Delaware Flip: why startups put a US holding company on top

A non-US company may opt for a new Delaware holding company for several reasons:

• The United States remains the most important market for venture capital and other private funding.
• Some of the world's leading stock markets are in the United States. An IPO and listing on the NYSE or NASDAQ usually opens the door to more capital and liquidity.
• A sale to US investors is often seen as the ideal "exit strategy", and a new US entity can make that sale easier.
• US companies find it easier than foreign companies to sell products to US or foreign businesses.

A US holding company achieves every one of these goals. That is why more and more non-US companies (including those with little or no US business today) are setting up a Delaware holding company, often alongside a private equity, venture capital or other private funding round.

1Why a US company?

Over the years, US private equity and venture capital firms have put a great deal of time and effort into standardizing the complex web of documents that comes with their investments. They are also generally most comfortable with the corporate law mechanics available to a US company. For example, they understand how preferred stock rights can be structured under US corporate law.

Many venture capital and private equity firms also believe a US company offers better exit options, whether through M&A or an IPO. The reasons, in short:

• US public markets remain attractive to investors. Non-US companies can list in the US too, but the process can be more expensive and demanding than listing a US company. Some US institutional investors are also barred from buying securities of non-US companies. On top of that, investment bankers and venture capital firms often argue that a NASDAQ listing of a US company can bring the company and its investors many advantages, including a higher valuation and more liquidity (which in turn lets investors exit with fewer drawbacks). Some market participants believe this "home advantage" may be a major reason foreign venture capital funds post lower returns than their US counterparts.
• Many potential investors are based in the US and are therefore usually more familiar with how a US target company works and is structured.

2Why a Delaware Corporation?

In the US, corporate law is set by the individual states. Delaware has one of the most sophisticated, comprehensive and respected legal systems in the country. That makes Delaware the jurisdiction of choice for investors who want predictability and certainty in complex transactions, and it is why most of the best-known US companies are incorporated in Delaware.

Several provisions of Delaware corporate law make both day-to-day business and major events easier, for example:

• Shareholders of a Delaware corporation can act by written consent with a simple majority, while many other jurisdictions require unanimity or a so-called "supermajority".
• A Delaware corporation can complete a statutory merger with the approval of a simple majority of shareholders. Knowing a dissatisfied minority can be outvoted can make a Delaware target company more attractive to potential investors. Likewise, under Delaware law a company can sell (nearly) all of its assets with simple majority approval.

Above all, Delaware companies and their investors can draw on a deep body of experience in structuring financing and corporate governance arrangements, such as the terms of preferred stock and investor voting rights, with a high degree of predictability and certainty.

3How it works

Moving from a foreign company to a Delaware Corporation usually happens through a share exchange between the newly formed Delaware company and the shareholders of the foreign company. After the exchange, ownership of the Delaware Corporation mirrors the previous ownership of the non-US company, which then becomes a wholly owned subsidiary of the Delaware Corporation. All outstanding options to buy shares in the non-US company are also exchanged for options to buy shares in the new Delaware parent.

4Tax considerations

The potential tax consequences of a flip are highly complex and need careful analysis. Both the company and its shareholders should get thorough advice from tax experts before the flip.

Where possible, a properly structured flip should be tax-neutral for both the non-US company and its existing shareholders (and option holders). Existing tax benefits enjoyed by the non-US company and its shareholders (and option holders) should be preserved, such as the "carryover" of holding periods and original cost basis for capital gains tax purposes.

5Tax home of the US company

After a flip, the Delaware Corporation is a holding company with no operations. Its only asset (at least at first) is 100% of the share capital of the non-US company. Over time, the business may benefit from running some or all of its existing operations directly through the Delaware parent.

6Possible drawbacks

A Delaware holding structure has potential upsides and potential downsides. Possible pitfalls include:

• The tax implications are complex and require detailed analysis. Failing to follow these very specific rules and requirements could cost valuable tax benefits or cause other adverse consequences.
• Setting up a parent company in Delaware may expose the business to US litigation risk earlier than it otherwise would be. Without a US presence, the risk of a US lawsuit could be lower.
• If the company ultimately lists on a foreign stock exchange, a Delaware holding structure can make compliance considerably harder. In particular, the company is subject to US securities laws and can only issue securities under an effective registration statement with the Securities and Exchange Commission or under an exemption from that registration requirement.

7To flip or not to flip?

Setting up a new Delaware holding company is a major undertaking. It takes significant time from management and shareholders, plus the involvement of legal, accounting and tax advisors. The process gets more complex later in a company's life, as its capital structure and business relationships grow more complicated. So the management team is well advised to consider early in the funding cycle whether a Delaware flip makes sense. Despite the hurdles, the flip can be a promising path to new funding and long-term growth in company value.

Why Delaware is so popular with corporations and investors is covered on our pages Why Delaware is so attractive to big US corporations and Delaware for Dummies; everything else is collected in our Delaware hub. Here you can learn how we form a Delaware C Corporation for you.

In short

• In a Delaware flip, a new Delaware holding company is placed on top of the foreign company, often in connection with private equity or venture capital rounds.
• The reasons: the largest venture capital market, IPOs on the NYSE or NASDAQ, sales to US investors, and investors who know how a Delaware Corporation works.
• Technically, the flip runs through a share exchange: the shareholders then own the Delaware Corporation, the foreign company becomes its wholly owned subsidiary, and options are swapped for options in the new parent.
• Tax-wise, the flip is complex. The goal is a tax-neutral conversion, and both the company and its shareholders get advice beforehand.
• Drawbacks include earlier US litigation risk and US securities law if you later list on a foreign exchange. The earlier you look at a flip, the easier it gets.

How we help you

• Form a CorporationThe US corporation (Inc) for growth, investors and your visa.
• Delaware holdingThe holding above your US companies, with one consolidated tax return.
• Tax structureA clean structure between parent company and US subsidiary, or between you and your US company, coordinated with your accountant.
• Company formation consultationEntity type, state and tax consequences, before you commit.