When an Australian company wants to raise money by issuing new shares, the law does not simply let the directors invite investors in and take their cheques. Chapter 6D of the Corporations Act 2001 (Cth) (the Corporations Act) generally requires the company to give prospective investors a formal document, called a disclosure document, before they can accept the offer. The same obligation can apply when securities are sold to new investors in certain indirect ways.
Disclosure exists to protect the people putting their money in. A disclosure document sets out critical information about the company so that an investor, and their adviser, can assess the risks before committing funds. It acts as the information base for a decision about a largely intangible purchase: buying a stake in a business on the strength of how that business is described.
This article explains how the disclosure regime operates, starting with what triggers the need to disclose, working through the two main disclosure documents and the exemptions that let a company raise money without one, and finishing with where the rules most often bite and when a lawyer becomes useful.
Who is involved in the process
Three groups interact in a capital raise that is caught by the disclosure rules.
The company and its directors are the ones raising the money. They decide what to offer, prepare and lodge the disclosure document, and bear the legal risk if the document is incomplete or misleading. Directors personally can face enforcement action for breaching the fundraising provisions.
The investors are the people the offer is made to. The system works by giving them information and, for certain types of investor, treating them as sophisticated enough to look after themselves without a lengthy disclosure document.
ASIC, the Australian Securities and Investments Commission, is the regulator. A disclosure document must be lodged with ASIC before it is issued to investors, and ASIC can take action if the document is defective or an offer is made without one.
When disclosure becomes necessary
The core rule is in s 706 of the Corporations Act 2001 (Cth). An offer of securities for issue needs disclosure to investors under Part 6D.2 unless an exemption in s 708 or s 708AA applies. In plain terms, the moment a company invites someone to subscribe for new shares, the disclosure obligation is engaged unless the offer fits within one of the carve-outs described below.
The regime also catches some offers of existing securities for sale. In certain cases, a sale of shares by a controller or shareholder can amount to an indirect issue, bringing it within the disclosure net so the existing holder cannot sidestep the rules by selling on an investor's behalf. For a typical private company raising fresh capital, the starting point is the same: an offer of new shares triggers the obligation.
The word "offer" is read broadly. It covers an offer to purchase, or an invitation to apply to purchase, a legal or equitable right or interest in a share or debenture. Advertising the securities or otherwise promoting them publicly can itself amount to making an offer to the public, which is why the exemptions that rely on a "personal" offer are strict about advertising.
Once disclosure is required, the offer must actually be made in, or accompanied by, the disclosure document. Section 721 of the Corporations Act 2001 (Cth) makes that clear, and s 727 makes it an offence to offer securities without a disclosure document or to issue securities that were not validly applied for under one.
The two main disclosure documents
Where disclosure is required, the company must prepare a formal disclosure document. There are two that matter most for a small-to-medium business raising capital.
Prospectus
A prospectus is the standard and most comprehensive disclosure document. Under s 709 of the Corporations Act 2001 (Cth), a prospectus must be prepared for an offer that needs disclosure, unless the offer is small enough to use an offer information statement instead. There is no cap on the amount that can be raised under a prospectus, which is why larger or more complex offers tend to use one.
A prospectus has the broadest information requirements. Among other things it must set out an overview of the offer and the key risks in a balanced way, describe the company's business model and how it proposes to generate income or capital growth, explain the company's financial position and prospects, give the background of the directors and key personnel and any interests or benefits they hold, and set out the terms of the offer and the proposed use of funds. It is a substantial, lawyer-heavy document, and the liability that attaches to a defective prospectus is correspondingly serious.
Offer information statement
An offer information statement is a shorter, less demanding disclosure document. A company can use one instead of a prospectus only if the total amount to be raised, added to all amounts previously raised by the company and related entities under an offer information statement, is $10 million or less. The $10 million threshold sits in s 709(4) of the Corporations Act 2001 (Cth).
An offer information statement must still do real work. Under s 715 it must identify the company and the nature of the securities, describe the company's business, state what the funds will be used for, describe the risks of investing, give details of amounts payable, and include a financial report. That financial report must be prepared under accounting standards and, in practice, must be recent enough to be current when the securities are first offered. The offer information statement must also state clearly that it is not a prospectus and has a lower level of disclosure, and tell investors to obtain professional advice before accepting.
Whichever document is used, it must be lodged with ASIC before it goes out to investors, and the offer can only be made in or with the document. This is not a formality to bolt on at the end of a funding round.
The exemptions
A large share of private company capital raising never needs a disclosure document, because the offers fall within one of the exemptions in s 708 of the Corporations Act 2001 (Cth). The most common are the small scale exemption, the sophisticated and professional investor exemptions, and the exemptions for people already connected to the company.
Small scale offerings
The small scale exemption, in s 708(1), is the one most private companies rely on. An offer does not need disclosure if it is a "personal" offer and it stays within two ceilings.
