Setting up your business in Silicon Valley - what international entrepreneurs need to know

www.dlapiper.com 1Date

SETTING UP IN THE USA:SUBS/FLIPS, OPERATIONS & VC FINANCING

Louis Lehot and Philipp TsukanovSeptember 9, 2016

TRACTION CAMP +


About DLA Piper LLP (US)


About DLA Piper

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Louis Lehot

Partner

DLA Piper LLP

Voice: (650) 833-2330

Mobile: (650) 796-7280

[email protected]

Philipp Tsukanov

Associate

DLA Piper LLP

Voice: (650) 833-1593

Mobile: (510) 701-7649

[email protected]

mailto:[email protected]



Setting Up in the US


What are my choices?

– Go direct

– Branch

– Subsidiary

– “Flip” – creating US Holding Company

Setting Up in the US

8


Fundraising: Accessing US Venture Capital

– Will US VC invest directly in foreign company?

– Are you ready for VC financing?

– VC financings

Setting Up in the US: Fundraising

9


Objective: Established foreign company (“TechCo”) needs US subsidiary for

local presence and contracting, hiring, benefits, limited liability, IP/tax

structuring

Key Steps:

– Delaware corporation

– One Shareholder

– One Director (or more)

– Officers: President, Chief Financial Officer, Secretary

– Common Stock (ordinary share equivalent)

– Timing: as fast as 1 day

– “Qualify” in California or other States where operate

– Consider operations and need for intercompany IP agreement

– Consider tax optimization and intercompany services agreement and

transfer pricing

Setting Up in the US: Subsidiary

10


Objective: TechCo needs access to US venture capital and focus operations

in US

Process: “Flip” the business from abroad to the U.S. by inserting a new US

“Parent” company above TechCo

Key Steps:

– Incorporate a new Delaware company (“US Newco”)

– Existing shareholders of TechCo contribute their TechCo shares to Newco in

exchange for US Newco shares

– NewCo seeks US venture financing – using $ to fund operations in the US

and for TechCo

– Business conducted in US by US Newco; certain foreign activities continue

through TechCo or other subsidiaries, as needed

– CEO and sales staff typically US based

– R&D; technical, development and support staff abroad

“Flips” – Setting Up a New US Parent

11


“Flips” to US seen from: Western Europe, Israel, Australia, Canada

– Tax issues/valuation of TechCo – tax rollover/deferral

– Tax considerations going forward

– IP – Keep IP in TechCo or migrate to US

– US Newco management and capital structure

– Consents/approvals of TechCo and viability of flip

– Compel exchange of TechCo shares for US Newco shares?

– Effect flip sooner rather than later, prior to creation of significant

‘value’ in TechCo

– Required legal and accounting team in place for transaction

– Time/expenses to effect flip

“Flips” – Setting Up a New US Parent, continued

12


“Flips” – Setting Up a New US Parent, continued

Non-US Corp

Shareholder 2

Pre-Restructuring

US NewCo

Shareholder 1 Shareholder 2

Post-Restructuring

Non-US Corp

Intercompany

Relationship

New Investors

Shareholder 1


Intergroup Agreements


Intercompany Agreement – Five Compensation Methods Option 1: US is a service provider

– US office provides sales and marketing services and/or R&D services and earns

a cost plus return

– home country parent bills customers and retains other activities

Home Co. Customers

US Office

Sales, marketing, R&D servicesPayments for services


Intercompany Agreement – Five Compensation Methods Option 2: US is a distributor

– US office can be compensated as a distributor earning a targeted operating

margin

– US office with the US office billing customers

Home Co.

Customers

US Office

Distribution rights, goodsEarnings minus operating margin

Distribution


Intercompany Agreement – Five Compensation Methods Option 3: US licenses IP from home country parent

– US is an entrepreneur licensing IP from home country parent and paying a

royalty to the home country parent

– US office engaging in high end activities and billing customers

Home Co.

Customers

US Office

RoyaltyIP license


Intercompany Agreement – Five Compensation Methods Option 4: US buys IP from home country parent

– Migration of IP to US with US becoming the parent and the residual profit

claimant

Home Co.

Customers

US Office

Migration of IP to US with

US becoming the Parent


Intercompany Agreement – Five Compensation Methods Option 5: US and home country parent cost share IP development with each

retaining the rights specific to their territory

– US pays for the rights to use the IP in its territory and then co-develops

the IP with the home country parent

Home Co. Home Customers

US Office US Customers

Co-develop IPRight to use IP


U.S. Startup Formation Basics


U.S. Startup Formation Basics: Type of Entity

C corporation vs. S corporation or LLC

– Primary Distinction for Domestic Investors

– Double taxation v. single layer of tax

– C Corporations are subject to “double taxation” — tax on both (a) profits of US subsidiary

and (b) distributions to home country parent

– “Pass-through entities” (LLC, Branch Office) are not themselves subject to US income tax;

all profits and losses are passed through to parent

– This distinction is less relevant for non-US investors as they are not

afforded the benefit of a single layer of tax

We typically recommend using a

C Corporation for the following reasons:

– Limited liability for parent company for acts of US office

– Protects the parent’s books and records from investigation by US tax authorities or

US litigants

– More certainty as to revenue and expenses attributable to US

– Incentive stock options are easier to administer through a C Corporation


U.S. Startup Formation Basics: Location of Entity

We recommend incorporating in Delaware:

– broader ability in Delaware to limit monetary liability of directors for

breaches of the duty of care;

– broader ability in Delaware to indemnify officers and directors;

– greater flexibility in Delaware to adopt measures to protect against hostile

takeovers; and

– general reputation of Delaware law as more favorable to management,

combined with the greater predictability of Delaware case law.

