ACTIVIST VC BLOG
As promised in our last blog entry, we will now cover the mechanics of a Delaware flip in more detail.
While there are many ways to do a flip, one of the more common ways is described below. (In our example, we use Finland and US as the origin and target countries.)
- Incorporate a new company (usually a Delaware C-Corp) in the US (Delaware Inc).
- Make the share classes and other legal documentation similar to the original Finnish company (Finnish Oy).
- Next, all of the shareholders of the Finnish Oy exchange their shares to the corresponding Delaware Inc shares.
- Now the Finnish Oy is a wholly owned subsidiary of the Derlaware Inc.
As the cap tables of both companies are identical, all shareholders have been treated transparently and equally. The outcome is a US parent company giving us some potential advantages as discussed in our previous blog: Should I flip my startup to the US?
The ideal transaction structure and execution mechanics depend on your exact circumstances and jurisdiction. Be sure to consult an experienced lawyer and a tax specialist to make sure you structure the deal right.
Below we have listed some of the most typical issues to be carefully considered before a flip:
- What are the tax implications resulting from the share swap?
In some jurisdictions (like Finland) the share swap described above is a taxable event. In our experience, this has not been a problem if the flips have been done early enough: the flipped entities were at that time still very small, heavily loss-making and the balance sheets were quite light. The swapped shares were considered practically worthless by the local tax authority resulting only in minimal taxes.
- What is the right timing for the flip? As a general rule, the earlier the easier: cap tables are simple, there are fewer shareholders, the balance sheet is light, there are fewer other commitments potentially limiting the moves, etc. Making the flip just before the next funding round can sometimes help: the company running out of cash and being about to go belly up supports the low value of the flipped entity and helps the valuation discussion with authorities.
- How to implement employee options tax-efficiently? Could the low valuation validated during the flip help us to grant shares or options to the employees to create more tax efficient incentives?
- How the IPRs and technology will be shared between the two entities?
- How to handle possible transfer pricing between the two companies?
- Do we have any contracts that require third-party consent in a change of control situation?
Here’s one further possibility to consider: create a Delaware parent company for your startup from the get-go. This is a worthwhile option especially if your startup’s success is likely to require US-centric business, follow-on funding, and exit path.
As stated in the previous blog entry, our recommendation in most cases is to avoid a full flip but to Americanize the company by transferring sales and key executive management to the US but leaving the parent company in the Nordics.