Doing a Delaware flip - Think before you flip, or it might be a flop

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We are increasingly working with UK companies doing business in and seeking investment from the US. While the legal systems in the UK and the US have similar concepts of corporate structures, the differences can create anomalies.

It may be necessary or beneficial to attract US investors for a UK company to put a US holding company in place. This is often referred to as a Delaware flip, where a new US holding company is created to hold the shares of an existing UK company. This is typically achieved by the shareholders of the UK company exchanging their shares for shares in a newly-formed US corporation, usually a Delaware “C” corporation. After the flip, the UK shareholders own shares in the Delaware corporation which owns all of the shares of the UK company. The terms of the UK company’s investment and shareholder documents will be reflected in the Delaware corporation’s constitutional documents. The UK company, now a wholly-owned subsidiary of the Delaware corporation, usually continues to employ its staff and conduct business as prior to the flip.

Based on our experience with Delaware flips, we recommend thinking through the rationale for the flip, as well as the timing and preparing well before undertaking a flip, or it may turn out to be a flop.

Early-stage investment

Prior to embarking on a Delaware flip, UK companies may accept US investment under a SAFE. A SAFE (Simple Agreement for Future Equity) is a US-style of investment contract between a start-up company and an investor that gives the investor the right to receive equity of the company when certain events occur, such as the next equity financing in excess of an identified amount. SAFEs are typically based on a standard form of agreement which originated with Y-Combinator.

When a UK company accepts a SAFE investment, there is a potential mismatch between the provisions of the SAFE documents and the UK company’s corporate structure. For example, a SAFE will typically be triggered by the issue of preferred stock and refer to common and preferred stock, while a UK company may not have these classes of shares. The UK company will also need to understand the governance requirements for any share issue authorization under the SAFE and may need investor consent.

Why flip it up?

Entry. While US investors may be open to investing in early-stage UK companies (via a SAFE or otherwise), there remains some resistance, and US investors may require their investment to be made in a US entity. Some US accelerators will only accept a US company onto their programmes. If the disconnect between the provisions of the negotiated SAFE documents and the UK company’s corporate structure are significant enough, a Delware flip might be the best solution.

Exit. Forming a US holding structure may facilitate a sale to a US acquirer or going public on the NYSE, NASDAQ or another US public market.

The in-between. Since some US buyers may prefer to “buy American,” forming a US company may increase US business (although this may also be achieved more simply by forming a US operating subsidiary of the UK company).

Timing is all

Implementing a Delaware flip is less common in growth-stage financing (Series B or later), and more prevalent in the early investment stages (Seed and Series A). This is likely because a Delaware flip becomes a far more significant undertaking the more a company grows and its capital structure becomes more complex - the fewer things to migrate, the better. Involving external advisors to advise on a Delaware flip without the assurance of immediate investment may be unnecessarily expensive and time-consuming and if attracting US investors in the early stages is not essential for a company, the Delaware flip may not hold such an advantage.

The comparative US and UK corporate tax rates may also be a factor. US federal corporate tax rates were historically higher than in the UK. However, since 2018, the US corporate income federal tax rate has been 21%, and despite President Biden’s promise of an increase in corporate income tax to 28%, the federal tax rate is now closer to the UK rate.

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As a Delaware flip can be complex, time-consuming and involve a significant number of documents, pre-planning is key.

The UK company’s records and share registers should be reviewed to confirm that they are up to date and in order – the starting point for the flip should be a “clean”, compliant UK company.

As the flip process involves migrating a UK company’s shareholdings fully to a US corporation, 100% shareholder approval is required. Companies should identify shareholder support of the proposed flip, consider if a drag along is required and, if so, feasible and the time frames involved.

Any convertible loans and SAFEs should also be transferred to the Delaware corporation. While the standard form of SAFE has a built-in consent to this, a convertible loan may not and investor consent would be required. As shares in the Delaware corporation would be issued for any SAFEs or convertibles, any restrictions on assignment and change of control provisions of commercial contacts should be reviewed. Third-party consents may be required.

There may be many documents to be signed and it is often useful in practical terms to ask shareholders to sign a power of attorney to authorise the UK company’s directors to sign the flip documents on their behalf. Some investors may not agree to do so, and the logistics and timing of the signing process should be considered.

With advance planning and tax advice, a flip may be executed without incurring UK taxation on the share-for-share exchange. If the UK company has any EIS investors or EMI options, there are additional tax implications of the flip which may be addressed with sufficient planning.

If there is a US subsidiary corporation set up for the UK company, a separate US corporation would generally be required for the “flip up” to a US holding company, as the holding company will sit above the UK company as the group holding company.

A UK company should be sure that a Delaware flip is the best option for its development – it is not easily undone and the inversion of going from a US to a UK holding company (doing a “backflip”) could have negative tax and other consequences. In expanding and accessing the US market, or in seeking early-stage US investment, a Delaware flip may prove beneficial if not essential. If a company does not necessarily need early US investment, or if its future plans do not include a US base then executing a Delaware flip may offer more challenges than benefits.

MBM’s US Team has experience in preparing for and advising on Delaware flip transactions, so if this is something you are considering or would like to understand more please contact us for more information.

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