Perils and promise of foreign funding

As air miles are racked up in the search for LP commitments, be cautious of these three common pitfalls writes Peter Townshend of Perkins Coie.

In boom times, a typical Silicon Valley startup might never look beyond the valley for funding. In the current economic environment, however, sources of funding are much more scarce and private companies at all levels of development, and in all geographies, are casting much wider nets for their next rounds of funding.

Peter Townshend

An important element of that broader financing strategy is foreign investment sources, including wealthy individuals, sovereign funds, foreign venture capital and private equity funds and government funds. This piece is intended to alert companies setting their funding sights abroad to a few of the most critical issues.

Know your investor: Any company raising money, whether abroad or in the US, has an obligation to know its investor, either from a pre existing relationship or through basic due diligence. The US Department of Commerce provides extensive guidance on how to avoid transactions with “unauthorized persons,” including providing lists of particular foreign individuals with whom any transaction, financing or otherwise, is prohibited. Some foreign funds are well know and respected.  However, when securing funding from a smaller foreign fund, remember to ask for both the managers of the fund and the investors backing the fund, and to do basic due diligence on both.  

Be cautious of using brokers/finders:  It is common when dealing with foreign funding sources to work through finders that may ask for a percentage of the investment amount, in cash and/or equity, as compensation for their services. In the US, such finders would be required to have a broker/dealer license or face civil, or even criminal, penalties.  Companies using unregistered finders in the US risk non-compliance with Regulation D, potentially giving investors – including but not limited to those that were brought by the finder – the right to rescind their investments. Companies using such finders abroad therefore must be absolutely certain that such finders are themselves not US persons, operate entirely outside of the US and interact exclusively with potential investors abroad.  

Keep general terms consistent with US financing: Companies raising foreign funding are likely to come back to US investors for future funding.  They may also want to be able to go public on a US exchange. Companies should therefore try to keep the terms and conditions of any foreign investment reasonably consistent with US best practices.  For example, companies raising rounds in the Middle East are often asked to modify their offerings terms substantially in order to comply with sharia law. If the company is simultaneously offering the same terms to US investors, the company should understand that those sharia law modifications are likely to be unpalatable to the US participants in the round. So such a company may have to choose between terms acceptable to Middle East investors and terms acceptable to US investors – or otherwise separate the round into two simultaneous offerings on different terms, which can be a logistical and marketing challenge.

These are just a few of the complex issues faced by companies seeking funding from foreign sources. As always, such companies need to measure the opportunity afforded by foreign capital with the risks. But for those able to migrate the right path, foreign funding may the critical key lifeline to sustain or grow a company that might otherwise not survive if limiting its funding options to the US.

Peter Townshend is a partner with the firm's emerging companies practice at law firm Perkins Coie.