“Flipping” your Company to the US?

I mainly help U.S.-based companies set up shop and scale for revenue in non-US regions. But I see more and more interesting deals where European or Asian companies are coming to the U.S.

(Disclaimer!)

There are usually two considerations why companies (startups and enterprises alike!) set up a dedicated U.S. entity: international regulations and litigations, and taxes.

International Regulations and Litigation

I’ll try to not get carried away here. It is sufficient to say that under the Trump administration enforcement of international regulations is quite active. As a company, you are subject to U.S. jurisdiction for a variety of reasons, even without an office in the U.S. Examples are the use of U.S.-origin goods or the use of the U.S. financial system. U.S. international regulations include

  • Anti-money laundering laws
  • U.S. export control regulations, such as the Export Administration Regulations (EAR) and the International Traffic in Arms Regulations (ITAR)
  • Economic sanctions regulations by the Office of Foreign Assets Control (OFAC)
  • Foreign Corrupt Practices Act (FCPA)

Besides international regulations, setting up an independent company in the U.S. (versus a branch office) reduces some risks from (frivolous) lawsuits that could consume quite a bit of energy and also somewhat shields your trade secrets, emails, employees, from (e-)discovery. It is much harder and more costly to sue you, summon employees for depositions, or demand documents if your main company does not have a branch office here. A branch office also exposes your company’s global earnings to U.S. tax law. An incorporated company limits legal and tax exposure to that company’s U.S. earnings as long as other earnings are recognized elsewhere, and you do not choose to do the “flip”.

Taxes

For early-stage companies, the interplay between tax laws of your home country and the U.S. are probably more relevant than the litigation risks. You should consult with a law firm that has some experience in that area (personally, I’ve worked with Orrick, Bird & Bird, Foley & Lardner, Squire Patton Boggs). The right solution depends on your specific situation, but here are three starting points to think about.

Option 1: Foreign Parent, U.S. Subsidiary

This is relatively simple. You chose a jurisdiction for your company. It doesn’t have to be Delaware and could be any other business-friendly state. You set up a U.S. subsidiary. You need to set up annual accounting and file quarterly corporate income taxes. Your U.S. subsidiary might have a very different cap table structure than your foreign subsidiary. And you need to name required officers. Your new corporation requires a legal document called “bylaws” that defines the various procedures for elections, size of the Board of Directors, officer titles and functions, or shareholder meetings.

From a VC perspective, I most likely would need to invest in the foreign parent that controls the U.S. subsidiary. Not every VC is comfortable doing so. Sometimes their Limited Partners Agreement (LPA) specifically restricts them to U.S.-only investments. In that case, I would not be sure what I would be investing in: Who owns the intellectual property, who votes, how much control do I have? And how would an acquisition by a large U.S. entity work out? But this setup does shelter your foreign parent somewhat from the litigation risk and tax events of U.S. operations.

There are also some business practices you still need to follow, despite your own U.S. corporation.  Generally speaking, you absolutely do not intermingle employees, executives, customer meetings, etc. If your foreign salespeople fly into the U.S. and close deals, then your foreign country might want to claim taxes on that income, and you might get into trouble without a work visa, and in any litigation, all the emails from that salesperson might become discoverable as they were doing substantial business in the U.S. Furthermore, I hope your salesperson did not communicate any business-related topics over WeChat or WhatsApp or other mobile apps — all these records, even private ones, might now be discoverable, too!

Second, you establish and document (!) an Inter-Company Agreement (ICA) between the foreign parent and the U.S. subsidiary that has “fair pricing” for goods and services exchanged between your two companies and fair interest rate for any debt financing and capitalization. Generally, you do not want to commingle funds. But you need to capitalize your U.S. subsidiary. Interest on debt incurred by a U.S. corporation is deductible. That creates an incentive for debt-financed operations. But if your interest rate is too high, the U.S. tax authority might shake their fist for tax evasion, and if the interest rate is too low, your foreign tax authority might do the same — fun with knives!

The same is true for goods and services exchanged: If you charge a meager fee for services delivered by the foreign parent, then your foreign parent might barely make a profit. Your foreign tax authority might suspect tax evasion.  If, on the other hand, you charge a very high fee for services delivered by the foreign parent, then the profit of your U.S. subsidiary is very low, and the U.S. tax authority might suspect tax evasion or, worse, money laundry.

Intellectual property usually remains in the foreign parent. Your Inter-Company Agreement will define a fair fee for your U.S. subsidiary to use intellectual property. More nuanced, any invention in the U.S. subsidiary is likely assigned to your foreign parent that then grants usage rights back to the U.S. subsidiary.

If you hire employees for your U.S. subsidiary (likely!) employ a payroll service provider, remember health care insurance (depends on your state!), and don’t forget the wide variety of other insurances (property, liability, D&O, casualty, …)

Option 2: Brother & Sister

This is a bit more work. As above, you incorporate in a state of your choice. But now you create the same cap table structure for your existing shareholders and executives. IP remains in the foreign company. The founders get ownership through direct issuance, maybe even restricted shares because you do not want to trigger a taxable event at home!

Otherwise, you operate as above option 1, with an Inter-Company Agreement and strict separation of funds and employee activities.

Option 3: U.S. Parent and Foreign Subsidiary (the “Delaware Flip”)

This is usually a major undertaking, with significant impact on shareholders, taxation, IP, fees. However, some U.S. VC investors might only feel comfortable to invest in a U.S. parent, where they understand case law and what happens when things go sideways (or even well!).  Moving your new U.S. company out of the U.S. or winding it down for any reason becomes very difficult under U.S. tax laws.

You establish a new U.S. holding company, a U.S. “TopCo” above the existing foreign company as a new parent. The U.S. TopCo has U.S.-sourced income (21% taxes). You create a share exchange agreement, and all foreign owners exchange their shares for shares of the TopCo. You also exchange any outstanding options to purchase shares of the foreign company for new options to purchase shares of the new U.S. parent. Foreign-sourced income is tax-deferred unless it’s a dividend.

A few caveats:

  • Your main operations are now in the U.S. That means you are more exposed to the risk of litigations and regulations than before. Be wise regarding trade secrets and intellectual property.
  • The Inter-Company Agreement specifically spells out handling of Research and Development: While invented in the U.S., you assign the IP to the foreign subsidiary and license its use back to the U.S. TopCo, at a fair price.
  • Be careful with loans and pricing, as above. Be especially careful if you happen to have a government research grant or other subsidies: you might trigger repayment or penalties if you move out of your country!
  • Often, these “flips” might incur significant exit tax owed by the shareholders in their home country. The tax basis also might be different: we have seen countries where the tax basis might be assessed up to two years after the exit: “I understand that your valuation was only $500,000 when you flipped to the U.S.  But now, two years later, you just raised a funding round at a $50M valuation – so your value potential, when you flipped, was actually $50M. We’d like to get these taxes on the $50M instead of the $500,000.” While the taxes might be reasonable, they need to be paid in cash. Make sure your shareholders (including probably you!) have some cash!
  • Your current investors now hold shares of a U.S. entity. I hope they understand what that means regarding venture law, practices, dynamics, governance, etc. Moreover, going back to list on a non-US stock exchange might become legally very complicated (you are now subject to US securities laws and can only issue securities according to effective registration statements on file with the US Securities and Exchange Commission (“SEC”)… there are some exemptions, but few).

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