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What Aussie startups need to know about the Delaware Flip
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Moving your startup to the US doesn't need to cause a flipping nightmare. Here's what you need to know before you get started.

Over 66% of Fortune 500 companies are incorporated in Delaware, and it’s not because of its stunning beaches or rich history. Delaware is the state of choice for many early-stage tech startups because of its company-friendly corporate laws and tax systems. Or, as David Brunori, a George Washington University Law School professor and tax expert, puts it:

“Delaware is an outlier in the way it does business…what it offers is an opportunity to game the system and do it legally.”

To take advantage of this favourable legal and regulatory environment in Delaware, many Australian startups go through a “Delaware flip”, where a company incorporated in Australia can “flip” its legal structure to become governed by Delaware laws. 

The Delaware flip can be a complex process. You’ll want to work with experienced legal and tax professionals familiar with the process to ensure you get it right. 

If you’re thinking about flipping, here’s a basic summary of what you should know and some preliminary considerations before you get started. 

What is a Delaware flip?

A Delaware flip is a corporate restructure that involves a new parent company registered in Delaware (US TopCo) being inserted between your existing Australian company (AusCo) and its securityholders. 

The typical steps of a flip include:

  1. Setting up the US TopCo in the state of Delaware.
  2. Arranging for the existing shareholders in AusCo to transfer their shares to the US TopCo, so the US TopCo becomes the 100% owner of the AusCo.
  3. Arranging for US TopCo to issue new shares to the previous AusCo shareholders (in their identical numbers and proportions) in return for the shares it received under step 2.
  4. If the AusCo has any convertible notes, SAFEs, options (including ESOP), warrants or other convertible instruments on issue, these will need to be transferred to the US TopCo too.  

How long does it take?

A simple flip typically takes 4-6 weeks. However, this timeframe can easily be affected by:

  • Multiple stakeholders being involved (e.g. large numbers of shareholders or holders of options or other convertible securities, and their respective professional advisors).  
  • Foreign stakeholders operating in different time zones, with different interests and levels of sophistication.
  • Your company records are not in order.
  • A capital raise or other form of financing transaction is being conducted in parallel to the flip.

How much does it cost?

The costs of a flip generally relate to tax, accounting and legal advice. Assuming the flip is basic and straightforward,, the fees would be roughly US$30k (at a very high level), comprised of US$10k for tax/accounting advice and US$20k for legal advice (covering Australian and US advice). 

However, these fees can vary greatly, with any of the following matters causing them to balloon:

  • AusCo has a complex cap table with many securityholders (e.g. investors holding shares, options, SAFEs, or Con Notes).
  • AusCo has complicated and bespoke rights/protections that need to be transferred to the US TopCo.
  • Setting up a non-standard group structure (with numerous entities in different countries or using an existing Delaware company and varying it to act as the US TopCo).
  • AusCo has an ESOP in place that needs to be reviewed and updated to reflect the new group structure.
  • Proceeding with a flip without the support of the AusCo investor base (it can sometimes take one minority shareholder to derail the process).

Companies also often carry out a flip in conjunction with a capital raise. These processes can run in parallel and will take roughly 6-8 weeks together. The costs of a combined flip and capital raise would be higher than the figures mentioned above (and subject to greater variability), however, companies usually pay the costs with the proceeds of the capital raise. 

You should always ask your professional advisors for an estimate of the costs and request frequent updates. 

Why flip?

Bottom line: US (and some international) VCs prefer to invest in Delaware companies over any other type of business entity. It won’t increase your chances of raising from a US investor; think of it more as table stakes for seeking US investment. 

The flip is also popular for the following reasons:

  1. Market for products/services. Having a presence in the US can give your business access to a larger overall market, allowing you to engage more effectively with US customers.
  2. Potential for an exit via a trade sale. There is a greater number of potential buyers in the US, and having operational and legal structures they’re familiar with can facilitate any potential sale of your business.
  3. Access to Talent. It increases your business’s ability to attract and tap into the larger talent pool in the US.   
  4. Financial Reporting. Under Australian law, private companies must lodge audited accounts with ASIC if they are “large proprietary companies” (defined, at the date of this article, as those with at least two of the following: ≥$50m in consolidated revenue; ≥$25m in consolidated gross assets; or ≥100 employees).  Anyone can access copies of these audited accounts for a small fee (being <$50 at the date of this article), which may give competitors access to sensitive financial information. In contrast, companies in the US can keep their financial information private until they go public.

