During negotiations with a US venture capital fund, an Italian startup may face a condition precedent to investment: completing a Delaware flip.
This requirement may arise as early as the term sheet, the document outlining the key economic and governance terms of the proposed investment round. Rather than simply incorporating a company abroad, a Delaware flip involves a corporate restructuring that affects the group’s ownership structure and tax position.
Why US investors require a Delaware flip
A Delaware flip involves establishing a US holding company above an existing Italian operating company. The holding company typically takes the form of a C-Corporation (C-Corp), a corporation taxed as a separate legal entity in the United States.
This structure is familiar to US investors and allows them to rely on established legal instruments and standardized documentation, including preferred shares, governance rights, equity incentive plans, and provisions governing future exit transactions, such as the sale of shares or the business itself.
A Delaware holding company may facilitate access to US venture capital, subsequent financing rounds, and potential acquisitions. However, it does not automatically result in more favorable investment terms or higher valuations.
How the transaction is structured
In the most common structure, a Delaware C-Corp is incorporated, and the shareholders of the Italian limited liability company (S.r.l.) contribute or transfer their equity interests to the US holding company in exchange for its shares.
As a result, the Delaware corporation becomes the sole shareholder of the Italian company, which continues its business operations, while new investors acquire equity in the US parent company.
The transaction documentation must address the exchange of equity interests and account for existing articles of association, shareholders’ agreements, convertible instruments, equity incentive plans, and intellectual property ownership.
Key considerations before implementing the flip
What are the tax implications for existing shareholders? Transferring equity interests to a US holding company may trigger taxable capital gains in Italy, even without any cash consideration. The startup’s valuation and the timing of the transaction are therefore particularly relevant.
What happens to previously claimed tax incentives? Investors who benefited from Italian tax incentives for innovative startups should assess whether contributing or transferring their shares could trigger the forfeiture of those benefits, particularly before the expiry of the minimum holding period, generally three years.
Where is the holding company effectively managed? Incorporation in the United States does not prevent the Italian tax authorities from challenging the company’s tax residence if its effective management or ordinary business management is predominantly exercised from Italy.
How will the two companies interact? Services, financing, personnel, and intellectual property arrangements require appropriate intercompany agreements, a proper allocation of functions, and compliance with transfer pricing rules, which govern transactions between related companies.
Can the transaction be reversed? A Delaware flip is not legally irreversible. However, reversing the structure may involve significant legal, operational, and tax complexities, particularly after external investors have entered the company’s capital.
A strategic decision to make before the investment round
A Delaware flip is a corporate and tax structuring decision, not a mere formality. Its suitability should be assessed before executing investment agreements, through coordinated legal and tax advice in Italy and the United States.
EXP Legal advises startups and investors on the assessment and planning of these cross-border transactions.