Доступна версія українською: на Medium.
Investment in the start-up.
In Ukraine and in the USA.
More than 300 million new start-ups are founded worldwide each year, according to the British marketing firm Get2growth. At the same time, in the USA, according to various calculations, the activity of at least 20 000 technological startups is actively carried out.In Ukraine, according to multiple sources, as of 2021, the total number of startups is between 1000 to 4000.
The review of the current mechanisms for luring investments into Ukrainian start-ups is highly relevant even during the war as the country’s IT sector continues to grow.
What is a start-up?
The term “start-up” is currently not defined by law in Ukraine. The English verb “to startup” means “to start something”.
In plain language, a start-up is a newly formed business that needs to draw in funding for further research and development of an original business concept.
The definition of the organizational and legal form of the firm is a crucial step in the legal preparation for a start-up.
For instance, most start-ups in the United States of America are registered in Delaware as C-corps. If a start-up is registered in a different way, professional investors and venture funds may decline to invest in it. It is rather a business custom than the requirement of law.
The best and most balanced choice in Ukraine is to register a limited liability company (LLC / ТОВ) because the country’s legislation regarding investments in start-ups is still in its infancy.
Ways to rise investments in the USA.
One of the most popular countries to establish a business and get investments is the United States. The following reasons help to facilitate this process:
- developed investment culture;
- eco-system for the development of startups (Silicon Valley);
- extensive legislative regulation of raising funds procedure for start-ups;
- public interest in the emergence of new companies.
The main ones include:
- Raising funds through crowdfunding platforms;
- Attracting funds directly from private investors (angel investors, FFF (friends, family, and families);
- Attracting investments from venture funds.
The peculiarity of investing in American startups is that each of the investment mechanisms is subject to several regulatory rules:
- Regulation Crowdfunding and Regulation a+ are the most commonly used for crowdfunding;
- Regulation D and Regulation S are mainly used to attract funds from investors without the involvement of crowdfunding platforms.
What are the differences between these mechanisms and regulations?
The primary distinction is that under US law, crowdfunding investments can only be raised through certain platforms that have been accredited by the SEC, whereas using crowdfunding platforms is not required to raise investments directly from private investors.
In addition, there are certain differences between these mechanisms and regulations:
- different caps on the amount of capital that start-ups can attract;
- restrictions on the accreditation of investors;
- prohibitions on the public promotion of investment offers;
- requirements for compliance with the Blue Sky laws of certain states;
- the necessity of additional SEC validation requirements.
- Regulation Crowdfunding:
- permit a company to raise a maximum aggregate amount of $5 million through crowdfunding offerings in 12 months;
- require all transactions under Regulation Crowdfunding to take place online through an SEC-registered intermediary, either a broker-dealer or a funding portal;
- limit the amount individual non-accredited investors can invest across all crowdfunding offerings in 12 months: depending on the income or net worth of the investor: up to either the greater of $2,200 or the lesser of 5%-10% of investor income or net worth;
- require disclosure of information in filings with the Commission and to investors and the intermediary facilitating the offering.
To become accredited investor, certain criteria must be met:
to have an annual income exceeding $200,000 ($300,000 for joint income) for the last two years with the expectation of earning the same or a higher income in the current year;
to have a net worth exceeding $1 million, either individually or jointly with their spouse.
Additional criteria:
If a person can demonstrate sufficient education or job experience showing their professional knowledge of unregistered securities, they can be also qualified as an accredited investor.
2. Regulation A+:
Regulation A+ provides two tiers of offerings.
Key provisions of Regulation A+ (Tier 1 and Tier 2) offerings include:
- Annual offering limits from $20 million to $ 75 million;
- Limitations on Investors: Tier 1 — no limits (both accredited and non-accredited investors can invest); Tier 2 — a non-accredited investor may invest no more than (1) 10 percent of the greater of annual income or net worth (for natural persons); or (2) 10 percent of the greater of annual revenue or net assets at fiscal year-end (for non-natural persons);
- Requirements for SEC filing (issuers must file with the SEC a Form 1-A);
- In comparison to Regulation Crowdfunding, the process for organizing the investment round is more complicated, and stricter transparency rules apply to start-up financial information.
3. Regulation D:
Among all types of this regulation, we decided to focus on Regulation D (506(b), as the requirements of this regulation, are the most loyal for start-ups, as follows:
- No annual offering limits;
- Rule 506(b) allows you to sell securities to an unlimited number of accredited investors and up to 35 non-accredited investors;
- No general solicitation or advertising to market the security;
- A company must give any non-accredited investors disclosure documents that generally contain the same type of information as provided in Regulation A;
- A company is required to file a notice with the Commission on Form D within 15 days after the first sale of securities in the offering.
Ways to rise investments in Ukraine:
As we stated at the outset, the legal basis for of investing in Ukraine is still developing.
Some investment mechanisms for attracting and legally registering investments for Ukrainian start-ups become accessible in conjunction with the Law of Ukraine “On encouraging the development of the digital economy” coming into force: convertible loan and option.
The mechanisms above are frequently used in nations with an Anglo-Saxon legal system and have demonstrated their efficacy and value in luring investments.
The following articles from the Digilaw team will provide further details about contracts for start-up investments. Sign up so you don’t miss anything.
In contrast to US law, Ukrainian legislation does not have a well-developed set of mechanisms for attracting investments in start-ups, and the existing ones are complicated and insufficiently optimized.
Let’s take a closer look at the primary mechanisms:
- The attraction of investments into the LLC through a convertible loan;
- The attraction of investments into the LLC through the conclusion of the purchase-sale agreement of a share with postponed circumstances.
What to consider while attracting investments into an LLC in Ukraine:
- It is essential to conduct due diligence on the company and create a step-by-step plan for attracting investments in LLC;
- It is necessary to create a properly drafted charter with special provisions that will permit the implementation of the chosen mechanism for attracting investments;
- The company should have a reserve capital;
- It is important to specify when the investor receives the right to a share of the LLC’s authorized capital;
- The order of all procedural points and part transitions must be correct.
Conclusions:
We believe that the tendency of Ukrainian legislation to adopt some components and mechanisms of investment from English law is positive because it highlights the country’s investment potential and provides investors with the opportunity to invest in Ukrainian startups.
At the same time, Ukraine’s current investment mechanisms require expansion and improvement. At the legislative level, it is essential to increase the possibility of attracting investments into Ukrainian start-ups through crowdfunding. This mechanism enables start-ups and investors to attract sizable amounts of capital from around the globe in a more or less automated manner, greatly accelerating and simplifying the investment process.
The Digilaw team will serve as a legal partner in supporting your decision to launch a startup or rise investments.
Yaroslav Barvenko
Lawyer at Digilaw