For Australian startup founders with global ambitions, structuring your company for international success is crucial. One increasingly popular approach is the “flip-up” structure, where an Australian company establishes a US parent company. This article explores why and how Australian founders might consider this strategic move.
A number of Australian tech companies undertake a US Flip Up every year. If you’re seeking extra traction with investors and employees in the United States you may be investigating the manuevoure of flipping up your Australian entity. The procedure can often be difficult and expensive but let’s go through some of the key details.
What is a US flip up?
A “flip up” is a reorganisation in which an existing startup in one nation interposes a new holding company in the US (HoldCo) between it and its existing shareholders, and effectively move the head entity’s location. The existing shareholders’ present interests in the existing startup are exchanged for similar interests in HoldCo as a result of the flip up, and the existing startup becomes a completely owned subsidiary of the US holding company.
Given the importance of the US market to many businesses, we frequently see flip ups to the US in Australia. Singapore and the United Kingdom are also popular flipping locations.
Why undertake a flip up?
• To raise money from an often bigger pool of foreign investors – a flip up is a common restructure that fast-growing Australian companies go through in order to raise money from US-based institutional venture capital funds. The majority of US investors prefer to invest in a company with US headquarters. With over 9 of the top 10 global VCs being based in the US, this is a difficult point to overlook.
• To concentrate a company’s operations on a foreign market – relocating a company’s headquarters to a new market is an obvious step toward operational growth. A flip up frequently occurs in conjunction with a business plan to expand operations in the United States, and the flip up facilitates this process (e.g. the business is enabled through the US entity to employ staff, lease an office and issue US shares under an employee share option plan).
• To take advantage of US intellectual property development concessions – Whilst Australia offers enticing research and development incentive scheme – this is often challenging for most tech businesses, while the US has recently introduced a reduced rate for royalties on intellectual property generated in the US.
• To allow the group’s head firm to easily deal with customers and suppliers based in a foreign market – many US corporations (and banks) prefer to do business with other US companies.
What are the key steps involved in a US Flip Up?
• Incorporate the holding company (generally a Delaware structure – C-Corp is used)
• HoldCo and existing startup shareholders enter into a stock exchange deal (i.e. scrip for scrip).
• Existing shareholders are given US HoldCo shares – usually with a situation mirroring the Australian captable.
What US corporate structure to choose for US flip up?
Usually Delaware C-Corporations are taken up to meet investment requirements (including the influential Y-Combinator). The US state of Delaware is a popular choice for US firms because of its favorable tax and regulatory rules. Most high-growth technology companies form Delaware C-Corporations for a variety of reasons, which you can learn more about here. Usually US lawyers are engaged to form this organisation, although many businesses use Stripe Atlas to do so. A legal firm with international ties will help you resolve a lot of the more detailed aspects of the cross-jurisdiction setup.
US flip up procedure and the structure of the group company
Usually companies considering the flip up have already been registered and operating in Australia as a private company limited by shares with a previous capital raise in their history.
The ‘flip up’ involves relocating the share capital table (i.e. founders and investors) from the Australian company to a new parent organisation in the United States (the new Delaware C-Corp entity). This is accomplished by conducting a ’share swap’ between the US and Australian entities, in which the Australian shareholders exchange their shares in the Australian company for shares in the US entity. Often companies still retain Australian bank accounts and pay their Australian employees through the Australian company, which is now a wholly-owned operating subsidiary of the US parent company.
Documentation and actions for the flip up process
You’ll need to update your ASIC registration with your new business structure and shareholder information, as well as cancel your Australian constituent documents (shareholder’s agreement, options plan, and share certificates). You’ll also need a US lawyer to draft a stockholder agreement (the terms of which will very certainly need to follow US standard practice if you want to raise US funding), 83b forms, board consents, securities exchange agreements, regulatory filings, and other documentation.
Some US setup basics
Employee identification number (EIN) – The Internal Revenue Service will issue you an EIN (IRS). The EIN can serve as a company’s social security number (SSN) and it can be fairly difficult to do anything as a business without one (e.g. opening a bank account). Getting an EIN can be simple – here’s the link to the EIN application website.
State registration
You may need to register your company in specific states in the United States.