A personal offer is one that can only be accepted by the person it is made to, and that is made to someone likely to be interested, for example because of previous contact or a professional connection. The practical consequence is that the offer cannot be advertised or promoted to the public, because a public campaign would turn a personal offer into a general one.
The two ceilings are popularly called the "20/12/2 rule". The offer must not push the number of people the company has issued securities to above 20 in any 12 month period, and it must not push the amount the company has raised by issuing securities above $2 million in any 12 month period. Both ceilings are 12 month rolling limits, and both must be respected at the time each offer is made. Cross a ceiling and the exemption is lost, with the offence provisions in s 727 available against directors.
There are subtle traps in the small scale exemption. Amounts that will be paid later on partly paid shares or on the exercise of options count towards the $2 million ceiling. Issues to people under other exemptions, or offers received outside Australia, do not count toward the ceilings. And ASIC can aggregate the transactions of bodies it considers closely related, so splitting a raise across related companies does not defeat the limit.
Sophisticated investors
An offer to a sophisticated investor does not need a disclosure document. Under s 708(8) of the Corporations Act 2001 (Cth), an investor qualifies in one of two main ways:
- $500,000 commitment: The investor commits at least $500,000 for the securities on acceptance of the offer. Money lent to the investor by the person making the offer is disregarded, so the investor's own funds must be doing the work.
- Wealth or income tests: The investor meets wealth or income tests, evidenced by a certificate from a qualified accountant given no more than six months before the offer. The investor must have net assets of at least $2.5 million, or gross income of at least $250,000 in each of the last two financial years. Offers to a company or trust controlled by a person who meets those tests are also covered.
Professional investors
The professional investor exemption in s 708(11) applies to offers made to a professional investor as defined in the Act, or to a person who has or controls gross assets of at least $10 million, including assets held by an associate or under a trust the person manages. Broadly, a professional investor includes holders of an Australian financial services licence, bodies regulated by APRA, and trustees of superannuation funds with net assets of at least $10 million. These are investors the law assumes can fend for themselves.
People associated with the company
A company can also issue securities without disclosure to people who are already connected to it. Under s 708(12), offers to a senior manager of the company or a related body, or to their spouse, parent, child, brother or sister, are exempt, as are offers to bodies those people control.
Under s 708(13), an offer of fully paid shares to existing shareholders under a dividend reinvestment plan or a bonus share plan does not need disclosure. These exemptions recognise that the people involved already have the information and connection that a disclosure document would otherwise provide.
Where the rules most often bite
The exemptions look generous, but the boundaries are strict and well short of a blank cheque. The most common mistakes come from treating the exemptions loosely.
The small scale exemption is defeated by any public advertising. A founder who takes out a social post or a public pitch that promotes the offer has, in effect, made a general offer rather than a personal one, and the exemption falls away. Restricting who you approach, and how you approach them, is part of what keeps the exemption alive.
Counting errors are another source of trouble. Because the 20 investor and $2 million ceilings are rolling 12 month limits, a company doing several small raises across a year can drift past them without noticing. The offence in s 727(4) can apply once either ceiling is crossed, making it an offence to continue issuing without disclosure.
Mixing exemptions can also undo the arithmetic. Issues to sophisticated investors do not count toward the small scale ceilings, which is useful, but the aggregation power means ASIC can look through related entities. A structure built purely to stay under the numbers can attract scrutiny.
A defective disclosure document carries its own risk. Under s 728 it is an offence to offer securities under a disclosure document that is misleading or deceptive or that omits material information. Compliance is not just about having a document; it is about having a document that is accurate and complete at the time the offer is made.
When a lawyer becomes essential
The disclosure regime is a space where a modest investment in advice early saves far more than it costs. Getting the classification of an investor wrong, misreading a ceiling, or preparing a prospectus that misses a required item can each expose directors to personal liability and derail a funding round that was otherwise on track.
A capital raising lawyer can map the intended investors against the exemptions before any offer is made, so the company knows whether it needs a disclosure document at all. Where a document is required, a lawyer will prepare and review the prospectus or offer information statement, check the figures and risk disclosure, and manage the lodgement with ASIC. Where the plan relies on a personal or sophisticated investor exemption, a lawyer can put in place the records, certificates and acknowledgements that show the company stayed inside the boundaries.
The point where a lawyer is most useful is the very start, before a single investor is approached. That is when the structure of the offer is decided, and it is far cheaper to decide it correctly than to unpick an offer already made in breach.
Making the call on your raise
The decision that concentrates value and risk in any private capital raise is whether the specific offer can rely on an exemption, and if so which one. A company that correctly falls within the small scale, sophisticated or professional investor exemptions can raise money quickly and cheaply without a disclosure document. A company that misjudges the same facts faces not only a failed raise but potential director liability under s 727.
The figure, and the identity of each investor, matter more than the general shape of the plan. Work through each proposed investor against the relevant test, in writing, before you approach anyone. Where the answer is not obvious, or where the cumulative picture across several raises is unclear, a short conversation with a lawyer will confirm whether a disclosure document is needed and, if it is not, which exemption keeps the company safe.