Flipping a foreign entity into a Delaware corporation has become a popular strategy for entrepreneurs and businesses looking to take advantage of the favorable business environment and fundraising opportunities in the United States. Below we explore the process and legal considerations of flipping a foreign entity into a Delaware corporation, along with the reasons why foreign entities choose to flip. Additionally, we will discuss important considerations such as intellectual property (IP) licensing, treatment of existing preferred stock, convertible notes, SAFES (Simple Agreements for Future Equity), and tax implications.
Why Flip a Foreign Entity into a Delaware Corporation? There are several compelling reasons why entrepreneurs and businesses choose to flip their foreign entities into Delaware corporations:
- Attractive Legal Framework: Delaware has a well-established and business-friendly legal system. It has well-defined corporate laws, a judicial system specialized in efficiently interpreting the state’s corporation laws and in resolving disputes, extensive case law, and flexible governance structures that make it an attractive jurisdiction to organize business entities..
- Investor Confidence: Many investors prefer investing in Delaware corporations due to the familiarity and certainty provided by the well-developed legal system. This can enhance investor confidence and increase fundraising opportunities.
- Access to Capital: Being based in Delaware can provide easier access to venture capital and private equity funding, as investors often prioritize companies incorporated in Delaware due to the factors outlined above.
IP Licensing: During the process of flipping a foreign entity into a Delaware corporation, it is crucial to address intellectual property (IP) ownership and licensing. Existing IP owned by the foreign entity should be properly assigned or licensed to the newly-formed Delaware corporation to ensure seamless continuation of operations and protection of IP rights. Many investors will also want the protection of knowing the Delaware corporation in which they made their investment has full ownership of or rights to use the IP.
Treatment of Existing Preferred Stock: If the foreign entity has preferred stock, the treatment of existing preferred stock depends on various factors, including the terms of the stock, any shareholder agreements, and the specific objectives of the company. Typically, the conversion of foreign entity stock into Delaware corporation stock involves negotiation with existing shareholders to ensure a fair and equitable transition into the Delaware entity, often mirroring the existing foreign rights as closely as possible in the Delaware corporation.
Treatment of Existing Convertible Notes and SAFES: Similar to preferred stock, the treatment of existing convertible notes and SAFES will depend on their terms and conditions. The conversion process may involve discussions and negotiations with the note holders and SAFE holders to determine the appropriate conversion mechanisms and terms. Often, an existing convertible note or SAFEholder will choose to exchange their SAFE in the foreign entity for a similar convertible note or SAFE instrument in the Delaware corporation.
Tax Treatment: Flipping a foreign entity into a Delaware corporation may have tax implications that require careful consideration. It is essential to consult with tax professionals to understand the specific tax consequences in the country where the foreign entity is organized, the countries where the founders are located, and the United States. Depending on the circumstances, tax issues such as transfer pricing, exit taxes, and foreign tax credits may need to be addressed.
Flipping a foreign entity into a Delaware corporation offers numerous advantages, including access to a favorable legal framework, investor confidence, and better fundraising opportunities. When undertaking this process, businesses should pay close attention to important considerations such as IP licensing, treatment of existing preferred stock, convertible notes, SAFES, and tax implications. Seeking the guidance of legal and tax professionals throughout the process is crucial to ensure compliance with relevant laws and the rights of existing investors, as well as to maximize the benefits of the flip.
By Sara Clasper and Larry Bard, NEXT Team
