Understanding A Delaware Flip

How Does a Delaware Flip Work?

In a Delaware flip, a US holding company is created (usually a Delaware “C” corporation), that will hold all or majority of the shares in your existing non-US company (Nigeria, South Africa, Kenya, Guinea, Ghana etc). Basically, the shareholders in the non-US (local) entity will exchange their existing shares for shares in the US entity. The ownership structure remains the same, but now these shareholders hold shares in the Delaware corporation, and the local entity will be a subsidiary of the Delaware corporation. 

To do a Delaware flip, What do I need to do?

Basically these two major things:

a. incorporate a new company in Delaware

b. transfer asset, ownership of the existing local company to the newly incorporated Delaware company

How to do a Delaware flip?

The steps involved in a Delaware flip may vary depending on how you decide to implement the flip. The most common approach involves a process in which shareholders in the non-U.S. company effectively swap their existing shares for shares in the new U.S. holding company. As part of this process, the non-U.S. company becomes a wholly owned subsidiary of the new U.S. company. 

To illustrate this process, let’s use an example of a fictitious Kenya limited company called Teddy Tag Ltd. This Kenya-based company has a number of existing shareholders, including the founders, early employees, and a few seed investors.

If Teddy Tag Ltd wants to do a Delaware flip, the process may involve the following general steps:

1. The company files Delaware articles of incorporation. This begins the process of creating a new corporation in Delaware called Teddy, Inc. As part of this process, the company will also need to enlist a Delaware Registered Agent who will be responsible for liaising between the company and the state.

2. Existing shareholders in Teddy Tag Ltd agree to give up their existing shares to Teddy, Inc. This agreement includes an understanding that any shares they give up will be replaced with new shares in the U.S. holding company.

3. Teddy, Inc. acquires all of the existing shares in Teddy Tag Ltd. This results in Teddy Tag Ltd becoming a wholly owned subsidiary of Teddy, Inc., which now serves as the U.S.-based holding company

4. Shareholders receive their new shares in Teddy, Inc. The new shares are typically issued on a proportional basis with the old shares, so a shareholder with a 1% ownership stake in Teddy Tag Ltd ends up with the same 1% ownership stake in Teddy, Inc.

Rather than a definitive guide, this is intended to serve as a high-level overview of a process that will likely involve a number of idiosyncrasies depending on the company involved.

Also, it’s important to note that this is not the only way to execute a Delaware flip. Another way, for example, may involve the creation of a U.S. company that functions in tandem with the existing non-U.S. company rather than subsuming it entirely. (This is less common and possibly less enticing to investors, whose principal desire is usually to simplify the corporate structure to make it more suitable for their investment.). 

Does this Flip Also affect my existing Safeholders in the local entity?

The flip involves restructuring the ownership and legal structure of the company, which would affect existing investors, including Safeholders. They will have to transfer their existing Safes in the local entity to the US entity. You will need them to sign waivers including board resolutions approving the transfer.

Equity incentives. An important part of a flip transaction is making sure that all rights to securities are moved to the new US HoldCo including any allocated ESOP in the local entity.

Do I Need to Have Employees in the US?

No you do not. Most companies will not have staff in the US as a result of the flip as the local entity usually continues to employ its staff and conduct business prior to the flip through the local entity. In due course, the Company may appoint a US based team to manage US operations and certain operations to be conducted in the US (if required) although it is NOT a MUST have.

Is Delaware the Only Country?

No, however, the US is one of a few options but a popular one given its quick, cost effective and highly regarded by many potential investors. For instance, some accelerators like YCombinator, amongst others and VC firms will only accept and invest in a US company. They are more familiar and therefore comfortable with US corporate and tax law. US corporate law is governed by individual states and the state of Delaware has developed a sophisticated and respected corporate legal regime over time, hence why it is preferred. Generally, investors prefer to invest in countries with clear and stable legal systems and Delaware seems to be more viable, especially in terms of cost for set-up as well for founders. Also, the Court in Delaware has a reputation for quickly and amicably resolving issues brought before it. The Delaware law is just flexible, easier and fast. That’s what makes it one of the best jurisdictions in the world for incorporation of world-class companies. 

