The origins of ‘flipping up’
As we continue to see start-up ecosystems grow and flourish in many parts of the world, investment and collaboration become necessary across these regions. When it comes to building companies, many founders continue to see the United States as a significant source of private capital which is typically mixed in with local funding as well. As such, it has become quite popular in recent years for many foreign start-ups to seek out funding from US-based Venture Capitalists.
The problem is that many founders are still not quite sure how to set up their corporations and entities to receive US funding. Additionally, many founders cannot quite grasp what is actually required for a US flip-up and simply put it off until it becomes too late. This becomes a severe limitation and could potentially hinder a company’s growth and potential in the long term.
Here we provide answers to some pressing questions on the US flip-up.
Who is this article for?
This article is for founders of non-US-based companies who are interested to learn more about seeking US funding. In many cases, such founders are also thinking about US market entry as well. We highly encourage you to use this FAQ as a reference down the road as you prepare your company for US private investment.
FAQ
What is a flip-up and how does it work?
In a flip-up, the owners of a company will exchange their interests for shares in a company located in another jurisdiction, in our experience most likely a U.S. company. When the transaction closes, the original company becomes a wholly-owned subsidiary of the new/U.S. company, and the new/U.S. company is owned by the former owners of the original company.
Why would certain companies consider flipping up into another geography like the US?
The most likely reason a company may decide to engage in a US flip-up is to gain access to US private equity markets, as many US based investors have restrictions against making foreign direct investments. There may be other reasons such as qualifications for certain government contracts or grants, or preparation for listing on a US exchange, for example.
How do we know the right ‘time’ to do this? Is it before raising capital in the US or after?
Flip-ups occurring during the early stages of a startup’s life are typically easier to accomplish than later-stage flip-ups because the number of affected stockholders, debt providers and material agreements is usually smaller, though the ongoing costs associated with running a business in a multi-jurisdictional corporate structure (including accountants, lawyers, tax advisors and periodic filing fees and certain corporation taxes) are necessarily somewhat higher than in a simpler one. In any event, a company considering a flip-up may do so prior to seeking financing in the US or may complete that transaction concurrently with the US raise, but taking the latter route may complicate that fundraising round.
How much does it cost, and are there economical ways to do this?
The cost to complete a flip-up transaction will vary based on the existing complexity of the company’s capital structure, regulatory environment and other factors. In the simplest terms, the transaction can be completed with a few form contracts and filings, but care should be taken to ensure that the company is well advised on tax and structuring considerations to avoid errors that can be cheap to make today and very expensive to address years down the line. We have worked on transactions of this sort ranging in total cost from a few thousand dollars into to the tens of thousands, depending on complexity.
How long does it take to perform?
A startup with a simple capital structure and organized documents can complete the flip-up process in less than a month. A startup with a complex cap table and incomplete or disorganized records can take longer and cost more. Completing the flip-up process at the very beginning of a startup’s journey will ensure that the process will be completed more quickly and with less expense due to the simplicity of the shareholding structure and the absence of significant contracts or assets in the company.
What happens to the existing entity in Australia when a flip-up is executed?
Once the flip-up is completed, the Australian company becomes a wholly owned subsidiary of the new holding company. The shareholders will own the holding company and the holding company will in turn own the Australian operating company. We note that we typically also advise that any American operations be housed in a ‘sister’ subsidiary rather than the holding company itself, meaning that the holding company will have at least 2 subsidiaries if the business is actually operating in the US and Australia, and it would add additional subsidiaries when entering other jurisdictions, as well.
What are the various legal structures we should consider? What’s recommended?
Startups that decide to flip-up into the US will almost always incorporate in the state of Delaware and be taxed as a “C-Corporation” at the US Federal level, meaning the company itself is a taxpayer rather than a “flow through” entity. Forming as a corporation rather than an alternative legal entity is the gold standard for high-growth startups because it provides limited liability, ease of use, ease of setup, the ability to issue stock options, and many tax benefits (including a potential for US tax-free capital gains in certain scenarios). Incorporating in Delaware specifically also offers a standardized and comprehensive body of law, allowing for legal and compliance predictability–angel investors, private equity firms, and venture capital firms almost always prefer for the companies they invest in and conduct business with to be formed in Delaware, which eliminates the need to understand another state’s particular variations in corporate law.
What are the main tax considerations for Australian parent companies?
First, at the shareholder level, shareholders will want to consider the capital gains tax treatment associated with disposing of shares in the Australian company as this disposal may trigger a capital gain or loss. Importantly, there are exemptions and rollovers that may allow shareholders to reduce, defer or disregard their capital gain or capital loss into the future, and certain structuring choices to be made to ensure one treatment versus another. Second, at the company level, there may be tax implications to moving valuable assets from the Australian company to the American company, particularly if the American company will not be purely a holding company and will have some operations in the US. One way to avoid the tax implications of moving valuable intellectual property from the Australian company to an American company, whether the holding company or a sister operating company, is for the Australian company to merely license the intellectual property to the American one.
What level of ongoing legal advice is recommended for companies moving into the US market given the difference in the litigious landscape?
Retain good legal counsel! Effective legal counsel can help a company (i) set up its corporate governance structure to protect the company and its shareholders; (ii) establish a compliance program that ensures that the company complies with all applicable federal, state and local laws and regulations; and (iii) draft the company’s core contracts and create a playbook for protecting the company and its interests in all contract negotiations.
How does a company handle the novation of existing documents i.e. SAFE notes, contracts pre, and post-flip?
“Novation” is a technical term describing when the existing parties to a contract replace one of the parties in the agreement with someone not party to that original agreement, a ‘third party,’ with the agreement of all old and new parties. A flip-up, however, is going to be designed in a way that achieves a similar effect without actual novations, for example by use of a “share exchange agreement” that provides for all the existing shareholders to receive 1 share in the new holding company for each 1 share in the existing Australian company, which ensures that the capital structure of the new US company mirrors the capital structure of the Australian company. Any convertible loans and SAFEs should also be “exchanged” in a similar way for new similar instruments issued by the US corporation. While we have seen standard Australian forms of SAFE have a built-in consent to this exchange, that may not always be the case, and investor consent may be required; however, unless the holders of SAFEs or convertible notes have veto rights on the flip-up itself, it will be in their interest to make the exchange and avoid having an interest only in a subsidiary company going forward. In addition, although typically existing contracts will not need to be moved to the new holding company, management and counsel will want to review all existing material contracts and determine whether any third-party consents will be required and/or whether any contracts do need to be assigned to the US company.
Can we still take advantage of R&D tax benefits in Australia after the flip-up?
In order to take advantage of the Australian R&D tax incentives, the intellectual property created typically has to be generated and owned by the Australian entity, so it is still possible provided that certain conditions are met and procedures are followed. Specific tax advice is recommended. In addition, in the U.S. there is a R&D tax incentive system with similar principles as the Australian R&D tax incentive.
About Metagroves Ventures
Metagrove Ventures is an early-stage technology fund focused on investing in and supporting the next wave of emerging founders and companies across ANZ/SEA and the US disrupting traditional industries through technology i.e. AI/ML, Blockchain, Automation, 5G, IoT, etc. They are creating a founder-friendly ecosystem powered by mentors and experts from Silicon Valley and top-tier companies to support their founders to grow and scale into the US market.
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