In this blog post, we talk about the ‘Delaware Flip’; the snappy title for switching your business structure into a US-owned one by topping it up with a Delaware holding company. We will dive into reasons and steps, and ‘do the technical bit’ from a Dutch background. Much of the talk will ring true for other non-US bases as well, but keep in mind that despite the buzzword branding, a Delaware Flip cannot be productized and proper implementation is always subject to good local counsel. That being said: let’s dive in!
To build some rapport first, here’s a little bit about us:
Bas Jorissen | Tax Lawyer at Archipel [NL]
My name is Bas, your ‘Tax Guy’ for this blog. I am a practitioner in the Netherlands and like many of my friends in the trade, I have a special interest in the United States.
For me, the fascination definitely cristalized when I lived in Connecticut with my family for three years as a schoolboy [left pic, Sum41 inspired]. While I realize I am profoundly European, I feel very much ‘at home’ in the US and I feel like I got a decent view of America’s ‘inner workings’.
An instinctive alliance was born, and I’ve had an extra eye on my ‘home away from home’ ever since. And I am blessed to work with many a client with whom I share the Transatlantic Fascination these days, and it was on an Archipel-rooted trip to New York City that I reconnected with our Expert Jan Joosten!
Jan Joosten | Partner at Pierson Ferdinand LLP [USA]
Jan moved to New York City in 1997 after finishing Law School in the Netherlands to pursue a career in US Law. His track record is impressive, with over twenty years of NYC Partner-level experience at top tier firms like Hughes Hubbard & Reed LLP and Baker McKenzie.
He went on to become a founding partner at Pierson Ferdinand LLP, America’s fastest growing and tech-focused law firm. As per their introduction: Jan specializes in corporate transactions, including mergers and acquisitions, capital markets transactions and joint ventures, often with cross-border aspects.
A native of the Netherlands, Mr. Joosten has extensive experience in representing Dutch and other European companies that do business in the United States in a broad range of matters.
I can concur: Jan is a go-to guy when it comes to helping the Dutch understand and do business with Americans, both from a legal and a personal perspective. And his contextualizing ‘Four Corners of the Contract’-lecture is legendary, if you ask me!
Now let’s dive into the matter at hand: the Delaware Flip.
The Idea behind the Delaware Flip: US Investors want to Invest Locally
Much has been said about the depth of American capital markets and the propensity of US Investors to fund innovative and scaling ventures. And it’s true: even though the investment level appears to be more volatile, the absolute depth of the US Capital Market is unrivaled:
That is one reason why Dutch and other European Founders and businesses may find themselves ‘looking at America’ at one point or another. Other reasons, of course, can be market fit or just plain adventure. Riding off an capital raising / investment opportunity, however, you may soon enough be confronted with the notorious American Home Bias.
The American Home Bias
As it turns out, Americans prefer investing in American stock. Such ‘Home Bias’ can be observed the world over, and is explained by a multitude of familiarity factors. As per Investopedia:
The term home bias refers to the tendency for investors to invest the majority of their portfolio in domestic equities, ignoring the benefits of diversifying into foreign equities. This bias was originally believed to have arisen as a result of the extra difficulties associated with investing in foreign equities, such as legal restrictions and additional transaction costs. Other investors may simply exhibit home bias due to a preference for investing in what they are already familiar with rather than moving into the unknown.
The American Home Bias, however, is stronger than average; Americans invest about 80% of their funds on their home market, while the Euro Area averages a little over 50% and famously open economies like the United Kingdom and the Netherlands allocate only about 25% of their funds domestically. As per Simply Wall Street:
When you find yourself in talks with a US Investor as a Dutch or European business, you can therefore choose to do two things, provided you want to close the deal: [1] try to convince them to invest across borders [20% chance], or [2] give them something American to invest in [80% chance]. This is where the ‘Delaware Flip’ comes in, and I ask Jan for some insights.
The Expert Talks: What is a Delaware flip?
Jan: “A Delaware flip is the process of changing the corporate structure of a Dutch (or other non-U.S.) company by creating a new top holding company in Delaware and turning the original Dutch company into a wholly-owned subsidiary of the Delaware corporation.