Is it better to do it right away or can I wait? 

Opting for a Delaware flip sooner rather than later is advisable, particularly if you're aiming to secure funding. Delaying this transition can lead to increased complexity and higher associated expenses. The earlier you finalise the process in your business journey can potentially simplify matters compared to addressing it later when your business operations, contractual obligations, investment funding rounds and other intricacies have become more intertwined. As your business expands, the transition process progressively becomes more complex. Promptly considering a Delaware flip is a prudent approach to minimize challenges and costs over time. Also, most investors will not invest in the local entity, hence it is advisable to get it done.

What type of entity Do I have to set up in Delaware and Why?

In Delaware, the entity of choice for startups seeking investment is typically a C-Corporation (C-corp). This choice is driven by several factors that align with the needs and expectations of both investors and the startup itself. Unlike Limited Liability Companies (LLCs), C-corps offer clear and straightforward ownership transfer mechanisms. Selling and transferring ownership shares in C-corps are easier, making them an attractive option for investment-related activities. C-corps are often preferred over LLCs for VC firms with tax-exempt partners. LLCs can sometimes pose challenges when it comes to partners with tax-exempt status, as they may face limitations on receiving active trade or business income. C-corps offer more flexibility in accommodating such partners. C-corps can issue various classes of stocks, allowing for customization of investor rights, dividends, voting power, and conversion options. 

Further, Delaware C-corporations are even considered over Delaware S-corporations as S-corporation shareholders can only be US citizens, residents or just natural persons. Venture capital firms, as entities composed of multiple partners, may not meet the eligibility criteria for being shareholders of S-corporations. C-corps, on the other hand, are not restricted by the same eligibility limitations and can accommodate VC ownership.

If I set up a Delaware entity, will I qualify for Qualified small business stock (QSBS)?

QSBS is a beneficial tax treatment available to founders of C-corporations. If your shares qualify as QSBS, you can potentially save up to 100% of your capital gains taxes on the sale of your shares in future years. Note that your shares generally need to be owned by you for at least five years from the vesting date (or from the share purchase date, if you are making the <83(b) election>). Make sure you carefully read the full <list of eligibility criteria>, as well as the events that can disqualify your shares. The company itself is also required to follow certain rules in order to allow its shareholders to qualify for QSBS treatment. Refer to the guidance linked here.

Do I need to do a Delaware flip if I haven’t incorporated yet?

No! It’s called a flip because it describes the act of flipping from one corporate structure to another. If you’re the founder of a non-U.S. startup that hasn’t yet incorporated in your country, you may want to consider incorporating in Delaware first.

Starting as a Delaware C-corporation (as opposed to flipping from a foreign corporate structure to a Delaware C-corporation) may make more sense in the long run—especially if you know you’ll eventually want to raise money from investors.  A foreign corporate structure refers to the legal framework of a corporation that is registered and organized in a jurisdiction outside of Delaware but is seeking to do business within the state of Delaware. When a company is formed in another country and wishes to conduct business in Delaware, it typically needs to go through a process called "foreign qualification. This process is often used by larger companies that want to operate a subsidiary in Delaware, it is not recommended for startups. 

What if I have already registered a US and Local entity?

You just need to ensure that the local entity is wholly or majorly owned (which is the flip itself). You do not necessarily have to dissolve the local entity.

Does this mean I have to pay taxes in the US? 

Yes, in addition to the taxes you file in your local country, you will need to file taxes in Delaware and one of the taxes is the <annual Franchise tax>. Also, you may be required to file annual consolidated taxes to be filed with the tax authorities. You can engage your finance team and legal team to help with transfer pricing arrangements. To better understand the tax requirements, <read this article>

Does the flip trigger any taxes if the local entity already has a specific value attached to it?

