What is a Delaware Flip?
Q: A Delaware Flip is:
A. An advanced gymnastics move credited with helping Sunisa Lee win gold for the USA in the Tokyo Olympics
B. Joe Biden’s favourite dessert
C. way for you to more easily access the deeper and broader US capital pools
A: It’s definitely C.
It has been a growing trend for UK tech scale ups to ‘move’ to the US to help them raise the larger sums required in later funding rounds. US investors tend to be both bigger and braver in the cheques they are willing to write, as well as often reluctant to invest overseas with an unfamiliar legal system and unfamiliar documents. In fact, some investors and accelerators, such as Y Combinator, will only invest in companies headquartered in the US. As the tech funding market tightens, we are seeing even more interest.
How does it work?
- Share for share exchange. It is not possible to ‘move’ a UK company to the US. You would have to incorporate a new company in the USA, generally Delaware for tax reasons, and then your existing shareholders sell all of their shares to the Delaware Newco in exchange for the Delaware Newco issuing them with new shares in the Delaware Newco. The net result is that you have a US holding company and a UK subsidiary and all of your shareholders hold shares in the US holding company.
- New shareholders agreement and constitution. Unfortunately, your existing legal documents, under English law and intended for an English company, won’t travel. You will need US lawyers to prepare new documents under US law for the Delaware Newco.
- ASAs/Convertible Debt/Options. Any Advanced Subscription Agreements, convertible debt and/or share options will need to be transferred to the new Delaware company, with the precise requirements depending on their specific terms, and potentially requiring consent from the investor or option holder.
What are the advantages?
- Makes Fundraising in the US Easier. US investors will now be familiar with your corporate form, and can invest using documents they are familiar with (some funds may even be prevented by their fund rules from investing in non-US companies). However for some US investors this won’t be enough – they will want to see ‘boots on the ground’ and a meaningful, physical US presence.
- Makes Doing Business in the US Easier. US customers and US employees will prefer dealing with a US entity. However the same benefits might be achieved by incorporating a US subsidiary.
- US Tax Breaks. Your investors and US employees may be able to benefit from US tax breaks like the Qualified Small Business Stock exemption.
- Easier US Exits. If your eventual exit is an IPO in the US or a sale to a US buyer, selling a US company tends to be easier. However some US buyers (with cash held outside of the US that would be taxed if they repatriate it) actually prefer buying a non-US company (as a way to use that trapped cash without paying US taxes on it).
What are the drawbacks?
- S/EIS. S/EIS benefits can be retained, but the process is not straightforward and requires pre-clearance.
- Higher Tax Rates. You will become subject to US corporate taxes, which tend to be higher than those in the UK, although recent US corporation tax rate reductions have helped reduce the gap.
- Cost – in time, effort and professional fees. There is paperwork to produce and you will need the consent of shareholders to undertake the flip. Going forward you will need US lawyers and accountants (potentially in addition to your existing team) and they tend to be more expensive than UK advisors.
- Hard to reverse. Although an ‘inversion’ or ‘back-flip’ where you change from Delaware back to the UK is possible, it generally comes with unattractive tax consequences.
I‘m still interested– what do I do?
- Consider exactly why you want to do it.
- Make sure you take specific legal and tax advice in both the UK and the USA to ensure you will achieve what you hope, and to flag any unintended consequences.
- Given the potential drawbacks (and there being no guarantee of finding US investment) we generally recommend it is undertaken once you have an investor who requires it, and not speculatively.
Who do I talk to?
Us! You will also need input from your tax advisors and US lawyers – we can introduce experienced specialists, if you don’t already have advice. We can also co-ordinate the whole process if required.
For further information, please contact David Martin (david.martin@smb.london) and Simon Halberstam (simon.halberstam@smb.london).
Authored by David Martin and Simon Halberstam, partners in the SMB corporate/tech teams.