There is something incredibly humbling about Washington DC. Yes, the monuments and Capitol Hill are awe-inspiring, but it’s more than that. It’s the energy. It’s the way that people hustle from building to building in their awkward suits, clutching their piles of documents to their chests. It’s the hushed conversations that seem to be happening on every corner, in every restaurant, in every room. It’s the eager, young interns who shadow every meeting, quietly opening doors and taking notes for their superiors. It’s the simultaneous accessibility and inaccessibility of it all. It’s the sense that the world is changing right here and right now, and everyone is trying to figure out what the hell they can do about it. In fact, that is exactly why I was there myself.
I recently returned from two, fascinating days in Washington DC at the VCs-to-DC conference with the National Venture Capital Association (NVCA), where I met with federal regulators and members of Congress to discuss how potential regulations could impact venture capital and tech startups. Since moving back to the United States from Asia, it has been fascinating to sit at the intersection of technology, globalization, and early stage companies.
Two major themes have emerged in the last few months:
- Tech’s reputation — and especially that of Big Tech — has taken a big hit in Washington. The push for regulation is strong on both sides of the aisle. When it comes to data privacy, protecting consumers, combating fake news, and alleviating zeitgeist political movements, the days of unfettered growth have come to an end.
- National security has taken center stage. Whether it’s China’s development of a surveillance state, Russia’s interference in the US election, or North Korean hackers, the internet enables bad behavior from state and rogue actors. The concerns over national security are leading to a rise in protectionism on both sides of the aisle.
Consequently, legislators are feeling a palpable sense of urgency for legislators to demonstrate that they are taking action to protect American jobs, intellectual property, and data — especially from China. This has prompted the Trump administration, with the support of Congress, to push for an expansion of scope and power of CFIUS (Committee for Foreign Investment in the US), a previously obscure interagency committee in charge of reviewing mergers and large transactions by foreign entities.
Why does CFIUS matter and what changed?
In the past, companies were required to file with CFIUS and were subject to certain export controls, only if:
- They had a controlling foreign investor or owner (“controlling” could mean significant equity ownership, board directorship, etc.)
- Their product was deemed “critical technology” for national security, which was a narrow group of mostly hardware related companies, AND also had foreign stakeholders (minority investments, board directors, founders, etc.)
As of last November, in response to the escalating trade war with China, the administration dramatically broadened the scope and reach of CFIUS review. The new rules are currently in a “pilot program” stage, and permanent rules are being drafted for enactment next February. The new rules are impactful in the following ways:
- Companies with any direct foreign investors may be required to file, even if they are minority owners
- “Foreign” means any non-US country, not just Saudi Arabia or China, but also Canada, EU countries, Japan, etc.
- The definition of foreign investor could include offshore funds, funds that have any foreign investors or LPs, and even funds with GPs who are non-US citizens. You may not realize it, but nearly every single institutional venture fund falls into this category, including ours.
- The definition of “critical technology” may be broadened to include a wide variety of horizontal applications like “AI/ML” and “biotechnology”
This means that even the smallest of startups may need to file with CFIUS, and could be subject to control/regulation by both the Treasury Department and the Department of Commerce if they:
- Use artificial intelligence or machine learning in their product in any way (who doesn’t?!), and
- Have any non-US direct investors (more on this here from the stories of Grindr and PatientsLikeMe who actually had to kick out Chinese investors), or
- Have any US venture funds as investors who have non-US LPs or non-US GPs on their team, or
- Employ any non-US citizens in a product or technology capacity (more on this here)
So fine…if you have to file with CFIUS, what’s the big deal?
Under the pilot program, if you fall into any of the above categories, you or your investor will be required to file with CFIUS 45 days before the transaction is completed. This is a big deal because:
- Even an expedited approval can take 30 days and is not guaranteed, in which case the investment could be blocked.
- For some startups, delaying funding closing by 30 days (and even the need to file 45 days before closing) can break a business.
- Even if your investment is approved, you may need additional oversight to hire foreign nationals or sell to foreign customers.
- You may need to file every time you close follow-on financings, and will definitely have to file if your foreign investor does more than their pro-rata.
- Filing is complex, ambiguous, and changing quickly.
- Every tech company of every size that is subject to CFIUS will need to retain legal counsel — which we all know is not cheap.
Unless we get the final rules in a better spot than the pilot rules, both investors and founders will take on more risk, and America’s role as a global innovation powerhouse could be compromised. We need to speak up and educate Washington on what these rules could really mean for us. If you are worried about how it could affect your business going forward, you absolutely should be!
What can you do?
Here are some ways you can get involved and make a difference:
- Engage your investors: If you work in a startup, tell your lead investors about your concerns and urge them to get involved on behalf of their entire portfolio.
- Get involved with NVCA. NVCA is on the front lines representing VCs and our portfolio companies’ interests in Washington DC. They have strong relationships with the agencies, staffers, and intimate knowledge of what is happening, when, and who is best positioned to make a difference. Reach out to Stephanie Volk (email@example.com).
- Participate directly. Submit comments on proposed rules when they are released (these are called NPRM or Notice of Proposed Rulemaking). You can comment as a firm, company, individual, etc. Follow NVCA or #CFIUS on Twitter, or sign up for their newsletter here to be alerted when the new rules come out.
- Meet directly with Treasury and Commerce officials who are shaping the rules. We met with Thomas P. Feddo, Deputy Assistant Secretary of Investment Security (focus is on CFIUS), and Richard E. Ashooh, Assistant Secretary at the Department of Commerce Bureau of Industry and Security. Even if you can’t meet with them directly, their job is to collect information about the potential impact of these rules, so they or someone from their office would be highly motivated to hear from you.
It’s easy to sit on the sidelines and assume that this will all get sorted out. After all, these regulations are not targeted at small venture funds and early stage companies. That’s what I thought, too, until I sat across from the people drafting this regulation and realized they have likely never met an early stage startup founder. Why would they? Startup founders are hustling day and night to make ends meet and don’t have the time or resources to head to DC to explain what they do. Big tech companies do, however, and are able to be a part of the regulatory process. This leaves Washington regulators totally unaware about the impact their proposed legislation could have on everyday entrepreneurs and our broader innovation economy. They won’t know unless we tell them. The time to engage is now.