The US has always been a hotbed of venture capital investment. In 2015, the National Venture Capital Association reported $58.8 billion was invested in the US, with VCs investing 5.4 times more money in the US than in Europe.
According to Tech.eu’s recent funding report, European technology startups raised around €16.2 billion in 2016. Despite the fact that those numbers don’t touch the US investment numbers, we still see increased interest in UK and European start-ups from US investors.
The deep pockets of Silicon Valley VCs have filled the dreams of entrepreneurs around the world, but diving into a US funding round without understanding the US regulatory framework can lead to significant problems.
Whether you’re looking for a current round or investment down the road, here are three key issues to look out for and discuss with a US lawyer before you take action.
Keep your shares exempt from SEC registration
The sale of stock, notes and other securities to US investors is regulated by a series of laws administered by the Securities and Exchange Commission (SEC). Any offer or sale of securities must be registered with the SEC unless an exemption is available.
It’s not recommended for start-ups to go down the road of registration. Registration is typically an expensive and time-consuming process that includes ongoing reporting obligations to the SEC; all of which can be a drain on an early stage company both in terms of time and money. Registration also requires the public filing of corporate information – the type of information that founders may prefer to keep private. Safe harbours, such as Rule 506, provide convenient ways to avoid these potential burdens.
Know who you’re selling to
You can only offer or sell securities under Rule 506 to accredited investors. Accredited investors are individuals or entities with a defined level of wealth and sophistication, making them better able to handle risk. The SEC rules are designed to prevent companies from taking advantage of ‘ordinary’ investors who may not have the experience and high net worth to invest wisely.
While 506 allows you to sell shares to an unlimited number of accredited investors and up to 35 non-accredited investors, it’s almost always best to avoid the latter. The SEC requires you to provide non-accredited investors with the same level of information provided in a registered offering, which largely defeats the purpose behind making an exempt offering. Accredited investors on the other hand, must have the opportunity to ask the company detailed questions but no other strict information requirements exist.
Be careful about solicitation and advertisement
Be careful how you make contact with the investors you sell shares to. You should be thinking about using pre-existing relationships or direct person to person communications to find investors and avoiding any broad communication to the market that can be deemed to be ‘general solicitation’.
Under new rule 506(c) the SEC now allows broader communications, as long as you only sell to accredited investors. The downside is that when using 506(c), there’s a high burden for the Company to prove that investors are accredited. As a result, despite the potential benefit it hasn’t been heavily used since its adoption.
If you’re thinking about selling into the US, here’s the short list:
- Avoid registration via an appropriate exemption / safe harbour.
- Be careful that you’re only offering / selling to accredited investors.
- Don’t communicate your offer to sell shares too broadly, focus on existing relationships or private communications.
- If you’re considering raising funds from US investors, make sure to consult with a US lawyer to make sure that your investment documents contain specific provisions that fit your transaction.
This post was co-written by Robert Glass, Associate at JAG Shaw Baker and a California qualified venture capital lawyer. The information in this blog post is provided for general informational purposes only, and may not reflect the current law in your jurisdiction. No information contained in this post should be construed as legal advice from JAG Shaw Baker or the individual author, nor is it intended to be a substitute for legal counsel on any subject matter.