– Section 2115 of the California Corporations Code applies to Delaware

corporations which have significant operations in the State of California and

more than 50% of their outstanding voting securities held by California

residents.


U.S. Startup Formation Basics - Employment

A foreign entity can engage employees to do business in the U.S. U.S.

employers are required to obtain a federal EIN, pay applicable payroll

taxes and withhold certain tax contributions from its employees.

Employers may be required to register employees with the specific state

in which they are employed (varies from state to state).

Employment contracts are not required and if used do not require

specific terms. In most states, absent an agreement to be employed for a

fixed period of time, the relationship is for an indefinite term and deemed

‘at will’ (i.e. either party may terminate the employment relationship at

any time, with or without cause, and with or without notice).

Independent contractors must be truly independent and not be closely

directed by the principal. There are multiple factors utilized (on both the

federal and state level) to determine whether an individual is properly

classified as an independent contractor.


Venture Capital Financing


Convertible Debt vs. Equity – the “Form” of the security

Convertible Debt:

– now a stand alone financing (typically up to $1.5M)

– investment converts into next equity round on same terms at a

discount

– faster

– often no diligence (or limited)

– investors are individuals, angel groups, VCs

– simple documents (document generator)

– fast (1-2 weeks)

– lower transaction expenses

– company often leads (solicitation package)

Venture Capital Financing

25


Equity:

– preferred equity

– typical venture model terms (see NVCA model documents)

– rights and preferences and higher valuation than common stock

– contemplated to be successive rounds of financing at increasing

valuation as the company progresses

– takes more time than convertible debt financing (3-5 weeks)

– due diligence and negotiation of terms and multiple investment

agreements

– higher transaction expenses and company reimburses investor

counsel

– investor leads

Venture Capital Financing, continued

26


General considerations:

– “best in sector” standard

– partnership for the future

– decisions now (structure; valuation; terms; vetos) impact the future

– company capitalization table needs to be dynamic

– no common stock financings!

– have your house in order

– be prepared for due diligence

– expect a process and the need to build relationships

– sell business first then address jurisdiction/structure issues with

your proposed new partner

Venture Capital Financing, continued

27


Thank you


Louis Lehot advises late-stage emerging private, going public and public

companies and their investors in forming, financing, building, scaling and achieving

liquidity for technology, healthcare, energy and innovative businesses.

Louis’ recent emerging private company clients have included AdKnowledge, Inc.,

AdoTube (acquired by Exponential Interactive), Binatone Global (buyer of Motorola

Mobility’s companion products business), CheckALT (buyer of Diebold's check

processing business), Centric Software, Docea Power (acquired by Intel), Double

Beam (acquired by Verifone), Kerensen Consulting (acquired by salesforce.com)

and MetricTest (acquired by Microlease plc), and public company clients including

CBRE, CHC Helicopter, Hanwha Q Cells, MMI Technologies, Model N, Samsung,

Seagate, SK Planet and STMicroelectronics.

Louis’ institutional and fund clients have included venture capital firms Foundation

Capital, Hony Capital, NEA and Oak Investment Partners, private equity firms Cetus

Capital, Silver Lake Partners and Hellman & Friedman and corporate venture funds

at CBRE, CSR plc, GE, Hanwha, Samsung and SK Planet.

Louis practiced in New York, London and Paris before returning home to the Silicon

Valley in 2005, and helps European companies large and small in doing business in

the United States.

Louis Lehot

Louis LehotPartner

T: +1 650 833 2330

F: +1 650 687 1223

[email protected]

Education

Boston College Law School J.D.

Georgetown University B.S.

Institut d'Etudes Politiques de

Strasbourg (France) C.E.P.

Admissions

California

New York

Silicon Valley Office

2000 University Avenue,

East Palo Alto, California, 94303



Philipp Tsukanov focuses his practice on representing public and

private companies in M&A transactions and other corporate matters.

Prior to joining DLA Piper Philipp worked as an associate in

corporate/M&A and real estate practices in the Moscow office of one

of the leading international law firms. He was representing Russian

and international clients in joint ventures, M&A transactions and other

general corporate and real estate matters.

Philipp Tsukanov

Philipp Tsukanov

AssociateT: +1 650 833 1593

[email protected]

Education

University of California, Berkeley,

School of Law, LL.M., 2015

Moscow State Academy of law,

Diploma in Law, 2007

Admissions

New York

Silicon Valley Office

2000 University Avenue,

East Palo Alto, California, 94303

