So why would you want to do one? Why pay a bunch of lawyers and accountants a minimum of $25k AUD to put you through such an ordeal?
We get asked this a lot so we put together a webinar for Blackbird founders with Tyler Hollenbeck of DLA Piper in Seattle and Matt Fairhurst, co-founder of Skedulo. Matt flipped up last year, and Tyler helped him do it.
The aim was to explore what flip ups are, why you would want to do one and what some of the mistakes founders make while doing them.
This blog post is a summary of that discussion. The video contains more in depth analysis and opinion.
Before we get into it, a healthy disclaimer: this article and the video linked above are no substitute for good legal and accounting advice. Under no circumstances should you attempt a flip up on your own and none of the information in this article should be taken as formal legal or accounting advice.
What is a flip up?
The term ‘flip up’ describes the process of getting a company from one jurisdiction (i.e. Australia) into a company from another jurisdiction (i.e. USA).
Why would you flip up?
The simplest answer to this question, is that if you want money from US investors, you usually have to have all the assets and IP owned by a US company.
One founder told us that “American investors only want to invest in an American parent company that owns all the assets.”
Is it possible to raise money from US investors if you don’t flip up? Yes, “they will make exceptions of course, but that generally occurs when they are desperate and you don’t need their money”, said one founder we asked.
However don’t flip up expecting it will increase your chances of raising from US investors. Think of it as a minimum requirement rather than a selling point. We’ve heard of founders flipping up without an interested US investor at the table. This will cost you money but it won’t increase your chances of raising any money. More commonly founders flip up when they have a US investor ready to go.
What does a flip up look like?
This is very simple illustration of what happens in a typical flip up. First you set up a US C Corporation, probably in Delaware which is a taxable US company and is the preferred entity of most US investors. Take good advice before considering structures other than a Delaware C Corp.
On the left, you have your Australian company and its shareholders (e.g. founders, investors and employees). All those shareholders agree to transfer their shares in Aus Co to US Co in exchange for receiving new shares in US Co. Through this exchange, the shareholders of Aus Co become the owners of 100% of the shares in US Co, and Aus Co becomes a wholly-owned subsidiary of US Co.
The equity ownership of the Australian subsidiary is effectively duplicated at the US C corp level. Meaning that all your Australian investors, employees or anyone else with equity in the Australian entity would become equity holders in the US C Corp with identical rights.
What are the tax implications on the Australian side? What about the US side?
You will need to consider tax implications of the following:
- Any capital gains tax for shareholders, including founders and employees pre and post flip up;
- Transfer pricing implications;
- R&D tax rebate implications
If you exactly duplicate the rights and the ownership of the Australian company’s equity at the US company level, then it should be a tax-free exchange on both the Australian and the US side. If your Australian company has a simple cap table, perhaps just founder owned ordinary shares or one series of preference shares, this is fairly straightforward.
However, duplicating the rights and ownership can become tricky if you have a more complicated cap-structure. For example if you have multiple series of preference shares, convertible notes, options or warrants, then duplicating the rights and ownership is more complex.
What are you going to f*** up?
So many things! Here are some landmines described to us by founders:
- “After the flip up, pay attention to revenue recognition and transfer pricing. When you charge USD to USD customers and AUD to AUD customers, you can get f***** up.”
- “If you own shit in Australia through discretionary family trusts, and they’re done without a corporate trustee, they’re seen in the US as a complete pass-through so any gains you accrue through sale/disposal are completely personal, which will impact your tax position.
- “If you leave, you have a disposal event with the ATO for Capital Gains Tax purposes. I had no idea, and most people I talk to have no idea either. If they catch you out, you’ll be on the hook for the Capital Gains Tax value at the time you left. If you leave Australia early in the life of your startup, and the company wasn’t worth shit, then you won’t have too much of a bill. But if you leave later with a good valuation, you’re up for a big capital gains tax bill. You can defer it as a person, but not if you’re a trust.”
- “Your employee share plan. It’s caused us so many headaches trying to recreate that in a way that was on par for our original Australian employees. US tax law is different so this wasn’t easy to do. My advice — get very good tax advice on transitioning your employee share plan from an Australian to a US scheme.”
