A Delaware Flip involves inserting a US holding company above your UK company or group structure either to attract US investors or as a condition of a US investment.
This article explores what is involved in a Delaware Flip, the advantages and disadvantages and the need to give careful consideration as to whether it is the right route for you.
What is a Delaware Flip?
In a Delaware flip a new US holding company is created, typically in Delaware, that will hold all of the shares in your existing UK company. This is achieved through a ‘share for share’ exchange where the shareholders of your UK company exchange their shares in that UK company for shares in the Delaware company.
Why you might contemplate a Delaware Flip?
US investors nearly always drive the need for a Delaware Flip. They are more familiar and therefore comfortable with US corporate and tax law. US corporate law is governed by individual states and the state of Delaware has developed a sophisticated and respected corporate legal regime. US investors looking to the longer term also see benefits in terms of easy access to the US public markets and also, as an exit strategy, to potential US buyers.
To which stage of funding does a Delaware Flip apply?
A Delaware Flip will typically apply in the early investment stages, namely in relation to seed funding or Series A.
It is a rarity in later funding stages as it becomes a much more complicated and therefore expensive process as there are more assets, third parties and operational issues involved.
Even at the early investment stages, a Delaware Flip involves a lot of external professional advice, which equates to cost and expense. It is therefore essential that the promised US investment will be immediate on the Flip being put in place and that the Flip is absolutely necessary for that investment.
What are the benefits of a Delaware Flip?
The principal benefit of a Delaware Flip is that you can access US investment, particularly US venture capital. Additional longer-term benefits include:
- A US holding company gives easy access to US public markets. Whilst a non US company can list on US markets, the process is expensive and cumbersome.
- A US holding company may create additional exit options through access to the large US market of potential buyers, who may only wish to buy US entities.
- A US holding company may give easier access to the US consumer market, though this may also be achieved through a US subsidiary of a UK company.
What are the drawbacks of a Delaware Flip?
The main drawback of a Delaware Flip is the expense involved in putting one in place, principally in meeting the legal requirements and also in navigating two tax regimes. It is therefore critical to be sure that the Delaware Flip is the correct route for you and absolutely necessary for any proposed investment to occur. Additional drawbacks include:
- It raises complex tax implications and potentially exposes you to a higher tax rate in the US than in the UK. There may also be transfer-pricing implications.
- It exposes you to the risk of US litigation.
- It increases the legal compliance burden as both US and UK legislation will apply.
- If you decide to list on a non US market in the long run, then that will be a more expensive and complex procedure.
- There is usually no going back or ‘backflip’ for tax reasons.
What is involved in a Delaware Flip?
The Delaware Flip involves the incorporation of a new US corporation, typically in Delaware. All of the shareholders in the UK company will then exchange their shares for shares in the US corporation, which becomes the holding company of the UK company. No cash changes hands. The shareholders own shares in the US corporation in the same proportions as they did in the UK company and with the same rights and benefits.
The UK company is now a wholly owned subsidiary of the Delaware corporation and continues its business as it did before the Flip.
What due diligence do you need to do?
A Delaware Flip is a complex transaction. The following due diligence will require to be undertaken:
- Shareholder consent: as all shareholders are required to exchange their shares, all shareholders will have to consent to the Delaware Flip.
- Share options: if the existing UK company has granted any share options then these will have to be dealt with, typically by replacing them with options in the US corporation.
- Tax clearances: any tax clearances and consents will have to be obtained.
- Third party consents: the consent of third parties, for example in customer or supplier contracts, may be required in order for contracts to be assigned to the new US corporation or as a result of change of control provisions.
- Intellectual property: decisions may have to be made as to which company owns any intellectual property and if any additional intellectual property applications need to be made.
- Licences: if there are any licences to operate or in relation to any assets or technology, checks will have to be made as to whether these can continue, given the change of control in the corporate structure or whether any consents are required.
- Insurance: a review of your insurance requirements will be needed, especially in relation to the increased risk of US litigation.
- Contracts: a review of your contracts will be required in order that they comply with any additional US legal requirements.
A Delaware Flip, whilst appearing simple in concept and potentially giving access to the vast US investment market, is not to be undertaken lightly. It is complex, time consuming and expensive. It therefore not only has to be an actual requirement for an immediate investment in your company but also has to fit your long-term vision and plan for your business.
There is no harm in being robust with your current business structure and insisting to US investors this does not change. We have supported several of our clients in doing so and none has lost the proposed investment as a result, once we were able to make the US investor comfortable about the UK structure.