From Riches To Rags

One night you’re considered a high-net-worth investor, the next morning you’re not.

This isn’t the work of a market fall, rather an increase to limits and changes in definition in the Financial Promotion Order exemptions for high-net-worth individuals and sophisticated investors.

These exemptions, designed to facilitate SMEs in raising capital from investors, are getting a makeover.

At a time when most allowances are frozen at current limits, why are these definitions in need of a makeover?

Original Rules

The Financial Promotion Order exemptions have been a crucial aspect of the financial landscape since their inception.

They allow small and medium-sized enterprises (SMEs) to seek investments from high-net-worth individuals and sophisticated investors without the burdensome compliance procedures.

Under the existing rules, a high-net-worth investor is defined as someone with an annual income of £100,000 or more or net assets exceeding £250,000.

These assets exclude their primary residence, insurance contracts, and certain benefits, in particular, pension plans. Additionally, high net worth individuals should be comfortable with the significant risk associated with investing in these types of business, which may result in the total loss of their investment.

The other definition, a sophisticated investor, is someone with sufficient knowledge and experience to understand the risks associated with high-risk investments. This can be demonstrated in various ways, such as being part of a business angel network, having made multiple investments in unlisted companies, or working in the private equity sector.

The New Rules

With effect from 31 January 2024 the following changes come into force.

Income

The income threshold for categorising as high net worth investor will increase from £100,000 to £170,000

X2Z Comment: A 70% increase. This moves the dial from the top 3% of earners to the top 1% of earners. That’s still a lot of people however I would argue this is way too high, and that someone who earns more than say, 90% of other earners, should be entitled to do what they want with their excess income.

There are less restrictions placed on someone walking into a bookmaker.

Perhaps a limit on the amount you can invest in a single investment, based on a percentage of liquid assets would be better.

Assets

The net assets threshold for categorising as high net worth investor will increase from £250,000 to £430,000, excluding the primary residence or pension.

X2Z Comment: A 72% increase, not 70%. Seeing this anomaly, I figured someone at the Treasury was a little OCD, and a 70% increase resulted in an odd number. But no, a 70% increase on £250,000 is £425,000. Now seeing the £430,000 is triggering my OCD!

Previous Investments

A sophisticated investor will no longer be able to rely upon having made previous investments as an indicator of sophistication,

X2Z Comment: this exemption is being removed due to the huge increase in online investing. Crowd funding has led to a huge increase in the number of people making small investments, and this is a welcome change as two £50 investments online do not a sophisticated investor make.

Company Directors

A company director can still be sophisticated, but the company turnover proxy for sophistication has increased from £1m to £1.6m.

X2Z Comment: I never understood this exemption. There is no correlation between being a director of a company with a certain level of turnover and any sophistication regarding your investment ability. And oddly, a 60% increase for this one!

The Real Reason Behind the Changes

There could be various motivations for these changes. One reason cited is aligning the thresholds with inflation. However, it's notable that other financial limits, such as inheritance tax allowances and income tax bands, have remained untouched over the years.

The actual motive behind these changes appears to be limiting the number of individuals taking risks in private equity and online investments, possibly due to the higher potential for failure in such investments. In a culture where blame is often assigned, if individuals incur losses, they may look to the government for allowing such investments. This raises the question of personal responsibility and government intervention. Until this dilemma is resolved, we may continue to see restrictions imposed on our financial choices.

Consider the Risks and Diversify

If you're an investor or a business in search of capital, it's vital to stay informed about the latest restrictions and requirements introduced in these financial promotion exemptions.

Remember that when you venture into high-risk investments, such as private equity, you're entering a realm fraught with inherent uncertainties. In such scenarios, diversifying your investment portfolio remains a prudent strategy to spread and manage risks effectively.

However, it's worth noting that these new regulations may not be set in stone.

Pressure is mounting on Chancellor Jeremy Hunt to revisit these changes.

The StartUp Coalition is among those advocating for a re-evaluation. They argue that these alterations may inadvertently restrict access to high net worth investor status for fewer individuals, particularly women and ethnic minorities.

I think however Mr Hunt has larger priorities on his desk right now...