If you predominantly sell to US businesses you will likely need to register for US sales taxes. Part of the registration may involve filing for a Certificate of Good Standing from the state where you’re incorporated (i.e. Delaware). You then apply to be registered in the state with your certificate of good standing – allow for possible snail mail turnarounds.
Another common reason for registering your company is to enable health insurance coverage for your employees.
Employee option plan
Often the Australian company have an employee share option plan in Australia before migrating to the US, which requires transferring to the new US parent organisation. US lawyers can prepare a new US option plan, and employees who were previously on the old option plan have their option agreements moved over. Carta & Cake are common apps to handle your US employee option plan.
Bank accounts
Not all US financial institutions make it straightforward for international founders to open accounts. To open an account usually a physical bank branch visit is required, and the bank needs to conduct background identity checks on all shareholders with more than 25% shareholding.
Business online banking is often described as cumbersome although Wise is well recommended to reduce exposure to foreign exchange fees here.
IP: You’ll have to decide whether or not to transfer your Australian company’s IP to the parent company in the United States. Given the tax implications of moving your IP, but you should seek tax guidance on where your intellectual property should be stored. If you want to take advantage of R&D tax breaks in Australia, you need think about the ramifications of relocating your IP and what contracts might be required.
In addition to the foregoing, below are some general guidelines for redomiciling your business in the United States:
- Keep your investors informed: You will likely need your existing investors to support the company’s move to the United States. This may require favours, such as putting up with the potential shareholder tax ramifications of moving to the US (e.g., it could be a taxable event, and ESIC incentives may be lost) and the necessity to amend their initial shareholder rights (so they mirror US practice). Given this, you should make every effort to provide them with as much visibility and notice as possible during the process, as you will eventually require their assistance.
- Use software to your advantage: The US tax, employment, and legal systems are well-known for being difficult to manage, especially when both state and federal laws are taken into account. On the other hand, the United States has low-cost software designed to make the life of entrepreneurs easier. Gusto is often used for payroll, Carta for share capital table administration, and Divvy for spending and cost management software.
- Prepare to ‘Americanize’ your business: Many features of early-stage Australian companies’ corporate structures are unfamiliar to US investors, particularly when it comes to shareholder rights and early-stage investment arrangements. If you’re committed to the US and want to raise capital here, you’ll need to understand (and persuade your investors to accept) that these Australian quirks need to be removed and brought in line with US standard practice.
- Social Security Number: When banks run background checks on you, for example, having an SSN makes the procedure much easier.
- Support from the Australian consulate: If you intend to land in the United States, you should contact the Australian authorities. Austrade’s San Francisco Landing Pad, can possibly give you access to resources, specialists, and office space, making the shift to the United States much smoother.
Common FAQ’s Around Flip Ups
Whom should I seek for advisors?
Prudent founders seek out skilled tax and legal counsel with specialists in both jurisdictions. We can direct you to our partners in the US should you need assistance.
In most US flip ups involving an Australian entity, the US lawyers handle the HoldCo’s formation and draft the US paperwork, such as the bylaws and other HoldCo incorporation documents, as well as any US financing arrangements (if there is an investment taking place post flip). Australian lawyers create the necessary resolutions for the share exchange and tax advisors like Fullstack can analyse the tax implications for the shareholders participating in the transaction.
When is the best time to do the flip up?
If the flip is being done to get access to a US investor, it should take place right before the US investment is made. We don’t see any major benefit in doing this sooner, because US investors are becoming more familiar with the flip up process and are less concerned about it being a condition prior to investing.
What are the Australian tax consequences?
Normally, because the owners in the previous startup are disposing of a capital gains tax (CGT) asset, the exchange of shares in a flip up would result in capital gains tax for them (being their shares). There are a few CGT rollovers possible for flip ups, though:
• Division 615 rollover
• Subdivision 124-M rollover
Relief from rollovers
In general, rollover relief has the following effect:
• Division 615 rollover relief does not apply to options.
• Shareholder capital gains triggered by the flip are ignored at the moment the Flip happens, and
• The cost base of the replacement equity transferred or issued to shareholders (i.e. shares in holdco) is equal to the cost base of the original equity (i.e. shares in the existing startup) for CGT purposes, so any unrealized capital gain is deferred or preserved, and CGT is only triggered when the shareholders later dispose of their replacement shares.
What are the key conditions for rollover relief?
