Jack Shelton is a co-founder of Aegis Space Law.
In the investment landscape, we often encounter a scenario like the following: Three friends from college found a startup in the space industry. Two of the co-founders are American citizens, but the third is an Indian citizen, who is in the U.S. on a student visa.
The company begins R&D with respect to a type of spacecraft called an “orbital transfer vehicle.” Sometime later, the co-founders negotiate a $3 million investment in exchange for 20% equity and a board seat from an investment firm based in Singapore.
Based on such a fact pattern, we can ask the following questions:
• Does the Committee on Foreign Investments (CFIUS) regulate the initial founding by the foreign co-founder?
• Does CFIUS regulate the investment by the Singaporean investment firm?
• Does the company have any obligation to file anything with CFIUS?
In this article, we will attempt to explain how we would approach this fact pattern.
An Overview Of CFIUS
If CFIUS has jurisdiction over an investment, and if it believes that the investment could result in a relationship between the foreign investor and the U.S. target company that poses a national security risk, then the committee can prevent the transaction from occurring.
If the transaction has already occurred, CFIUS can:
1. Recommend to the President of the United States that the President cause the transaction to be unwound.
2. Impose civil penalties if any regulations were violated.
3. Impose a variety of mitigation measures.
In short, companies want to avoid such outcomes whenever possible.
The Foreign Founder And CFIUS
With respect to the foreign founder’s involvement in our earlier scenario company (assuming the founder is a true cofounder who has been involved with the company since the very beginning), CFIUS shouldn’t have jurisdiction over his/her actions in co-founding the company, because such actions should constitute a “greenfield investment.”
CFIUS only has jurisdiction over foreign transactions with already-established U.S. companies, not over the founding of a new U.S. company by a foreign person.
That said, the foreign founder may be restricted from accessing the company’s technology due to other regulations, namely the International Traffic in Arms Regulations and the Export Administration Regulations.
The Singaporean Investment Firm And CFIUS
Going back to our example, in respect to the investment from Singapore, which is not a greenfield investment (it occurs after the company has begun to operate), there are two pathways by which CFIUS can have jurisdiction to review the investment: If the investment represents a “covered control transaction” (defined at 31 CFR 800.210) or if the investment represents a “covered investment” (defined at 31 CFR 800.211).
A covered control transaction can result from any “control” (defined very broadly) that the investor obtains in the target company (even through a “dominant minority” stake or certain contractual relationships) to determine important matters affecting the target company.
A covered investment can result when the U.S. business is involved in what are deemed critical technologies (among other things), and the foreign person has:
1. Access to material nonpublic technical information.
2. The right to participate in board meetings, either as a member, observer or through the ability to nominate someone to the board.
3. Any involvement in the substantive decision-making of the company with respect to certain matters.
Note that hardware and technology that is specific to the space industry tend to be “critical technology” because they are either on the International Traffic in Arms Regulations’ (ITAR’s) U.S. munitions list, or controlled under the Export Administration Regulations (EAR) for certain listed reasons such as national security.
If a target company develops critical technology, and the investor will have a dedicated board seat, then the investment will likely be classified as a “covered investment.” Furthermore, because of the extent of the investment in our scenario (a 20% stake), coupled with the board seat, it’s also likely that the investment could be a “covered control transaction.”
Mandatory Declarations And Voluntary Filings
As the investment is currently structured, it’s quite likely that the target company would be required to file a mandatory declaration with CFIUS before making the investment. For more information, I recommend looking into 31 CFR 800.401, particularly subparagraph (c), which requires a mandatory declaration to be submitted to CFIUS when an export license would be required for the foreign investor to access the target company’s critical technology.
There may be ways to restructure the deal to avoid CFIUS jurisdiction. However, due to the sensitivity of the space industry to national security concerns, it could still be prudent to voluntarily submit a declaration or notice to CFIUS and obtain approval to proceed with the transaction, rather than risk the possibility of CFIUS intervening later and disrupting the deal.
Such a risk, even if merely looming in the shadows, could also scare away future investors; and in the event of a future raise that does require a CFIUS filing, CFIUS will then seek to review the prior investment.
Conclusion
If it is not clear by now, CFIUS is a tricky beast. If you get it wrong, the committee can impose massive penalties per violation. CFIUS may also impose stringent mitigation measures, the costs of which could quickly dwarf those penalties.
The information provided here is not legal advice and does not purport to be a substitute for advice of counsel on any specific matter. For legal advice, you should consult with an attorney concerning your specific situation.
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