Disclosure to investors
The central premise in the Corporations Act regarding capital raising is that an offer of securities needs disclosure to investors unless otherwise exempted. Therefore, unless the company is conducting an offer that does not require disclosure, a disclosure document such as a prospectus would be required.
Of the offers that do not need disclosure, the exemptions most often used are the small scale offerings and offers to sophisticated or professional investors.
Small scale offerings
To rely on the small scale offering, the offer will need to satisfy the following:
- each of the offers is a personal offer
- none of the offers results in a breach of the 20 investor ceiling or the $2 million ceiling in any 12 month rolling period.
Offers to sophisticated or professional investors
Offers to sophisticated investors also do not require disclosure. For example, offers under which the minimum amount payable on acceptance is at least $500,000 (including top ups on previous investments), are offers that do not require disclosure.
Offers to a person certified by a qualified accountant as having a gross income over the previous two financial years of at least $250,000 per annum or net assets of at least $2.5 million, are also offers that do not require disclosure.
Offers made through a financial services licensee who is satisfied, on reasonable grounds, that the potential investor’s previous investment experience allows the investor to assess the offer, and where the investor has signed an acknowledgement that no disclosure document will be provided, are also offers that do not require disclosure.
Further, offers to professional investors as defined in the Corporations Act (such as financial services licensees or trustees controlling net assets of at least $10 million) are also offers that do not require disclosure.
Using an information memorandum
If the Corporations Act does not require a disclosure document to be used for the capital raising, companies may nevertheless decide to use an information memorandum to make some level of disclosure of the investment opportunity to potential investors.
Although there is no legal obligation to include all material information in that information memorandum as there would be if a disclosure document was required, many companies find it advantageous to prepare the information memorandum as a comprehensive document to include all material information and use it as the sole document in the capital raising process.
Changing the corporate structure If the company proposing to raise capital
is a proprietary company, and either:
- the nature of the offering is such that it cannot be undertaken without disclosure, or
- the company has 50 members or may likely to have 50 or more members after the capital raising,
then it may need to consider restructuring before undertaking the capital raising.
In that case, the proprietary company may have to be converted to a public company, or the assets of the proprietary company may need to be assigned to a newly incorporated public company which would then undertake the capital raising. There may be significant tax, stamp duty and other transactional costs, as well as timing considerations that the proprietary company needs to be aware of when considering a restructure to prepare for a capital raising.
Using disclosure documents
Where the capital raising cannot be structured as an offer that does not require disclosure, the company would need to use a disclosure document to raise capital. The Corporations Act broadly provides for four types of disclosure documents to be provided to investors:
- offer information statement
- short form prospectus
- profile statements.
A prospectus is used most often and it can be used to raise any amount. An offer information statement may only be used if the amount of money to be raised, when added to all amounts previously raised, is under $10 million. However, an offer information statement has minimum financial report requirements and therefore may not be appropriate for all circumstances, particularly newly incorporated companies.
In practice, many companies have found that using any of the above disclosure documents will incur a similar level of due diligence and costs, and therefore many companies would opt for a prospectus, as it is most commonly used and understood by advisers and investors.
The Corporations Act does not specify in detail the content requirements of a disclosure document such as a prospectus, but requires that a prospectus contain all the information that investors and their professional advisers would reasonably require to make an informed assessment of the rights and liabilities attached to the shares, and the assets and liabilities, financial position and performance, profits and losses and prospects of the company. Furthermore, such information needs to be accurate and not misleading.
To ensure that all such material information is included and to reduce the likelihood of the information being inaccurate or otherwise misleading or deceptive, a company issuing a prospectus would carry out a systematic and detailed investigation, commonly referred to as due diligence. Such a process should also ensure the availability of statutory defences to liability that may be incurred by the company and its directors involved in the issue of a defective prospectus.
Extensive obligations are placed on the company and those involved in the capital raising to accurately and fully disclose material information. This applies to any promotion of a securities offering, whether via an advertisement, an information memorandum or a prospectus. The Corporations Act specifically deals with statements and opinions as to future matters in these capital raising documents, and companies engaged in capital raising activities need to be aware of these potential liabilities.
If the disclosure requirements are not complied with, directors of the company, the company and persons involved in the non-compliance may be exposed to both criminal and civil liability, as well as compensation actions.
Particularly in relation to forecasts, a person is taken to have made a misleading statement about a future matter if they do not have reasonable grounds for making the statement.
Defences to criminal and civil liability
There are a number of statutory defences available for both civil and criminal liability for the purposes of disclosure. A defence of due diligence for prospectuses is specifically provided for under the Corporations Act, which provides that a person does not commit an offence, and is not civilly liable, in relation to a misleading or deceptive statement (or omission) in the prospectus if the person proves that they:
- made all enquiries (if any) that were reasonable in the circumstances
- after doing so, believed on reasonable grounds that the statement (or omission) was not misleading or deceptive.
Accordingly, companies and the directors find it particularly important that specialist corporate legal advice is sought and a formal due diligence committee be established for any capital raising by a company. Furthermore, a verification process (where each material statement in the disclosure document is verified against external source materials) should be incorporated as part of the due diligence process.
The use of convertible notes to raise capital
In addition to raising capital by the issue of shares, a company may also raise capital by the issue of convertible notes. Although technically the issue of notes is associated with the raising of debt finance, the convertible nature of these notes means there is an element of equity finance as it allows the note holder to convert the debt (the notes) to shares in the company according to their issue terms. Convertible notes have particularly been “in vogue” recently as a number of listed biotechnology companies have used them to raise money.
There are also other variations of convertible notes, including notes that automatically convert on agreed triggers, or other hybrid debt/equity finance instruments such as certain equity finance facilities with tranched drawdowns.
The use of these instruments to raise capital usually involves similar considerations as raising capital by equity finance. Specifically there will be a focus on whether the disclosures by the company to the convertible note investors have been misleading or deceptive, including whether full and accurate disclosures have been made.
However, convertible notes also involve other considerations and the drafting of the documentation is usually a complex exercise, as there are a number of competing factors at play. For example, the company would need to consider matters such as the rate of conversion and how it is calculated, whether the company may pay out the notes early, whether there are corporate control issues to be considered, the level of restrictions on the company’s operations under the notes, whether the convertible notes would be secured or unsecured, or whether there are restrictions on the note holders disposing of the shares.
As is apparent from the above, companies considering undertaking a capital raising process need to be aware of a number of matters, and are well advised to seek specialist corporate legal advice.