🧪 Bio Manufacturing Launchpad, US Fundraising
Here's your Campfire for the 13th of November, 2023. Find today's deep dive on raising in the US below.
💼 This issue of Campfire is sponsored by Shepherd and Wedderburn's initiative to supercharge start-ups and scale-ups. Be sure to follow the Start to Scale LinkedIn page for useful videos and posts designed to help founders.
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🦸♀️ Fundraising in the US
By Robert Gelb
This is part four of a series about simple things you can do early to save time and money when planning your first fundraise written in partnership with Shepherd & Wedderburn.
In my experience, the prospect of raising investment in the US scares founders in Scotland. Heck, raising down south seems to scare folks too. Perhaps there are decent reasons for this, or perhaps the system up here encourages a more insular look for early-stage incubation. One that might be grounded in a combination of perceived ease and comfort, but also one that sets us up for unnecessary challenges down the road.
It also often opens founders in Scotland up to a perception that everything about raising in the US will require a cosmic shift in their approach. From new company structures to completely re-doing docs - we're almost conditioned to think that what we start with here will never be good enough for the 'grown up' USA.
The reality, as is often the case, is not that black and white. Speaking with Stephen and John from Shepherd and Wedderburn, they had a lot to say about the differences between the way rounds can sometimes work in the US and gave some useful tips for minimising the issues you might have when it comes time to raise in the states.
As a disclaimer: we get into quite a few areas, so this article is a bit beefier than usual. I'll admit, they started getting positively giddy when ‘nerding out’ about very specific structural differences, but they're lawyers, what can you do?
Common differences in deal structures
One overarching observation Stephen and John convey is that the differences between the US and the UK in terms of deal structures, term sheets, and funding round approaches are increasingly aligning. What had been true a few years back might not be true this year, or even the case going forward. In essence, you're going to see me use a lot of 'usually's' and 'in general's'. Apologies in advance.
Historically, the US has been seen as more 'founder-friendly' (however that's becoming less of an issue). By 'founder-friendly', they mean things like ‘less likely’ for founders to be expected to provide warranties and preferring relatively standard vesting of equity over a period of time (like four years with a one-year cliff) without the concept of a good leaver or bad leaver. In the UK it's more common to have good leaver, bad leaver, and sometimes 'normal' leaver clauses. This means that in the (generalised) UK approach, there might be a consequence for leaving, such that if the founder left, then possibly their vested shares would have to be offered for sale to other existing shareholders in the company, meaning the founder might be less likely to get benefit from the future growth in the business. In the (generalised) US approach, it's just time vested.
It's not necessarily the case that the US versions/approaches are better than the UK ones, just that they're different. There are, for example, some good arguments for good leaver/bad leaver provisions, and it's not to say having them is a dealbreaker for raising US investment, it's just something to consider.
As John noted, "The 'recommended' deal docs put forth by the BVCA (British Venture Capital Association) are increasingly aligning with that of the NVCA (National Venture Capital Association) and, for example, now use vesting / deferral of shares on leaving and are no longer asking for founders to provide warranties."
Stephen then expanded, "On the other hand as a result of the lack of warranties, it's usually the case that US VCs take a more active approach to due diligence than UK ones."
Making your life easier when going for US money
US investors have a lot of access to early-stage opportunities, so it is most common for UK companies to start engaging with US institutions later in their fundraising journey. That's not to say you shouldn't be seeking out US angels or pre-seed funds earlier, but as a gross generalisation, 'US money' seems to be most common (and consequential) when looking to build institutional rounds.
Because of this, it's often the case that in the early days, Scottish founders might have quite a large number of people to come on board in exchange for relatively modest amounts of money. While that's not inherently bad, often the types of conditions and docs that are used for those earlier raises might not be fit for purpose. Things like high levels of investor control, consenting rights, appointment rights for the investor in respect of board seats or observer/information rights that are not tagged off any minimum shareholding in the company, and broad pre-emption rights.
"Seeing things like this might cause a US investor to scratch their head, particularly around the control issues, because while there's some sense in major investors having a say in a company for so long as they remain major investors, if they are diluted into becoming a minor investor does it still make sense to have a board seat (for example)?" John said. We dug into this in an issue two weeks back, so head there if you want more info.