Dutch startups and other privately-held companies are typically organized as a B.V. (a private company with limited liability). Their investors will hold shares in the Dutch B.V. and there will be a shareholders agreement governed by Dutch law. In order to do a Delaware flip, the current shareholders will have to exchange their shares in the Dutch B.V. for a proportionate number of shares in a newly established Delaware corporation. Their existing shareholders agreement will have to be replaced with U.S.-style agreements, often following the models published by the National Venture Capital Association.”
[Note: despite the hook name, a Delaware flip is a major corporate undertaking that requires the cooperation of the founders and the existing investors as well as the assistance of sophisticated legal and tax advisors].
I would visualize this as follows:
OK, looks doable. But Jan, is it always Delaware? Even if you want to business in New York or California?
“In the U.S., corporate law is governed by individual states. The State of Delaware has developed one of the most sophisticated, comprehensive and well-regarded bodies of corporate law in the U.S. Many, if not most, U.S. investors prefer to invest in a corporation or other entity organized under Delaware law. Indeed, the model agreements published by the National Venture Capital Association are tailored for Delaware corporations.“
As I understand, any company’s State of incorporation [i.e.: the State under whoms laws you chose to organize] also dictates where it’s legal affairs should be litigated, and Delaware is generally accepted as having the most developed code as well as the best organized judiciary system. This notion is self-cementing, because as more disputes are litgated in Delaware, its case law expands and this further improves the clarity and applicability of its legal frameworks. So Jan’s message is: choose Delaware to incorporate. This does not prohibit you from doing business elsewhere, but just allows you access to the best legal and court system.
What are some Advantages of a Delaware Flip?
“The main argument for a Delaware flip is that a company will obtain improved access to U.S. investors; some U.S. investors may not be permitted to invest in non-U.S. companies and other U.S. investors may simply prefer to invest in U.S. companies.
However, many U.S. investors may be willing to invest in a Dutch company, in which case a Delaware flip will not be necessary. Given the significant cost of implementing a Delaware flip and the near impossibility of reversing a Delaware flip, it is generally advisable to hold off on doing a Delaware flip until it is clear that it is absolutely necessary to do so.
Some observers believe that doing a Delaware flip will result in a higher valuation and better exit options (whether through an M&A transaction or through an IPO on Nasdaq or the New York Stock Exchange).
Another advantage of doing a Delaware flip is that U.S. investors and U.S. employees will be able to take advantage of certain tax advantages such as the Qualified Small Business Stock exemption. This exemption is not available if the top holding company is a Dutch B.V.“
And what are some Disadvantages?
“As mentioned above, a Delaware flip is a complicated corporate transaction that will require the assistance of sophisticated legal and tax advisors, resulting in significant out-of-pocket expenses. A Dutch company should generally not incur the significant expense of executing a Delaware flip unless there is a high level of confidence that the flip will result in one or more U.S. investors investing a significant amount in the company. We would generally advise Dutch companies to convey to potential investors in the term sheet phase that they are willing to consummate a Delaware flip—but that they will do so only immediately prior to the closing of the investment transaction.
Through the Delaware flip, the Dutch founders and investors will become shareholders in a Delaware corporation. Some of them may become directors and officers of a Delaware corporation. This will require them to become familiar with Delaware law, which adds some complexity to the company’s operations and may result in additional legal expenses.
Typically, unless the Delaware corporation holds substantial U.S. real estate investments, the Dutch shareholders will not be subject to U.S. income tax except with respect to dividends received from the Delaware corporation. Capital gains from the disposition of the shares in the Delaware corporation would generally be exempt from U.S. income tax. However, shares of the Delaware corporation would constitute U.S. situs property for U.S. estate tax purposes, so additional planning is required to minimize potential U.S. estate tax exposure.
From a Dutch tax perspective, the flip may impose additional tax costs on Dutch investors and founders due to the fact that dividends paid by the Dutch BV may – post flip – in cases become subject to a 15% Dutch withholding tax when paid on to the Delaware parent, whereas prior to the flip dividends could be paid to the Dutch investors and founders free of Dutch tax.
Another potential disadvantage of doing a Delaware flip is that it is generally a one-way transaction. Because of U.S. tax rules, it may be very expensive tax-wise to reverse a Delaware flip.If there is no investor pushing for a Delaware flip, Dutch companies should consider whether just setting up a Delaware subsidiary will be sufficient to help the company obtain a foothold in the U.S. For example, if a Dutch company merely needs to hire U.S. employees or sell its products in the U.S., having a Delaware subsidiary is often an adequate solution.“
Which would look something like this, I’d say from my Tax Designer desk:
So in cases where US Top Structure makes sense, is a Delaware Flip ‘enough’?
