The “Delaware Flip” as a U.S. Capital Access Tool for International Businesses
In our legal practice, we look for opportunities to use the law to create strategic business opportunities for our clients. One of our most high-impact structuring techniques, especially for our non-U.S. early-stage clients, comes into play when they seek access to America’s well-developed venture capital eco-system. (We use variations of these techniques for our U.S.-based clients so everyone can get some mileage from our structuring experience!)
Because U.S. venture capitalists overwhelmingly prefer to invest in Delaware corporations – for a variety of reasons, including the familiarity of VCs with Delaware corporate governance rules and the ease with which Delaware corporations can be listed on the world’s largest and most active stock markets – we often find ourselves taking a non-U.S. corporation (“OpCo“) and turning its owners into the stockholders of a Delaware corporation (“HoldCo“), using a tax-savvy method with the cheery-sounding name of a “Delaware flip.”
A Delaware flip is not a diving maneuver; it is a capital access strategy that can be game-changing, especially for businesses founded outside of the U.S. These are businesses that will continue to operate around the world but will find investors in the United States of America, which even in 2023 remains home to the largest pool of venture capital in the world.
Mechanically, the Delaware flip can restructure the capital structure of an entire company group or simply an existing OpCo. Depending on the country where the original OpCo is organized, the number of steps involved in the “flip” may vary; however, the basic steps are similar across all the various flip transactions.
To initiate a flip, the governing body (board of directors or its appropriate equivalent under local law) and the equity holders of the existing OpCo will vote to approve the Delaware flip transaction. This step is critical, not only for corporate governance reasons but because the shareholders of OpCo will become equity holders in a new Delaware entity, HoldCo. Thus each equity holder in the foreign OpCo may experience a tax consequence due to the initial “flip.” The tax consequences of the Delaware flip will depend on where the original foreign OpCo is established, as well as (potentially) where its operations and shareholders are located (if different than the jurisdiction of its incorporation) and, finally, the impact of relevant US tax laws. Therefore, a notice outlining the foreign OpCo’s well-organized plan for the Delaware flip – outlining the new HoldCo structure, terms of a proposed equity exchange between owners of the OpCo and HoldCo, and high-level guidance on any tax planning considered by the OpCo in deciding to recommend the flip, should be sent to all current equity holders of OpCo to prepare them for their vote.
The second step of the Delaware flip is to create HoldCo, the holding company in Delaware. This will involve creating and filing HoldCo’s organizational documents in Delaware. Depending on the country’s laws where the original OpCo is formed, additional intermediate entities may be created in the U.S. and the foreign jurisdiction to facilitate the flip. For example, if the OpCo was originally formed in India, there likely needs to be a second company created in both the US and India to implement the “flip” using a valid legal structure under Indian law; our Indian affiliate law practice, Stoicus Legal, is a great resource for the deals we do “flipping” companies out of India.
Depending on the country where the original OpCo is organized, a third step may be required before implementing the flip. This would be the case in a jurisdiction, such as India, where we expect OpCo would require a set of mergers, or perhaps the sale of all of OpCo’s assets, to comply with all applicable legal requirements (such as India’s Foreign Exchange Management Act) in effecting a flip. Another example of a structural step that could be added when “flipping out” of some countries is a trust for the benefit of the original holders of equity in OpCo. In this type of deal, the trust would receive HoldCo equity in exchange for OpCo equity and “mere” trust beneficiary status (for the founding owners of OpCo) would replace a direct grant of ownership of HoldCo shares issued in the flip. As with our example of India, “local” (i.e., home country) tax or corporate law reasons may make using a trust desirable to optimize the outcomes for the founding owners of OpCo. In all of these varying jurisdictions and structures, documentation must be prepared to allow the intermediate entities to be formed and/or the intermediate transactions to occur before the flip.
The final step, after the directors (or their local equivalents) and the shareholders of OpCo have voted to approve the Delaware flip, is that the HoldCo is created, the internal organizational documents of HoldCo are adopted, and finally the existing equity holders of OpCo exchange their shares in OpCo for shares in HoldCo. Again, in some jurisdictions, such as India, this step would involve several more steps and require executing mergers between various companies in the overall “flip” structure. However, the steps may be organized; once the equity exchange is completed, all future investment capital will go directly into HoldCo, the Delaware entity, and HoldCo will wholly own the foreign OpCo. In many cases, OpCo will continue to own its intellectual property, to operate in the country of its original formation, and otherwise can be largely unaffected by the occurrence of the “flip,” except for the increased access to capital created by placing HoldCo on top of OpCo, structurally.
We’ve seen many clients benefit tremendously from implementing the Delaware flip, and at a glance, it does look pretty straightforward. Due to differences in the preferred approach country-by-country, however, we wouldn’t be lawyers if we didn’t remind you that it is important to approach this flip strategy thoughtfully, seeking experienced legal and tax advice to ensure that the transaction is structured properly and complies with all applicable laws and regulations. We’re happy to discuss your company’s goals to help you decide whether a flip is in your future!
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