Much has been said and written about how start-up founders can
raise initial capital to launch and grow their businesses by getting funds from
their friends and family, angel investors or VCs. I would like to bring to your attention an additional
source of capital: foreign investors and U.S. citizens or residents located
outside of the Unites States.
Issuing equity or debt to foreign investors or U.S. citizens
or residents located outside of the United States is a securities offering,
just like issuing convertible notes or Series A preferred stock to domestic
investors. However, registration
requirements of the Securities Act will not apply to such offering so long as it
is conducted outside the United States. Regulation
S, which comprises five rules, reflects the territorial approach of the Securities
and Exchange Commission: only the offers and sales of securities inside the
United States are subject to the registration requirements of the Securities
Act.
Typically, the Securities and Exchange Commission decides on
a case-by-case basis whether an offer and sale is made inside or outside of the
United States. Regulation S provides certain
conditions, which, if met, help determine when the offer or sale is made
outside of the United States. There are
two general rules. First, the offer or
sale has to occur in an “offshore transaction” (i.e., a transaction where
offers or sales are made only to persons located outside of the United States
at the time of purchase and either the buyer is outside the United States or
the seller reasonably believes that the buyer is outside of the United States
at the time the buy order is originated).
This means, generally speaking, that a U.S. citizen can purchase a
security of a U.S. company in a Regulation S offering as long as that person is
located outside of the United States at the time of the purchase. Second, no “direct selling efforts” are made
in the United States in connection with the distribution or resale of the
securities (i.e., no activities that may condition the U.S. market, such as
advertising to the U.S. investors).
In addition to these two general requirements, there are
certain other conditions (certifications, legends and reselling restrictions)
found in Rule 903 that founders of a U.S.-based startup conducting a Regulation
S offering should comply with. Although
securities sold pursuant to Regulation S are freely tradeable as long as sold
offshore to someone who is not a citizen or permanent resident of the United
States, buyers have to hold these securities for at least 40 days for debt
offerings and one year for equity offerings before they can resell to U.S.
persons.
In conclusion, conducting a Regulation S offering is not onerous
for a small company. There is no
prohibition on general solicitation or advertising so long as such activities
are not directed into the United States.
There is no limit as to the number or nature of investors. Regulation S does not require any specific
disclosure information or financial statements (but there are requirements as
to stock legends, buyer certifications, notices and other documentation). However, start-up founders need to be
careful: Regulation S will not apply to any scheme or plan to avoid
registration under the Securities Act.
This article is not a legal advice, and was written for general informational purposes only. If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga. Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.