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6 Costly Capital Raising Mistakes Businesses Make and How to Avoid Them

Sara-Jane Mok | July 5th, 2017

Entertaining as TenPlay’s Shark Tank might be, the reality TV series actually gives its viewers a glimpse into how sophisticated investors think and operate when it comes to capital raising. The “Sharks”, who play the role of investors on the show, are not benevolent charitable providers of funds – they simply want the most bang for their buck.

Some of the most common mistakes we see made by the entrepreneurs on Shark Tank (and in real life) are incorrectly valuing their financial projects, targeting the wrong investor audience and being unprepared with the information an investor might want to see when investigating the business.

On top of these, there are a number of legal regulatory requirements entrepreneurs need to be aware of.

The Corporations Act 2001 sets out strict disclosure requirements for offering equity to investors. There are a number of exemptions to this, such as small scale offerings, offers to sophisticated investors or offers with a minimum subscription of $500,000 among other exemptions.

Handpicked related article: Raising Capital for IP SMEs – Understanding the Disclosure Requirements

If you own a small to medium enterprise (SME) or start-up business that is exempt from the formal disclosure requirements under the Corporations Act 2001, the Australian Consumer Law will still apply to you. Anything that you tell investors about your business must be substantiated and not misleading. After all, they are investing in your business on the understanding that it has reasonable prospects of success.

Below we have outlined some of the key capital raising mistakes that all SME and start-up business owners should avoid:

1. Not having an Information Memorandum

Just because you do not need to comply with the formal disclosure requirements in the Corporations Act does not mean that you can forget about providing informative documents to investors.

You should have, at the very least, an informal disclosure document (although it should still look professional) such as an information memorandum. Most investors will want to be able to refer to information about the business and its prospects before they choose to invest.

Having the right documents that substantiate the information you have provided to investors can also help mitigate the risk of investors making a claim against your business for misleading or deceptive conduct if they make a loss on their investment.

2. Having overly optimistic financial forecasts

On the one hand, you’re really excited about your business and you want the investor to be interested because of the high potential future value of your business. But on the other hand, you don’t want to be misleading about the future prospects of your business and have the investor make a claim against you later for misleading and deceptive conduct.

You should ensure the figures in your financial forecast are based on reasonable and realistic estimates and that you strike the right balance in keeping your statements optimistic and accurate.

3. Grand sweeping statements about what your business can do

You want to impress investors with all the great things your business has achieved so far so you overstate how well your business has done.

By way of an example, your Information Memorandum declares that “We have patents in 125 different countries” but you have only filed a Patent Cooperation Treaty (PCT) application, which is still pending, and the patents are not actually registered yet.

Alternatively, your Information Memorandum claims that the use of the “Fish are Friends reprogramming machine”* for sharks can also be used on salmon-loving grizzly bears, when experiments and tests have not been conducted to substantiate this claim, and it is only a mere hypothetical possibility at this stage.

When making grand sweeping statements like these, you increase the risk of investors making a claim against your business for misleading or deceptive conduct when they find out the truth and realise they have made a loss on their investment. To avoid this situation arising, you should ensure that the statements that you do make about your business are accurate and can be supported by evidence.

4. Omitting relevant information

Before you can even start selling your goods or services to the market, there may be a number of regulatory barriers that the business needs to overcome, such as pharmaceutical or food safety standards.

If these regulatory barriers are likely to delay the commercialisation of your product or service, this is likely to be a disincentive for investors, so you might be inclined to leave that little important detail out of the Information Memorandum.

The problem is that silence or omission can also be considered to be misleading or deceptive conduct. Rather, you should be upfront, and articulate to investors what regulatory barriers there are that might affect the business.

5. Not offering shares in accordance with your company constitution

Expressions of interest from potential investors are pouring in and you are sending out share subscription forms to them before their interest wanes. But what about the majority founding shareholders who want to keep control of the company that they started? Have you reviewed your company constitution to see if there are any processes that need to be followed before you can issue new shares?

Quite often, a company constitution will require that new shares must be first offered to existing shareholders in their respective proportions, and only if they decline to take up the new shares can they be offered to third parties. These rules are known as pre-emptive rights, and they are designed to protect existing shareholders from having their stake holding diluted by the issue of new shares.

You should always read the fine print of your company constitution, and, if applicable, shareholder agreement. If you fail to follow the prescribed process, you run the risk of the new share issue being invalidated.

6. Not having a clear share purchase process

Have you thought about the types of shares you are offering to investors? Or the process to implement the share purchase? Or when the offer will close and when all the ASIC forms need to be submitted?

If you do not have a clear share purchase process in place, interested shareholders may not submit their forms in time or know where to send their forms to. Further, if there is no clear process in place, it could also affect the investor’s perception of your business and give them the impression that the business is disorganised and mismanaged.

From a logistical point of view, you should know when all the ASIC deadlines are. In your communications to investors, clearly state when the share offer closes, where they can send their forms to and the type of shares (and rights) they will be receiving.

Always get someone to review your Information Memorandum

Capital raising is not as simple or straightforward a process as one might think.

In fact, it is best if you get a second set of eyes to review your Information Memorandum to ensure that statements made in your documents are accurate and can be substantiated, that any prescribed share issue process in your company constitution and/or shareholder agreement has been complied with and that the share purchase process is clear and easy for investors to follow.

If you would like to speak to someone at mdp about your capital raising process please do not hesitate to contact us.

*please note that this is not a real invention and is being used only for hypothetical purposes. Patent searches have not been conducted to confirm the current state of the art for this type of technology.

Sara-Jane Mok

Sara-Jane's experience encompasses a range of services such as property, commercial and intellectual property. Prior to joining mdp, Sara-Jane worked in Research & Development Tax at one of the ‘Big Four’ professional services firms assisting companies with preparing their Research & Development Tax Incentive claims.