The Origin
Delaware, famously known as The First State, earned this title by being the first to ratify the US Constitution in 1787 with its status as a corporate hub dating back to the late 19th century. Delaware enacted its General Corporation Law in 1899, offering businesses flexible governance structures and reduced taxes on out-of-state revenue. The state further cemented its appeal by establishing the Court of Chancery, renowned for its specialized expertise in corporate law. These elements, along with legal predictability and low franchise fees, have made Delaware an attractive destination for companies worldwide.
Despite having a relatively small population of about 1.1 million, Delaware is home to over 1.9 million legally incorporated companies. This includes more than half of all public companies in the US and 60% of the Fortune 500 firms. Notably, the top 10 companies featured in Fortune Magazine’s rankings are incorporated in Delaware underscoring the State’s appeal as a corporate-friendly location. It is worth noting that the choice of Delaware as the State of incorporation in the US is not driven by tax considerations. In fact, there are no tax advantages to speak of; the choice is really driven by corporate law considerations and investors’ familiarity with the legal form of Delaware entities.
What is a Delaware Flip?
The term “Delaware Flip” describes the process of a non-US business establishing a US holding company, thereby forming a new group structure. This restructuring is most often undertaken to meet the requirements of an attractive investment proposition put forward by a funding partner based in US. The new US corporate entity will then own all the shares of the pre-existing UK holding company.
The process is executed through a “share-for-share” exchange, where shareholders of the UK company swap their shares for equivalent shares in the newly formed Delaware entity. This initial exchange ensures continuity of ownership for the existing shareholders. It is then followed by a dilution of their equity in the new US company as the new US investors come onboard.
The key steps involved in a Delaware Flip include:
- Incorporating a US holding company (New TopCo) in Delaware, with no (or only subscriber) shares in issue.
- Making a clearance application to HMRC to help ensure the share swap does not result in a tax charge for the existing UK investors
- Issuing new shares in the US TopCo to the UK company’s former shareholders in a share for share exchange.
- Addressing the transfer of convertible instruments such as convertible notes, SAFEs (Simple Agreement for Future Equity), options (including ESOPs or Other Employee Incentives) and warrants from the UK TopCo to the US TopCo, ensuring all financial and ownership structures are aligned.
- Application for relief from UK stamp duty on the transaction (if available).
Running operations through a US entity comes with substantial tax and compliance responsibilities. Therefore, non-US entrepreneurs should carefully evaluate these factors before deciding to set up in the US.
Special care is also required if any of the existing UK investors have benefitted from either Enterprise Investment Scheme (EIS) relief or Seed Enterprise Investment Scheme (SEIS) relief. Whilst it is still possible to maintain these reliefs with a US
TopCo, the compliance burden can be considerable.
Although entering the world’s largest commercial market is highly beneficial, the associated costs don’t have to be excessive. However, without proper attention, the complex US tax and regulatory landscape can lead to increased expenses.
Why Consider a Delaware Flip?
Early-stage US venture capitalists, particularly those investing at the Seed or Series A stage, often require non-US based companies to undergo a Delaware flip before committing funds. Their familiarity with these corporate structure offers a more straightforward investment process with fewer tax and compliance complications.
For later-stage financing, such as Series B or beyond, US investors are less likely to demand this restructuring. Growth-stage investors are generally more understanding of the additional complexity and costs associated with investing directly in a UK company. Regardless of the nationality of the holding company, UK companies seeking early-stage funding typically need a strong presence in the US, such as having a founder based there, as well as demonstrable traction in the US market to attract a lead investor from the region.
For early-stage financing, shares in US companies offer tax benefits under the US tax code that UK company shares cannot match. As an example, the Qualified Small Business Stock (QSBS) exemption allows eligible investors to shield up to $10 million in federal capital gains, or up to 10 times the cost basis of their investment if greater, on shares held for more than five years. This is compared to the less generous Business Asset Disposal Relief (BADR) in the UK where the relief is capped at £1m for a lower rate of capital gains tax and is available to employees of the company only (not investors). This puts UK ownership structures at a disadvantage in competitive investment market when seeking to allure US investors.
By undertaking a Delaware Flip, companies can align their structure with US norms and take advantage of these strategic benefits, positioning themselves more competitively in the global marketplace.
When Is the Right Time to Flip?
For the vast majority of UK founders, attracting US Venture Capital (VC) Investment will be the primary driver for undertaking a flip. Many argue that proactively executing a Delaware flip before securing a term sheet helps reduce friction with potential US investors; however, this approach can be premature and counterproductive. UK founders would likely be better served communicating their openness to ‘flipping’ for the right investor and favourable deal terms. With careful tax planning, a UK limited company can restructure at any stage often without incurring significant UK tax liabilities, allowing flexibility to postpone the flip until necessary. This approach preserves financial stability and maintains flexibility for future growth and investment.
Balancing flexibility and financial opportunity should be the primary focus for UK entrepreneurs courting US investors. Paying external advisors to execute a Delaware flip without the certainty of immediate funding can place unnecessary strain on a company’s financial resources. Moreover, once a UK company flips into a US holding company, reversing the process (“Delaware backflip” or inversion) is extremely difficult and can result in long-term tax consequences that are unfavourable for the business.
Positioning Your Business for Success in the US
Expanding into the US presents a wealth of opportunities for businesses seeking to tap into a vast and dynamic market. Whether through a Delaware flip or establishing a subsidiary, strategic planning is essential to minimize tax exposure and ensure compliance with US regulations. By addressing these considerations early and leveraging expert advice, businesses can mitigate risks, avoid unnecessary costs and position themselves for long-term success in the US market.
At Frazier & Deeter, our integrated team of US and UK advisors works seamlessly to support businesses through every stage of expansion. With a global approach and local expertise, we help companies navigate the complexities of cross-border structuring, tax planning and compliance. Contact us to learn how we can guide your US expansion with a strategy tailored to your needs.
Contributors
Malcolm Joy, Managing Partner, FD UK
Jonathan Clark, Tax Partner