Proposed CFIUS reform bill raises concerns over foreign LPs in U.S. venture funds

A proposed bill intended to update the procedures of the Committee on Foreign Investment in the United States (CFIUS) has raised concerns from the National Venture Capital Association, which argues the legislation is ambiguous in regard to requirements for venture firms with foreign LPs. The NVCA also said it could damage the U.S. venture sector’s global competitive advantage.

On Jan. 18, NVCA Board Chair Scott Kupor, who is a managing partner at Andreessen Horowitz, testified before the U.S. Senate Committee on Banking, Housing and Urban Affairs regarding potential unintended consequences of the bill that might discourage foreign investors from becoming LPs in U.S. venture funds or make strategic investments in U.S. companies.

The bill, the Foreign Investment Risk Renew Modernization Act of 2017, was introduced in November 2017 by Senate Majority Whip John Cornyn (R-TX). An identical bill has been introduced in the House of Representatives, and the proposals have received strong bipartisan support, according to an analysis from the law firm White and Case.

The legislation would expand CFIUS’s authority to address national security concerns resulting from foreign investments in U.S. companies, notably from Chinese investors who might attempt to access critical U.S. technology. It would extend the committee’s review time frames, expand the range of transactions subject to the committee’s authority, make certain notifications mandatory, and require those notifications to be submitted 45 days before a transaction is completed.

But the legislation leaves much grey area for foreign LPs in venture funds, and its reporting requirements are incompatible with the time frame of the venture capital industry, Kupor argued in his testimony before the senate committee.

“The legislation does not specifically speak to the common practice of a foreign person that invests in a U.S. venture fund, which in turn invests in a critical technology company,” Kupor wrote in prepared testimony. “We are concerned that this ambiguity—especially when combined with a broad grant of rulemaking authority to CFIUS—will cause unnecessary confusion, cost, and burden for the venture capital industry, as venture firms will be left without a clear understanding of whether they must file with CFIUS and under what circumstances.”

As it is written, the legislation could discourage foreign investors from channeling their dollars to the U.S. venture industry, whose market share of global VC s already shrunk to 54 percent, down from 90 percent in 1990, Kupor said. Much of that money is now going to Chinese startups instead of American companies, Kupor said. China attracted $35 billion in venture investment in 2016, he said, and is now the second largest destination in the world for venture capital.

Kupor proposed three modifications to the proposed legislation:

• First, the bill should be amended to specify that U.S. venture funds with foreign LPs do not fall under the covered transaction definition, and the fund does not take on foreign personhood merely because it has foreign LPs.
• Second, the bill should specify that a CFIUS filing is not needed if the foreign strategic investor takes a de minimis stake in the startup and broaden the passive investment test to assure to foreign strategic investors that they are not impacted by the new legislation.
• Lastly, Kupor recommended that the bill allow CFIUS to grant exemption from the covered transaction definition to more countries that are U.S. strategic partners, since many such countries are critical capital sources for U.S. private companies.

The senate committee has scheduled another hearing on CFIUS reform for Jan. 25