You're a foreign angel investor or venture fund looking to invest in start-ups located in the United States and are wondering: What are the differences in terms that I can expect? What other considerations should I know about? Well, we are here to outline some of the key considerations for international venture capital investors investing in the US.
Understanding the US Landscape
Investing in the US start-up ecosystem can be exciting yet challenging if you're unfamiliar with how things work. As an international VC, you'll want to understand some key differences before diving in.
- Structure of Investment. When looking to invest in US start-ups as an international VC, you need to understand some key aspects of the investment landscape. In the US start-up ecosystem, companies and investors generally follow the National Venture Capital Association (NVCA) model documents to set the terms of their investment (similar to the British Private Equity & Venture Capital Association templates). It has also become more commonplace — and for increasing larger investment amounts — for earlier start-ups to issue SAFEs (Simple Agreements for Future Equity) to investors using the templates published by Y Combinator (a start-up incubator and seed investor). Of course, there are some companies that have bespoke investment documents in place, but the general consensus is to use NVCA-style agreements because investors have become used to those terms, and this helps streamline the legal process.
- State of Organization. In the US, entities are formed in one of the 50 US states and not on the federal level. As to the applicable state, the overwhelming majority of US start-ups are incorporated in the State of Delaware due to established business laws and legal precedents. Generally speaking, Delaware corporations are viewed as one of the entities, globally, that is most protective of officers and directors. In addition, the reporting requirements are truly minimal, with no disclosure requirements as to the identities of officers and directors, financial statements, shareholders, etc. As an international investor, you'll want to familiarize yourself with Delaware corporate law to understand your rights and responsibilities, including, without limitation, your duties as a director of the corporation (if you are taking a board seat) and your rights as a stockholder of the corporation under Delaware law and also under the investor agreements that you enter into. Because the information disclosure requirements are minimal, an investor will want to ensure it has a contractual right to the information it requires or desires.
- Terms. In recent years, terms of investments were more founder-friendly than international investors may have been used to, with investors taking less control over corporate governance matters. Recently, terms have shifted to be a bit more investor-friendly, with flattening valuations, more governance control over the start-up, more veto rights for investors, etc. We are also seeing more down-rounds and cram-downs. As an international VC looking to invest in US start-ups, make sure you understand all these factors so you can find the best opportunities and negotiate fair deals. Although a granular comparison is a topic for another day, in general, terms in the US tend to be a bit more company-friendly than in some other jurisdictions, with provisions like a redemption right being much less common and representations and warranties being made personally by the founders being significantly off-market.
- Relationships. The US VC community is big, but also tightly knit. Many of the best deals come through introductions and co-investing with other reputable VCs. Get to know firms at your target stage, especially those focused on your sectors of interest. Look for opportunities to co-invest together and develop those relationships. These relationships also can be great sources of follow-on funding for existing portfolio companies.
Regulatory Considerations
The US regulatory environment has become a bit more complex of late, but nevertheless, it remains a very business-friendly regime.
- CFIUS. The Committee on Foreign Investment in the United States (CFIUS) reviews certain foreign investments in US companies for national security risks. CFIUS has been expanding its scope in recent years, so your investments may face additional scrutiny. If the committee finds a risk, it can block the transaction or force the foreign investor to divest. It is important to obtain input from a specialist early in the investment process, even if on a high level, both to ensure the investment won't raise issues and also to ensure that applicable representations and warranties in the financing documents can be made.
- Currency Controls. Although the US government does not impose these controls, some governments impose controls on currency exchange and capital flows in and out of the country. International investors should check their domestic and local regulations and policies if there are any limits on transferring funds, repatriating profits and dividends, or exchanging currency. These controls can complicate or add expenses during the investment process and impact your exit strategy.
- Industry Regulations. In the US, certain industries like health care, financial services, and telecommunications are heavily regulated. Make sure any start-ups operating in these sectors have obtained proper licenses and permits to do business. Failure to do so can jeopardize their operations and your investment.
- Data Privacy. Like the EU and other European countries, in the US, there are federal and state requirements governing "personal information," "personal data," "personally identifiable information," and other similar data collected from individuals who reside in the United States. It will be important to understand any differences between the US data privacy laws and those of your home country, as well as between US federal and state requirements. For example, in California, the state laws and regulations governing data privacy are more robust than in other states and federal laws and regulations.
It's best to consult legal experts on any regulatory matters to ensure your deals comply with regulations.
Navigating US Tax Implications
Taxes are another key difference. The US has a relatively high corporate tax rate, though many start-ups take advantage of incentives like the R&D tax credit to reduce their burden. Of course, many start-ups are not profitable, and that also serves to mitigate taxes! As an investor, you'll need to consider the tax implications of your investments on both the company and fund levels (or as an individual). The US also has a complex system of state and local taxes that vary significantly between states and cities.
Generally speaking, international investors in the US will be taxed in accordance with the laws and regulations where such investors are domiciled. That said, depending on your citizenship or residency status, or your fund structure, you may be taxed under US tax laws and regulations as well.
It will be important to consult with a tax advisor or legal counsel on these tax issues that are unique to international investors investing in the US.
Conclusion
Although some cultural, legal, and regulatory differences might be applicable, tapping into the world's largest start-up ecosystem can be well worth the effort required to navigate these differences. Understanding the US venture ecosystem, the prevailing terms of investment, the market, and the regulatory issues affecting your investment and tax issues (both US and international) will be instrumental in your success.
With the right approach, international VCs can overcome these challenges and thrive in the US market.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.