A non-US company may choose to form new Delaware holding company structures for several reasons, including:
- The United States remains the principal source of venture capital and other private financing.
- Some of the world’s premiere stock markets are located in the United States and an initial public offering (IPO) and stock exchange listing on NYSE or NASDAQ can lead to better access to capital and offer a potential path to liquidity.
- A trade sale to a US acquirer is often seen as an ideal potential “exit” and re-incorporating in the US can help facilitate a sale.
- Sales of products by US companies to US or non-US companies are easier than by non-US companies.
Operating through a US holding company achieves each of these objectives. Consequently, an increasing number of non-US companies — including companies that currently have minimal or no operations in the US — are choosing to form Delaware holding company structures, often in connection with private equity, venture capital or other private financing rounds. This article examines some of the key considerations involved in “flipping” a non-US company into a Delaware holding company structure.
Over the years, private equity and venture capital firms in the US have devoted substantial time and effort to developing standards for the complex web of documentation involved in their investments. Private equity and venture capital firms in the US also generally feel most comfortable with the corporate mechanics available in a US entity — for example, they understand and are comfortable with the way in which the rights of preferred stock can be structured under US corporate law.
In addition, many venture capital and private equity firms believe that a US entity will offer more advantageous opportunities for an exit, either through an M&A transaction or an IPO, because:
- The public markets in the US remain attractive to investors. Although non-US companies can list on US markets, the process can be more expensive and cumbersome than a listing for a US company. In addition, some US institutional investors are prohibited from buying the securities of non-US companies. Further, investment bankers and venture capital firms often argue that listing a US entity on the NASDAQ can result in numerous benefits to the company and its investors, including a higher valuation and increased liquidity (which in turn can enable investors to exit the company with fewer adverse trading consequences). Some market participants believe that this “home turf advantage” may be a primary reason for the lower investment returns of non-US venture capital funds compared with those of their US counterparts.
- Many potential acquirers are based in the US, and these potential acquirers will likely be more comfortable dealing with the corporate mechanics and structuring of the acquisition of a US target.
In the US, corporate law is governed by the individual states. The State of Delaware has developed one of the most sophisticated, comprehensive and well-regarded bodies of corporate law in the US. So Delaware has become the most favored jurisdiction for investors seeking predictability and certainty in complex transactions. For this reason, the majority of the best-known US companies are incorporated in Delaware.
Certain provisions of Delaware corporate law facilitate the management of both a company’s day-to-day operations and its significant corporate events. For example, under Delaware law:
- The stockholders of a Delaware corporation may act by written consent with only a simple majority vote, while many other jurisdictions require unanimous or super-majority consent.
- A Delaware company can effect a statutory merger with another company with the consent of a simple majority of stockholders. The certainty of being able to eliminate an unhappy minority may make a Delaware target more attractive to a potential acquirer. Similarly, under Delaware law, a company can sell all, or substantially all, of its assets to a potential acquirer with the consent of a simple majority of stockholders.
Most significantly, Delaware companies and their investors can draw upon a substantial body of experience in structuring financing and corporate governance arrangements — for example, the terms of preferred stock and the voting rights of investors — with great predictability and certainty.
The flip from a non-US company to a Delaware corporation is usually effected by a share-for-share exchange between the newly formed Delaware company and the existing shareholders of the non-US company. After effecting this exchange, the shareholdings of the Delaware corporation will mirror the pre-existing shareholdings of the non-US company, and the non-US company will be a wholly owned subsidiary of the Delaware corporation. In addition, any outstanding options to purchase shares of the non-US company will be exchanged for new options to purchase shares of the new Delaware parent company.
The potential tax consequences of a flip are very complex and must be analyzed and considered carefully. Both a company and its shareholders should seek detailed tax advice from tax advisers prior to effecting a flip.
To the extent possible and practicable, a properly structured flip should generally be tax neutral to both the non-US company and its existing shareholders (and optionholders), and the existing tax benefits enjoyed by the non-US company and its shareholders (and optionholders) should generally be preserved (such as the “carry over” of the holding periods and original cost bases for capital gains tax purposes).
Following a flip, the Delaware corporation will be a holding company with no operations. Its sole asset (at least initially) will be 100% of the share capital of the non-US company. Over the course of time, the company may benefit from conducting some or all of the existing operations directly through the Delaware parent.
A Delaware holding company structure, offers both potential benefits and potential drawbacks. Possible pitfalls include:
- The tax implications of the flip are complex and require detailed analysis. Any failure to comply with the very specific rules and requirements could result in the loss of valuable tax benefits or cause other adverse consequences.
- By forming an ultimate parent company in Delaware, the company may become exposed to the risk of litigation in the US at an earlier point in time than would otherwise be the case. With no presence in the US, the risk of litigation in the US could otherwise be remote.
- If the company ultimately chooses to list on a non-US stock exchange and not to list in the US, the creation of a Delaware holding company structure may significantly complicate legal compliance matters. In particular, the corporation will be subject to the US securities laws and will only be able to issue securities pursuant to an effective registration statement on file with the US Securities and Exchange Commission or pursuant to an exemption from such registration requirement.
To flip or not to flip?
Forming a new Delaware holding company structure is a major corporate undertaking and requires significant investment of management and shareholder time, as well as input from legal, accounting and tax advisors. The process grows more complex later in the life of a business, as the capital structure and commercial relationships of a company become more complicated. A company’s management team would do well to consider whether a flip makes sense for the company in the early stages of its financing lifecycle. Despite the hurdles, the flip may provide a promising route to new financing and increased shareholder value over the long term.
