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If your startup is looking to raise capital, you may face restrictions or disclosure obligations. These may affect both whether you can raise capital and how you can do so. However, exemptions to disclosure obligations may mean that these restrictions or obligations no longer apply. Two of these exemptions are the exemptions for professional investors and sophisticated investors. This article will discuss what professional investors and sophisticated investors are and how your startup can take advantage of this exemption when raising capital.

How Do Professional and Sophisticated Investors Affect My Startup?

Many startup founders raise capital to help fund their startup’s operations and grow the business. If you have a public company, the general rule is that when you raise capital, you must comply with the disclosure obligations under corporations law and issue a disclosure document. However, there are several exemptions to these disclosure requirements. If one of these exemptions apply, you do not need to issue a disclosure document. 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.

If you have a private company, you cannot raise capital if doing so would mean that you would have to issue a disclosure document. Accordingly, you must either:

Many startups seek to take advantage of the small-scale offering exemption (otherwise known as the 20/12/2 exemption). The other exemptions which startups commonly seek to use are the exemptions for ‘professional Investors’ and ‘sophisticated Investors’.

What Is a Professional Investor?

The definition of a professional investor encompasses several factors. The key qualities to look for are whether the investor:

  • holds an Australian Financial Services License (AFSL);
  • is regulated by the Australian Prudential Regulation Authority (APRA); or
  • controls at least $10 million worth of assets.

What Is a Sophisticated Investor?

A sophisticated investor is an investor who has a certificate from a qualified accountant certifying that they have:

  • net assets of at least $2.5 million; or
  • a gross income for the previous two years of at least $250,000.

The investor will also be sophisticated if they are investing at least $500,000 in your startup.

What Does This Mean for My Startup?

The assumption is that professional and sophisticated investors understand the nature and risk of their investment. As a result, there is no need to protect them by requiring a company to prepare a disclosure document. Therefore, if your investor is either a professional investor or a sophisticated investor, your company does not have to issue a disclosure document.

Your company can combine disclosure exemptions. In other words, your company can take advantage of different exemptions for different investors in the same capital raise.

For example, professional investors and sophisticated investors will not count towards the 20 investor threshold in the small-scale offering exemption.


An Example Case Study

A startup is seeking to raise $1.2 million from 12 investors. It has never raised capital before. Currently, the startup can make use of the small-scale offering exemption because it is raising less than $2 million from less than 20 investors during a 12-month period. However, the small-scale offering exemption operates on a 12-month rolling basis. This means that if the 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 professional or sophisticated investors. Together, these four investors invested $600,000. The company does not have to include these investors (or the $600,000) in the small-scale offering calculation. By excluding these investors, the company has now freed up the ability to raise an additional $600,000 from an additional four investors using the small scale offering exemption should it need to.

Keeping Track of Your Investors

It is your company’s responsibility to keep clear records of its capital raises and the disclosure exemptions it relies on. This includes whether its investors are professional or sophisticated. You should also keep track of which investors are professional investors or sophisticated investors so that you can work out which exemptions are available to you going forward.

The common practice is to ask an investor who falls within one of these categories to provide a statement in their share subscription agreement stating that they either a professional investor or a sophisticated investor. This way, your company has it on record. If the investor is found to be in breach of this statement, your company can bring a claim against the investor for any loss it suffers because of the breach.

Key Takeaways

As a startup, you will likely need to raise capital at some stage. There are several requirements and obligations that a company needs to comply with when it raises capital, including ensuring that the disclosure requirements do not apply. There are several exemptions to the disclosure requirements. One of these exemptions is when your investor is either a professional or sophisticated investor. Subject to other requirements (for example, that you have less than 50 shareholders), your startup can raise as much capital as it chooses from any number of professional or sophisticated investors without having to issue a disclosure document or stay under a 20-investor limit. If you have any questions about disclosure obligation exemptions, get in touch with LegalVision’s capital raising lawyers on 1300 544 755 or fill out the form on this page.


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