Orrick's Founder Series offers monthly top tips for UK startups on key considerations at each stage of their lifecycle, from incorporating a company through to possible exit strategies. The Series is written by members of our market-leading London Technology Companies Group (TCG), with contributions from other practice members. Our Band 1 ranked London TCG team closed over 320 growth financings and tech M&A deals totalling US$9.76bn in 2022 and has dominated the European venture capital tech market for 27 consecutive quarters (PitchBook, Q3 2022). In our previous instalments, we have guided founders through the process of incorporating a private limited company, building their team, how to use share options to attract and incentivise their employees, protect their ideas, identified key compliance considerations, what to consider when raising their round, and how to navigate the evolving cyber threat landscape.
Many UK founders consider moving their company to the US at some point in their lifecycle. Whether companies are looking to access funds from US VCs or capitalise on the US product market, many startups ultimately incorporate a Delaware holding company (or US TopCo) in a transaction often referred to as a “Delaware flip.” In the eighth instalment of Orrick’s Founder Series, our London-based, US qualified TCG lawyers offer top tips on some of the key issues arising in these transactions for founders leading their companies in a US expansion.
- Why flip to a US corporation. There are three primary reasons why a UK company might decide to flip to a US TopCo. First, flipping gives UK companies easier access to US capital. Whilst an increasing number of US VCs are happy investing in UK companies, in the most part US investors feel most comfortable with the corporate mechanics and standardised forms of investment documents of a US corporation, and so in some cases US investors may require UK companies to flip to Delaware before closing their investment. Some incubator and accelerator programmes (such as YCombinator) have also historically required non-US companies to flip to the US before providing funding. Second, flipping to the US may provide access to more US exit opportunities, including IPOs on US stock markets. Third, UK companies may expect their employees, product market and operations to be primarily in the US in the future, such that incorporating a US parent is desirable.
- Tax considerations. When restructuring any company, tax considerations are often paramount. UK companies engaging in a Delaware flip will want to ensure that they consult counsel on the tax implications of the transaction for their shareholders, as well as the UK and US companies themselves. 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 under section 138 of the Taxation of Chargeable Gains Act 1992 to HM Revenue & Customs (HMRC) seeking comfort that the proposed flip is effected for bona fide commercial reasons. Following the flip, the new US TopCo may also seek relief from stamp duty arising on the acquisition of the shares of the UK company by submitting a 'section 77' application to HMRC.
- EIS / SEIS / VCT investors. If your startup has EIS, SEIS or VCT investors, it may be possible to carry over the relevant tax reliefs in a Delaware flip. There are critical requirements to maintaining these tax reliefs, including obtaining the section 138 clearance mentioned above. It is imperative at the beginning of the flip process to identify such investors to counsel. This is to ensure that such tax reliefs are accurately described in the clearance application to HMRC, other requirements for such reliefs are maintained, and the constitutional documents of the US company are adapted to meet the relevant requirements for maintaining these tax reliefs. EIS waterfalls are difficult to translate to US constitutional documents so it’s best to get to the front of these conversations from the start of the process.
- US certificate of incorporation and shareholders’ agreement. Similar to how the British Private Equity & Venture Capital Association (BVCA) form documents used in the UK, many VC-backed Delaware corporations utilise standard form venture capital financing documents distributed by the National Venture Capital Association (NVCA). UK companies engaging in a Delaware flip will often be expected to adopt a certificate of incorporation and shareholders’ agreement based on the NVCA forms. This is whilst also incorporating concepts from the company’s existing UK articles and shareholders’ agreement. Using these NVCA forms provide potential investors and/or buyers of a Delaware corporation a certain level of predictability when evaluating their investment.
- Equity incentives. An important part of a flip transaction is making sure that all rights to securities are moved to the new US TopCo. Companies will want to ensure that the tax treatment of any existing equity incentives is rolled over to the new Delaware holding company in the flip process.
Once the flip is completed, companies will also want to ensure that they consult counsel to adopt a stock plan in the US TopCo which allows them to grant tax favoured options in the US and UK. Companies will also need to consult US and UK incentives experts when granting options to individuals in each jurisdiction. There are numerous pitfalls when granting options in multiple jurisdictions and companies will want to ensure that option grants do not result in penalties or loss of tax incentives. For more tips about options, you can read our instalment, Top Tips to Follow to Incentivise Your Team.
- Convertible securities. When flipping to the US TopCo structure, existing convertible securities will often need to be moved to the US TopCo. Companies will find it beneficial to engage tax counsel, the company’s accountants, and the existing convertible holders early in the flip process. This is to ensure the existing convertible securities are efficiently moved to the US entity. UK companies will especially want to engage existing holders of convertible securities early in the process where the holder may have specific requirements for the conversion of securities, for example where the company received funding from the UK Government’s Future Fund.
- US securities filings. When companies issue securities in the US, they need to ensure that the issuance is in compliance with US federal and state laws and regulations aimed at protecting investors. The Securities Act of 1933 requires that the offer or sale of securities be registered with the SEC unless they qualify for an exemption from registration. Many companies conducting equity financings will rely on safe harbor exemptions under Regulation D of the Securities Act of 1933, which requires the company to file a notice of exemption with the Securities and Exchange Commission. Each US state also has separate and distinct laws and regulations that may require companies to notify states of the issuance of securities to investors in those states. Companies should work with US legal counsel to ensure these filings are properly completed and filed within the relevant timeframes.
- Uncertificated stock and electronic stock certificates. If approved by a company’s Board of Directors, Delaware corporations are allowed to issue what is known as “uncertificated stock” or electronic stock certificates, rather than paper stock certificates. “Uncertificated stock” means that a stock certificate does not need to be issued to a stockholder to represent ownership of shares in the corporation. Instead, Delaware corporations may send a stockholder a notice of issuance of shares. Electronic stock certificates provide the same information as a paper stock certificate but in electronic form. Many capitalisation table management platforms for US companies facilitate the distribution of electronic stock certificates, which will ease the administrative burden of having to issue paper stock certificates.
- Founder vesting. US market practice for founder vesting differs from many European jurisdictions. Founders are often only subject to time-based vesting and are not subject to a clawback of vested shares in the event that they are deemed to be “Bad Leavers.” It is also market practice for founders’ shares to be subject to double-trigger accelerated vesting in the event of termination in connection with a change of control of the company. For the UK perspective on Founder vesting, you can read our instalment, Top Tips to Follow to Get Ready to Raise.
- 83(b) elections. Founders will want to consider filing a US tax election with the IRS, known as an 83(b) election, within 30 days following the date on which they are issued stock in a US corporation that is subject to vesting. The 83(b) election is an election to be taxed on the value of the shares at the time the shares are issued rather than as the shares vest over time. This may be applicable even for non-US taxpayers if they subsequently become US taxpayers while their shares are still vesting and should be considered.
Orrick's London TCG practice reflects London’s role as one of the world’s leading financial markets and a centre for international commerce. Nothing inspires us more than helping tech companies develop novel strategies and push boundaries. Through our extensive client portfolio, deal volume, and relationships in the tech ecosystem, we provide commercial and legal insight to each company’s strategy. We work with tech companies on all aspects of their business plans: financing strategies, protecting intellectual assets, retaining talent, securing and monetising data, and advocating for innovation-friendly public policy.
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If you would like more details on any of the issues above, please contact Jamie Moore or Jason Wu.