What is a Delaware Flip? A Startup Guide.
27 May 2021
Your company’s legal structure is the last thing on the mind of most founders when they first get started. Soon after finding early traction though, some companies begin thinking about expanding into the US; which could mean taking investment from US investors, selling to US companies or both.
We meet businesses that are thinking about expanding to the US every month, and we've noticed there tends to be hesitation right up to the point of hiring a lawyer.
We think this is because not much is written about how to expand to the US, so in this article we'll break down the main mechanism companies use to expand into the US: the Delaware flip! This isn't right for everyone though, so we'll get into that as well.
What is it anyway?
A ‘flip’ in this sense, is the process of legally creating a new holding company, with your existing company now being owned by the new holding company. The actual process involves creating the new company, and then ‘flipping’ it above your existing company by swapping the shares you own now, for shares in the new company. The holding company in return, takes your shares in the existing business, as it now owns it.
What’s so special about Delaware?
Delaware has more corporate entities (companies) then people for a reason.
Delaware has put considerable effort into ensuring its corporate legal system is robust and modern. No need to worry about obtuse laws preventing random things from the 1800’s. They have even gone one step further and created a separate court system to deal with corporate issues. This means the judges are specialised and extremely knowledgeable, not to mention due to the vast amount of companies, there is a precedent for most things. Lawyers and VC’s are most familiar with Delaware law as a result, and so it’s easier to do business there.
Delaware has one of the best tax regimes in the US, although it is still subject to taxes (like franchise tax and something horribly complex called GILTI).
Who does it?
All companies? No, not at all! Generally this process is only for companies who have incorporated in a country (eg UK) and in order to take investment, they need to create a new holding company in the USA. The investors in this scenario will be insisting that they will only invest in a US company, and so you give them a US company to invest in, and in doing so you create a corporate group which will include your original overseas company.
It’s expensive and a little complicated, so unless you have to, it’s not for you. More on this below.
How do I know if I should do it or not?
As I said above, unless you’re asked to, don’t. Adding complexity to your corporate structure will result in higher legal bills, higher accounting bills and more stress, not to mention the potential to expose your future profits to higher taxes. It also eats up time that could be better spent. If you can carry on with your existing company, go for it.
That being said, there are situations where it makes sense. Mainly this is almost always around investment. Some US based VC’s and accelerators won’t invest unless you are in a jurisdiction they want, such as the US. In that case, it is what it is, and you need to make a call on if they are worth it. Sometimes, this is a question of appetite, that they prefer US-based holding companies and therefore it’s easier to close the deal with them, and some have strict rules which they can’t override no matter how much they want to. One of the reasons behind this is the tax regime for US citizens.
The other main reason an investor may want you to do a flip, is because they see the exit route as needing to be in the US, either through trade sale or because they think you will be better off doing an IPO with a US exchange. This is definitely a reason to consider delaying, and getting outside advice before you commit as it’s much harder to “un-flip”, or invert if these opinions turn out to be incorrect. Europe and the UK have become much more attractive for trade sales in light of the tax environment in the US, and more and more tech unicorns are doing an IPO on a non US exchange.
It can often make sense to open a US company as a subsidiary (a company owned by your existing company, not the other way around) if you need to for a few of reasons, such as:
You want to employ staff in the US
You have customers in the US
By creating a subsidiary, rather than a flip, you are introducing less complexity and it will be an easier not to mention, cheaper process.
Aside from the legal fees, paper work and stress, remember you are adding tax complexity, so you will most likely need expensive tax advice to ensure you get things right, and don’t get caught up with tax issues (which will be ongoing by the way). It’s also worth noting that currently the US has a higher tax rate then then many other countries (with state and federal taxes combined) although this can and does change regularly.
Locations such as the UK and Ireland have lower tax rates and have a variety of government grants, incentives and credits to help you along. The US does have R&D credits, but the scheme is different and can often work out to be more generous in the UK.
Tax changes, such as those announced by President Biden can also mean that investors may be more open to the UK rather than insisting on US investments only, but these can and do change.
Alternatively, if you are planning to crowdfund or take a lot of small investors, speak to a lawyer to see if it might be more beneficial to do the flip first. When you complete the flip, each shareholder exchanges their shares in the existing company, for shares in the new holding company on a one for one basis. So by doing it before you take on lots of shareholders, you skip what might be a very lengthy process (and when it comes to lawyers, lengthy = expensive)
Do it when absolutely necessary, and wait till the last possible moment. Check with your lawyer and accountant if you are not sure when this moment is.
Think through do you really need it? Could you have a subsidiary instead? Or stay as-is?
Things change. What might have been right for a company 5 years ago might not be right for that same situation in the current economy