Any securities lawyer worth their salt knows that a “covered security” means more applicable laws, more regulations, more oversight, more time consumed in the transaction, and more expense. Enter CFIUS, the U.S. Treasury Department’s Committee on Foreign Investment in the United States and its oversight of certain transactions involving foreign investment in the U.S. that may impact national security (called “covered transactions”). If you have been paying attention, you know CFIUS has been in the news for some high profile actions regarding China Mobile’s FCC license application, PatientsLikeMe, a healthcare startup, Grindr, the LGBTQ dating app, and HealthTell. We previously wrote about CFIUS in New CFIUS Rules Shut Down Chinese Investment in U.S. Technology, U.S. Legislation Against Huawei/ZTE That Will Rock the World, and New Restrictions on High Tech Technology Transfers to China. CFIUS has been operating since 1988, though it was recently rejuvenated and its oversight expanded with passage and implementation of FIRRMA, The Foreign Investment Risk Review Modernization Act, which was signed into law on August 13, 2018. Now CFIUS has jurisdiction over all FDI deals, not just those resulting in a foreign entity owning a controlling interest in a U.S. business. China has analogous laws restricting investments in certain industries, though it is loosening some of those restrictions, but in practice every piece of data generated in China has potential national security (or national sovereignty) implications.
CFIUS in its more robust oversight role has been targeting Chinese-related investment in the U.S., though not exclusively. Deals with Canadian, English, and other countries have also received scrutiny from CFIUS in recent years. But FDI from China dropped precipitously in 2018 from prior years. As we said in a previous post:
Chinese companies did not lose interest in the United States. What happened is that the U.S. government’s security review system has made Chinese investment in any form of technology company virtually impossible. New legislation and regulations adopted in 2018 will make those investment barriers formal and permanent. These restrictions will survive any trade “deal” made on the current Section 301 tariff dispute with China. The investment restrictions have become part of the “new normal” in US-China economic relations.
The below are some key takeaways from this new normal for U.S. companies seeking investors from abroad:
1. Technology deals will continue to get reviewed. Technology is a massive part of most deals that will be attractive to foreign investors, whether it be biotech (pharmaceuticals, medical devices), computing (computers, electronics, semiconductors), aerospace, energy, data processing, software, or R&D. Data is the new universal currency, particularly data about customers or users, and that data can be exploited in many ways, including those areas impacting national security.
2. Small startups will not be exempt. A large percentage of startups involve technology in some way, with at least 47% of startups in the past decade considered “technology-based.” Technology is the way to scale a business, and that is what founders and investors want the company to do. If a business is not scalable, investors will take their money elsewhere. Even startups that do not consider themselves technology-heavy may be included in the larger technology group, especially if their business can be tied to national security in any way.
3. Any investment size and type may be scrutinized. Regardless of debt, equity, or derivative investments, and especially if the investment is coupled with some management rights or may lead to assimilation of technology by the foreign investors, CFIUS may take action.
4. No deal is safe and no statute of limitations applies outside the safe harbor provided by the review process. If CFIUS determines that a deal will impact national security, it can block the deal, require significant modifications, undo the deal after it has closed, require certain owners to divest their ownership interests, or require the sale of the entire business or all of its assets after the closing.
5. CFIUS’ jurisdiction extends to deals involving foreign investors, not just Chinese investors. This means that (1) Chinese investors looking for a backdoor entry into U.S. tech companies will be scrutinized and (2) deals will not be safe just because they do not involve Chinese investors. Companies looking for FDI dollars must conduct due diligence of potential investors to determine whether a prospective investor is on any of the U.S. government’s persona non grata lists.
6. There is available capital outside of China. Even if the U.S. proceeds with slapping tariffs or other restrictions against other allied countries, investors from those countries will not be subject to the same capital controls or the same national security concerns as investments from China. The U.S. State Department reports a massive backlog of EB-5 visa applications for foreign entrepreneurs (with an estimated 2-4 years to process the application). Why? Because along with the freedoms U.S. citizens enjoy, the U.S remains the preeminent market for stable investments, including U.S. capital and real estate markets. India and Vietnam top the EB-5 application list after China.
CFIUS has and will continue to cause FDI from China to drop, but it is unlikely to completely shut off the flow. CFIUS’ review process is not the only factor in the marked drop, but it is a major factor. If you are a U.S. technology company seeking FDI, you need to court non-Chinese investors. Where should you look? Our international lawyers regularly work with companies seeking investment dollars from Asia, Europe, Latin America, and Africa. Or stay close to home if you are more risk-averse. Even though the baby boomers are well into retirement and the generation X’ers are nearing retirement (and getting less adventurous and free with their capital), there are domestic investors who continue to look for good companies and projects in which to invest. They speak your language and understand the dynamics and economics of your home markets and this familiarity can eliminate many potential friction points in the investment negotiations.
Investment in U.S. companies is always changing and CFIUS is just one element of that.
What are you seeing out there?