Depending on which one applies, the circumstances for rollover relief differ. When both Division 615 and Subdivision 124-M rollovers are applicable, the Tax Act establishes a “tie breaker” rule that gives Division 615 preference.
For each sort of rollover relief, the following are some of the main conditions that must be met (this list is not exhaustive):
Rollover in Division 615
• The shareholders must sell all of their current startup shares to the holdco in exchange for HoldCo shares and nothing else.
• The percentage interest and market value of each shareholder’s shares in the HoldCo must be the same as they were in the current startup right before the flip, and vice versa.
• Following the flip, the existing startup’s shareholders must own all of the shares in the HoldCo, or another shareholder (e.g. the original HoldCo shareholder) can own 5 or fewer shares in the HoldCo, as long as those shares are of nominal value.
Rollover in Subdivision 124-M
• Existing startup shareholders trade a similar stake in the company for a similar stake in the holding company (i.e., share for share, or option for option).
• The HoldCo must acquire at least 80% of the voting shares of the existing startup as a result of the exchange.
• The arrangement is one in which at least all owners of voting shares in the existing company can participate, and participation is available on basically the same conditions for all owners of a particular form of interest in the existing startup.
How long does a flip up take?
The time it takes to accomplish a flip up might vary depending on the complexity of a company’s cap table, as well as the commercial motivations and decisions that go into it.
Given the potential negative consequences of not obtaining rollover relief, care must be taken to ensure that the existing startup’s rights and interests are replicated in the HoldCo, which can be complicated by the existing startup’s cap table containing options, preference shares, and convertible notes.
Furthermore, when there is an investment pre-flip or post-flip (or both!), there are additional parties involved in the process, and investors will want to study the flip paperwork to ensure they are not harmed. Multiple individuals reviewing the documents might add a significant amount of time to the process.
What if the company has Employee Share Scheme Shares/Options on issue?
Employee Scheme Options and Shares (ESS or ESOP) can add to the complexity of a flip since, unlike ordinary shares, these shares may be subject to vesting limits and unique tax laws concerning when they are taxed (one of which can be disposal).
A Subdivision 124-M rollover can be used to convert options into shares, and the same offer must be made to all option holders.
Even if rollover relief is achieved under Subdivision 124-M, there may be significant tax ramifications for option holders due to the ESS provisions in the Australian Tax Act. For example, in a tax-deferred plan, disposing of an option in the flip may result in a taxation point on the option or violate the three-year holding period in a startup plan.
As a result, the ESS regulations include its own type of rollover relief to ensure that no negative tax consequences arise (ESS rollover).
If ESS rollover is secured, the new choices will be viewed as a continuation of the previous ones. As a result, it is critical that the ESOP adopted in the United States replicate the previous Australian scheme – this may require some tweaking.
Regardless, you may find difficulty accessing a rollover where an employee holds more than 10% presently.
Other Considerations
A flip up might have broader ramifications, both tax-wise and otherwise. The following are some of the tax implications that should be considered in the future:
• Franking credits will not be available to shareholders after the flip — most startups that conduct flips aren’t expecting to pay dividends in short to medium term and are instead focused on capital gains, so this isn’t an issue.
• Location of IP – no rollovers are available for a move of IP to the US company so a consideration of the scenario of moving the IP vs licensing the IP from the Australia entity is required.
• Existing shareholders’ shares kept on revenue account may have distinct tax ramifications.
• R&D Tax Incentive — need to assess how a move of IP or R&D staff might impact your claim.
• International tax concerns like transfer pricing on any payments made to the intellectual property holding organisation after the flip up.
Some other factors to consider are:
• Contracts from the existing startup may need to be assigned to the HoldCo.
• The Corporations Act disclosure requirements will apply to the issuing of replacement shares in the HoldCo to shareholders, and the necessary exemptions must be satisfied to avoid the need for a prospectus to be prepared and filed.
• The Corporations Act’s shareholder protections will not apply to the US company; instead, Delaware law (or whichever US state you choose for the incorporation) will apply – a new investor rights and voting agreement may be required, and it should follow US best practice.
• Creating the necessary agreements between the existing startup and the HoldCo to allow them to operate in both jurisdictions.
• Preparing Australian shareholders for tax compliance obligations in the United States.
If you’re considering taking your business overseas, feel free to reach out to our tax experts to help guide you through the logistics and tax considerations of your US flip up.
