Many foreign founders and investors that are coming to the US are full of anxiety about moving their startup there. One of the main fears is the complexity of the flip transaction. Undeniably it is complicated process and no flip is the same, but there are some basic transaction issues and standards that you should keep in mind when planning a flip transaction. In this post, we wanted to share our experience and shed some light on the various flip “pain points” and “myths”.
As you can imagine, this arcane area of the law requires an understanding of US and foreign venture capital/startup standards, US and foreign tax implications, and cross-border planning. At the end of this blog posts, a foreign founder and venture capitalist should have a basic roadmap of how to move a startup painlessly to the US.
What is a flip?
A flip is the process of reincorporating the startup in the US, simultaneously making the foreign entity a subsidiary of the new US company and reissuing US shares to foreign shareholders (founders and/or investors). Sounds simple but in terms of corporate and securities law there are at least four corporate issues that are complicated. Firstly, correctly transferring shares of foreign shareholders to the US company or creating mechanisms that allow foreign shareholders to enjoy the benefits of the US corporation without actually transferring such shares. Secondly, correlating and mirroring shareholder rights from the foreign entity in the new US entity, including vesting, investor rights, and intra-founder arrangements and then if need be adjusting them to US standards. Thirdly, replicating the foreign cap table or, more commonly, readjusting the cap table to US VC standards. Finally, there are multiple US securities law issues that both foreign founders and investors have to keep in mind when receiving US shares. We will address these issues in separate blog posts soon.
The flip consists of three steps. Step one is the formation of a Delaware corporation by the current shareholders of the foreign company. Step two consists of transferring of 100% of ownership of the foreign company to Delaware company. This might require a transfer deed and in many jurisdictions a notary. In exchange, the foreign shareholders receive US shares. Step three foreign shareholders founders and investors) enter into US style venture documents. Usually European style documents consist of the investment agreement and articles of association while US style documents consist of the charter, stock purchase agreement, voting agreement, investor rights agreement and ROFR and co-sale agreement at minimum.
Tax, tax and tax again.
One of the main drivers of flip structuring and the flip documents are foreign tax considerations. There are significant foreign tax considerations when the shares are transferred as (i) a contribution to new company, (ii) exchanged (swap) or (iii) donated to the US company by the foreign shareholders. Each scenario has to be examined by foreign tax counsel before the flip and properly documented by the US transaction lawyers. For example, the transfer of foreign shares to the US might trigger income recognition by the founders or investors. Many times, investors and/or founders do not have the liquidity to pay for such an unexpected tax event. A US flip might also trigger repayment of obligations of foreign grants or benefits, such as EU funds. A foreign tax might be also triggered when ownership holding periods for the shares are not satisfied.
Other issues that are important in the flip transaction are labor law considerations and intellectual property. In terms of labor law, it is crucial to determine where the founders will be employed to properly plan cross-border employment matters such as US visa issues, or withholding taxes for foreigners in the US. Another item that is crucial is whether and when foreign IP is being moved to the US.