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.