What is a "Delaware flip"?

Here at SSM PC, one of the most frequent questions that we receive from our foreign entrepreneurs with businesses in their home countries is how to set up a US-based entity so that they can do business in the States.  

Are you seeking venture capital financing in the States?

One of the most important deciding factors in determining how to set up American operations is whether American venture capital funding is a predominant part of the equation.  

By way of example, when a startup from Europe who has received limited funding in its home country comes to the States to raise a more substantial round of funding from American investors, American venture capitalists might advise the startup to do what is colloquially called a “Delaware flip.”  

Conversely, if the foreign company is not a traditional startup and is not seeking equity investment here in the States, it does not necessarily have to do a “Delaware flip.”  It can simply create a Delaware subsidiary of its foreign parent.  

What is a Delaware flip?

In a Delaware flip, all of the shareholders who hold equity/shares in the foreign company exchange their equity/shares with the newly-formed Delaware C corporation, in order to receive proportionate equity/shares in the newly-formed Delaware C corporation.  When this happens, the foreign company essentially becomes a wholly-owned subsidiary of the Delaware C corporation, as it now has a single owner, the Delaware C corporation.  The shareholders instead own equity/shares in the Delaware C corporation.

[Caveat: In the cases of startups operating in regulated industries in the United States, such as FinTech startups, it may also be wise to consider flipping into the Cayman Islands instead because of complications arising from compliance with American securities laws.  The resulting structure may be that the foreign shareholders own the newly-formed Cayman’s entity, which then owns a Delaware entity in full, which then owns the abroad entity in full.]  

What happens after a Delaware flip is accomplished?

The foreign company continues its operations in the home country.  Frequently, American venture capitalists investing in the new Delaware C corporation ask the key C-suite level officers of the company (i.e., the CEO, for example) to manage the operations and team here in the States.  The new funding received from American investors will be used predominantly  to fund the Delaware C corporation’s operations, but may also be used to fund some activity by the foreign corporation.  There may be a sale of technology from the foreign entity to the new Delaware C corporation during this process as well, such that the new Delaware C corporation owns the technology previously created/owned by the foreign company.

What are some common considerations that accompany the Delaware flip?

Below are some questions that owners should consider in accomplishing a flip:

1. What are the tax implications resulting from how the technology will be either shared between the two entities or sold from one entity to the other via a licensing agreement or sale agreement, respectively?  
2. Can the Delaware flip be accomplished on a tax-free basis?  
3. Is the foreign company now subject to taxes in the States?
4. Do any contracts previously entered into by the foreign corporation require third-party consent in the event of a Delaware flip transaction?
5. Does the Delaware C corporation have liability insurance in the United States?
6. Is the timing right?  Often, it is strategically more advantageous to flip the ownership interests when the company is still young.  

An accountant that frequently works with clients who have cross-border transactions, or a tax lawyer familiar with international tax concerns may research and advise as to the answers to the first three questions.  

Oftentimes, the lawyer in the home country who previously set up or consulted with the foreign corporation to establish operations abroad is already familiar with the foreign entity’s legal documents.  He or she can advise as to the fourth question, as well as draft the necessary board consents for the foreign company to enter into the Delaware flip transaction.  Lawyers here in the States can set up the Delaware C corporation.  The home-country lawyer will work with American lawyers to accomplish the flip transaction.

Smith Shapourian & Mignano, PC is available to answer any questions or concerns you may have regarding a Delaware flip.  

This blog does not constitute solicitation or provision of legal advice, and does not establish an attorney-client relationship. This blog should not be used as a substitute for obtaining legal advice from an attorney licensed or authorized to practice in your jurisdiction. You should always consult a suitably qualified attorney regarding any specific legal problem or matter in a timely manner, as statutes of limitations may bar your claim.