Main Differences Between US & UK Early Stage Venture Deals
By Daniel Glazer and Robert Mollen
Spark Labs & Fried Frank are now seeing an increasing number of UK companies expanding to the US market. Most of them will be looking for US VC funding and they should be aware of the differences in how early stage funding works across the Atlantic. US VC and angel investors are showing increasing interest in investing in English holding companies, however they have a different set of expectations to their UK counterparts.
Some of these differences are mainly nomenclature and reflect the oft-observed dynamic of the UK and US being ‘two countries divided by a common language’. For example, common stock and ordinary shares, and preferred stock and preference shares, are pretty much alternative terms for the same kinds of equity, although, of course, there are differences between UK companies law and US corporation law.
However, some differences are more substantive, for example some US investors may encourage you to ‘flip’ to put in place a Delaware holding corporation over your existing UK company.
Below we investigate the key areas when considering the differences between venture deals in the US and the UK.
1. SEIS and EIS tax schemes drive early stage UK investment
UK early stage investment is heavily driven by the substantial UK governmental support provided through the SEIS (Seed Enterprise Investment Scheme) and EIS (Enterprise Investment Scheme) tax incentives (Venture Capital Trusts also play a role). Only UK taxpayers can benefit from these incentives. To qualify for the SEIS and EIS, the companies and the investments must meet a number of requirements. One of these requirements is that the investors can invest only in ordinary shares. These shares have the same rights as the shares held by entrepreneurs.
SEIS and EIS investments are typically made by UK angel investors and early stage SEIS and EIS qualifying funds. The SEIS limit is low (a company can only raise £150,000 under SEIS), however companies can raise up to £5 million over one or more 12-month periods under EIS (subject to a company gross assets limit).
2. Convertible debt offerings are preferred by US angels
In contrast, while US ‘friends and family’ investors and some US angels may invest in common stock, most early-stage US professional angels prefer to invest in convertible debt (or less frequently, convertible equity). This is structured to convert, in a subsequent Series A (i.e., first) convertible preferred stock round, into convertible preferred stock at a discount to the price in that Series A round (typically also subject to a cap on price).
As highlighted below, convertible preferred stock gives holders preferred rights. The use of convertible debt at the seed stage puts the US professional angels in parity with later stage venture capital investors, rather than, as in the UK, subordinate to them.
So, if professional angels want to be in parity with later stage venture capital investors, why are they prepared to invest in convertible debt rather than insist on directly buying convertible preferred stock? Mainly because, at this early stage, there is a desire to minimize legal fees, and negotiating and documenting the preferences and shareholder arrangements that are typical in a venture round involve significant legal expense (even though the lawyers typically cap their fees in a Series A venture round).
3. Series A convertible preferred stock terms
The terms of Series A convertible preferred stock/preference shares in the US and the UK are quite similar. Convertible preferred stands in front of the common/ordinary shares held by entrepreneurs in an exit scenario. Additionally, at this stage (if not before), entrepreneurs should expect more detailed shareholder agreements that address such matters as board representation, ‘reverse vesting’ (i.e., forfeiture) of some founder shares if the founders leave within a specified period, ‘drag along’ rights that facilitate a sale of the company as a whole (and ‘tag along’ rights that protect the minority from being left behind) etc.
In the US, Series A investors will also want ‘registration rights’ that put them in a position to force an initial public offering (IPO) so that they can freely dispose of their shares without violating US law.
These days, US Series A convertible preferred stock rounds typically start at a minimum of $5 million (at current exchange rates, around £3.3 million). Levels below are considered seed investment. In the UK, in contrast, Series A VC rounds may start as low as £1 million, sometimes even less.
4. Want to know more?
This topic is pretty dense. You can contact Spark Labs directly in order to learn more about US expansion & US VC funding. You can find out more about how US venture capital fundraising works by reading Brad Feld and Jason Mendelson’s book Venture Deals: Be Smarter than Your Lawyer and Venture Capitalist. Their book provides a very clear description and is written for entrepreneurs about how venture funding works in the US.
**About the Authors**
Daniel Glazer is a partner at Wilson Sonsini Goodrich & Rosati, where he leads the New York office’s technology transactions practice and also advises UK and other non-US companies on US expansion, fundraising and strategic partnership transactions. Dan’s practice focuses on commercial, IP, and technology matters, with a particular emphasis on licensing, sourcing, and services arrangements. His clients range from early-stage start-ups to Fortune 100 companies.
Robert Mollen is an experienced US M&A/corporate/securities lawyer now focused on helping non-US early stage and growth companies address a broad range of US issues. These include cost-effective US establishment, contracting with US commercial counterparties, dealing with potential US investors. He also mentors on early stage funding and other start-up issues.
**About Spark Labs**
Spark Labs is the global network for innovation. We believe that fostering great businesses starts with having the right environment, team, mentors and local connections. Being entrepreneurs ourselves, we know that launching or expanding a company into the US can be difficult. That’s why we’ve decided to develop a revolutionary ecosystem for entrepreneurs with a very strong focus on community, network and relationships. You can read more about Spark Labs on our website spark-labs.co.