U.S. Market Entry - The Flip-Up

July 17, 2012, by Robert V. Hawn

San Jose and Santa Clara are such vibrant places to do business that many foreign companies want to relocate to Silicon Valley. As a corporate lawyer working with start-up companies, I have helped a number of ventures enter the U.S. market, and have worked with companies from Australia, Canada, China, Denmark Finland, India, and Israel, among others.

In past blogs, I have discussed some of the threshold considerations faced by companies leaving their home countries and relocating in the U.S. I have also discussed some of the entity forms that companies can adopt when deciding to access the U.S. market merely to sell their products or services.

Companies that decide that they want to access the private equity markets and managerial and technical talent resident in Silicon Valley often relocate their headquarters here in the U.S. For these companies, a "flip-up" will allow them to grow their company in the U.S. by being in a position to access local capital and hire a sophisticated workforce.

A flip-up is essentially a corporate reorganization. At its simplest, owners of the foreign company will exchange their interests for shares in a U.S. company. When the transaction closes, the foreign company is a wholly-owned subsidiary of the U.S. company, and the U.S. company is owned by the former owners of the foreign company.

A successful flip-up will require coordination among a company's U.S. and foreign tax advisors, legal advisors, and advisors for the foreign company's stockholders.

Flip-ups occurring during the early stage of a company are typically easier to accomplish than late-stage flip-ups. This is because the number of affected stockholders is usually smaller, as is the number of outside relationships that require special attention. If a company is considering a flip-up and a financing transaction, it should flip-up first and then close the financing. Often, U.S. investors will require that a company flip into the U.S. as a condition to a funding transaction.

A related reason for engaging in a flip-up early is that older companies usually have a capital structure and stockholder agreements that can be challenging to manage through a transaction. Companies that have closed numerous financing rounds often are subject to constraints that add complexity to closing. These constraints include stockholder rights enabling particular groups to have veto rights over reorganization transactions, outstanding options, warrants, and other convertible securities, and large numbers of stockholders. In addition, securities laws compliance can become relatively more expensive because the laws of the jurisdiction where the issuer (i.e., the U.S. company) resides, and the laws of the jurisdiction where each of the stockholders reside, must be followed.

On the other hand, new companies may face unique constraints. For example, young foreign companies may have received government grants to help them develop technology and grow their operations. Because these grants often require that the company be owned by citizens of the funding government, the terms of each grant must be reviewed carefully to determine whether the terms of the grant will permit a flip-up.

Whether accomplished when the company is young or more mature, a flip-up's structure needs to be carefully reviewed by experienced tax advisors to minimize or eliminate any tax impacts, particularly on the stockholders. This is particularly important because flip-ups rarely generate cash for any stockholders, and any tax liability would have to be paid out of a stockholder's other resources. Tax advisors should also be consulted in connection with determining where the company's intellectual property should reside for tax purposes after the flip-up is closed.

Flip-ups almost always require the approval of a company's stockholders. This will require the company to review its stockholder approval procedures, especially any voting agreements that might exist, and any relevant law. Likely, there will be minimum notification procedures that must be followed. In addition, disclosure documentation may be required. The cost and time of each of these must be built into the transaction so that the parties have a realistic expectation of the closing schedule.

Flip-ups are one of the best methods for a company that wants to take advantage of U.S. private funding opportunities and enter the U.S. market. The earlier the company can make the decision to reorganize as a U.S. company, the easier the transaction will be for all concerned.

The information appearing in this article does not constitute legal advice or opinion. Such advice and opinion are provided by the firm only upon engagement with respect to specific factual situations. Specific Questions relating to this article should be addressed directly to the author.