Should you do the Delaware flip?

Recently PEO argued that becoming a US corporation was increasingly attractive to most European VC-backed companies. SJ Berwin's Simon Witney is not so sure.

Some European venture backed businesses have recently been thinking about using a US (usually a Delaware) corporation as a holding company for their operating group. For some, there are good commercial reasons to do so. Companies that have an active business in the US, and an imminent intention to raise money there, might well find that a US company is the most convenient structure. But for businesses without any existing direct connection with the United States, the logic is far from clear. For them, there is a significant risk that the flip flops!

Of course, the US hosts the most attractive IPO market in the world for technology companies, and there is some evidence – including a study of Israeli companies – to indicate that floating an 'American-looking' business on NASDAQ delivers greater liquidity and better valuations than a non-US entity. For European companies going to the US public markets there may come a point when it does make sense to put a Delaware holding company at the head of the group (although it is perfectly possible to float a European company on NASDAQ too).

But the question, even for those companies, remains: when to do the 'flip'? There may be some advantages to doing it early – tax charges may be lower when the group has less value, for instance. But that cost issue has to be carefully weighed against the downsides of using a Delaware corporation in a group which has no other connection with the United States. The US is the most litigious country in the world and establishing a connection with it (indeed, effectively putting all your assets – shares in the underlying companies – there) earlier than necessary for speculative future benefits is not a decision to be taken lightly. There can also be securities law issues if the company ultimately chooses to float on a non-US market, and those can add time and cost to the flotation process. What's more, if the exit is a trade sale to a non-US buyer, who might be against buying a US company, you may have to unravel the structure.

Delaware is a business friendly jurisdiction, and NASDAQ listings can argue in favour of US structures. But the judgements are finely balanced, and the issues should be carefully thought through. The downside risks are considerable, and the upside benefits often speculative, at best.

SJ Berwin is a pan-European law firm with a specialisation in private equity.  Further information on the firm is available at www.sjberwin.com or from Simon Witney (simon.witney@sjberwin.com).