America has appealed to global startup companies for years – and for good reason. The US market promises access to US-based investors, accelerator programs, and a very large market of potential customers and strategic partners.
Businesses that demonstrate success in the US market have the ability to dramatically accelerate their global growth, which may ultimately lead to even greater investment opportunities.
In most cases, a startup seeking to join an accelerator or secure VC funding in the US must first set up a US legal entity.
Since VC investors and most accelerators will get equity in the startup company, it’s likely they will require the startup to establish its US entity as a US parent company as opposed to a US subsidiary. This big question a startup then faces is how and where does a global business owner set up a US parent entity, and what type of legal entity should it be?
Entity and Jurisdiction
The most frequently used legal entity when entering the US is a C-Corporation (“C-Corp”). VC investors tend to favour investing in a C-Corp and not a limited liability company (“LLC”) in order to avoid the pass through tax treatment of losses and gains usually associated with an LLC.
When the time comes to add employees, there are benefits to being a C-Corp when establishing an equity incentive plan (stock options plan) with incentive stock options available to employees.
There are also significant tax benefits if a C-Corp qualifies for a Qualified Small Business Stock Exemption and shares are held for five years or more.
After deciding to set up a C-Corp, you must then select the state in which you will form the C-Corp. Delaware has maintained a global reputation for being the most frequently selected jurisdiction for incorporation. It has predictable corporate laws, a robust infrastructure of services for new and established businesses, and specialised courts known for fair and speedy decisions. There is also an ability to have documents that require a state filing to be processed with incredibly rapid turnaround time – often within the same day or hour!
For the reasons noted above, the US venture economy is heavily based around investing in Delaware entities. Typically, an investor’s legal agreements will be based on Delaware law, so from this perspective, being a Delaware C-Corp reduces the time and cost to complete an investment.
The Delaware Flip
A “Delaware Flip” is the most common way for a startup company with a legal entity already in existence in its own country to incorporate in the US. Through a Delaware Flip, a founder exchanges their existing company stock or interest for stock in a Delaware C-Corp, and their existing company becomes a wholly-owned subsidiary of the Delaware C-Corp.
The founders will also need to decide if any of their shares in the Delaware C-Corp will be subject to reverse vesting, which provides protection to investors and co-founders if one of the founders leaves the company before their equity interests are fully vested.
This process can be arduous, and is best executed with the support of a US startup attorney who has familiarity working with global startups entering the US market. As a founder, you will need to have a number of legal documents, in addition to obtaining an Employee Identification Number (EIN), securing a virtual or physical office, and carefully transferring any intellectual property to the new parent company – all in the most tax and time efficient manner possible.
Raising Capital in the US
Once the legal entity is established, the process of raising capital for your new Delaware C-Corp may begin. Startups must work to be investor ready – which requires all legal documents to be properly prepared and readily available, the founders to have spent significant time preparing and practicing their pitch, and a five-year financial model has been created.
For those just getting started with a seed round of funding, this round is typically completed through either a Simple Agreement for Future Equity (SAFE), a Convertible Note, or a priced preferred stock round (Series Seed Preferred).
Both SAFEs and Convertible Notes will often have a Valuation Cap – a pre-negotiated ceiling imposed on the price at which a SAFE or Convertible Note will convert to stock ownership in the future – and a Discount Rate, which drives the price that preferred stock is sold to investors. The investor in a SAFE or Convertible Note will receive the lower price based on the Valuation Cap and the Discount Rate. Convertible Notes will also have an interest rate and maturity date that need to be agreed upon.
A Series Seed Preferred stock round is more complex and involves a number of terms in addition to valuation that need to be negotiated. These may include information rights, preemptive rights, liquidation preferences, and protective provisions that require investor approvals for certain actions taken by the company.
You will also be required to comply with US federal and state securities laws for any of these types of fundraising. Working with your startup attorney will be critical advising you throughout the financing transactions.
Immigration and Employment
Entering the US market touches on several other important legal areas that need to be analysed and addressed. Immigration is one key area that involves visa requirements for founders looking to move or spend time working in the US.
Another critical focus is to ensure compliance with employment laws, an area that heavily relies on both federal and state level regulations. All hired individuals must be correctly classified as employees or independent contractors. The business must have all of the employment and consultant agreements prepared and in place for each employee and consultant, and understand rules around job applications and interviews.
Entering the US market is a very exciting milestone for a global company, but one filled with many risks that may lead to potential pitfalls. Being educated as to what is involved, and making sure you have the right legal counsel to guide you through formation, financing, immigration, and employment areas will be critical to the long-term success of your startup.
This article was originally posted on upmarketry.