While the flip does have various advantages, there are several complexities that you should also consider:

  1. Foreign jurisdiction. A different set of Delaware rules will apply to Australian shareholders that they’ll need to understand and comply with.
  2. Implementation and compliance costs. In addition to the cost of carrying out the flip, there are ongoing compliance costs that are generally higher in the US compared to the equivalent services in Australia. 
  3. Different litigious environment. The attitude towards litigation in the US is different compared to Australia. Depending on your business's industry, you may have an increased risk of litigation or more aggressive and restrictive regulatory laws. 
  4. Foreign investment. The US venture capital market can be more competitive and access to capital may be easier in Australia (particularly with Australian government incentives that encourage investment in Australian startups).

When’s the right time to flip?

Startups commonly flip before raising from US investors (or sometimes in parallel) for a few reasons: 

  • Ease. Fewer stakeholders (shareholders and investors) are involved, with less complicated shareholder rights and obligations. This makes the process of migrating the stakeholders and the existing AusCo suite of rights and obligations simpler. 
  • Tax. A startup’s market value is lower, which can be beneficial for CGT purposes. This is less relevant in cases where rollover relief is available (more on that below). 
  • Investor preference. If a US investor values a company doing a flip, the investor may require the flip to happen before they invest. 
  • Reduced cost. Lawyers and accountants may have to duplicate advice and costs, advising your business about the raise, and then the flip. 

Who’s involved?

To make the flip process as painless as possible, you’ll want to engage a team of advisors who can cover all elements of the flip:

  • Australian corporate lawyers: advise you from an Australian law perspective on the aspects of the flip and draft the necessary corporate transaction documents and approvals related to the AusCo.
  • US corporate lawyers: arrange the US TopCo’s incorporation, draft the US TopCo’s constituent documents to reflect the rights and obligations of the AusCo (including the certificate of incorporation and by-laws), and prepare all documentation to issue the necessary securities in the US TopCo. 
  • Australian accountants/tax lawyers: advise on the Australian tax implications for the AusCo as part of the flip.
  • US accountants/tax lawyers: advise upon the tax implications for the AusCo and US TopCo as part of the flip.

For all legal requirements, using a single firm that operates in Australia and the US creates efficiencies, streamlines management, and often simplifies the fees. One recommended vendor is K&L Gates, a global law firm we frequently use in Australia and internationally. They’re familiar with the Australian and international startup space and have lawyers who specialise in venture capital orientated transactions globally.

Considerations

Tax

The tax implications of a flip can be complex; however, with the help of qualified tax professionals in Australia and the US, the process can be structured to minimise tax liabilities. We work closely with Pitcher Partners in Australia. 

Tax liabilities/issues you may encounter through the process include:

  • Capital gains tax (CGT), triggered by the exchange of the shares in your AusCo for shares in your US TopCo, which the ATO may consider a “taxable event”. 
  • To avoid paying CGT, you may be able to rely on a CGT rollover exemption, where the ATO recognises the transaction is the exchange of like-for-like assets (rather than a disposal), and defers payment of CGT. A few CGT rollovers are possible for flips, including Division 615 rollover and Subdivision 124-M rollover (explained further below).
  • Typically, the AusCo retains ownership of the business IP and licences it (rather than sells it) to the US TopCo. This helps avoid any upfront tax payment the ATO may require on transfer of the IP. 
  • Double taxation if the AusCo transfers its IP or other assets to the US TopCo before conducting the flip. You should carefully consider any proposal to transfer assets/IP outside of the AusCo.
  • Your US TopCo will likely be treated as an Australian tax resident if your operations are still based in Australia with little to no activity in the US. If your US TopCo subsequently commences/increases operations in the US (and is no longer treated as an Australian tax resident), you may be hit with an ‘exit tax’ by the ATO. 
  • It will no longer make sense for any ESOPs to be granted by the AusCo, and you’ll need to issue replacement options in the US TopCo. Ensure that the cancellation of AusCo options and the issue of replacement US TopCo options don’t trigger renewed tax consequences for ESOP participants. You can generally seek restructure relief, but that can be a complicated process (sometimes requiring a private binding ruling from the Commissioner of Taxation). 
  • If you  set up an ESOP under your US TopCo, you need to consider (with professional advice) the best way to issue options to Australian employees. 
  • AusCo will generally be entitled to retain any R&D tax benefits it has received, provided there hasn’t been a merger, and AusCo’s revenue has increased. 
  • Australian shareholders in the US TopCo will no longer be able to access franking credits on dividends, as they’ll receive the dividends from a US company. This likely won’t be an issue for a long time, as most startups won’t be issuing dividends until they’re more mature.

