When a priced round is out of reach, the most willing investors are often the ones already on your cap table. A pro rata offer to every existing shareholder — a rights issue — looks like the cleanest way to top up the bank account, and a search for the rules quickly lands on section 708AA of the Corporations Act 2001 (Cth), the “rights issue exemption” from prospectus disclosure. The catch: section 708AA is not available to an unlisted startup. Here is what it actually does, and what a proprietary company relies on instead.
What Section 708AA Actually Covers
Chapter 6D of the Corporations Act requires a disclosure document (usually a prospectus) for an offer of securities unless an exemption applies. Section 708AA is one such exemption, but it is built for listed entities. Among other conditions, it applies where:
- the offer is a “rights issue” as defined in section 9A — offered to every holder in the class, pro rata, on the same terms (with limited carve-outs for overseas holders);
- the securities are in a class that is quoted on a financial market such as the ASX, and trading in that class has not been suspended for more than five days in the previous 12 months (or since quotation, if shorter); and
- the company gives the market operator a cleansing notice within the 24 hours before the offer is made, confirming compliance with its financial reporting and continuous disclosure obligations, disclosing any information previously withheld from the market, and explaining the potential effect of the issue on control.
Listed shareholders already have the benefit of continuous disclosure, so a fresh prospectus adds little. A proprietary company has no quoted shares and no continuous disclosure record. It cannot satisfy section 708AA, and Chapter 6D has no unlisted equivalent: there is no general exemption for cash offers to existing shareholders.
The Section 113 Misunderstanding
Founders sometimes point to section 113(3) as the answer. It prohibits a proprietary company from engaging in activity that would require disclosure under Chapter 6D, except for offers of its shares (or options over them) to existing shareholders or employees, and crowd-sourced funding offers.
That exception does not remove the disclosure requirement. It only means a proprietary company is permitted to make an offer that needs a disclosure document if the offer is confined to existing shareholders or employees. The document is still required unless a Chapter 6D exemption applies. So the working question is the same as for any other raise: which section 708 exemption covers each offeree?
The Exemptions Startups Actually Use
Run every shareholder on your register through section 708. In practice, four exemptions do the work:
- Small scale personal offers (section 708(1)). Personal offers that result in securities being issued to no more than 20 investors, and no more than $2 million being raised, in any 12-month period. An offer to an existing shareholder will often meet the “personal offer” test, because the existing connection makes it likely they will be interested, provided it can only be accepted by the person it is made to. The limits apply across any 12-month period, so earlier issues in that window count against them unless they were covered by another section 708 exemption, made under a disclosure document or made to offerees outside Australia.
- Sophisticated investors (section 708(8)). Offers where at least $500,000 is payable on acceptance — or where that amount plus what the holder has already paid for shares of the same class totals at least $500,000, which is useful for existing investors — or where a qualified accountant’s certificate given within the two years before the offer shows net assets of at least $2.5 million or gross income of at least $250,000 in each of the last two financial years.
- Professional investors (section 708(11)). This covers AFS licensees, large superannuation funds, listed entities and anyone who has or controls gross assets of at least $10 million, which picks up many, but not all, VC funds.
- Senior managers and their families (section 708(12)). Offers to senior managers of the company or a related body (extended to directors and secretaries by ASIC Corporations (Disclosure Relief—Offers to Associates) Instrument 2017/737), their spouses, parents, children and siblings, and bodies corporate they control. A founder’s holding company will usually fit; a family trust with an individual trustee will not.
Issues made under the other exemptions are disregarded when counting towards the 20-investor and $2 million limits (section 708(5)). So classify your wholesale and insider shareholders first, then check that the remaining holders fit inside the small scale limits. See our guide to the sophisticated and professional investor tests.
If your register has outgrown the small scale limits — say, 30 retail angels — the fallback is a disclosure document, at which point most startups restructure the round instead.
Pre-Emptive Rights: The Other Half of the Analysis
Section 254D is a replaceable rule for proprietary companies. Unless your constitution displaces it, the directors must offer new shares of a class to existing holders of that class in proportion to their holdings, by a statement setting out the terms and the period the offer stays open. Shares not taken up can be issued as the directors see fit, and the members can authorise a particular issue without the pro rata offer by resolution at a general meeting.
Most venture-backed companies displace section 254D in the constitution and set out bespoke pre-emptive rights there or in the shareholders’ agreement (see right of first refusal vs pre-emptive rights). A shareholders’ agreement alone does not displace a replaceable rule (section 135(2)), so check that the constitution actually excludes it.
Pricing, Dilution and Directors’ Duties
A rights issue is formally fair, because everyone gets the same offer. It can still be attacked. A deeply discounted offer that the board knows some shareholders cannot afford to take up shifts ownership towards those who can. If the dominant purpose is to dilute a minority rather than to raise needed capital, directors risk breaching their duty to act for a proper purpose (section 181), and the affected shareholder may have grounds for an oppression claim under section 232. Board minutes should record why the company needs the money and how the price was set.
A Practical Checklist
- Read your documents. Check pre-emptive rights, investor consents and any anti-dilution provisions a down-priced issue might trigger.
- Map the register. Record the section 708 exemption relied on for each shareholder, and keep the evidence.
- Plan for shortfall. Shares not taken up that go to a new investor need their own section 708 exemption.
- Check overseas holders. An offer to a shareholder in another country must also comply with that country’s securities laws.
- Keep the offer private. Section 734 prohibits advertising or publicising an offer that relies on the small scale exemption. Send the offer to holders individually.
- Finish the paperwork. Update the share register and notify ASIC of the change in share structure within 28 days.
Getting It Right
A rights issue can be the quickest and fairest way to fund extra runway, alongside the other bridge and extension round options. But the one exemption written for rights issues is the one a private company cannot use. If you are planning an offer to existing holders, our startup lawyers in Sydney can help you map the register and structure the offer as part of our venture capital and capital raising work.
This article is general information only and does not constitute legal advice. You should obtain advice specific to your circumstances before acting.