The process of taking a company incorporated outside the USA and making it into a Delaware corporation is often referred to as the “Delaware flip.” Many overseas startups make this move to become a US company to access the US venture startup ecosystem when raising a larger round of financing.
Not sure you’re ready to do the Delaware flip? If you're building a fast-growth startup and you want to raise later stage venture capital, it may be your best option. Most US venture capital funds typically only invest in companies registered in the US due to the preferential tax treatment for capital gains and exemptions under QSBS. This article covers how to get started.
Heads up: If you’re based outside the USA and haven’t already incorporated in your own country, it’s easy to incorporate a Delaware C Corporation as a foreign founder.
Why do the Delaware flip?
Bottom line: Investors prefer Delaware corporations over any other business entity type. Many VCs and angel investors won’t even consider investing in a startup unless it is already incorporated in Delaware—or prepared to become a Delaware corporation before the investment.
Delaware’s large body of corporate case law, efficient Chancery Court, and tax benefits all make it attractive to investors, which in turn makes it attractive to companies looking to incorporate. Nearly 100% of startups that have incorporated in the past five years are incorporated in Delaware, as are more than 66% of Fortune 500 companies. As a result, serious investors are very familiar with how a Delaware corporation works. And they aren’t really interested in investing in corporations residing elsewhere.
For a full rundown of the reasons investors prefer Delaware corporations—and the benefits of incorporating there—see our article, Why Do Startups Incorporate in Delaware?
When to do the Delaware flip
Typically, entrepreneurs who have incorporated their startups somewhere other than Delaware do the Delaware flip when:
- They’re about to start approaching investors to raise capital
- They’ve found a lead investor, but the investor requires the startup to incorporate in Delaware before they make an investment
- The startup is preparing to hire US employees, and wants to issue them equity as part of their compensation
When you’re about to start approaching investors, it makes sense to do the Delaware flip because being incorporated in Delaware will help make your Startup UK Ltd.ppealing to a wider range of investors.
When you’ve found a lead investor, they’ll typically require you to incorporate in Delaware before investing, for all of the reasons covered above in “Why do the Delaware Flip?”
When you’re preparing to hire employees—particularly, employees in the USA—you’ll need a Delaware corporation in order to attract them with equity. A Delaware corporation is the standard structure for startups, so shares in any other type of company have considerably less value on the secondary market. As a result, tech workers who want to be compensated with equity want equity in a Delaware corporation, specifically.
Timing the Delaware flip
Most startups can’t afford to be flippant about the Delaware flip. Moving your corporation to Delaware—in name, if not physically—can be a significant undertaking, particularly if your Startup UK Ltd already has more than two or three shareholders, or holds intellectual property.
As covered in more detail below, shares and intellectual property must be transferred between business entities during the Delaware flip. The more that needs to be transferred, the more work you have to do. Or, more precisely, the more work your lawyer has to do—and the bigger your legal bills will be.
With that in mind, you may be inclined to do the Delaware flip as soon as possible, and reduce the amount of baggage you have to deal with later on. But, for an early stage startup, even a relatively simple Delaware flip can put a strain on finances.
Deciding when to do it is a balancing act—but, if your startup is incorporated anywhere other than Delaware, the Delaware flip is almost certainly necessary if you want to raise funds from investors. Delaware corporate law is widely understand by both US and foreign investors, so you will gain access to a wider pool of investment capital after converting over to a Delaware C Corp.
How to do the Delaware flip
In most cases, for most companies, the Delaware flip looks like this:
- You have a company registered outside of Delaware, called Startup UK Ltd.
- One or more founders—and possibly employees or very early investors—hold shares in Startup UK Ltd..
- You file articles of incorporation in Delaware, creating a stock corporation. It’s called Startup USA Inc.
- You also hire a registered agent for Startup USA Inc. Typically, this registered agent is a company located in Delaware; they act as your point of contact for communicating with the State of Delaware. (You’re required by law to have a registered agent in the State of Delaware.)
- You offer to issue shares in Startup USA Inc to everyone who owns shares in Startup UK Ltd. In exchange, they agree to give all of their shares to Startup UK Ltd.
- Startup USA Inc acquires all of Startup UK Ltd’s shares.
- Once Startup USA Inc has received 100% of shares in Startup UK Ltd, Startup UK Ltd becomes a subsidiary of Startup USA Inc.
- Typically, each individual who gave Startup UK Ltd shares to Startup USA Inc now holds an equivalent number of shares in Startup USA Inc. For instance, if your co-founder owned 25% of Startup UK Ltd, they should now own 25% of Startup USA Inc.
You can think of your new Delaware holding corporation as a sort of “container” for your original company. By holding stock in the Delaware company, each shareholder in turn holds an interest in its assets—your original company.
Clearly, this is a highly simplified overview. Every company is different, and some factors—such as intellectual property, which (following our example above) must be purchased by Startup USA Inc from Startup UK Ltd.—may complicate matters.
You will need to contact all of the stockholders and offer them an agreement whereby they receive shares in your new company in exchange for their shares in the old one. In order to do this, you’ll need to hire a law firm, or use a tool like Capbase.
This is one task that absolutely must be carried out with the help of lawyers, or with a service like Capbase, which uses lawyer-approved paperwork. If you hire a lawyer, this is the reason having a large number of shareholders in your non-Delaware company can make a Delaware flip more expensive than it would be otherwise.
If your first company holds significant assets—intellectual property, cash, etc.—a lawyer can help you determine if or how these assets should be transferred to your new company. You may also want to consult with your tax accountant, in case the transfer of assets has the potential to create extra tax liability.
Additional considerations about the Delaware flip
A couple extra, perhaps not-so-obvious points to consider when planning a flip:
- Staff. Typically, staff already employed in your current company will remain employed in that company once it becomes a subsidiary of your new Delaware corporation. New US employees, in this case, would be hired and employed by the Delaware corporation.
- Convertible notes, SAFEs, and similar instruments. Expect non-US equivalents of convertible notes and similar guarantees of future equity to complicate your Delaware flip. Depending on the details in these contracts, you may need to exchange new instruments for the old ones, or obtain consent from noteholders for the flip.
- Local tax implications. Depending on the laws in your home jurisdiction, there may be tax consequences to converting your company to a US entity. You should seek legal advice, in addition to consulting with tax experts in your home country, before finalizing the process for making your local entity a subsidiary of a newly registered Delaware corporation.
- Tax and reporting requirements for your new Delaware corporation. US corporations are required to file an annual tax return with the Internal Revenue Service or IRS. In addition, you will be required to make an annual report and pay franchise taxes in Delaware every year. Depending on how the financial relationship is structured between the foreign company and the newly created parent company in Delaware, it may be possible to minimize the annual income tax obligation for both entities. Get tax advice from financial advisors with experience dealing with multi-national corporate structures.
Reducing the cost of the Delaware flip
One way to reduce the cost of a Delaware flip is to outsource the more standard legal operations—like filing articles of incorporation, authorizing shares, or filing an 83(b) election for your new corporation—to a service that costs you less money than hiring a lawyer would.
When you use Capbase, you file your articles of incorporation in minutes, and get a comprehensive dashboard for raising funds, signing contracts, and tracking your cap table. You also employ a Delaware registered agent. In effect, you get all the tools you need to issue shares in your new company to shareholders in your old company.
Even if you are the only shareholder in your company—you own 100% equity in it, or it’s a pass-through entity (sole proprietorship or LLC)—you need some way of issuing shares in your new Delaware corporation to your person. Capbase allows you to issue those shares easily.
You’ll still need to hire a lawyer to draw up agreements for shareholders in your old company, and to help complete the transfer of old shares to your new company. But a significant portion of the work—plus later tasks, like using SAFEs and convertible notes for fundraising, and issuing employee stock options—is handled by Capbase for a fraction of the price of hiring a lawyer to do the same.
- Startup investors in the USA and abroad prefer companies incorporated in Delaware. Many US investors won’t even consider a startup registered elsewhere. If you’re based outside the USA, Capbase can create a Delaware corporation for you.
- If you have a company registered outside of Delaware, you need a Delaware corporation in order to raise capital on US markets. Even if you don’t register now, new investors will likely require you to form a Delaware corporation. Most US venture capital firms will only invest in a US registered corporation for tax reasons.
- Knowing when to perform the Delaware flip is a balancing act between your budget and your need to create an investable company.
- If you hire lawyers to do a Delaware flip, legal fees will be higher than the more shareholders you have in your existing company. But using Capbase, you can complete basic tasks—like filing articles of incorporation and hiring a registered agent—for a fraction of the price of hiring a lawyer to do the same.
Some founders preparing for the Delaware flip are intimidated by the Delaware franchise tax. It looks big on paper, but if you know how to file properly, you can drastically reduce your State tax burden. Learn how to avoid paying thousands of dollars in Delaware franchise tax.