A company “flip” has become a ubiquitous method of accessing the U.S. markets, whether for fundraising or commercial growth. A “flip” involves formation of a corporation in the United States, typically a Delaware corporation taxed under subchapter C of the Internal Revenue Code (a “Delaware C corp”), and transacting with your home country company, rendering it a subsidiary of Delaware C corp, with the goal of attracting U.S. investors and customers.
Delaware is most often the best choice for new startups, whether the business is born in the United States or elsewhere. Forming a Delaware C corp offers many benefits, such as access to venture capital and other private financing markets, as well as a step along the path to one of the world’s premier stock exchanges, with access to deep and diversified pools of capital and future liquidity. Delaware also offers a more standardized and comprehensive body of law, allowing for legal and compliance predictability. Investors, private equity firms, and venture capitalists typically prefer (if not always prefer) for the company they invest in and conduct business with to have its domicile in Delaware. When a non-US based company grabs the attention of a US based investor, it is frequently asked to do a “flip” into Delaware in order to facilitate investment into the entity.
So How Does a “Flip” Work?
In a “flip,” a non-US based company (“HomeCo”), whether based in Europe or elsewhere, creates a new Delaware C corp, or “Topco.” The stockholders of HomeCo contribute shares in HomeCo to Topco in exchange for shares of Topco, and become shareholders in Topco. HomeCo becomes a wholly-owned subsidiary of Topco, and TopCo becomes the parent of HomeCo, with all shareholders and assets moving into that entity.
Similarly, HomeCo can contribute its assets to TopCo in exchange for shares, and the legacy HomeCo shareholders can thereby become indirect shareholders in TopCo through their continued holdings in HomeCo. This transaction frequently triggers a taxable event for HomeCo, which can be advantageous if done early, and costly if done later.
In another twist, HomeCo can license its intellectual property and know-how to TopCo in exchange for shares of TopCo, or for a license fee.
Below are some considerations for owners when debating whether a “flip” is a fit for their company:
- Consider tax implications resulting from how the technology will be either shared or sold from one entity to the other via a licensing agreement or sale agreement, respectively.
- Can the Delaware “flip” be accomplished on a tax-free basis?
- Ensure that the share exchange between HomeCo and Topco is completed in the same proportion as the way in which shares are held in HomeCo. It is important not to treat shareholders differently in this case.
- A non-US based company will stand to benefit tremendously if it conducts a “flip” in the early stages of its operations. The longer the non-US based company waits, the “flip” will become more costly and legally complicated.
- Consult local tax and legal professionals of the jurisdiction where the non-US based company is incorporated.
- Are executives and stockholders also relocating as part of the “flip”? If so, consider whether an exit tax will be applied by the home country. France is well known for imposing an exit tax on entrepreneurs expatriating and flipping to third countries.
- A share exchange agreement must be entered into by each shareholder of the non-US based company and the US company.
- Shares are not usually available immediately, as there is a waiting period in non-US based countries to register shares in Topco.
The tax consequences of a “flip” are complex, and shareholders may want to seek the advice of tax advisers before a “flip.” To the extent possible, an adequately structured “flip” should be tax neutral to the non-US based company and existing shareholders and should generally preserve the current tax benefits enjoyed by the non-US based company and its shareholders.
Once the “flip” is completed, if Delaware is chosen, the Delaware corporation will be a holding company absent of operations, and its sole asset will be 100% of the share capital of the non-US based company.
A Few Disadvantages
If Delaware is chosen, a Delaware holding company structure has its benefits and also its drawbacks, such as:
- There can be tax implications of the “flip” that require further detailed analysis. A company’s failure to comply with the precise requirements may result in valuable tax benefits or create other consequences.
- By forming a parent company in Delaware, the company could become exposed to the risk of litigation in the US earlier in the process than would otherwise be the case.
- US corporate and income taxes will apply to your new entity.
- Delaware applies a franchise tax to corporations.
- Individual states where a permanent establishment is maintained will also apply income, sales and payroll taxes.
- Litigious environment for doing business.
A “flip” is a popular transaction for non-US based companies that seek US based investment; however, it is not to be entered into without careful consideration. While a “flip” can provide a promising route to new financing and increased shareholder value over the long term, the non-US based company’s management team should consider if a “flip” truly makes sense in the early stages of the company’s financing lifecycle.
Careful consideration should be given before “flipping” to a Delaware LLC. The LLC offers many tax efficiencies, but complexities abound, particularly when attempting to raise funds from tax-sensitive investors, or compensating local talent.
A “flip” is only one avenue among many for non-US based companies when considering how to access US markets.