Guest Blog: Barriers to investment

Thanks so much to Scott Preece, Senior Associate at Ashfords, for putting together this guest blog on legal barriers to investment – everything you need to know before closing that funding round.

On 4 January 2022, new legislation came into force which introduced one of the most significant changes to the UK investment scene for a number of years – the National Security & Investment Act 2021 (the “Act”). 

We’re now over one year into the Act’s life and, whilst supporting both founder teams and investors through investment rounds of many shapes and sizes, we at Ashfords have seen the impact it can have on the investment process. However, when we speak with founders of tech-based businesses we often find that they have little, if any, awareness of the Act or its implications. 

So, what exactly does the Act say and what impact is it having?

At a high level, the purpose of the Act is to provide the UK Government with new powers to intervene in transactions that may pose a risk to national security. This may not seem a risk to the vast majority of businesses, and in truth it likely isn’t, but the Act focusses in on a few specific sectors of the UK economy in particular and, due to some fairly broad definitions, businesses within these sectors will need to take particular care.

Here are the key points to note:

• The Act lists 17 sectors as being of key importance to the UK economy and places additional requirements on these sectors. These include:
  • Advanced Materials
  • Advanced Robotics
  • Artificial Intelligence
  • Computing Hardware
  • Cryptographic Authentication
  • Quantum Technologies
  • Synthetic Biology

Also covered are suppliers to Government (which can include the NHS, for example) and some more obvious risk areas such as Defence, Military and Energy. 

• Definitions of the key sectors are broad. If your businesses potentially operates in one of these sectors we would strongly recommend that you familiarise yourself with the official guidance and think about whether or not your business falls within scope.
• Broadly speaking, if any one investor (or group of related investors – eg funds managed by a single VC) acquires more than 25% of the shares in your company and you are in one of the key sectors, then a mandatory notification must be made to the UK Government for permission for the transaction to proceed. 
• If a mandatory notification isn’t made, the investment round will have no legal effect. You may have signed documents and you may have received the funds, but in the eyes of the law that could all be undone.
• The above also applies to exits – as you would likely be selling more than 25% of your company! 
• The requirements are not limited to “foreign” parties – they apply equally to investors / acquirors from within the UK, even established VC funds. 
• Even if you aren’t in one of the identified key sectors, the UK Government can call in any transaction where it feels there could be a risk to national security. Companies who are undergoing a change in their “control” should therefore carefully consider how the Act might impact on their plans. 
• The Act also introduces a system for voluntary notification, which can be advisable in edge cases or where there may be a potential national security concern. 
• There are other obligations even where someone is not acquiring 25% or more of the company’s shares. If someone gains a right to “materially influence” your company then it can be worth thinking carefully about how the Act applies. 
• The Act can, in certain circumstances, apply to sales of material assets. If you are within a key sector or there is any possibility of national security concerns we would strongly advise taking expert advice before proceeding with such a sale. 

The primary obligations under the Act fall on investors, who can face heavy fines and criminal sanctions for failures to comply. However, it is equally as important for companies and business owners to be aware of these requirements as a) ultimately investors will rely on the businesses to tell them whether or not they sit within a key sector, b) they can have a significant impact on transaction timescales (see further below) and of course costs, and c) spending significant time and cost on your investment round / exit, only to have it all undone by the UK Government, is not a good place to be.

More detail on the Act including flowcharts which hopefully help to clarify its implications can be found in our guide here.

1. Prepare the notification: If the transaction is within scope, the investor must prepare a notification form to provide details about the parties involved, the nature of the investment, the value, and other matters. Investors will want companies to assist with this process. 
2. Submit the notification: The investor must submit the notification through an online portal. The Government may request additional information if necessary.
3. Initial assessment: The Government will conduct an initial assessment to determine whether the transaction poses a potential risk to national security. They will notify the investor within 30 working days of receipt of the notification whether the transaction will be subject to a further assessment.
4. Further assessment: If the Government determines that a further assessment is necessary, it will conduct a more detailed review, which may include consultations with other agencies and external experts. They will provide the investor with a decision within a further 30 working days of completing the assessment.
5. Conditions or prohibition: If the Government determines that the transaction poses a risk to national security, it may impose conditions on the investment or prohibit the transaction altogether.

Over the past 12 months or so we have been involved with a number of notifications to the UK Government, including preparation and submission of applications on behalf of investors, and assisting with applications on behalf of companies seeking investment. Here are some of our findings:

• We tend to see that the Government will take very close to its full 30 working day allowance to respond to applications. It is therefore absolutely key that parties take this into consideration when assessing deal timelines and cash runway. 
• Having ensured that initial applications are as clear as possible and contain all required information, we have not received any requests from the Government for further information on submitted applications, and therefore have not had review timelines extended as provided for by the Act. 
• No applications we have been involved with have resulted in any national security concerns or any restrictions imposed. 
• The market has not embraced the use of voluntary notifications and we have not seen these used by investors or tech companies to date. This is likely because the likelihood of real national security risk is low, particularly where parties are all UK based. Though we would recommend caution and where non-UK parties, particularly from at-risk jurisdictions, may be taking on any “control” of a UK company would suggest that the parties consider voluntary notifications as a safety measure. 

In total the first year of the Act’s lifecycle has seen hurdles placed in front of many businesses. We recently provided feedback to the UK Department for Business, Energy and Industrial Strategy on steps that could be taken to streamline the process, including:

• A fast-track “pre-assessment” mechanism whereby the Government could comment on whether or not a formal notification may actually be required in certain cases. Hopefully providing more clarity to the market and fewer unnecessary formal applications. 
• An “approved party” system, whereby established and UK-based investors who invest in many businesses every year are subject to a less detailed notification process, helping to speed up these more regular and low-risk transactions.

It remains to be seen if these, or other improvements, will be taken up.

The Act sets out a complex regulatory regime for investors and businesses operating in designated sectors in the UK. It requires careful consideration and planning for any investments or acquisitions falling within scope, with notification of transactions required well in advance of completion. The Act can also have a substantial impact on deal timelines and costs.

If you have any questions about how the Act might affect your upcoming investment round, or about investments or exits of tech businesses generally, please feel free to reach out to the Ashfords Tech team. 

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