With the technology sector awash with capital, new companies pitch enthusiastically for a piece of the pie and in the process make representations about the prospective growth of their business. The recent ruling in Ebbsfleet Pty Ltd atf Ebbsfleet Superannuation Fund v Semantic Software Asia Pacific Ltd (no 3) [2017] NSWSC 78 suggests that companies must think very carefully about how and what they pitch to investors.
Mark Bradley, Semantic’s principal, outlined two patents and one patent application as the company’s key assets next to statements suggesting IBM were monitoring Semantic for ‘potential acquisition or partnership’. Bradley went further to suggest that such an arrangement was ‘likely’. The Court found that Mr Bradley and Semantic made a fundamental promise in the share issue agreement that the share value would triple within a two year period which overrode the general time limitation of 12 months and monetary limit of the purchase price plus 25 percent.
To digest this ruling, GBL spoke with Director of Motus Legal and start-up capital raising expert, Craig Yeung. Put simply, Craig suggests that when clients are looking to attract investment they have to be very careful about what kind of promises and financial returns they are saying they are going to make in the future. This may seem contrary to the main objective of marketing your business’s potential value, i.e. ‘how can you attract investment if you don’t tell them how great the business is?’, but Craig suggests that not crossing the fine line between good marketing on the one hand, and misleading statements on the other hand, is crucial. He clarifies this position by pointing out that many genuinely sophisticated investors are well positioned to undertake their own due diligence, are usually familiar with these types of investments, and ‘make up their own minds’ about the real value of your business. Therefore, there is no need to make promises of 10x or 15x returns in one year. If an investor is looking for those sorts of promises from you before they invest, you may want to question whether they are the right sort of investor for the business. However, Craig conceded that striking the balance between being too bullish and optimistic versus being too conservative in your approach is a difficult process. When articulating the strengths of your business it is important to ‘provide evidence and supporting documentation’ so that these ‘statements as to future matters’ are given on a reasonable basis. Craig adds that having signed agreements with locked in revenues in the future is usually a good basis for forecasting those revenues, but it may not be good enough to simply say the goal is to have five per cent of a $1 billion market in three years as the basis of forecasting revenues.
The role of lawyers in this process is a crucial one; Craig says good lawyers who understand the industry will be able to guide clients through the balancing act of making the business look as investable as possible but not to mislead investors. Craig says that sometimes, good experienced lawyers do more than just advise clients on the strict legal position, but also act as the sounding board for the current market practice, stakeholder relations and a guiding hand for the complex and challenging process of a capital raise. His final message is that ‘it is all about finding a balance on the spectrum between being too conservative and losing that investment on the one hand, and being too bullish and misrepresenting the value of the company on the other’.