If the local entity already has a specific value attached to it, such as real estate or equipment, then the Delaware flip could trigger taxes in the state where the local entity is incorporated. This is because the transfer of assets and liabilities could be considered a taxable event. If the flip involves a transfer of shares, which is often the case, you would have to pay capital gains tax. In the early stages, the shares will be cheaper and therefore the tax bill would be far less than a flip at a stage where you have received many rounds of funding or the business has become profitable and large. 

The specific taxes that may be triggered by a Delaware flip will vary depending on the state where the local entity is incorporated. Additionally, there are certain circumstances in which a Delaware flip should not constitute a disposal of shares by shareholders, which would otherwise constitute a taxable event. Many companies will first submit an application for clearance seeking comfort that the proposed flip is effected for bona fide commercial reasons. Following the flip, the new US holdCo may also seek relief from stamp duty arising on the acquisition of the shares of the local entity. Depending on the circumstances, you will need tax advice from a cross border tax expert.

Will stock transfer during the flip trigger tax treatment?

Yes, stock transfers can indeed trigger tax treatment, and the implications can vary based on multiple factors including the type of stock being transferred, the tax jurisdiction, and the specific circumstances of the transfer. For instance, when stock is transferred, any gain realized from the transfer may be subject to capital gains tax. 

The exact tax treatment will depend on factors such as the holding period of the stock, the applicable tax rates, and any available exemptions or deductions. In some jurisdictions, holding assets for a certain period might qualify for preferential tax rates or exemptions.

It is important to consult with your tax advisor to determine the specific taxes in each circumstance.

Do I have to be an expert on US laws to run the entity? 

No, you don't need to be an expert on US laws to run the entity. However, having a general understanding of key legal and regulatory aspects is beneficial. It's highly advisable to have a US lawyer who specializes in business and corporate law and understands the intricacies of the legal landscape. 

Who can I call for help? 

You will need input from your tax advisors and US lawyers –if you don’t already have advice, you can reach out to these providers which we are happy to make introductions to. In order to save costs, it is best to have your internal counsel or local counsel handle the local structure for you while these providers only help with the US part of things. 

What Is The Cost Implication For a Flip Process?

Depending on the complexity and level of clean-ups required, the flip process is usually within a minimum of $3,000 which is dependent on other factors such as the expertise of the lawyer, level of work done, and regulatory fees within your local jurisdiction. This is inclusive of preparing a Shareholders Agreement post the flip. You may also need to pay a tax consultant. To effectively minimize the cost of an account, ensure to have your financial statements and balance sheet prepared by your internal accountants.

Do I Have to Be a US Citizen to Set Up an Entity in the US?

No! you do have to be a US citizen before setting up a Delaware entity. You can refer to <this> on the requirements and costs for setting up a Delaware entity. 

Can I Set Up A Bank Account in the US Entity as a Non-US?

Yes! You do not need to be a US citizen to be able to set up an account in Delaware. However, you will need your Employee Identification Number (EIN)- which you should have gotten during incorporation. In addition, you will need these other <requirements> which differ between banks. Be aware that the requirements are now stringent after the SVB crisis. 

Do these Banks accept Remote Banking Relationships or do I have to be physically present?

Neo banks can be more accommodating, however, global banks like JPMorgan, HSBC etc are unlikely to accept a ‘remote’ banking relationship. They will require you to open an account in person, and the process will be easier as an American resident or citizen who can prove their residency with a valid visa, green card, or passport, as well as a valid residential address where you can prove you live. 

What other options do I then have?

Open a bank account with a Neo Bank with less stringent requirements. You can also try banks like Silicon Valley Bank (SVB) now a division of First Citizen Bank, Mercury, and Signature. Feel free to read more on the available banking options. Also, with a lot of very talented people currently out of large US tech firms, you can:

● apply for the <O1 visa>. Platforms like Vesti can help. There are also other law firms like Mayer Brown LLP which we would be happy to introduce you to if you qualify. 

● If you have the resources, consider hiring a US person who can act as a control person for your firm. 

