The United States has strict laws at both a federal and state level aimed at protecting its citizens from being induced into inappropriate investment activity. These laws place certain restrictions on promoting and selling shares into the US. This note sets out certain high level issues of which a company should be aware if it intends to receive investment from a person present in the US.
Start-ups are less likely to have long lists of individual potential investors and, to begin with, individual angel investors are one of the more likely sources of early stage venture funding. In the UK, founders and companies may already be familiar with the concept of the “High Net Worth Individual” (HNWI) to whom shares may be sold without tripping over the UK financial promotion regulations, provided that certain criteria are met. In the US and in accordance with the US Securities Act of 1933, it is the “Accredited Investor” who enjoys the ability to have private share issues marketed to them but only if they too meet certain criteria. Most US states have enacted what are known as “Blue Sky” laws that regulate the offer of securities in that state and offer exemptions to certain registration requirements, and companies will have to comply with both US-wide federal securities laws and local state laws (and filing requirements). Companies will want to ensure compliance with the Securities Act, as if an investor gets cold feet and seeks a refund on their investment this may the first thing they will use to challenge the basis of their investment.
Under the US Securities Act, securities can be offered to an unlimited number of accredited investors and up to 35 non-accredited investors (more on those below) on a private offering basis. Accredited investors are a limited group and in respect of natural persons include (amongst others) the officers of the company offering the shares, individuals with a net worth of £1 million (excluding the value of their primary residence) and individuals with income in excess of $200,000 in each of the last two calendar years. Since the coming into force of the Jumpstart Our Business Startups Act (JOBS Act), it has also been possible for companies to undertake public offerings of shares provided they meet certain of the accredited investor tests and comply with additional information and validation requirements.
Individuals and families with wealth in the US make much more use of family trusts and investment companies than their UK counterparts. It is not unusual to find that an investor wishes to invest through their family trust or investment company. For tax reasons, investment companies will often be a limited liability company (LLC).
An LLC or trust is not automatically recognised as an Accredited Investor. The principal criterion is to meet an assets test of $5 million. Certain other enumerated entities with over $5 million in assets qualify as accredited investors, while others, including regulated entities such as banks and registered investment companies, are not subject to the assets test. The result is that the LLC or trust will need to have $5 million in assets to be able to be an accredited investor or else the LLC or trust can be deemed an accredited investor if all of its individual members (or settlors in the case of a trust) are accredited investors in their own right.
Recognising that many start-ups seek investment from friends and family who may not meet the accredited investor test, companies may offer securities to non-accredited investors but only when the company satisfies an additional information requirement. The requirement, in the words of the SEC, is to provide “disclosure documents that are generally the same as those used in registered offerings,” which is a very high standard. The cost of such work and the advice needed may put some start-ups off seeking investment from those friends and family that are not accredited investors.
With the excitement of closing out your funding round, don’t forget to make the filings for any US investors. You will need to file a Form D with the SEC to comply with federal law and then file the Form D in each state the company has sold shares, (i.e. where the investors reside). Filing requirements differ from state to state and online filings, whilst making things easier in some regards, often require a layers of identity validation and can take time to set up so getting on top of the filing requirements early is a great recipe for an easier life.
Talk to the team at MBM early in the fundraising process to check on whether your potential investors meet the accredited investor test.