EUROPEANS FEAR THE “US FLIP”

Having recently assumed the annual post of chairman of the European Private Equity and Venture Capital Association (EVCA), Herman Daems of Belgian growth investor GIMV has stressed in a number of public pronouncements that two issues in particular are high on his priority list: firstly, promoting more seed and start-up investment and, secondly, encouraging capital markets to be more receptive to growth companies.

Cynics may greet this news with a shrug of the shoulders. After all, any new EVCA chairman failing to pay lip service to a lack of equity for entrepreneurs and the need for a viable IPO route for the star companies of tomorrow would surely be failing in his or her duty. While some may accuse him of tokenism, Daems is in fact motivated by what he sees as the need to head off a significant threat to the future of the venture capital market in Europe. This threat comes in the form of a phenomenon being referred to as the “US flip.”

Mature companies, whether based in the US or elsewhere, have commonly registered in Delaware to take advantage of various tax breaks. But now, lawyers say they have noted an increasing tendency for young European businesses – often disillusioned with a lack of finance and poor IPO prospects in their domestic markets – to go through the relatively cheap and quick process (normally four to six weeks) of establishing a Delaware holding company.

the venture capital environment is seen as more conducive in the US

Herman Daems

For the companies in question, this means little real change: unless they desire to move to the States, motivated perhaps by closer proximity to a significant part of their customer base, they can continue to operate in their domestic jurisdictions. The real benefit is in gaining better access to sources of US venture capital as well as paving the way for a possible future IPO on Nasdaq.

There are two main reasons why a flip makes firms attractive to US investors, says Charles Fuller, a partner at international law firm Latham & Watkins. For one, some US investors can only invest in US-registered entities. In addition, registering in Delaware means that funding rounds and IPOs become mere “box ticking” exercises due to familiarity with the documentation.

“With the US increasingly being perceived as the most likely exit route for European tech companies, it is a frequently debated issue,” says Fuller. “The trend of younger tech companies doing US flips is increasing, especially where US venture capitalists are involved or may become involved in later funding rounds.”

Daems reluctantly concurs with Fuller's assessment. “It's clearly a growing phenomenon, because the venture capital environment is seen as more conducive in the US,” he told Private Equity International. “It is also precisely the reason why when I took over from [previous EVCA chairman] Jean-Bernard Schmidt I was keen to promote the idea of a European high growth market.”

But Daems has a fight on his hands to stop Europe's present generation of entrepreneurs from turning their backs on European sources of finance and liquidity. As the European venture market struggles to keep up with its US counterpart both in terms of capital provision and availability of exit options, it appears that its resident entrepreneurs have identified a way of taking matters into their own hands.