The answer, again, is flip. A flip is when you put a Delaware, or U.S.-based, holding company status on top of a non-U.S. corporate structure.
It may not be talked about that often. But at a recent private equity conference, I witnessed a partner at a well-known multinational venture capital firm announce that more than one-third of the European companies in the firm’s portfolio either had completed a flip or were evaluating whether to do so.
A flip is simple. It is implemented by a share for share (and option/warrant for option/warrant) exchange. Conceptually, it involves an existing foreign company and a new Delaware corporation.
After a flip, the new Delaware corporation will use the existing foreign company’s name. But it will continue to manage its existing non-U.S. operations either directly or through a U.S. subsidiary that it could form. As part of the plan, the new company also issues new shares to investors and new options to employees. Several factors appeal to those who have implemented flips. Among them are the following:
Facilitates North American M&A. If the company wishes to grow through acquisition, a flip gives the ability to use U.S. shares as acquisition currency. It is much more difficult for a European or Pacific Rim company to purchase a U.S. target with its shares, as U.S. sellers are often uncomfortable with becoming stockholders in non-U.S. corporation given that their legal rights as a stockholder may be different here than abroad.
Facilitates raising U.S. venture capital. If the company seeks VC-backed funding from the United States, it will find that U.S. private equity investors are significantly more accepting of a U.S. corporate vehicle than a foreign-based one. In fact, it is not uncommon that the internal rules of a U.S. institutional investor prohibit it from investing in non-U.S. corporations. In addition, over the years, the U.S. venture industry has adopted investment norms and customs that are predicated on the target portfolio company being a Delaware entity. Thus, flips might be viewed as a form of financial strategic alliance, in which the U.S. venture capitalists bring to the company not only financing, but their knowledge of, contacts in and generally their guidance for the U.S. markets.
Facilitates Access to Public Markets, Such as Nasdaq. A U.S. corporation is easier to list on the Nasdaq and other major U.S. exchanges than a foreign corporation. It is not merely that the mechanics of listing foreign shares (or their American Depositary Receipt counterparts) is more expensive and complex than listing U.S. shares. It is also an issue of the market’s preference, given that underwriters and investors generally prefer buying -and are willing to pay a higher price for- U.S. shares. After all, investors understand the legal rights and responsibilities of the corporate players in a U.S. corporation, but they are not as familiar with British, French, German, Danish, Swedish, Dutch or other corporate vehicles and rules.
Appeals to North American customers. Most companies with international ambitions know that between 30% and 60% of the market for their products is in America. In some sectors, at least, using a U.S. corporate vehicle can be attractive to trading partners and customers. Not only does having a U.S. parent corporation signal a marketing commitment to the North American market, but it also supplies a contracting vehicle that is familiar and more predictable to those partners and customers.
Enhances M&A liquidity. If the company has a product or technology that is of interest to North American M&A buyers, adopting a U.S. corporate form enables the use of methodologies that may simply not be available with a non-U.S. vehicle, such as the U.S. style of “forward or reverse triangular statutory merger.” In Europe, for instance, the legal framework for statutory mergers does not yet exist, although proposals for implementing legislation have been made.
Helps in recruiting and hiring of U.S.-based employees. Just as investors find comfort in the familiar U.S. corporate structure, so, too, do U.S. employees. A prospective employee may be concerned about the non-U.S. company’s commitment to the U.S.-and, thus, the employee’s job -or the differences in employee “rights” between U.S. and non-U.S. companies.
Flips do have disadvantages, of course. For example, implementation of the Flip may result in significant tax liability unless there is a tax exemption for the share-for-share exchange, or unless there is little or no appreciation in the value of the exchanged shares. If a flipped company decides to list its shares on a European stock exchange rather than on Nasdaq, then it will likely endure the legal complexities of a U.S. company listing in Europe, while still remaining subject to U.S. securities laws. Also, the management time and professional fees to plan and complete a flip can be costly.
Understandably, employees of a foreign company are concerned when the topic of a flip arises. Common reactions can include a fear of losing their jobs or rank within the company, and natural anxieties about the changes when a group of entrepreneurs have used their blood, sweat and tears to create and build a company in their own country and community, only to see the prospect of a flip moving it to the U.S. It takes a certain corporate maturity for employees to ultimately be willing to move beyond such uncertainty so that investors or M&A partners or customers can feel more comfortable.
There are also legal issues relating to corporate governance and to terms of employment that arise in most flips. For instance, under the laws of a company’s formation in another country, employees may be entitled to appoint an observer to or actual member of the board of directors, and may have certain rights to notice and consultation in the event of material corporate events. Some of these rights might be lost or modified if the parent company for the group is a U.S. corporation.
Although certain employees are likely to be asked to undertake responsibilities for certain activities of the U.S. company, most employees will remain employed. Implementing a flip does not in and of itself require that a company change the timetable for developing its U.S. operations.
But, on the positive side, a flip may enable certain benefits that might not have been available for employees in the old company. For example, employee stock options in some countries are structured with pricing, duration and other terms that may be more rigid than is common in U.S. corporations. To the extent that the option program is driven by the corporate laws of a foreign country, the flipped company may not be similarly constrained under Delaware law and U.S. federal law.
The process of designing and implementing a flip benefits from consensus. Not only must the company’s key players favor the step, but also it is best to obtain consensus from even the smaller, less influential participants (such as minority stockholders). In short, the goal should be 100% approval, a goal that is easiest to achieve in companies with a small number of stockholders or in which the flip is timed to coincide with a major corporate financing. The prospect of the company obtaining additional funding from new investors is usually more convincing than even the most persuasive presentation of the rationale for the change.
Nonetheless, all parties must plan for possible dissent by a few stockholders (for example, a disgruntled former employee). While most countries have legal mechanisms for forcing some corporate changes on a small minority of stockholders, such mechanisms can be costly and result in considerable delays. Most companies use adroit planning and open stockholder communications to avoid having a problem with minority stockholders.
In addition to obtaining stockholder consent for a flip, companies will want to be sure that no other consents or approvals are needed. For instance, if a foreign company has been financed by a government loan, might the terms of that loan affect the flip (such as requirements to remain a local corporation or to spend the loan locally)? Similarly, are there licenses or permits that might be affected by the flip?
So, whether a flip is the answer for your company requires consideration, study and debate, weighing disadvantages against the benefits of more ready access to U.S. private and public equity and M&A markets.
Albert L. Sokol is a partner in the Private Equity & Venture Capital Practice Group at Edwards & Angell, a law firm with more than 300 attorneys nationwide focusing on technology, financial services and private equity. Stephen L. Pike is also an attorney in the Private Equity/VC group. They may be reached at asokol@EdwardsAngell.com and spike@EdwardsAngell.com.