Delaware Flip — A flip without the flop

As a founder, deciding where to register a start-up is an important and defining moment, and you must have heard about flipping a company to another country, usually in countries/states other than their base of operationsA flip can be done anywhere. But in this article we focus on a Delaware flip as  over 70% of African start-ups incorporated outside the continent are domiciled in Delaware. Before we delve into discussing the process of a Delaware flip, we need to understand why companies flip or incorporate in Delaware.

 Why do African start-ups incorporate in Delaware?

● Attract investors - to obtain funding from an investor in another jurisdiction; a flip is a common restructure that fast-growth companies undertake to attract financing, particularly from institutional venture capital funds who are most familiar with this jurisdiction. 

● Business-friendly environment - Most African start-ups incorporate in Delaware because the state has comprehensive and well-regarded corporate laws that allow predictability and certainty in the regulatory environment. The issue of political instability in most African countries makes policies grossly unreliable, which has affected foreign investors' confidence in investing in a start-up that is locally incorporated with no foreign parent company. It is also very difficult to enforce laws in Africa. Consequently, most investors require portfolio start-ups to incorporate in Delaware or other business-friendly jurisdictions.

● Getting accepted into Y Combinator- Y Combinator requires start-ups in the accelerator to have their parent company incorporated either in the US, Canada, Singapore, or the Cayman Islands. African start-ups accepted into YC must incorporate/register in a foreign jurisdiction, and Delaware is the most likely choice. 

What is a Delaware flip? 

Flipping a company to Delaware is the process of legally creating a new holding company with an existing company owned by the holding company. A new company will be incorporated in Delaware and flipped above an existing company by transferring the shares held in the existing company to the newly incorporated one. A Delaware flip creates a 'group structure' with the Delaware parent company at the top and the existing company as a subsidiary. A flip hasoccurred when you move from being a Kenyan or Senegalese or Nigerian or Ghanaian-owned company to being a Delaware company with a Senegalese subsidiary.

 There are different corporate structures for foreign companies in Delaware, and start-ups can flip to any of the structures available, such as Public Benefit Corporations; Public Benefit LLC; Limited Liability Partnerships (LLP); Limited Partnerships; Limited Liability Companies (LLC), corporations, etc. The preferred option is the Corporation structure, which allows start-ups to conduct business in more than 100 countries. There is no minimum capital requirement to form a corporation, and it can be incorporated with a single director and shareholder of any nationality. It is also not compulsory for corporations to have a resident director or physically conduct business in Delaware. 

 A Delaware Flip can be implemented through a business transfer, merger, or a share-for-share exchange. After effecting the flip, the ownership structure of the newly incorporated company will mirror the pre-existing shareholdings of the non-US company, and the registered company will be a subsidiary of the Delaware corporation. Any convertible loans, Options, and SAFEs will also be transferred to the Delaware corporation. The Holding Company (HoldCo) incorporated will hold all the shares, options, and ownership structure of the existing company, now "Subsidiary", and the ownership percentage of the existing investors and shareholders of the Subsidiary will be reflected in the HoldCo. 

What are the key steps?

● Incorporate the Holdco (usually a Delaware structure); 

● Existing shareholders of the existing start-up enter into a stock exchange agreement or a share surrender/transfer into Holdco (Holdco now owns all the shares in the existing start-up). The current shareholders in the Nigerian entity will need to sign documents transferring/surrendering their shares to the registered Holdco(There is a need to engage a lawyer to assist with this process). For instance, in a flip involving a Nigerian entity, the US lawyers take care of the incorporation of the holdco and draft the US documents (including the incorporation documents involving the holdco. For the share transfer/exchange, the Nigerian lawyers draft the resolution and file all necessary documents to give effect to the flip at the Corporate Affairs Commission for processing. There are instances where the company needs to increase the share capital of the Nigerian

● Existing shareholders are issued shares in Holdco- Ensure to keep the shareholders informed before going ahead with a flip.

What is the Cost Implication?

Please note that the cost implication varies depending on different factors within the company (For instance, for a flip involving a Nigerian entity, the fee may cost up to 5million or more. However, there are single entities who currently provide all the services to founders without having to engage with lawyers in both jurisdictions. This also makes the process more efficient, seamless and cost effective. Working with an expert saves you a lot of time and ensures things are done correctly.

Timeline to Complete a flip?

Just like the cost, the timeline for a flip varies- it may take weeks or even months, however, the consultant you have engaged will be able to provide guidance on how long it will take based on the circumstances of each case

 To Flip or not to flip?

It is best to Implement a Delaware flip at the early stage of the company. This is because a Delaware flip becomes a far more significant undertaking as a company grows and its capital structure becomes more complex, so the earlier, the better. 

Before doing a Delaware flip, it is essential to weigh the options and consider if there are other means of having a subsidiary or getting incorporated in Delaware without actually doing a flip. It is advisable not to do a flip if it is not necessary or required. Flipping a company can create exposure to higher tax rates, high legal and accounting fees, tax complexity and lots more paperwork. Generally, the exchange of shares in a flip would give rise to capital gains tax for the shareholders in the existing startup as they are disposing of a capital gains tax asset (being their shares). (Please consult a tax specialist on this before you proceed). 

Conclusion

The decision of whether or not to flip should not be made in haste because it is not easily undone, and the inversion of going from the US to a non-US holding company (doing a "backflip") could have adverse tax and other consequences. Please note that if you are licensed by a regulator in the existing company, you will require an approval from the regulator before you can successfully flip to the Holdco.

Are you thinking of a flip? Feel free to reach out to the team. For more information, please get in touch with us at [.]

Disclaimer:

This article does not constitute solicitation or provision of legal advice, and does not establish an attorney-client relationship. This article should not be used as a substitute for obtaining legal advice from an attorney licensed or authorized to practice in your jurisdiction. You should always consult a suitably qualified attorney regarding any specific legal problem or matter in a timely manner.