precedent legal documents without the support of solicitors. The result in many cases is that founders are at risk of committing serious criminal offences carrying potential custodial sentences by failing to comply with their obligations.
Financial Promotions Regime
The Financial Promotions Regime regulates (amongst other things) who can make angel investments in start-ups where the “financial promotion” has not been approved by a regulated financial advisor. In simple terms, to make an investment in a start-up as an individual you must be (a) a high net worth investor (b) a sophisticated investor or (c) be advised on the risks of the investment by a regulated financial advisor. With effect from 31 January 2024 the definitions of “high net worth investor” and “sophisticated investor” changed.
A “high net worth investor” is a person who had an annual income (excluding pension withdrawals) in the last year of at least £170,000 and/or net assets of £430,000 or more. Net assets the investor’s primary residence, any loan secured on it, or any equity released from it; the investor’s pension (or sums withdrawn from it) or any rights under insurance contracts. These thresholds are considerably higher than under the previous regime.
A “sophisticated investor” is a person who (a) has worked in a professional capacity in the private equity sector, or in the provision of finance to SMEs, within the past two years (b) been a director of a company with an annual turnover of more than £1.6 million in the past two years and/or (c) been a member of a network or syndicate of business angels for the past six months, and is still a member. Crucially, a condition in the previous regime that an investor could be a sophisticated investor if they regularly made investments in start-ups has been abolished. This has removed a large number of investors from the definition of “sophisticated investor”.
In order for an investor to fall within the regime and be eligible to invest, they must complete and sign a certificate (a) specifically for each investment and (b) with the name of the start-up in which they are investing written on the face of the certificate and provide that certificate to the start-up.
The certificate must contain specific language confirming that the investor is eligible to receive a financial promotion, understands that they have no recourse to, or protection from the FCA, the Financial Ombudsman Service and/or the Financial Services Compensation Scheme and that they accept that they could lose all the money they invest.
Failure to comply with this regime results in each director of the start-up committing a criminal offence punishable by imprisonment and/or significant fines. Moreover, directors are required to reasonably believe that the statements given by investors when signing the forms are true.
Money laundering and sanctions evasion
The UK has operated a sanctions regime for many years. The breadth and scope of the regime massively expanded after the start of the Ukraine war. It imposes specific targeted sanctions on individuals as well as geographic and thematic sanctions, for example on anyone resident in Russia (subject to certain exceptions). For several years directors of start-ups have been legally required to ensure that they are not dealing with sanctioned persons with serious criminal offences flowing from any dealings with sanctioned persons. There is significant evidence that sanctioned persons are seeking to invest in start-ups, directly or via proxies, and so it is vital that founders carry out checks, especially on angel investors. Taking investment from a sanctioned person, particularly if the start-up hasn’t completed appropriate due diligence, will likely result in the start-up going bust and the directors (and potentially even shareholders) being prosecuted.
The Economic Crime and Corporate Transparency Act 2023 introduced a new ‘failure to prevent fraud’ offence covering fraud, and by extension money laundering. UK law already contains other similar offences including “failure to prevent bribery” offence introduced under the UK Bribery Act 2010 and “failure to prevent the facilitation of tax evasion” offences introduced under the Criminal Finances Act 2017.
Historically money laundering compliance has primarily been viewed as the responsibility of solicitors (despite the Companies Act 2006 already containing fiduciary duties on directors which extend to preventing their company being used for criminal purposes), but the new legislation signals in clear terms the direction of movement of the government and regulators to a position where directors are expected to take pro-active steps to prevent money laundering, and are subjected to criminal liability if they don’t. As with sanctions breaches, if a start-up takes laundered money from an investor, it will likely go bust, suffer significant reputational damage to the business, the directors and shareholders (who become associated with money laundering), and/or be unable to raise further funding.
Founders need to be carrying out electronic ID and database checks and source of funds checks on all investors. In most cases, these don’t need to be particularly invasive, but they must adequately assess the risk of money laundering. Unless founders perform these checks, they cannot assess the risk that an investor is a well-disguised criminal. Investors should co-operate with these checks – they protect investors as much as founders. To put it bluntly, imagine if you are a high profile solicitor or banker and have invested in a start-up. It transpires that the start-up took laundered money as part of an investment round in which you invested, and a high profile trial ensues. Do you really think that there is zero risk that the press won’t associate your name with the start-up, and by extension, with money laundering?
Increased S/EIS oversight
In the past 12 months or so, HMRC has clamped down on Research & Development tax relief claims, rejecting many claims by tech start-ups on the basis that either the project in respect of R&D reliefs are claimed does not lead to a step change in science or technology, or that, whilst the original project did, the step change has occurred and the company is now simply carrying out development work that doesn’t meet the requirements of the scheme. HMRC’s enhanced oversight appears to have been driven by two things: (a) a government desire to cut costs and focus tax relief on genuinely innovative activities and (b) an acknowledgment that many R&D claims were being submitted by non-experts (start-ups themselves, automated grant platforms and consultants with little understanding of the complex tax requirements) with the result that in many cases, the requirements were simply not met.
There are signs that similar issues exist in the S/EIS space with applications made using precedent platforms being woefully inadequate and failing to reference material facts that would impact on the eligibility of the start-up for tax relief. We are already beginning to see increased client enquiries from start-ups who have secured an advance assurance using a precedent platform, but have subsequently run into problems with HMRC when claiming the tax relief for investors. Advance Assurances are only binding on HMRC where complete and accurate information has been provided to them. S/EIS are complex schemes with many obscure “gotcha” rules. It is in the interests of both founders and investors to ensure that they understand the complexities of the schemes and provide to HMRC complete and accurate information.
How can we help?
For start-ups: we handle all Financial Promotion Regime, Anti-Money Laundering and Sanctions compliance for our clients. We also review and handle S/EIS compliance for clients, ensuring that tax relief is protected for investors.
For investors: we can maintain a centralised compliance record for you and a single point of contact for all Financial Promotion Regime, Anti-Money Laundering and Sanctions queries. We also provide a tailored training regime for new investors to ensure that they understand the risks of investing, and can navigate investment documentation themselves. We review S/EIS compliance documentation and highlight any red flags or material omissions, as well as providing advice on how to resolve any potential issues.
Please contact us at [email protected] or on 020 7952 1723 if you would like to book a free consultation with one of our solicitors to discuss any of the above.