Raising Money Abroad
Picture this – your start-up is ready to raise seed money; you think your business has international appeal and you want to open the round up to foreign investors. This might be the right strategy for your business, but have you thought about securities compliance? Will you also open the round to US investors? How will you attract the investors? Will the prospective investors purchase securities with transfer restrictions? These are all important questions to ask when you’re considering taking on foreign investors and you want your securities to be exempt from registration requirements.
Regulation S of the Securities Act of 1933 (“Reg S”) provides an exemption from registration for “offers and sales of securities outside of the United States.” Companies issuing securities pursuant to Reg S must comply with certain restrictions on their offerings. Such restrictions are put in place to ensure that the exemption is not being used to improperly circumvent registration requirements and sell unregistered securities in the US. Reg S is comprised of five rules:
- Rule 901: General statement of regulation
- Rule 902: Definitions
- Rule 903 and 904: Safe harbor rules
- Rule 905: Resale limitations on equity securities issued pursuant to Reg S exemption
The focus of this post is the Category 3 safe harbor rule provided by Rule 903, which is available to US companies issuing securities to foreign purchasers. To qualify the following conditions must be satisfied:
- It must be an “offshore transaction.”
Rule 902 defines “offshore transaction” as an “offer not made to a person in the United States…and at the time the buy order is originated, the buyer is outside the United States, or the seller and any person acting on its behalf reasonably believe that the buyer is outside the United States.”
- There cannot be any “directed selling efforts” in the United States.
Rule 902 defines “directed selling efforts” as “any activity undertaken for the purpose of, or that could reasonably be expected to have the effect of, conditioning the market in the United States for any of the securities being offered in reliance on…Reg S.” This restriction is primarily focused preventing any advertising or offering of the securities in the US when the securities are being offered pursuant to Reg S. This ensure that the unregistered securities are only offered and sold to foreign purchasers and that a US purchaser will not learn of the issuance through any kind of public advertisement or publication in the US.
- The securities will be subject to a distribution compliance period and future sales will be restricted.
Finally, securities issued pursuant to the Category 3 safe harbor of Rule 903 are required to observe multiple transfer restrictions. Such securities are subject to a distribution compliance period, the length of which is dependent on whether the offering is for debt (forty days) or equity (one year) securities. During the compliance period, the securities cannot be re-sold to a US purchaser (with limited exception, discussed below). Further, any sale made prior to the end of the distribution compliance period is required to comply with the following requirements:
- The purchaser must certify that it is not a US person or that it is a US person purchasing the securities pursuant to an exemption from registration under the Act;
- The purchaser of the securities agrees that it will only re-sell the securities pursuant to Reg S or another qualifying exemption under the Act;
- The purchase agrees not to engage in a hedging transaction;
- The security instruments bear restrictive legend clearly stating the above-mentioned restrictions on transfer; and
- One or more of the charter documents of the issuer, i.e., its Operating Agreement or Articles of Organization, must explicitly state the transfer limitations to which its securities are subject.
Raising money is a complex process but taking the time to do it properly is critical. Failure to comply with securities regulations can lead to complex and costly enforcement actions with consequences ranging from fines to criminal charges. The good news is that these consequences can be avoided by creating a fundraising strategy that addresses securities regulations and complies with the applicable requirements.