Overview
In the life of almost every growing early-stage company in Europe or (increasingly) Asia, the day comes when the founders conclude that their development is being constrained by a limited pool of venture and next-round investors in their geography. Many turn to the United States as new ground for the next wave(s) of private capital needed to fund expansion. However, some U.S. investors are hesitant to commit capital to an entity governed by legal rules and market practices with which they are not familiar. In many cases, this gap can be bridged by transferring all or a portion of the company’s assets to a newly formed U.S. entity, in which both the founders (directly or through their overseas company) and the new investors will hold equity (in the vernacular, a “flip”). Although this can be an attractive path, there are many complexities that must be negotiated in order to arrive at a successful outcome. What follows is a high-level summary of some of the principal issues.
First-Tier Questions
- Who – In the first instance, the founders will have to decide whether some or all of them will need to relocate, on a short- or long-term basis, to the United States in order to make the establishment of the U.S. presence successful. The same question arises for key employees of the overseas company, as well as for any minority shareholders it may have.
- What - Traditionally, flips are executed into a newly formed U.S. corporation. But attention should be paid to whether, in a given case, a different vehicle might be preferable (such as a limited liability company or “LLC”): the choice may be driven by answers to the other questions in this section.
- When – The determination of when to execute a flip is delicate. Transfer the business to the United States too soon, and there may be only tepid interest among potential investors and a throttling of later-stage investment capital from other countries; wait too long, and the benefits of accessing the U.S. investor market may be impaired.
- Where – Because of its flexible company laws and experienced business courts, Delaware is by a long stretch the most popular destination for new U.S. entities. This does not limit where in the United States the new company’s activities may be conducted, or where it seeks new capital.
- How – Often, the flip is effected by a share exchange whereby equity in the overseas company is contributed to the U.S. venture in exchange for that entity’s newly-issued securities. However, other forms of transaction are available, driven in part by the extent and nature of any asset transfers to the new entity.
Follow-On Considerations
The answers to the preceding first-tier questions will lead to addressing the following matters (which in turn, depending on the outcome, may cause some of those earlier answers to be revisited, in a “virtuous loop” process from which the optimal solution may arise):
- Immigration – Shareholders and employees relocating to the U.S. in order to manage the new entity will need to secure entry and employment permissions through the various U.S. visa programs.
- Service Agreements – Employees and independent contractors of the new entity will require agreements covering their terms of service.
- Benefits – Although health and retirement benefits are often deferred until the new entity becomes more established, equity options are generally an integral part of the compensation paid to service providers. Exercise, cancellation or replacement of options outstanding with the overseas company will need to be considered as well. Where restricted stock is part of the compensation package, another set of (mostly tax-driven) issues must be addressed.
- Taxation – This is a multifaceted issue. Ongoing U.S. tax considerations are an important driver of the choice of structure for the new entity, and will affect the founders and service providers as well. These matters will need to be coordinated with the tax rules in the overseas company’s home country (and, if different, the residence country(ies) of the founder(s)), to minimize double taxation and avoid, if possible, the imposition of an exit tax upon a change of domicile.
- Asset Transfers – The contracts and intellectual property of the overseas company may need to be transferred, in whole or in part, to the new entity in order for it to conduct its operations. There may be restrictions or notice requirements built into those items; in addition, the effect of the flip on any subsidies that the overseas company enjoys must be taken into account.
- Securities Regulation – Although generally manageable, attention must be paid to ensuring that the equity issued by the new entity qualifies for an exemption from the onerous federal and state securities regulation requirements in the United States.
- Post-Flip Contracts – It is often the case that ongoing commercial relations are established between the overseas company and the new entity in conjunction with the flip. Since the parties are related to each other, those intercompany agreements must be structured and drafted with care to satisfy the tax and other regulatory requirements in the relevant countries.
Conclusion
There can be many reasons for thinking that a flip may be a solution to an overseas startup’s growing pains. Creating a U.S. entity may attract a wider range of venture capital investors (or even “angels”) who have experience and familiarity with the U.S. market, laws and pattern documentation. Accessing a large B2B or consumer market and facilitating an exit through a joint venture, strategic acquisition or public offering are other drivers frequently cited in support of flip transaction.
However, the summary above shows that a flip may not suit all overseas startups at their particular stage of growth, and that, even for those it does, it is emphatically not a “one-size-fits-all” solution. That said, with proper planning, multiple structural options exist that may make a flip a very desirable solution in appropriate circumstances; many experienced U.S. consultants in law, accounting, employment, and business development are available to assist in this process – most effectively, if they are introduced early in the process.