● If you cannot afford to hire a full-time person in the US, consider appointing a board member who meets the definition while adding them as a control person on your bank accounts.

Global financial institutions also have a concept of “fit and proper” assessments, so it is important to properly vet those you get into these sorts of relationships with to ensure they do not also compound your risk. 

Do I Have to Be in the US to Make Any Filings?

No, you do not. You can leverage your registered agents, US tax advisors or US lawyers for any filings

If I Do Not Have A US Address, What Address Can I Use For the Company in Delaware?

To efficiently manage costs, you do not necessarily need to have a dedicated office space. You can leverage service providers that offer the services of virtual office space within the US for your place of business service like Northwest Registered Agent. This establishes you as a virtual business with US operations and will reduce the barriers to passing risk checks at global financial institutions. It offers you office space at $29 per month and they will help scan and forward any correspondence received. 

What Preparation do you need to do?

The following due diligence and process will require to be undertaken:

1. Shareholder consent: This requires obtaining the approval of all shareholders to proceed with transferring their shares from the local entity to the new Delaware entity. While objections are rare, it's crucial to address any potential concerns. In situations where a shareholder's agreement exists, you are required to check what the shareholders' agreement provides for and if there is a “drag along” provision in the shareholders' agreement, it may be triggered. The "drag along" provision typically comes into play when a majority of the company's owners decide to sell the company or take a certain action. In this scenario, minority owners may be required to go along with the decision, even if they have reservations. This provision helps ensure that all shareholders are aligned on significant company decisions. For all intent and purposes, any existing shareholders agreement in the local entity will no longer be valid after the transfer has been finalised. Ensuring unanimous approval is vital for a smooth transition. 

2. Increase in share capital: In the process of a Delaware Flip, there's a need to increase the company's share capital (usually the local entity depending on the requirement in your jurisdiction). Share Capital is the total number of shares that a Company can issue. However, this might also be applicable to the US entity if the share capital is lower than the required threshold. However, it's worth noting that in some countries like Nigeria, there's a requirement to increase the share capital of Companies that want to do a flip to a specific amount. This is to accommodate for the allotment of shares to the Holding Company in Delaware. The minimum share capital required by the Corporate Affairs Commission in Nigeria for a restructuring like Delaware Flip  is NGN 10 million. You will require a board resolution for this.

3. Third-party consent: The consent of third parties, for example in customer or supplier contracts, may be required in order for contracts to be assigned to the new US corporation or as a result of a change of control provisions. Each term of agreement differs, if a contract does not allow you to proceed without the approval or requires only a percentage, then you may need to get all those consents before you proceed. Most contracts usually give room to provide that the consent should not be unreasonably withheld. Also, if the customer is unwilling, you may proceed to terminate the engagement to allow you to proceed with the transaction.

4. Inter-company arrangements and Intellectual Property: In general, companies that have entities in different countries put in place intercompany agreements to allow them to operate together under a structure driven by the most advantageous tax treatment.  This determination involves having accountants analyze which entity should own the IP and the flow of money in exchange for the use of IP (and any services provided by one entity to the other) which requires determining transfer pricing and the current market value of the IP and the services being exchanged. It is prudent for startups to have technology owned by the US entity post-flip. If the startup has plans for a future initial public offering (IPO) or public listing or other exit strategy, having important technology assets held by the US entity would enhance the company's valuation and market attractiveness. Investors and the market often place a higher value on US-based assets due to the robust intellectual property protection and business environment. Housing the IP in the US entity also provides a clear and straightforward ownership structure, reducing potential complexities and risks associated with cross-border IP management.

5. Licences:  if there are any licences to operate or in relation to any assets or technology, checks will have to be made as to whether these can continue, given the change of control in the corporate structure or whether any consents are required. If you hold a licence in a non-US company for instance, you may require a letter of ‘no objection’ from the regulator approving the change in ownership structure. Determine whether the existing licenses are transferable or can continue under the new corporate structure. Some licenses may have restrictions or conditions tied to the previous entity's ownership. Some licenses have clauses that require consent or notification in case of a change in ownership to the regulator.

