By Katharine Campbell, Growing Business Correspondent

Internet incubators may be breaching financial services regulations and opening themselves up to litigation if deals go sour, City lawyers in London warned on Monday.

The claim is the latest blow for a sector already hit by the downturn in technology shares and the lack of investor interest in new internet flotations.

any of the stream of incubators launched in recent months have not sought authorisation under the Financial Services Act - some because they did not think it applied to them.

But if they do not qualify for one of a number of exemptions or exclusions, they would be in breach of the act.

"There is a real risk people believe there isn't a problem because they think they are just running parties [internet networking events] or are just investing their own money," said Margaret Chamberlain, a partner at Travers Smith Braithwaite.

Dozens of internet investment groups have been formed this year, offering funds and expertise to new-economy companies in return for equity.

Paul Nield, a partner at Gouldens, the law firm, said the exemptions under the act were nebulous and it was easy for companies to fall on to the wrong side.

Lawyers believe problems could arise when a deal went wrong and the aggrieved party could argue the transaction was void because the act was breached.

"I can see it coming up if the other side wanted an excuse to get out," said Ms Chamberlain.

"To carry out investment business without authorisation is a criminal offence. More practically, if you enter into agreements when you are not authorised, you may not be able to enforce them."

The Financial Services Authority said it had noticed a "small increase" in the number of applications for authorisation in the last few months, but did not have figures for the number of incubator funds approved or seeking approval.

The section of the Act concerning "arranging" investments is particularly widely drawn, lawyers said.

"People don't realise how little they have to do to be caught by the concept of arranging," said Ms Chamberlain.

"There is an element of the act that just gets at someone who runs any kind of infrastructure that enables people to find deals."

Companies could also be caught if they were deemed to be "dealing" - as an agent or principal - or "advising" investors.

One quoted incubator said it had now decided to apply for authorisation.

RELATED ARTICLES
Internet incubator axes staff
OVERVIEW: Courtiers of high-tech Europe
NEWMEDIA SPARK: Incubator makes acquisition