While the venture capital market becomes increasingly global thanks in part to Europe, China, Israel, India, and Canada, the United States remains the leader in venture-backed financing. Although some American venture funds are willing to invest in foreign startups, the lion’s share of U.S. venture funds are not going overseas.
Most U.S. venture capitalists believe ROI from domestic deals will be superior to foreign ones. Investing in a foreign company exposes the U.S. venture fund to a new set of legal rules, compliance issues, and risks, leading to increased uncertainty and transaction costs for the American venture fund. Additionally, trying to replicate typical American VC terms, such as anti-dilution and redemption provisions, can be difficult to accomplish in a foreign market.
Does this mean my international (i.e., Non-U.S.) startup will be shut out from a majority of U.S. venture capital funding or from being acquired by a U.S. company?
Potentially–unless your international startup performs a Delaware Flip Transaction.
What is a “Delaware Flip Transaction?”
A Delaware Flip Transaction is the process of creating an American holding company for an international company. The end result is that the international company will be owned entirely by the new American company. Thus, the U.S. venture fund will invest in the new American company.
What are the mechanics of a Delaware Flip Transaction?
The basic mechanics of a delaware flip transaction is to create a U.S. holding company and insert it above the international company. Next, the shareholders of the international company execute a share-for-share exchange by exchanging their shares of the international company for the shares of the U.S. holding company. (Note that this share-for-share exchange may require some additional legal maneuvering depending on the jurisdiction of the international company. For example, it will likely be necessary to use a “scheme of arrangement” or other court-approved process to accomplish the exchange in the UK and other jurisdictions.)
Why Flip to Delaware?
Delaware provides the most comprehensive set of corporate law in the United States. No matter which American state the venture fund is located in, such a fund will
be comfortable with require Delaware law. Additionally, foreign companies are likely most comfortable with Delaware law, as Delaware provides a good neutral ground or “playing field.”
I previously wrote a post about why you should consider incorporating in Delaware here.
Final thoughts on Delaware Flip Transactions
Even if an American venture fund is willing to invest in (or purchase) your international startup, it still may be beneficial to perform the Delaware flip transaction. The reduction of legal uncertainty and the ability to replicate typical U.S. venture capital terms should dictate an increase in valuation and could facilitate a NASDAQ or other listing (although IPO exits for venture-backed companies are not very common). Alternatively, Delaware may provide neutral ground for funding or acquisition by a non-U.S. company or fund.
And finally, there are important tax implications that may result from performing a flip transaction, thus such a deal requires both U.S. and foreign accountants.
Thus, the Delaware flip transaction may not be for every international startup looking to be funded or acquired, but it should at least be considered.