New Company or Delaware Flip?
5 Jul 2021
We have written about Delaware flips in detail, but because the process can be costly, some founders are seeking ways to circumvent this need by winding up their existing startup and setting up a Delaware structure and overseas subsidiary from scratch. The hope is, that by doing this, you can use online, off-the-shelf incorporation and save thousands in fees. It's also substantially faster. The sad news is, it's probably going to cost you more in hidden costs and potential penalties, not to mention issues with shareholders at a later stage.
In case you were unsure, you might need to restructure your company to create a group with a new holding company at the top for a few reasons, one of which being to take investor cash. Some investors and accelerators, such as Y Combinator, insist that they can only invest in companies based in certain countries, such as the US. If you have a fantastic product but are based elsewhere, you need to create a holding company above your current company, in order to take that funding.
That process can be expensive (at least several thousand dollars), time consuming and very distracting.
Consider the below scenario:
Maya starts a company in Ireland - called 'Mayas AI'
She has built a basic MVP and gets accepted into a US accelerator, but they insist on a US company to invest in.
She has bootstrapped so far, never really incurred any costs, and done the work herself. She has no investors so far. She is wondering if she can just pretend her first company didn't exist and start a new Delaware group, with a new Irish subsidiary (to employ herself), in order to avoid the cost and inconvenience of the flip.
Generally speaking, Maya will hit issues doing this. The main reason for that is the IP resides with the existing company, not her personally.
By IP, we are talking about the technology created, the product. Most likely when Maya created the company, she did so with the standard documents for founders, stating that the IP generated was property of the company. If you have actually started building something, be it a few lines of code, wireframes, user testing, etc, it's likely you have IP. If you have founders' agreements or have documented anything relating to your work being owned by the company, this applies to you.
Alternatively - if you have nothing but an idea and a newly incorporated company, but nothing else, then most likely you are fine to close it and start again.
So by reincorporating separately, the IP won't just move over to the new company. It will remain in the previous one unless action is taken to move it.
Transferring IP can be a complex area and requires legal and tax advice to avoid causing issues around ownership, rights to use the IP and even where profits should be assigned. The tax authorities will most likely want to investigate should the new company become successful.
There can be significant added complications if you have additional shareholders/investors here. Shareholders can object to what you are doing, and may cause you a bigger headache with legal claims if you go ahead anyway. If you were to proceed down this route, get full shareholder consent and have a lawyer ensure that it is done properly.
But I want to do this anyway
If you still think this is the right route for your company, go ahead, however, be aware that you need a good lawyer, and you may have to pay some tax on the transaction.
You may see some concerns from later-stage investors as they will undoubtedly want to see confirmation that the IP is assigned correctly, and should there be any doubt or the potential for an unconnected company to claim rights over the IP (which technically, you and your 'old' company could do at a later stage if you don't fully close it down, stealing back the IP and running off with any future profitability), the investors could refuse to invest until its resolved.
The way around this would be that you would 'sell' or transfer the IP to the new company, however, this would create a profit in your existing company and a loss in your new co. This is a problem because you will need to pay tax on it, not to mention you would want a suitably experienced lawyer to help with the process, which may get expensive.
I'm still on the fence - should I do it or not?
The best course of action would be the flip. You should be able to get it completed for a few thousand dollars assuming you don't have too much of a complex situation. Transferring the IP would take a lawyer to review at least, plus further costs for any taxes generated. You could engage a legal and tax expert to get a more in-depth expert opinion to avoid it all, but most likely paying that person or team will cost the same amount as what you trying to avoid. Doing it the standard way will remove questions and headaches later down the line.