If you are a non-U.S. company raising capital from U.S. investors, then updating your register of members and making the required filings in your country of incorporation may not be the only filings required. Even though your choice of corporate and contract law may be non-U.S., one often overlooked issue in transatlantic financings is that you cannot opt out of certain core elements of U.S. securities laws. Simply put, if you offer or sell securities to someone in the U.S., you must be prepared to comply with U.S. law in that regard.
This article focuses on the relevance of certain U.S. laws to non-U.S. companies in early- and growth-stage financings, particularly U.S. securities laws. While this article is not an exhaustive summary of all requirements under U.S. laws, it focuses on the key requirements that may be required in equity and convertible note financings. If you have ambitions of raising a substantial U.S. investor-led financing round and/or exiting in the U.S. (whether by way of acquisition or IPO), staying on top of any required U.S. securities laws will ease the path for such transactions down the road.
What U.S. Laws Typically Arise in These Types of Deals?
There are usually four big categories of U.S. law that regularly arise in any deal involving a U.S. investor:
- Antitrust laws—These tend to be more relevant to the investor since they are obligated to comply, but the size of the investment could trigger a required filing with the U.S. government and a review period under the Hart-Scott-Rodino Act. For more on this, see our recent alert.
- National Security laws—Similar to the UK, the U.S. has certain rules regarding investment by non-U.S. persons in U.S. businesses. Interestingly, a company organized outside of the U.S. that is predominantly owned by non-U.S. persons could still be a “U.S. business” under the broad reach of the Committee on Foreign Investment in the United States (CFIUS) rules. For more on this, see this article.
- Tax laws—While the tax rules are more commonly a responsibility of the investor, U.S. tax laws require certain reporting by U.S. investors as to non-U.S. investments. As such, U.S. investors may also negotiate for assistance in their own compliance with U.S. tax laws. For more on this, see this article.
- Securities laws—These are the basic rules regarding offering and selling securities to U.S. persons. We will further explore the securities laws in this article while leaving the antitrust, national security, and tax topics to the other articles published.
Where Do U.S. Securities Laws Come From?
Following the stock market turmoil of the late 1920s, the U.S. government took decisive action to restore confidence in financial markets. The Securities Act of 1933 (known more commonly as the “Securities Act”) was enacted to protect investors by requiring companies offering securities for public sale to provide detailed and accurate financial information to the public, ensuring transparency and accountability. Pursuant to Section 5 of the Securities Act, all securities offers and sales must either be registered or conducted under an exemption.
How Do I Know When U.S. Securities Laws Apply to Me?
U.S. securities laws apply to any issuance of securities (which may include forms of debt also) to persons based in the United States. Anytime that a company, whether a U.S. or non-U.S., issues any securities, whether stock, options or compensatory equity awards, warrants, or convertible notes to a U.S. person, the company must comply with both federal securities laws. In addition, most U.S. states also have their own securities laws and regulations, known as “blue sky laws,” that govern the same activities at the state level and largely parallel the federal rules.
So, How Do I Exempt out of Registration?
When forming a company, securing financing, and issuing stock options, start-ups and scale-ups take advantage of various exemptions from registration under the Securities Act. Exemptions from registration are crucial in enabling companies to raise capital from, and to issue securities to, U.S. persons privately. The exemptions operate to protect the investor while allowing early-stage businesses to gain access to capital.
While there are multiple exemptions for types of securities and types of transactions, we will focus on the most commonly relied upon exemptions in venture financing. Start-ups and scale-ups often rely on Section 4(a)(2) of the Securities Act, which exempts “transactions by an issuer not involving any public offering” from registration requirements, commonly known as private placement offerings.
There are practical considerations when determining if the 4(a)(2) exemption can be used. For instance, companies should consider (noting that the below is not exhaustive):
- If the investors that they are offering securities to have enough knowledge and experience in finance and business matters to be considered sophisticated investors, which includes accredited investors. Most venture investors fall under this category.
- Limiting the number of offerees and purchasers to decrease the likelihood an offer is made to an unsuitable investor.
- Limiting general solicitation and general advertising of the offering by the issuer or anyone acting on its behalf.
- Requiring investors to buy the privately placed securities for their own account, without a view to immediately reselling or distributing to others.
Start-ups often seek to qualify under a safe harbor under Section 4(a)(2) known as Regulation D if it meets certain specific criteria for private placements limited to accredited investors. However, if a company seeks to rely on Regulation D, it must file a “Form D” with the U.S. Securities and Exchange Commission (SEC) within 15 days after the first sale of securities. However, since the Form D is a publicly accessible document filed with the SEC and searchable online by the general public, some companies that prefer to keep their fundraising activities more private may choose to rely on the Section 4(a)(2) exemption without the full assurance of the Regulation D safe harbor.
There Is More Than Just the Federal Laws?!
In addition to the federal requirements mentioned above, state regulations, known as “blue sky laws,” should also be addressed. Like federal laws, state securities laws are applicable to all issuances of securities to persons in that state, whether the issuer is public or private. Similar to the federal laws, state law compliance requires state registration of securities prior to the offering of such securities to proposed investors or reliance on an available exemption from registration. However, the state compliance is usually fairly similar in character to the federal laws.
Why Should I Care?
Both federal and state securities laws, typically provide for various fines and penalties against the issuer if it fails to comply with the Securities Act. An issuer could also be prohibited from relying on certain exemptions.
Most critically however, federal law and many states have a provision allowing an investor to rescind the transaction if the exemption was not met. This generally means that investors have a put option to return their shares and get their money back during the statute of limitations, which is often at least one year from the sale depending on the jurisdiction. As a result, other investors or buyers will have concerns about contracting with the company further if there is a risk that capital could leave the company. In extreme situations, the company may need to undertake a rescission offer broadly, which can be both embarrassing and potentially economically problematic. While these may seem administratively trivial, noncompliance can become a material issue in your next financing.
