Delaware Flip: Definition, methods, and working process

What is a Delaware Flip

A Delaware Flip is a legal reorganization where your foreign business becomes a wholly owned subsidiary of a newly formed US parent company. Structurally, this restructuring will look like this:

Typically, your shareholders exchange their equity for shares in the new US company, but there are also other ways to execute a Delaware Flip. Due to this, the US company then owns 100% of your foreign operating entity, and original founders and investors then hold shares in the US parent.

Importantly, a Delaware Flip doesn’t automatically move all your assets, employees, contracts, operations, and IP to the US. They generally stay with the foreign entity unless a separate transfer is carried out.

In other words, a Delaware Flip isn’t about relocating your business to the US. Instead, your foreign company can continue to operate as a subsidiary of the US parent. This setup makes your company more accessible and attractive to US investors, as it aligns with their investment structure.

This forms a Delaware corporation that meets seed, Series A, or institutional investor expectations.

Why should you consider a Delaware Flip

Beyond seeking US investors, you may choose to flip for several other reasons such as:

• Complying with a US investor’s preference or requirement for investing through a Delaware entity
• Meeting the requirements of a US accelerator, such as Y Combinator
• Expanding into the US market and hiring local employees to be part of your workforce strategy
• Setting up a US-compliant equity structure for employee equity grants and stock options
• Streamlining the legal structure of your company for a US-based exit or M&A strategy
• Streamlining the legal structure of your company for IPO plans or future acquisitions
• Establishing an IP ownership structure that complies with US law
• Aiding your long-term plans for running US-centric operations

When you may not need a Delaware Flip?

A Delaware Flip is not always necessary for non-US founders to conduct operations in the US. For instance:

What type of entities can be registered in Delaware

1. Corporation or C-Corp:

A Delaware C-Corp is the most common entity for a Delaware Flip. Founders typically flip into it through a stock-for-stock exchange, asset purchase, or cross-border merger. This structure gives you access to multiple stock classes and the Court of Chancery, making it the preferred choice for companies seeking an IPO or VC funding.

2. LLC

Members of the LLC trade their membership interests for stock in a newly formed Delaware C-Corp via an exchange agreement. Apart from that, LLCs can also execute a statutory conversion directly into the Delaware entity, if permitted by local and state laws. With fewer corporate formalities, this route is generally simpler. However, LLCs are often converted early since VCs typically prefer investing in a C-Corp structure.

3. General Partnership or GP

In this case, partners contribute their partnership interests to a newly formed Delaware corporation in exchange for shares. This effectively converts the GP into a corporate structure. As a GP offers no liability protection, this flip is often paired with legal steps to formally dissolve the partnership and transfer contracts and assets to the new entity.

4. Public Benefit Corporation or PBC

If you run a foreign mission-driven company, you can flip into a Delaware PBC through a stock-for-stock exchange or a merger, similar to a standard C-Corporation flip. You can also adopt a specific public benefit purpose in the charter. This will let your company preserve all the social or environmental mission under Delaware’s legal framework, while making you eligible to access VC funding.

5. LLP and LP

A contribution agreement is proposed in this route, enabling partners to exchange their partnership interests for shares in the newly formed Delaware entity. Since LPs and LLPs cannot directly convert into a corporation in most cases, a contribution agreement stands effective. This flip is less common and is mostly preferred only if your business is transitioning from a professional services or multi-owner partnership model towards an outside equity investment.

In what ways can a company make a flip

There are multiple ways you can structure a flip, and the most common approaches include:

Stock-for-stock exchange

In this, the Delaware company owns all shares of your non-US company. As founder of the company, you exchange your foreign shares for Delaware shares, making the transaction simple.

• Impact: Your foreign company becomes a 100% owned subsidiary. Founders and investors hold shares in the Delaware parent, instead of the original entity.
• When is it preferred: It is preferred when you want a clean and straightforward flip with full ownership transfer and minimal complexities.

Asset purchase

Delaware company purchases your business assets and intellectual properties. The payment may be in cash or as Delaware company stock.

• Impact: Only the selected IP and assets move to the Delaware entity rather than the whole company. This may trigger separate tax treatment on the sale.
• When to prefer: If you want to transfer selective assets or IP without carrying over all liabilities of the foreign entity.

Cross-border merger

In this approach, your non-US foreign company and Delaware firm merge, and the latter survives the merger.

• Impact: Foreign entity legally ceases to exist, and Delaware company absorbs all its assets, operations, and liabilities.
• When to prefer: If you want full consolidation of your foreign company into a single US entity, and are prepared to navigate through the added cross-border regulatory and legal compliance.

Partial stock acquisition

The Delaware company buys some of your stock, while you or your existing investors get to keep some of the shares.

• Impact: The ownership is split between the Delaware parent and existing shareholders, rather than being fully consolidated.
• When to prefer: If founders or investors intend to retain a direct stake in the foreign entity while still gaining a US structure for a considerable portion of ownership.

These are not the only methods to execute a Delaware Flip, but are the most common and simplest methods among all others.