Because of this, you could have a situation where the US VC is presented with terms that are unfamiliar and not aligned with the expectations of the US market. As Stephen noted, "well-advised UK companies will put in place equity documentation that will accommodate investors, whether those are European or US investors, rather than necessarily defaulting to what's just presented to them by the early-stage local investor. Oftentimes that kind of path of least resistance at the early stage will actually create barriers to making your subsequent round more straightforward." It's always a balance and making sure you have a well-drafted shareholder agreement that properly addresses (and manages) key issues, such as pre-emption rights, information rights, and consent requirements will be key.
I asked them both about problems that seem small and that you might not think about, and John immediately pointed to currency. "Currency sounds simple but you'd be surprised with how many heads end up getting scratched working it out. If a US investor is investing in dollars, but your angels or friends and family round was on Sterling, then when it comes time to run a capital stack on an exit it's obviously an issue." In essence, make sure you include provisions catering for the different currencies.
Self-certification was another area Stephen was keen to highlight. This is where your angel investors sign a self-certification form indicating they are, indeed, sophisticated investors. In the US, it's referred to as an accredited investor. "In the US, securities law is quite strict, and not having the right disclosures from your investors on either side of the Atlantic makes for potential issues going forward." He continued, "A later-stage investor will require that everyone has reported as being an accredited investor, and you want to know that at the point that you get to your final exit, there isn't going to be somebody creating an issue at the fact that they've been unfairly treated on the way through because they weren't a sufficiently informed person to understand what it was that they were investing in." Stephen and John have heard of this happen to others in the market and remedying it can be anything from a bit of a tedious headache to actually jeopardising a deal. Luckily if you're using a firm like Shepherd and Wedderburn that's used to US securities law and works with companies with major US investors, this is usually all taken care of as a matter of course in the earliest of stages.
Do you need to change your docs?
Short answer: it depends, but you shouldn't as long as you're using relatively standard documentation from a firm/source that understands US securities law. Documents are increasingly aligning as we discussed above, and you shouldn't feel like you need to completely re-write your articles because of some assumption that the UK's default is somehow wrong.
If, however, you've let Chat GPT design your articles, or you're working off of a non-standard/non-BVCA aligned set of docs, it's important to check to make sure everything is kosher.
Do you need a US entity?
Usually, no. It's entirely possible and common for US investors to invest in UK entities. Sometimes certain accelerators / incubators require you to, like Y-Combinator, which is one thing to consider when looking at those options. Creating a US topco / holding company makes sense if you are well networked in the States or you live in the States for a lot of your time and are likely to have exclusively US investors. In that case, you can easily set up a subsidiary here for operations purposes. The opposite is common as well where you set up a US subsidiary for hiring staff there. It's a well-trodden path, especially for operational efficiencies, but just not needed for investment.
They both spoke about a particular buzzword: "Folks often think they need to do what's called a 'Delaware flip' where a new entity in Delaware is suggested to make it easier for US investors to invest in an entity they are familiar with. If you're being asked to do one, it's important to think through the consequences. If you're not sure that there are real advantages, then it can be costly to maintain and difficult to undo on the documentation side." Stephen said.
TL;DR: It's absolutely possible to have UK documentation that meshes with US investment, easily deals with US securities law, and caters for common expectations from the US investor side. And it happens every day.
As with anything, these are generalisations, not absolutes, and it's important that while you're mindful of potential pitfalls, you don't let it prevent you from taking action that's to the greatest benefit to your business. From having the right rights in place to positioning your company for the least number of hurdles when it comes to docs that are right for either side of the ocean, making sure you're squaring off stuff early makes everything much more straightforward later on.
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🤝 22/11, 12:00 🗺️ Stirling: AccelerateHER + Techscaler Meetup: Central Scotland: The AccelerateHER and Techscaler by CodeBase teams are excited to be joining forces in bringing dedicated meetups to life across Scotland for this community and peer-support building activity to grow. Meetups where you can come together, hear inspiring stories from fellow women and non-binary founders, and connect for ongoing peer-support.. MORE INFO
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💻 29/11, 09:30 🗺️ Dumfries: Coworking Day [South of Scotland]: We’re excited to invite our tech and business community, and anyone wishing to connect with our local community to our coworking days, taking place at Flourish in Dumfries. We're hosting these coworking days every Wednesday from 25th October - 13th December 2023, where you can join us for startup chat, networking, and to get to know you local tech-curious peers. MORE INFO
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☕ Series: Unfiltered: A series of informal catch-ups with the digital tech community in Aberdeen, Stirling, and Inverness. Come for a coffee and stay for the hotdesking!
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