Negotiating cross-border investments: Insights from a seasoned investor

Today, there are great opportunities in the cross-border investment world. While early-stage funding continues to fall globally, some markets continue to thrive. Last year, foreign investment in the Latin American region rose by 51%. That number will likely grow this year as constraints on U.S. investment in China cause VCs to look for countries closer to home.

Unfortunately, not all of those investments happen under ideal circumstances. Many VCs now take 30% to 40% of startups’ equity in early-stage rounds. If you’re desperate to raise funding, it’s easy to get locked into these unfavorable terms, perhaps giving away more of your company than you had initially anticipated.

Getting ideal terms is even more complicated in cross-border investing, which is why you need to understand what you’ll be negotiating to navigate that market successfully.

LatAm founder challenges

While Latin American investments present a greater risk to investors in specific ways due to political and economic instability, they also typically offer a higher return profile due to increased market growth, low operation costs, and high demand for new technologies.

For LatAm startups, investments from foreign VCs present an opportunity to bring in experienced advisers and contributors who can help the company expand to new markets. However, there are a lot of complications to cross-border investment term negotiations in the form of negative VC perception of LatAm startups, as well as geographic distance and regulatory challenges.

Again, the perception that Latin American startups come with higher risks can put them at a disadvantage when negotiating with VCs. Investors are likely to look for higher returns to compensate for the added risk, which means they may also want to take a more significant portion of capital. And those risks can also contribute to an overall lower valuation for startups.

There’s also a substantial challenge of geographic distance. It might be harder for you to connect with your VCs for advice and assistance navigating the market when you’re dealing with different time zones, languages, cultural experiences, and market ecosystems every day. This situation can be frustrating, particularly for startups working on increasing their global visibility.

I remember one LatAm startup founder I worked with whose investors were all based in Los Angeles and lacked experience in LatAm investments. That made it much harder for the founder to connect effectively with their investors due to the language barrier, time difference, and, most importantly, the investors’ lack of understanding about market dynamics impacting Latin American companies. For instance, this month, Mexico’s lower house passed a bill to revamp national stock exchanges to boost trading and make it easier for companies to go public. The bill creates opportunities for startups that an experienced LatAm investor would easily be able to help them take advantage of, whereas a less experienced investor might not.

Then, there are regulatory challenges. Startups in Latin America face constantly changing regulations depending on the country they are based in and whether they have subsidiaries or holding companies in other regions or countries. Regulations can affect a startup’s tax status, privacy policies, partnerships, licenses, and the testing or verification process for new technologies.

For example, I worked with a Mexican pay tech company, Félix Pago, that is working to facilitate secure and rapid money transfers from the U.S. to Mexico through WhatsApp. However, a Latin American regulation that imposed anti-money laundering (AML) restrictions and standards for combating the financing of terrorism (CFT) presented a problem. Given the company’s model of leveraging WhatsApp, a platform not initially intended for financial transactions, the team had to innovate ways to authenticate transactions and users securely while also working to communicate with regulatory authorities effectively.

But, again, the biggest challenge is giving away far too much of your company too early in your funding rounds. During negotiations, you’ll need to ensure that you stay in operational control, especially in early rounds. That’s where your term sheet comes in. Investors provide a term sheet when they’re interested in your company and want to lay out the conditions of their investment. A term sheet will outline how much of your company and what portion of the governance belongs to VCs.

Managing cross-border relationships

Cross-border investments become less of a problem when you have a diversified cap table. Founders should work to attract VCs in Latin America and the U.S. who have already made a name for themselves working with startups in the region, understand the growth potential and know the risks.

One thing you can do to facilitate attracting VCs from different regions is to set up a holding company or subsidiary in those areas. For example, if your VCs are in the U.S., creating a U.S. holding company protects your investors under local law.

Holding companies play a critical role in influencing VC perception because you can establish them to align with the legal and tax advantages that VCs prefer. For example, Delaware is one of the most holding-company-friendly states in the U.S. due to its relatively less restrictive regulatory landscape. When opening a U.S. business bank account, you must set up a local entity, which will be helpful to receive your financing round proceeds.

Next, to help you navigate regulatory challenges, you should ensure you have VCs on your board who have experience in dealing with local regulations. They can offer valuable counsel and provide invaluable connections to help you keep abreast of the changing regulatory landscape. This is particularly relevant for cross-border fintechs that require money transmitter licenses (MTL), anti-money laundering (AML), or know-your-customer (KYC) best practices, for example. Being in business with partners that have helped other startups in the regulatory arena enables you to sleep better at night. It’s important to mention that consulting with local regulatory and compliance legal advisers is always necessary for these requirements.

Having a VC partner who can help you deal with cross-border initiatives can also impact your business’s commercial success. A local partner with deep ties to the U.S. and LatAm can help you close commercial partnerships in both regions, and when your company is ready for geographic expansion, they can help you land and expand in the U.S. At H20, we have been helpful with our portfolio founders when they migrate to the U.S., and our Miami team has provided immigration support, helped an entrepreneur find the first U.S. hire, and even worked with a Realtor for household relocation.

In return for all this help and to help ensure that you’re headed in the right direction, investors will often seek a board seat and other governance privileges as part of their term sheet. But what you don’t want to do is offer a perpetual board seat. Investors should be on your board for a limited duration, ideally the duration of the current funding round.

Imagine you permanently give away seats on your board to two different investors in your Series A round. By the time you get to Series C, you will have given away a disproportionate amount of your board, with the Series A investors no longer contributing much to your company’s success.

Ultimately, obtaining funding and securing the correct cross-border investment terms for your company can be a complex process, and it may have a lot of ups and downs. So don’t base your company’s future on raising the next funding round; build your company around the success of your product or service, and never settle for anything less than investors who are on your side and helping you continue to grow.