If you’re an international startup founder interested in expanding into the U.S., you may have heard of something called a “Delaware flip.”
While its name may confound, don’t worry—a Delaware flip doesn’t require extensive knowledge of geography or gymnastics. Instead, it describes what happens when a company incorporated outside the U.S. creates a new holding company within the U.S. (specifically, a Delaware C corporation) and “flips” it above the pre-existing company. This process is called a “flip” because it involves the swapping of shares in the pre-existing company with shares in the new holding company. The end result is a U.S. corporate entity that may be a much more attractive proposition to U.S. investors.
For reasons we’ll explain below, many venture capitalists and early-stage investors may not be interested in investing in your company unless it’s a Delaware corporation. But a Delaware flip can be expensive in terms of legal and accounting fees, and it adds a layer of complexity to your corporate structure that may not be necessary in every case.
Read on to learn if a Delaware flip is right for your non-U.S. startup. We’ll also review the basic steps involved in flipping a non-U.S. startup to a Delaware C corporation, so you’ll be more prepared if you do choose that route.
What is a Delaware flip?
A flip describes an event in which a company that’s incorporated in a non-U.S. country (e.g. Germany, the U.K., etc.) changes its corporate structure and establishes a U.S. holding company. This holding company is typically a Delaware C corporation, which is why this maneuver has come to be known as the Delaware flip.
Why even do this in the first place? In the vast majority of cases, a Delaware flip is executed at the behest of U.S. investors who want to invest in a non-U.S. startup but don’t have an appetite for navigating foreign corporate structures. Many venture capitalists and angel investors in the U.S. are comfortable with Delaware corporations and aren’t prepared to take on the additional costs and complexities of navigating a different corporate structure. Some venture capital firms may even have specific rules that bar them from considering investment in non-U.S. companies.
The specific mechanics and costs of a Delaware flip shouldn’t be taken lightly. This can be a complex and expensive maneuver, and in some cases an alternate approach might be wiser. For example, if your company only needs to register in the U.S. in order to hire U.S.-based employees, you may want to consider creating a U.S. subsidiary instead.
To truly understand the pros and cons of a Delaware flip, it helps to step back and consider what it is about Delaware, specifically, that leads so many companies to register there in the first place.
Why do so many startups incorporate in Delaware?
For such a tiny state, Delaware sure is home to a lot of businesses. The State of Delaware Division of Corporations brags that “more than 1,000,000 business entities have made Delaware their legal home.” This is due in large part to the state’s famously business-friendly tax and corporate legal system, the latter of which has produced so much corporate case law that there’s usually a precedent for any new issue that crops up.
Here’s an overview of some key potential advantages for an international startup considering registration in Delaware:
- Business tax benefits. While other U.S. states also offer favorable tax environments, Delaware really goes out of its way to attract founders’ attention. The state doesn’t collect corporate income tax from companies that don’t conduct business within its boundaries. It also doesn’t tax stock if the owner lives out of state.
- Business-friendly corporate requirements. Delaware requires only one person (a Delaware Registered Agent) to maintain an address in the state—so there’s no need to convince a founder or director to uproot and open a new office in Dover or Wilmington. And just one person is required to be a director, whereas other states may have more complex or onerous requirements.
- The Delaware Court of Chancery. The Court of Chancery is a specialized non-jury trial court that adjudicates a wide range of corporate cases. It relies on over 200 years of case law, and its decisions tend to be based on precedents that make the outcomes relatively predictable.
- Investor preference. All of the above reasons have led countless startups to register in Delaware—which, in turn, has led to VCs and angel investors becoming increasingly familiar with the state’s corporate environment. While it’s not true that U.S. investors are only interested in Delaware corporations, it’s common for a potential investor in an early-stage funding round to require a Delaware flip before agreeing to invest in a non-U.S. company.
When should a non-US company do a Delaware flip?
Let’s be clear: a Delaware flip is not appropriate for all non-U.S. startups. In general, you’ll only want to consider a Delaware flip if your startup has already incorporated in a non-U.S. country but you need to create a holding company in the U.S. to attract future capital investment.
