Flipping up, not out: navigating the path to introducing a US holdco
Corporate Law - 18 October 2019
The holy grail for most scale-ups is a reputable venture capital firm making a key investment — both financially and strategically. US investors are keen on Australian startups and scaleups, but they don't always like holding shares in Australian domiciled companies over the long-term.
There are two key reasons for this: firstly, they want senior management situated close to them to more efficiently coach and network them in the US to drive growth, and, secondly, Australian corporate law and regulation is not familiar to them and — in their eyes — adds to regulatory risk and transaction costs. Whilst this process can seem complicated, it is becoming a well-worn path provided you have experienced advisers to help navigate you through to completion.
Increasingly, we are seeing significant US investments tied to the condition of bringing the holding company or 'holdco' closer to the US investors. The jurisdiction of choice is Delaware…
The State of Delaware has the most comprehensive and flexible set of facilitating corporate law for venture capital. More than 50% of publicly-traded companies are incorporated in Delaware. You don't have to have your principal place of business there, meaning you can set up anywhere in the US.
We recently helped enboarder, a fast-growing Human Resources 'Software as a service' platform business, to redomicile (colloquially known as a ‘flip’) to Delaware. Below we share some insights for other investee companies who may be considering a similar path.
What is a flip?
Whether you call it a 'flip' (US) or a 'top-hat' (UK), in essence it involves incorporating a new entity in the foreign jurisdiction, moving all your Australian shareholders and optionholders ("stakeholders") to that new holdco, then leaving the Australian entity as a wholly owned subsidiary of the new holdco. This process is primarily underpinned by tax advice and structuring to ensure that you can ‘roll’ the exiting holdings into the new holdco without triggering a taxable event, executed by a carefully constructed legal documentation framework.
Moving your shareholders to the US involves a share-for-share exchange between the existing Australian entity and the new US holdco that is authorised by your shareholders. Moving your optionholders requires an offer being made by the new US holdco for new options on the same terms as their old options, and then the cancellation of their old options. The US investor will either invest just prior to the flip (i.e. subscribe for shares in the Australian company but with a condition that the flip happens) or invest immediately following the flip. Their investment commitment obviously needs to be watertight ahead of time as you don't want to bother with the flip if the money will not follow.
This process is a corporate flip and it looks like this:
Other ways to flip
Another option is a resource flip, which may satisfy a major investor without needing to complete a full (and costly) corporate flip. This is where key senior management are required to spend much of the year working in the US so that the US investor can have more direct access and influence), working more closely with them to accelerate the business such as making introductions and encouraging networking in the US.
You could also make a full flip, which starts with the corporate flip but also requires the transfer of all of the assets and the operating business to the holdco or a new subsidiary in the foreign jurisdiction. This would reflect a full pivot to the foreign jurisdiction where justified on a market basis or for tax reasons.
Our top tips
1. Offset the cost with a tangible upside
Having both legal and tax advice, in both jurisdictions, is essential to get this done. Consequently, it is better justified in the scale-up or late start-up phase of a company. To justify the cost of this, you need to see and extract the value-add that the investor will deliver to your business and market growth by being in the new country, whether by access to their market network, customer distribution lines, or in-house development team.
2. Get advisers with experience
This is a legally complex transaction but has been well-road tested, so experienced legal advisers can efficiently manage the flip within 4-6 weeks. Lawyers are needed in both jurisdictions, and a tax adviser with offices in both countries would be preferable. If some of your shareholders or optionholders reside in other jurisdictions, you may also want to consider getting tax advice to help them to determine the tax impact of the flip on their own position (otherwise they will need to get their own advice).
One of the advisers or someone in your own team needs to take the lead to set the timetable and coordinate all the inputs, of which there are many including ensuring compliance with Australian offer laws, incorporation of the new holdco and new shareholder agreements, the flip documents themselves, a new option plan and stock option agreements for your optionholders, the appointment of new board members, and a myriad of formal transfer paperwork that needs to be executed to finalise the flip.
Given how much there is to do, you need a team around you that are easy to work with and responsive to your timeframe.
3. Get your tax advice early
The tax implications are complex, and this complexity rises if you have foreign shareholders on your share register and employee options outstanding. You need a tax adviser who has experience in flipping companies to eliminate the risk of triggering an Australian tax event for your Stakeholders, and to make the process easier for you to navigate and explain to your shareholders and employees.
4. Your major shareholders need to be on board early
Before you commit the time and adviser costs to executing the flip, you should canvas your major shareholders to ensure that they are on board. The flip can only happen if every shareholder agrees to exchange their shares for shares in the new holdco. You may have the contractual right in your shareholder agreement to forcibly drag all your shareholders into the flip, but winning their approval is always a better way to go. Those shareholders will, after all, continue to be your shareholders after the flip.
5. A large shareholder body can be tricky
Apart from the practical difficulties in trying to get a large shareholder body to each agree to exchange their Ausco shares for shares in the new US holdco, there are also restrictions on making offers to your Ausco shareholders without a disclosure document (like a prospectus) unless all your offers qualify for an exclusion under law. The lesson here — if you are going to make a flip, go before your capital table becomes too complicated.
6. Shareholder agreement mis-match
Australian-style shareholder agreements (even one already amended to accommodate usual Venture Capitalist-required terms) are very different from the US-style, standard investor and governance agreements. For Australian domiciled shareholders, the flip only works to avoid Capital Gains Tax if they retain the 'same rights' after the flip as they did before — this can't be achieved if you simply move from an Australian shareholder agreement to a VC-standard shareholder agreement. There are a few ways to accomplish this, but we suggest that you tackle this early in your planning with advisers.
7. Dealing with employee options
Similar CGT rollover relief issues arise when trying to rollover your employee optionholders into options to be granted by the new US holdco. Standard US stock option plans contain concepts and restrictions that won't result in the 'same rights' for optionholders. You also need to ensure that the favourable start-up tax concessions for optionholders are maintained so that your employees are no worse off from a tax perspective after the flip — this is obviously important to secure their buy-in.
8. Communication is key
Your employees will be concerned about the flip and may have many questions about how it will impact them. While a formal communications document will need to accompany the final package of legal documents you send to all Stakeholders, you don't want to 'flip out' your employees by keeping them in the dark about what is going on. The story is a really positive one. A flip is usually a sign that the company is growing and the move to the US is transformational in terms of customers, markets, and scale — all very exciting stuff!
Need help making the flip?
We can put you in touch with advisers here in Australia and overseas to help you to take this big step… without flipping out!
Deanna Constable is an experienced M&A, corporate, and commercial partner at Lander & Rogers. She provides legal advice to foreign investors and supports startups and scaleups from establishment through to exit. Get in touch with Deanna below.
All information on this site is of a general nature only and is not intended to be relied upon as, nor to be a substitute for, specific legal professional advice. No responsibility for the loss occasioned to any person acting on or refraining from action as a result of any material published can be accepted.