Early-stage (Seed and Series A) US venture capitalists often insist they will invest in a UK company only if the company “flips” its corporate structure and establishes a US (typically Delaware) holding company. We addressed these dynamics in a 2015 article, noting that high US corporate tax rates were leading some early-stage US investors to reconsider their traditional insistence on a Delaware flip as a condition for investment. Many active and well-known investors were becoming comfortable with investing in UK parent companies and with UK-style documentation. However, the recent reduction of the US federal corporate tax rate from 35 percent to 21 percent, and our subsequent conversations with UK founders and US investors regarding the impact of these tax changes, suggest it may be time to revisit some of the arguments for and against the Delaware flip.
Besides the incremental complexity and cost, an argument early-stage US investors commonly make against investing in UK companies relates to employee equity. Shares in certain types of US companies (such as C corporations organized in Delaware) can provide US taxpayers with tax advantages that don’t extend to shares in a UK company. As a result, UK companies doing business in a highly competitive labor market such as Silicon Valley will be at a disadvantage relative to companies who can offer potential employees equity in a US company.
Another argument often advanced is that proactively executing a Delaware flip (i.e., before signing a term sheet requiring a flip as a condition of closing the round) reduces friction with potential US investors. However, paying outside advisors to execute a Delaware flip without the certainty of an immediate capital infusion can impair the company’s financial health.
Rather, UK founders willing to flip for the right US investor and the right deal terms should simply make their position known to any potential US investor raising concerns about investing into a UK holding company; there’s no need to flip at the preliminary discussion stage. With careful tax planning, a UK limited company usually can execute a Delaware flip at any point in its life cycle without incurring UK tax liability. Accordingly, there’s little downside to waiting until the flip is absolutely necessary, and the amount invested and value added by the US investor justify the costs.
The Delaware flip is a subject with which the GBx community clearly is very familiar, being the companies and investment firms at the front end of this decision-making. We would greatly appreciate your comments – are our observations consistent with your experiences?
The complete article “Revisiting the Delaware Flip” is available here as part of the Tech Nation / WSGR US Expansion and Fundraising series. The foregoing does not constitute legal advice and should not be relied upon for business or legal decisions.