For startups seeking investment, the journey often involves navigating various legal and financial considerations. One important decision that UK and other non-US companies may face when attracting US venture capital is whether to undergo a “Delaware flip.” This process involves restructuring the corporate entity and establishing a US (typically Delaware) holding company.
What is the Delaware Flip?
The Delaware flip, also known as a “domestication” or “reincorporation,” is a strategic move made by non-US companies seeking investment from US venture capitalists. It entails creating a new US holding company and merging the existing non-US company into it. The new US entity then becomes the parent company, and the former non-US company becomes its subsidiary.
Delaware is widely regarded as a corporate haven due to its business-friendly laws and well-established legal system. Many US companies, including large corporations, choose Delaware as their state of incorporation. Investors are familiar with Delaware corporations and are often more comfortable investing in companies with this structure.
Benefits of the Delaware Flip:
- Attracting US Investors: US venture capitalists often prefer investing in Delaware corporations due to their familiarity with Delaware law and the favorable business environment it offers. By flipping to a Delaware holding company, non-US startups become more attractive to US investors, potentially unlocking more significant funding opportunities.
- Legal Protection: Delaware’s well-established legal system provides robust protection for shareholders and offers clear and predictable corporate laws. This legal framework reassures investors about their rights and protections, contributing to a more secure investment environment.
- CFIUS Considerations: The Committee on Foreign Investment in the United States (CFIUS) has oversight over foreign investments in the US. Flipping to a Delaware holding company can help mitigate potential CFIUS concerns, making it easier for non-US companies to receive US investment.
- Enhanced Flexibility: Delaware law provides a wide range of options for corporate governance, making it easier for startups to implement different types of shareholder agreements and equity structures, which can be appealing to investors.
- Tax Benefits: While tax considerations are essential and may vary based on individual circumstances, some non-US startups may find tax advantages in a Delaware holding company structure, especially for employee equity incentive programs.
Challenges and Considerations:
- Cost and Complexity: The Delaware flip involves legal and administrative costs, including consulting with legal and financial experts, and filing necessary documents. Startups need to weigh these expenses against the potential benefits.
- Tax Implications: Flipping may have tax implications both in the home country and the US. It’s crucial for startups to seek professional advice on how this decision may impact their overall tax strategy.
- Shareholder Approval: Depending on the company’s jurisdiction and governing documents, obtaining shareholder approval for the flip may be necessary.
Key considerations for UK businesses to consider:
When considering a Delaware flip from a UK perspective, certain critical factors require careful attention. First and foremost, pre-clearance from HMRC is essential. The UK company must apply for clearance under section 138 of the Taxation of Chargeable Gains Act 1992 (TCGA 1992) to ensure compliance with tax regulations. However, pre-clearance will not be granted if the flip is perceived as an attempt to avoid tax or if it is part of any tax avoidance scheme. To qualify for genuine commercial reasons, the flip should primarily aim to secure US investment or facilitate smoother operations with US employees or commercial partners, without avoiding UK tax obligations.
Additionally, after the flip, shareholders’ rights should be mirrored between the former UK company and the new US entity. Shareholders of the UK company must receive shares in the US company that replicate the rights they had in the UK company, maintaining equity proportions as in the original structure.
Lastly, for companies benefiting from SEIS/EIS investment, it is crucial to maintain a UK “permanent establishment” during the three-year qualifying period from the last SEIS/EIS investment. This ensures that tax relief eligibility remains intact and guarantees adherence to SEIS/EIS program regulations.
Challenging the Delaware Flip: Arguments from a UK Perspective
From a UK perspective, there are several arguments against the Delaware flip, which involves restructuring a non-US company to establish a US (typically Delaware) holding company. These arguments are worth considering when evaluating whether the flip is the right move for a UK-based startup seeking US venture capital. Let’s explore some of the key points:
- Complexity and Cost: The Delaware flip involves legal and administrative complexities, which can be both time-consuming and costly. Startups may need to engage legal and financial experts to navigate the process, incurring significant expenses that could strain their financial resources, particularly in the early stages of their development.
- Tax Implications: Flipping to a Delaware holding company may have tax implications both in the UK and the US. While some tax advantages may be gained in the US, startups must carefully consider the overall tax impact, including potential UK tax consequences. It’s essential to consult with tax experts to assess the specific tax implications for the company and its shareholders.
- Shareholder Approval: Depending on the company’s jurisdiction and its governing documents, obtaining shareholder approval for the Delaware flip may be necessary. Securing unanimous consent from all shareholders might prove challenging and could introduce delays or roadblocks in the process.
- Maintaining UK Incentive Programmes: The UK offers attractive incentive programmes such as the Seed Enterprise Investment Scheme (SEIS) and Enterprise Investment Scheme (EIS) to encourage investment in startups. Flipping to a Delaware holding company could impact the company’s eligibility for these tax incentives, potentially discouraging UK-based investors.
- Home Market Advantage: Some UK startups may find it more advantageous to maintain their UK identity and legal structure to benefit from local support and incentives. They may prefer to build on the UK’s growing startup ecosystem, which offers access to government support, research institutions, and other resources.
- Competitive Labour Market: Startups based in the UK, particularly those operating in technology hubs like London, may face fierce competition for talent from other startups and tech giants. Offering employee equity in a US company as a result of the Delaware flip might put UK companies at a disadvantage when attracting top talent.
- Potential Investor Resistance: While many US investors are familiar with Delaware corporations and may prefer them, some investors may be open to investing in non-US companies without a Delaware flip. Opting not to flip might simplify the fundraising process and reduce friction with investors who are not insistent on a Delaware holding company.
For global startups seeking US venture capital, the Delaware flip can be a pivotal move that opens doors to increased funding opportunities and investor confidence. However, the decision to undergo a Delaware flip requires careful consideration of legal, financial, and tax implications.
It’s essential for startups to seek expert guidance to make an informed decision that aligns with their growth strategies and long-term goals. Seven Legal are able to help with UK startups debating whether or not this may be a viable option when looking for expansion opportunities. Do not hesitate to contact our team to see how we can work together.
The preceding information does not constitute legal advice and should not be relied upon for making business or legal decisions.