Advantages and disadvantages of Delaware Flip

Before you decide whether to move forward with a Delaware Flip, it’s worth weighing the advantages and disadvantages carefully. This is because a Delaware Flip may bring real benefits for accessing US capital, but it also comes with added tax exposure, costs and compliance obligations. The disadvantages can quickly outweigh the benefits, depending on your stage and business goals:

What are the key considerations for making a Delaware Flip

Here are some of the priority considerations that need your attention before you move ahead with a Delaware Flip:

Taxation

It is paramount to understand the tax implications in both the US and the home country before executing the flip. Depending on the structure you choose, this can trigger costs like capital gains tax on exchanged shares, exit taxes from the home country, and tax questions around moving IP to a Delaware entity.

Check whether your home country offers tax incentives, such as R&D credits or startup exemptions. This is because these benefits are tied to a domestic entity and may be lost if you don’t handle the Delaware flip carefully. The rules vary a lot depending on the country and preferred structure. So, it is best to work with tax or legal advisors who can guide you throughout the approach.

Corporate structure

Before going forward with the flip, you must review share capital, subsidies, contracts, debts, and other existing financial commitments. This assessment identifies the potential pitfalls for an exchange and allows proper planning to avoid them.

For instance, some contracts may have clauses that require third-party consent for structural changes, requiring careful handling before the flip transition.

Costs

Take into consideration the Delaware flip costs, which can vary depending on the method you choose for the transition. There will be legal and tax costs involved in the process, but that won’t be all.

You also need to budget for the operational expenses of maintaining the business structures in both jurisdictions during the transition.

How does the Delaware Flip work

Delaware Flip may be a complex and lengthy process, and here’s a step-by-step representation for a better understanding of how it works:

Convert multiple share classes into one

If your foreign entity has multiple share classes, it will make the overall exchange process complicated. Converting those shares into one standard share class beforehand is often recommended, as it tends to make the flip easier in the further steps.

Updating the shareholders’ agreement

It’s crucial to seek legal advice when updating your share classes, as the transaction may require amendments to shareholder arrangements, option arrangements, corporate approvals, and other documents. All of it needs to be handled and documented lawfully.

Appointing a US legal team

By this step, you’ve prepared your foreign company and its share classes for the Delaware Flip.

You must then appoint a US legal team to carry out the steps involved in establishing the new holding company in Delaware. They will initiate the incorporation process, involving drafting and signing the company formation documents.

Alongside the US legal team, most flips also require a Delaware-registered agent for handling statutory filings, a home-country tax or legal advisor, and a US tax advisor to manage tax implications of the new structure. They ensure the flip complies with all the local laws and doesn’t violate any existing regulatory or tax obligations.

Execute the share exchange

Now, the US holding corporation has its equity ready for the share exchange. You must then transfer the shares of your foreign company to the new US holding corporation. In return, you receive shares of the US parent, resulting in your company being a wholly owned subsidiary of the US parent corporation.

Coordinate the international tax clauses

A Delaware Flip transaction can often be structured to be tax-neutral or tax-free for US federal income tax purposes. However, this isn’t automatic because the tax treatment depends on your transaction structure, shareholder circumstances, applicable rules, and entities involved.

Therefore, proper planning is essential as rules vary widely depending on the home country. For instance, the UK does not tax the exchange, but Ireland imposes stamp duty on such share transfers, even in flips.

As the country-wise rules vary, you must involve both the US as well as your foreign counsel or tax advisors in the Delaware Flip process.

Finalizing the exchange agreement

This becomes the legal contract, outlining how your foreign stakeholders exchange their shares for shares in the Delaware company. It will have details such as the exchange ratio, associated transfer mechanisms, shareholder approvals, and how existing options, SAFEs, or convertible notes will be treated in the new structure.

Following that, the agreement also includes any potential founder vesting terms that need to carry over. It has all the representations and warranties from both parties, along with closing conditions for finalizing the exchange.

It is crucial to ensure that the exchange agreement and the way it’s carried out are compliant with the regulations of foreign countries. This involves notifying the relevant bodies in the country and updating the share register.

Establish your intercompany agreements or operational structure

Once the flip is secured, the US and foreign companies must work together to set a streamlined working process. For this, you must:

• Decide on the IP ownership, which the US parent often owns. However, this still depends on the business needs and tax planning.
• Structure your cash flow between the entities via intercompany loans, capital contributions, stock purchases, or service agreements, keeping the transfer pricing rules in mind. This way, the intercompany dealings can be priced at arm’s length.
• Set up intercompany services agreements for formalizing the support clauses for each entity, such as shared admin, management functions, or engineering.
• Clarify the payroll and employment arrangements, including which of the entities will be responsible for employing staff in each country, and how to maintain local payroll compliance.
• Determine which of the two entities contracts with customers, since this directly affects the revenue. Also, determine which entity bears the related liabilities.
• Decide where the expenses and revenue sit across the group, as this shapes the tax position and financial reporting of each entity.

What to do after the Delaware Flip

Once your Delaware Flip is completed successfully, here are the next steps you must adopt for wrapping up the entire process:

• Obtain an EIN, where applicable, to identify your new US entity for banking and tax purposes.
• Open a US business bank account for the Delaware entity to start operating in the country.
• Appoint or maintain a registered Delaware agent to handle all legal notices and statutory filings.
• Set up tax compliance and accounting processes for your new US entity, including any state or federal filings.
• Establish your intercompany agreements for formalizing how the foreign and US entities can work together, both operationally as well as financially.
• Update your equity administration to reflect the new share structure, and ensure all the stakeholders are properly recorded.
• Review the US state registrations in any state where your business has operations, employees, or physical presence.

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