Like we said, seek good accounting and legal advice before attempting your flip up.
How long does the process take?
It depends on the complexity of the existing cap table and how well you’ve documented everything. If you have a simple cap structure and your records are clean, then the process can take two to four weeks. However, if your cap table is more complex and your company records aren’t in order, flipping up will take longer and cost more.
Another thing that can slow the process down is the number of parties involved in the flip up. Often startups flip up because they have a US investor committed. In this case the US investor and their legal team will likely want to review all of the flip up documents and be involved in the process. This can add to the time it takes and will cost you more.
In some cases you might need to do some cleaning up of the rights before you flip up and this can drag out timelines. For example, if you have convertible notes and you can’t mirror those rights there are a number of alternative paths you’ll need to explore.
How much does it cost?
If you have a very simple cap structure with some ordinary shares and one series of preference shares, and if the process is kept to within 2–4 weeks, the costs could come out around US$15,000. This includes some stamp duty, analysis of the cap table, preparing the exchange documents and preparing the US company’s formation documents that parallel those of the Australian entity.
On top of this you then need to consider the implications of international transfer tax regulation and importantly on the IP ownership and R&D tax credits. All this considered the costs could come out at $25,000.
To be frank though, $25,000 would be getting out of it cheaply. There are always complicating factors and it’s rarely a straightforward process.
Should I just start off with a US C-corp and an Australian subsidiary?
If you know you are going to be raising capital from the US at some point, then that would save some money and trouble as you wouldn’t need to flip up. However then you need to factor in the complexity and cost of compliance with US laws, and any implications for your ability to claim the R&D tax rebate.
It is often very hard to foresee when you’re starting out what circumstances the company will be in a couple of years down the track. Although flipping up can be costly and time-consuming, if you plan for it well in advance and keep good corporate records, it is manageable. Usually the trigger for flipping up is a fundraising from US investors, so the money to pay for legal and accounting advice is also available.
Who do you need advice from?
Tyler and Matt recommend the following for your ‘Flip Up Team’:
- Australian corporate lawyers who advise on the rights of existing shareholders and the share exchange process;
- Australian tax lawyers who will advise you on the tax aspects of the share exchange;
- US corporate lawyers who will form the new US entity and advise on the share exchange process and if you are also taking investment at the same time, the US fundraising component. Unless there is complexity in your flip up, your US tax lawyers will probably be able to cover any US tax issues;
- US accountants; and
- Australian accountants.
If you are generating revenue then you will likely need international tax transfer pricing analysis. This could be done by the US or Australian legal or tax teams. Depending on who you use, larger law firms will have experts in house that can advise on this. You shouldn’t need to engage another party. It can also be beneficial to have an expert on the R&D tax grant in your team. Once the flip is complete there are a number of reporting and legal obligations which are affected by the flip up, and an R&D tax professional can help advise you on these. It can also be very useful having a ‘quarterback’ ie an all-rounder adviser to co-ordinate all of these different professionals, and this is one advantage to using an international legal firm like DLA Piper. In our case study, Skedulo worked with Tyler Hollenbeck, who had in-house access to Australian and US tax lawyers, as well as corporate lawyers. Tyler was able to co-ordinate all of these people which made the process easier for the founders of Skedulo.
What are the implications on the R&D tax rebate?
In order to take advantage of the R&D tax grant, the IP typically has to be owned and housed in the Australian entity. If it isn’t, you can still apply for the grant but the process is far more complex and you need to jump through a lot of hoops. The nuance and detail behind this is complex, and you absolutely need expert advice on it.
- Get good help: Lawyers are expensive and we all try and reduce the number of minutes we spend with them. However, the cost of getting a flip up wrong can be an order of magnitude greater, so you are better off spending a bit of time with your lawyers up front. This will save you spending a lot more on the back end.
- Save yourself time and money by making sure your house is in order before you start the process. Clean up your cap table, get all of your records in order and make sure you’re ready even before you start fund-raising.
- Make sure you understand all of the implications on the R&D tax grant. Again, this is a complex and nuanced area and you should get good advice.
Here is the full video:
And the audio file if you prefer: