Crossing Borders and Laws: The Legal Obstacles in Venture Capital Funding

Venture capital funding drives the innovation and growth of startups, supporting their progress on a global scale. In the first quarter of 2023, VC-backed companies raised over $44 billion. A rising trend is cross-border venture capital investments, expanding opportunities beyond home countries.

This article examines why cross-border VC funding is important for global entrepreneurship and how it deals with the legal challenges investors and startups encounter

From regulatory variations to compliance issues, navigating these obstacles is essential for success. Discover key legal challenges and insights to maximize the full potential of global startup and investment opportunities.

Key legal challenges for cross-border VC funding

In today's global economy, venture capital (VC) funding has become an essential driver for startups and innovative businesses. However, dealing with the complexities of cross-border investments brings a unique set of legal challenges that entrepreneurs and investors must tackle.

Companies can face several obstacles when exploring cross-border venture capital funding. Let's take a closer look at them.

Regulatory variations and compliance issues

Cross-border VC funding involves varying legal systems and jurisdictional laws in different countries. Determining the appropriate jurisdiction can be a challenging task. For instance, while most countries have adopted International Financial Regulatory Standards (IFRS) the United States has not. There are also differences in how the IFRS is applied in each country.

Local entity setup

Creating a legal business entity in a foreign country can be time-consuming and costly. Establishing a local entity can take up to 20 weeks in many countries. The initial cost can exceed $20,000, covering aspects like local registration fees, entity tax compliance, in-country capital requirements, and seeking local legal and financial advice.

Risk of non-compliance and legal consequences.

Non-compliance with cross-border VC funding regulations can expose companies and investors to potential legal problems. Failure to follow the specific legal requirements in each country can result in fines, penalties, or even criminal charges.

For example, Meta was fined $1.3 billion for violating the EU’s cross-border data transfer regulation.

Additionally, non-compliance can lead to reputational damage, strained business relationships, and the possibility of canceling investment deals. The recent outcry over the Chinese fast-fashion company Shein is a perfect illustration of the damage that can be done by non-compliance.

Cross-border taxation and double taxation treaties

Cross-border taxation poses significant complexities for VC investments due to varying tax laws, regulations, and treaties between countries. Companies must grapple with double taxation, withholding taxes on dividends and interest, and differing tax treatment of capital gains.

One example is a posted worker sent abroad for a short time in the EU, may have to pay taxes in the other country. When it comes to capital gains tax, Hong Kong doesn’t have it, while France has a 34% rate and the USA’s rate is 21%.

Businesses need to understand these issues can impede a cross-border VC investment, affecting costs, returns, and compliance.

How to overcome cross-border complexities

Although cross-border VC funding poses considerable challenges, there are proven solutions. Let's examine some answers to these issues.

Global law firm

A global law firm can provide comprehensive legal expertise and insights across different jurisdictions. They can assist in navigating complex legal systems, ensuring compliance with various regulations, and identifying the right jurisdictions for setting up business entities.

International law firms can advise on compliance with cross-border regulations, structuring investment deals, and resolving any legal disputes. They can help companies and investors work together smoothly in different places, making cross-border VC investments safer and more profitable.

Gain local expertise

For venture firms to succeed, local market knowledge, cultural nuances, and regulatory details are essential. Startups can team up with local venture partners, lawyers, accountants, and consultants to understand the markets they operate in.

A strong local presence and a well-equipped services bench are crucial for effective venture firm management, co-investments, and maintaining a competitive edge in the negotiation process.

Employer of Record (EOR)

Partnering with an Employer of Record (EOR) is a cost-effective alternative to setting up a local entity. By working with an EOR, companies save time and money and avoid legal risks, such as worker misclassification. The EOR manages hiring, payroll, taxes, and other important tasks in the host country, making market entry smooth and efficient.

Rise above compliance hurdles

Cross-border venture capital funding presents significant legal hurdles to investors and startups, including varying regulatory frameworks, compliance, and tax issues.

Understanding and addressing these challenges are vital for successful international startups. By managing these legal issues efficiently, companies can experience the full potential of global investment opportunities and promote innovation and economic growth internationally.