Division 615 rollover

Division 615 rollover is the most likely rollover to use in a flip as it was designed for the insertion of a new company between an existing company and its shareholders, often referred to as a “top-hatting”. It’s used where there is more than one shareholder of the AusCo and the US TopCo is merely a shell company.

Broadly, Division 615 rollover is available where all shareholders of the AusCo dispose of their shares to the US TopCo and receive shares in the US TopCo as consideration (and nothing else).

For Division 615 rollover relief to be available:

  • All shareholders must participate (noting that not all shareholders have to elect to obtain rollover relief)
  • The AusCo must be 100% owned by the US TopCo after the flip
  • The US TopCo must have nominal value before the flip
  • The relative shareholder interests and valuations in the AusCo before the flip have to be mirrored in the US TopCo after the flip

Subdivision 124-M rollover

Subdivision 124-M rollover is available to facilitate mergers of two (or more) companies and is, therefore, not generally used on a vanilla flip. In fact, where Division 615 rollover relief is available, Subdivision 124-M rollover relief is specifically unavailable. Nevertheless, Subdivision 124-M would occasionally be used where the US TopCo already exists or there is a requirement to merge two or more companies as part of the flip.

Here are the key conditions to satisfy for Subdivision 124-M rollover relief (assuming a merge of an AusCo and a new US TopCo):

  • The shareholders exchange a like interest in the AusCo for a corresponding interest in the new US TopCo (e.g. share for share or option for option). 
  • The US TopCo must acquire at least 80% of the voting shares of the AusCo as a result of the exchange.
  • All owners of voting shares in the AusCo can participate in the arrangement.
  • Participation is available on substantially the same conditions for all owners of a particular form of interest (generally shares or options) in the existing AusCo. 

Revenue recognition and Transfer Pricing

When AusCo flips to a US TopCo, it becomes subject to US accounting standards, including the Generally Accepted Accounting Principles (GAAP). Under GAAP, revenue can only be recognised when it’s realised, realisable, or earned. This means that revenue can’t be recognised until it’s earned, even if the payment has been received,which may differ from your current accounting practices. You’ll need to consider the timing of revenue recognition for each performance obligation.

Transfer pricing, in the context of currency exchange (in respect of charging USD to US customers and AUD to AUS customers), is not likely to be a material issue, but it’s something your advisors should look into during the flip. 

Preparation

Before kicking off a flip, here's a brief list of action items to help you be flip-ready:

  • Company registers: locate and check that your AusCo company registers are accurate and up to date (e.g. registers recording the holders of shares, options, warrants, convertible notes or SAFEs).
  • Cap raising history: collect all relevant transaction documents regarding the previous cap raising/s of AusCo.
  • Public registrations: ensure all public registrations and government records regarding AusCo are current and accurate (e.g. ASIC and IP Australia).
  • Company documents: find copies of AusCo’s most recent constituent documents (including the constitution, shareholders agreement and ESOP rules).
  • Data room: depending on how many documents you have, you might want to set up a dataroom (e.g. google drive) to provide the documents to your professional advisors. 
  • Shareholder comms: start communications with shareholders early, and provide frequent updates to ensure you can receive approvals and have documents signed quickly.

Post-Flip Checklist

Set yourself up for success by checking off all of these administrative requirements: 

  • Get your employee identification number (EIN). The EIN serves as a company’s social security number (SSN) and is required to open a bank account. Here's the EIN application
  • Transfer your ESOP to the US TopCo. US lawyers can prepare a new US ESOP, and cap table management software (such as Carta or Cake) can be useful to administer the US ESOP (as well as your cap table).
  • Set up your US Bank account. US financial institutions typically require you to visit a branch to open an account. The bank will also conduct background identity checks on all shareholders with more than 25% holding. 

We’re lucky to collaborate with partners who share our Open Source ethos. Thank you to Jake Berger from Pitcher Partners, and Dan Atkin and Simon Leslie from K&L Gates, who helped us prepare this article. 

This article contains general information only and does not constitute legal, financial or tax advice, nor does it take into account your personal circumstances. You should always seek independent professional advice before acting on any information in this article.
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