The United States (US) represents a massive opportunity for ambitious UK startups and forms a fundamental part of their expansion plans. With its vast market size, deep pools of venture capital and culture of disruptive innovation, the US venture ecosystem offers transformative potential; yet, this transatlantic leap is fraught with challenges—new legal structures, tangled tax regulations and differing accounting standards. Understanding the nuances in this landscape is key to unlocking American investor interest and achieving sustainable success.
Since 2019, Frazier & Deeter UK (FD UK) have supported over 400 ambitious technology & life science companies expand into the US. This article explores our learnings and strategic approaches necessary for UK startups to thrive in the competitive US venture capital landscape.
Why Look Across the Pond?
A Deeper Capital Pool
The US venture capital market is the freest flowing in the world, with over $170.6 billion invested in 2023 alone, dwarfing the UK’s £ 20.1 billion. This abundance of capital provides more opportunities for startups to raise larger rounds, extending their runways and fuelling their growth. Similarly, the US boasts a mature and extensive venture debt market, with over $14 billion in annual debt financing available to startups. This additional source of capital can be instrumental in fuelling growth and bridging funding gaps. For later stage companies seeking larger investment rounds, the US simply provides the best opportunity to gain the funding required to continue their growth.
A Launchpad for Global Ambitions
The US market’s sheer size and entrepreneurial dynamism make it an ideal proving ground for companies with global sales aspirations. The projected SaaS market size in the US ($190.1 billion) compared to the UK ($17.06 billion) by 2024 is a testament to the market opportunities it provides. Gaining traction in the US can open doors to worldwide expansion and establish credibility that investors worldwide recognize. With its common language, similar culture and robust commercial landscape, many scale-up companies see this as the logical next step for their growth.
Understanding the Challenges
While the prospects are enticing, UK startups face distinct challenges when courting US venture capitalists (VCs). These investors are highly discerning, with a keen eye for companies that can become industry leaders and “unicorns.”
- Proving US Market Relevance: Demonstrating a compelling value proposition, customer traction and a well-defined US go-to-market strategy is crucial. UK startups must articulate how they will navigate the Atlantic currents to reach the shores of American commerce.
- Valuation and Growth Expectations: US VCs often have higher valuation expectations compared to their UK counterparts. They prioritize companies with exponential growth potential over near-term profitability, requiring a bold but realistic vision for market dominance.
- Navigating Cultural and Operational Nuances: The US venture capital ecosystem is fast paced, with an acceptance of failure but equally high expectations around value creation and exits. UK companies may need to adapt their mindsets, operations and investor relationships to this unique culture.
To Flip or Not to Flip?
To successfully court US VCs, UK startups must address several key considerations across legal, strategic, financial and cultural dimensions:
Corporate Restructuring
Many UK companies opt to “re-incorporate” or “flip” their company to a Delaware C-Corp structure “Delaware flip,” as some US funds prefer to invest in US entities to avoid offshore (non-US) tax complexities. The benefits for a US venture capital investing into a US entity are that it avoids any potential complexities with Passive Foreign Investment Company (“PFIC”) and Controlled Foreign Corporation (“CFC”) implications that can be punitive for a US investor if not carefully managed.
PFIC Considerations
- A PFIC is a foreign (non-US) company which meets either the Income or Asset Test criteria.
- Income Test: at least 75% of the company’s gross income is passive income
- Asset Test: at least 50% of the company’s gross assets are passive assets
- Most active trading companies will typically not meet either the Income or Asset PFIC tests. However, companies which raise large amounts of capital from VCs many need to the consider the Asset Test criteria with the cash they hold on their balance sheet.
- PFICs are detrimental to US investors as they are subject to strict and complicated tax guidelines by the IRS and the investor could ultimately be subject to a higher rate of tax on their investment compared with a non-PFIC company.
- A flip to insert a US entity on top of the existing UK company means that the VC will be investing into a US company and therefore the PFIC rules no longer apply.
CFC Implications
- A CFC is a foreign (non-US) company which is directly or indirectly controlled by US shareholders. Control means more than 50% and can be in respect of either voting power or value of share capital. Where a foreign company has multiple US shareholders, the control test applies to each US shareholder who own more than 10% and who, when combined, can control the company.
- If a company is a CFC, the CFC provisions (GILTI, Subpart F, Section 956) apply to the US shareholders of that foreign corporation, requiring each US shareholder to report income and investments of the CFC on their returns – even though distributions may not have been made by the foreign company to the shareholders.
- CFC rules are very complex and therefore many US investors are keen to avoid investing in any foreign companies which could inadvertently bring them within these rules. For example, this could happen where two US VCs each acquire a 30% stake in a UK company, meaning together they control more than 50% of the foreign corporation.
SEIS/EIS Restrictions
- Many UK startups may have already raised some initial investment in the UK under either EIS or SEIS venture capital relief schemes in the UK. Those existing UK EIS/SEIS investors will be keen to preserve the company’s qualifying EIS/SEIS status as part of any US expansion.
- Where such a company undergoes a change in company structure, such a Delaware flip, maintaining the EIS/SEIS venture capital relief requires careful tax and legal planning and adherence to specific rules. This is key to ensure that the new structure still meets all the qualifying criteria to maintain eligibility to the UK tax relief for those EIS/SEIS investors.
- EIS/SEIS does not automatically prevent a UK company from conducting a Delaware flip but, does require advanced planning to ensure the necessary EIS/SEIS criteria can continue to be met after the corporate restructuring.
Navigating PFIC, CFC and EIS/SEIS rules is crucial when UK startups seek investment from US venture capitalists and decide whether or not to perform a Delaware flip. Proper tax planning is essentially to mitigate adverse tax consequences for US and EIS/SEIS UK investors.
Positioning Your UK Company as an Attractive Investment Opportunity
Robust Financials and Data-Driven Projections: Impeccable financial documentation, including revenue, growth rates, unit economics, burn rates, forecasting accuracy and profitability metrics, is essential. Most crucially, financial projections must be rigorous, conservative and backed by solid data and assumptions that can withstand intense scrutiny from highly quantitative US investors.
Compelling Vision and Competitive Advantages: UK companies must articulate a bold but realistic vision for their massive addressable market, global ambitions and sustainable competitive advantages. US VCs invest in companies they believe can become true industry leaders with defensible moats.
Relationship Building and Warm Introductions: Building strong relationships with the right US VCs well ahead of fundraising is crucial. Warm introductions from trusted sources like other founders, venture capitalists or lawyers can significantly improve chances of success.
A Promising Future for UK Innovators
While the path to securing US venture capital is challenging, it represents a promising opportunity for UK startups to unlock transformational growth and global impact. By carefully navigating the legal, strategic, financial, cultural and tax considerations, UK companies can position themselves as attractive investment prospects for discerning American investors.
As the UK continues to foster a thriving startup ecosystem, the ability to tap into the US venture capital market will become increasingly pivotal. It not only provides access to capital but also serves as a gateway to the world’s largest economy and a launchpad for international expansion.
For UK startups with bold visions and the determination to adapt, the journey across the Atlantic can yield rich rewards – propelling them to new heights and solidifying the UK’s position as a global hub of innovation and entrepreneurship.
For more information, please contact:
Jonathan Clark, Tax Partner | jonathan.clark@frazierdeeter.com
Thomas Wells, Senior Manager, R&D Tax | thomas.wells@frazierdeeter.com