'Venture capital rule changes spark diversity concerns'

The new rules disproportionately affect the number of women and underrepresented groups eligible to invest in UK start-ups.

This in turn will further increase the challenges faced by female founders in raising investment, as recent evidence indicates women are twice as likely to invest in female founders than their male counterparts.

The changes have caused an outcry in the angel investor community, leading to the formation of a campaign for change – InvestHER – who have recently sent an open letter to the chancellor urging the government to reverse the changes as part of the Budget on March 6.

The key changes, which came into force on January 31 2024, relate to the financial promotion exemptions for high-net-worth individuals (HNWIs) under the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (FPO).

The financial thresholds have been updated, which means that to qualify for the HNWI exemption, the individual must now have an annual income of at least £170,000 (previously £100,000) or net assets of at least £430,000 (previously £250,000) throughout the last financial year (excluding equity in the home or pensions).

The new thresholds will now only capture a much smaller pool of angels, so there will be fewer investors and less funding available to invest in early stage start-ups. 

The changes will directly impact UK start-ups, with a smaller and less diverse pool of angel investors able to invest.

The FPO exemptions are important for start-ups to allow them to promote investment opportunities to investors that meet the criteria, avoiding the cost and cumbersome process of seeking approval from a representative authorised by the Financial Conduct Authority.

Penalties on investors or businesses for non-compliance can be severe, including a two-year custodial sentence or an unlimited fine.

The government’s rationale for increasing the thresholds was to reflect the significant economic, social and technological changes since the FPO was introduced, and to address concerns around inappropriate use of the exemptions.

The new salary threshold goes further than an inflationary increase and is intended to capture the top 1 per cent of the population. These changes do not appear to take into account the gender or ethnicity pay gaps or variations in pay across different parts of the UK.

The impact on the number of women eligible for these exemptions is stark, with a projected reduction of 70 per cent across the UK, and up to 90 per cent and 100 per cent in some regions, with the North East of England and Northern Ireland having no women who fall within the new income threshold.   

The changes will directly impact UK start-ups, with a smaller and less diverse pool of angel investors able to invest.

While those missing out on the exemptions may be able to invest through regulated crowdfunding platforms (which instead apply a limit on the proportion of salary being invested), this route may not be appropriate or attractive for all start-ups, and they will miss out on the significant value brought by angels.

The benefit of a good angel investor is the ability to impart experience to the start-ups they choose to invest in, arguably increasing the chances of a business scaling.

This role and type of investment is very different to investing via crowdfunding platforms, where the input into the company and its direction is far smaller.  

Many angel networks are now applying membership charges, thereby adding yet more barriers.

These changes come at a particularly challenging time in the venture capital environment; community platform Female Foundry’s report on the "State of Gender Diversity in European Venture" stated that pre-seed rounds have been hardest hit by the economic downturn in 2023, seeing a 36 per cent reduction in deals, with fundraising being much harder for female entrepreneurs than it was 12 months ago. 

While there are other exemptions available, the HNWI exemptions were those most regularly used by angels and other exemptions will be harder to qualify for, such as the exemption for a director of a company with turnover of at least £1.6mn.

An exemption that has been retained is 'being an active member of an angel group for six months'. This may be helpful for existing angel investors that no longer meet the financial thresholds, but will be of little comfort to new angel investors as they can not rely on this during the first six months.

In response to these changes, many angel networks are now applying membership charges, thereby adding yet more barriers.

Start-ups will also need to take appropriate steps to ensure that they are only promoting investment opportunities to persons that qualify for the exemptions, noting that persons that may previously have been eligible to receive investment materials may no longer qualify for the exemptions.

Unless of course the InvestHER campaign and the facts showing the significant impact to the start-up ecosystem prove persuasive to a chancellor dealing with an economy in recession. 

Rosie Marston is a senior associate and Emma Wright is a partner at Harbottle & Lewis; Wright is also a co-leader of the InvestHER movement