The out-of-pocket costs involved in executing a Delaware flip can be steep. Depending on factors including shareholder interests and the number of prior fundraising rounds, companies can rack up legal advisory and other fees that can approach a total in the five- to six-figures. For this reason, it may not make sense to do a Delaware flip before the moment when it’s absolutely necessary. Flipping your company before you have a lead investor locked in can leave you exposed to downside that you may otherwise be able to avoid.
With that said, there may be cases in which a company considers doing a Delaware flip as a means of attracting new investors that otherwise wouldn’t give it time of day. A lot of this may depend on the country you’re flipping from, as U.S. investors may be more willing to accept certain foreign corporate structures more than others.
In any case, international founders should be fully aware of the consequences of a Delaware flip prior to doing one. In many cases a reverse or “backflip” won’t be possible, or it may come with considerable U.S. tax and legal consequences.
Do I need to do a Delaware flip if I haven’t incorporated yet?
No! It’s called a flip because it describes the act of flipping from one corporate structure to another. If you’re the founder of a non-U.S. startup that hasn’t yet incorporated in your country, you may want to consider incorporating in Delaware first.
Starting as a Delaware C corporation (as opposed to flipping from a foreign corporate structure to a Delaware C corporation) may make more sense in the long run—especially if you know you’ll eventually want to raise money from U.S. investors.
How to do a Delaware flip
The steps involved in a Delaware flip may vary depending on how you decide to implement the flip.
The most common approach involves a process in which shareholders in the non-U.S. company effectively swap their existing shares for shares in the new U.S. holding company. As part of this process, the non-U.S. company becomes a wholly owned subsidiary of the new U.S. company.
To illustrate this process, let’s use an example of a fictitious German limited company called Guten Tag GmbH. This Berlin-based company has a number of existing shareholders, including the founders, early employees, and a few seed investors.
If Guten Tag GmbH wants to do a Delaware flip, the process may involve the following general steps:
- The company files Delaware articles of incorporation. This begins the process of creating a new corporation in Delaware called Good Day, Inc. As part of this process, the company will also need to enlist a Delaware Registered Agent who will be responsible for liaising between the company and the state.
- Existing shareholders in Guten Tag GmbH agree to give up their existing shares to Good Day, Inc. This agreement includes an understanding that any shares they give up will be replaced with new shares in the U.S. holding company.
- Good Day, Inc. acquires all of the existing shares in Guten Tag GmbH. This results in Guten Tag GmbH becoming a wholly owned subsidiary of Good Day, Inc., which now serves as the U.S.-based holding company
- Shareholders receive their new shares in Good Day, Inc. The new shares are typically issued on a proportional basis with the old shares, so a shareholder with a 1% ownership stake in Guten Tag GmbH ends up with the same 1% ownership stake in Good Day, Inc.
Rather than a definitive guide, this is intended to serve as a high-level overview of a process that will likely involve a number of idiosyncrasies depending on the company involved.
Also, it’s important to note that this is not the only way to execute a Delaware flip. Another way, for example, may involve the creation of a U.S. company that functions in tandem with the existing non-U.S. company rather than subsuming it entirely. (This is less common and possibly less enticing to investors, whose principal desire is usually to simplify the corporate structure to make it more suitable for their investment.)
Alternatives to the Delaware flip
Unless you need to execute a Delaware flip in order to placate an insistent investor, you may be better off considering an alternative approach. Here are a couple of examples:
- Form a U.S. subsidiary. This may be a better route if your only or primary reason for expanding into the U.S. is operational in nature. For example, you may want to tap into the U.S. talent market and hire U.S.-based employees. A U.S. subsidiary could also make more sense if you simply want to sell products to customers in the U.S. or engage in some other commercial pursuit.
- Have a conversation with your investors. The investment landscape is changing all the time. Some investors may be increasingly willing to consider non-U.S. companies if the business case is compelling and the corporate environment isn’t too much of a deterrent. Depending on where you’re based, an investor may be willing to play ball. This isn’t going to be true for every non-U.S. startup, but it pays to have the conversation before jumping into an expensive and consequential shift in your company’s corporate structure.
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If you’re an international founder thinking of registering in the U.S., you may be wondering what business banking can look like on a global scale. Levro is building a one-stop shop for businesses looking to expand globally, with an infrastructure that grows alongside your business and continually optimizes for cost and compliance.