“Merely doing a Delaware flip is often not enough to attract U.S. investors. Typically, a U.S investor will expect to see significant traction in the U.S. market. In many cases, a U.S. investor will expect one or more of the founders to move to the U.S. (As a side note, a founder should carefully consider the tax aspects of moving to the U.S. well in advance of the actual moving date.)
So in short: a Delaware flip is a major corporate undertaking and requires a significant investment of time and money. However, if a Dutch company has a high level of confidence that a flip will result in one or more U.S. investors investing a significant amount in the company, it would certainly be a smart move to consider a Delaware flip!”
Many thanks Jan!
Bas’ Tax Considerations for the Delaware Flip:
Interposing the Delaware C-Corp
The Delaware Flip implementation process can be a pretty smooth tax ride due to the effects of the Dutch Participation Exemption. This provision allows Dutch companies to receive dividends and capital gains from owning ≥5% stakes in subsidiaries fully free from tax, provided a.o. that the subsidiary is subject to at least a 10% ETR and that the covered amounts are not deductible at the subsidiary level.
A Dutch subsidiary will meet such criteria, meaning that when the base structure already includes a [Dutch] HoldCo BV as the existing investment or ‘top’ holdding entity, the transfer of the shares in the operational entity [Target] that leads to the ‘interposition’ of the Delaware C-Corp [ultimately effectuating the Delaware Flip] can take place without incurring Corporate Income Tax on the potential Arm’s Length capital gain.
Things to look out for: if the investment structure does *not* yet contain an intermediate holding entity, the transfer to the Delaware C-Corp could trigger reorganizational tax costs still. The same applies when the Cap Table includes parties in a jurisdiction where Transfer Taxes apply, and a look-through provision can impose said tax on indirect transfers. Also: if assets have been transferred between the existing Holding Entity and the Target, the share transfer could trigger taxes on previously consolidated positions.
Upstreaming Dividends Post Flip
The Dutch Target would become fully US-Owned. For the Dutch operational entity, this means that dividends will be ‘upstreamed’ to a 100% US Shareholder. Dutch Tax Law contains a 15% Dividend Withholding Tax, but the tax includes a broad-based exemption. This exemption allows certain dividends paid to Qualifying Shareholders to be upstreamed without the standard 15% withholding tax and is designed to prevent double taxation and encourage investment. A Qualifying Shareholder would generally be one that owns a ≥5% stake and is located in a Treaty State, and meets certain substance and Beneficial Ownership requirements.
For our Flip, this means that the dividends can be upstreamed free from withholding tax [and generally received without pickup tax] if the structuring and agreements are tuned right. Special mind should be paid to the substance-based criteria here.
US Tax Considerations
For the involved non-US Persons, it maybe surprising how strong the US’ ‘pull’ on profits and money flows flowing under US ownership are, and how succesful the US are in securing taxing rights on such pulls in their treaties. For instance, the subsidiary would be considered a ‘Controlled Foreign Corporation’ if it became >50% US Owned [check the Cap Table!] and this status may trigger direct taxation on IP-related income if the Dutch Innovation Box applies. In addition, the Delaware C-Corp involvemtn could ‘drag’ the non-US Founders into US Tax Obligations, on account of having US-Sourced income.
So: always make sure to understand how your tax life looks post Delaware Flip too. We like to contact Jill Boland of CliftonLarsonAllen for this – she’s seen the Flip before and she’s had bitterballen.
Wrapping Up
The USA continues to be a Land of Opportunity, and your can give your US Investors as well as clients Table Service through a Delaware Flip –> give them ‘something American’ to do business with and adapt your legacy structure to make it work.
The Flip is a bit of a one way street, however, as US Law and Tax Law [like ‘anti-inversion’ rules] can make undoing it pretty difficult. And when entering the US Market like this for real, do appreciate how different the American legal system is to what you may be used to as a European. So: dig in and get advice. The Delaware Flip can be a valuable move. If done right!
Want to Discuss? Book a Slot – it’s on the House.
Here’s my Calendly – here when you need me an Jan and Jill are standing by🔥
