Flip Transactions

Foreign startups “flip” into a U.S. corporate legal structure for various considerations, including: exit opportunities (whether through acquisition or the public market); potential higher valuations; broadening their investor base (some U.S. institutional investors may have internal rules prohibiting their investment in non-U.S. companies); and most commonly, accessing U.S. venture capital, which generally only invests in U.S. companies.

The standard process is to incorporate a new U.S. company (U.S. Newco), typically a Delaware corporation, and then to require existing shareholders of the foreign startup to tender their shares to the U.S. Newco in exchange for U.S. Newco shares. New governance documents of the Newco and new shareholder agreements between the shareholders, all of which closely mirror the existing agreements, will be executed between the U.S. Newco and the existing shareholders. After the share-for-share exchange, the foreign startup becomes a wholly-owned subsidiary of the U.S. Newco, and can begin conducting operations in the U.S. through the U.S. Newco while operating abroad through the foreign subsidiary. However, there are tax, intellectual property and business implications to the startup on such flip transactions.

Tax implications. Whether the flip transaction can be completed on a tax-free basis depends partly on the laws of the foreign local jurisdiction and the shareholder composition. Shareholders may defer tax via a deferred exchange structure where the existing shareholders enter into a put and call agreement with the U.S. Newco agreeing to effect the exchange at a liquidity event of the U.S. Newco. However, following the flip, the company would likely be subject to the U.S. taxation on its worldwide income including its overseas profits. These adverse tax consequences may deter sophisticated U.S. and foreign investors.

Intellectual property implications. The startup needs to consider which company will own intellectual property and how intellectual property or associated rights will be shared between the U.S. Newco and the foreign subsidiary (e.g. a licensing/cost sharing agreement). Proper planning is needed to minimize U.S. and foreign taxes on any inter-company royalties.

Business implications. The startup needs to be aware whether any of its existing contractual agreements with third parties will require a third-party consent in the event of a reorganization. In addition, the startup may become exposed to the risk of litigation in the U.S., and may need proper planning for liability and asset protection purposes. Further, foreign venture capital may be hesitant to invest a U.S. corporation.

Whether and when a flip is right for a foreign company is something worth much thought. For foreign startups envisioning taking advantage of the financial opportunities in the U.S., performing a flip early can avoid more complicated issues as the company grows. On the other hand, entering the U.S. tax system, and the reduced attractiveness of the company to foreign venture capital, may cause the company to want to wait to flip. Further, a flipping company should consider that the flip may be an optimal time to create a more sophisticated, tax-efficient structure for long-term planning.

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Roger Royse

Roger Royse, the founder of the Royse Law Firm, works with companies ranging from newly formed tech startups to publicly traded multinationals in a variety of industries. Roger regularly advises on complex tax structuring, high stakes business negotiations and large international financial transactions. Practicing business and tax law since 1984, Roger’s background includes work with prominent San Francisco Bay area law firms, as well as Milbank, Tweed, Hadley and McCloy in New York City.
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