6. 83b election Filing: An 83(b) election is a provision in the U.S. tax code that allows individuals to "elect" to pay tax on their unvested shares upfront (when the value is likely low), so then, you won't owe any income tax as shares vest and you only owe capital gains tax later if you sell. The primary purpose of making an 83(b) election is to potentially reduce the overall tax liability. Stripe Atlas provides the platform to help you file your 83b election. Check <here> for the list of information and process to file an 83b Election.

7. Update Company register: The company’s records and share registers should be reviewed to confirm that they are up to date and in order – the starting point for the flip should be a “clean”, compliant company. A register of existing shareholders and the number of shares they hold including the % holding. This is required for both your US and the local entity. You can use this <template> to set up your registers.

List of Required Documents for the Flip

You can use these <templates> as a guide on the legal documents required for a flip

● Shareholders resolution: This needs to be signed by all shareholders of the non-US company approving the increase in share capital (if required, transfer by shareholders of Non-US to Delaware entity

● Share transfer forms:  from existing shareholders in the non-US company transferring their shares to the Delaware entity

● board resolution from the Delaware company approving the transfer of shares in the non-US company to the Delaware entity.

● Directors’ Resolution and Shareholder/stockholder’s resolution approving the SHA, approving the flip and the new subsidiary

● Shareholders Agreement (or common stock purchase agreement as the case may be) in the  Delaware entity: At the US level, equivalent shares will be issued to the existing shareholders. Relevant docs:

○ Waiver forms (where relevant)

○ Share allotment in the US

○ Board consents

● Amended and restated bylaws in the Delaware entity showing the new shareholders and ownership structure 

● 83b election filings

Post -Flip- What Next After a Delaware Flip

Tax filings: Tax return in Delaware, in addition to the one you were filing in your home country. As well as Franchise Tax for your Delaware entity.

Keep track of your cap table: Keep a spreadsheet that lists your shareholders, what their ownership is, and if you have any options issued. As you grow you can think about using cap table software, so it's good to get into the habit of recording this now.

Moving money around your new group: Transferring money between your US holding company and subsidiary, called an intercompany transfer, comes with compliance requirements that few founders are aware of ( you can't just wire funds from your US bank back home). This is because the subsidiary company is usually the operational entity where the sales come from, where employees are being paid etc. There are three ways of doing this:

1. Intercompany Loan: The parent company transfers money and records it in both accounts as a loan (with or without interest).

2. Equity (sometimes called capital contribution): The parent company sends the cash and records it as an investment. The subsidiary records the cash as capital (equity). Consider this an internal fundraise — the subsidiary can then issue shares in itself in return (although it’s already 100% owned by the parent, so no changes in that). A simple board resolution and a notification to your local company register (if required) and you’re done.

3. Exchange for services: You can structure a shared service framework whereby the subsidiary invoices for services done through the Nigerian entity. This is helpful for when the parent/holding company is simply an investment-taking entity. If you need to move funds between two companies that perform services for each other, then you need a services agreement, and you need to work out the transfer pricing or intercompany transfer arrangement. Transfer pricing is needed when two connected (same group/ownership) companies transact. E.g. sending money in return for overseas staff, software licenses, or other services. This can be more complex and might require your accountants and lawyers to guide you on the tax implications. You can have an inter-company agreement between the parent company and subsidiary company that outlines the terms and conditions.

Delaware Flip for a Nigerian Entity Step-by Step Guide

Please follow these <guide> 

Disclaimer: We assume no responsibility for any consequence of using these documents. These documents have been prepared for informational purposes and are not intended to (a) constitute legal advice (b) create an attorney-client relationship (c) be advertising or a solicitation of any type.  Each situation is highly fact specific and requires a knowledge of both state and federal laws and therefore any party should seek legal advice from a licensed attorney in the relevant jurisdictions.  We expressly disclaim any and all liability with respect to actions or omissions based on this article.