Cross-border venture capital financings can present entrepreneurs with unique growth opportunities, and U.S. start-ups may benefit from the perspectives and contacts (not to mention capital) that an offshore VC can bring to the table.
At the same time, cross-border financing raise additional considerations that should be factored into the planning and negotiation stages, including the following:
- Different Market Expectations: Start-up practice varies from place to place, and offshore venture capitalists have a different set of expectations for a “typical” financing. For example, foreign investors may ask a start-up to establish a compensation committee or enter into written employment agreements with the founders at an earlier stage than would be considered “market” in the United States.
- Foreign Tax Requirements: Offshore investors may structure their investments to qualify for tax incentives in their home jurisdiction (e.g. in the United Kingdom, “venture capital trust” (VCT) relief; in Luxembourg, qualification as a société d’investissement en capital à risque or reserved alternative investment fund; and so on). Foreign tax considerations may lead offshore investors to impose certain restrictions on their investments and the start-up’s business, including restrictions on:
- the size of the initial investment and the use of investment funds (for example, an offshore investor may require that funds be spent within a certain timeframe or may prohibit funds from being used for M&A activity);
- the start-up’s ability to enter into joint ventures or establish subsidiaries;
- how many employees the start-up may have at any one time;
- who is eligible to invest in the start-up at a later date (for example, certain foreign tax reliefs may limit a company’s ability to obtain government financing); and
- where the start-up conducts business (for example, the British VCT program requires companies to maintain a “permanent establishment” in the UK).
- Foreign Exchange Risk: Pay attention to foreign exchange (forex) risk. Offshore investors may ask start-ups to denominate, price and issue their shares in a foreign currency to mitigate exposure to currency fluctuations (as permitted in several states, including Washington State). But this merely shifts forex risk to the start-up: consider whether the investor is in a better position to hedge against forex risk before moving away from a dollar-denominated transaction.
- Regulation S: Large offshore transactions can typically be conducted under Regulation D or Section 4(a)(2). In some circumstances, a cross-border financing may also want to take advantage of the Regulation S safe harbor for offshore transactions – an attorney should be consulted at an early stage to ensure that the deal can rely on all three exemptions. Also consider whether the purchaser needs to give additional warranties to ensure compliance with foreign securities laws. For instance, a VC located in the European Union may need to represent that it is a “qualified investor” for purposes of the Prospectus Directive (2003/71/EC, as amended).