Doing the ‘UK flip’:
how to insert a UK holding company above an existing group structure

Companies searching for funding flock to the source, wherever that may be and whether or not that is within their own jurisdiction.

West Coast USA, New York, Austin Texas and elsewhere in the US have well-developed markets for venture capital, with high concentrations of venture capital investors and fund managers optimising for investments made in their own back yard.  So too does the UK.  In fact, the UK remains the largest market in Europe when it comes to financing start-ups and scale-ups.

UK companies and investors looking to the longer term will recognise the benefits of easy access to the UK public markets.  There is also a well-worn path here for company sales to UK or US buyers familiar with ‘UK deal structures’.  And the UK legal system, the English courts and English law are renowned and respected across the world.

One way to make yourself a more-visible proposition for investors is to flip your investee company to the home or otherwise preferred jurisdiction of those investors.  To do that, HoldCo can be incorporated in the relevant jurisdiction and put on top of the offshore Target as its holding company.

In executing a flip, there is usually no desire to change the current position as regards beneficial ownership (although the position will usually change post close when further equity investment is raised, sometimes immediately after the flip completes).  On that basis, arrangements are usually made so that the post completion shareholdings in HoldCo ‘mirror’ those of the pre-completion shareholdings in the Target.  There are also tax drivers behind this approach, which are examined further below.

A flip into the US involves inserting a US HoldCo above a non-US Target to attract US investors or as a condition to raising subsequent US investment.  US investors tend to be most familiar with Delaware C-corporations and as such use Delaware as their US state of choice for HoldCo’s incorporation; hence, the term ‘Delaware flip’.

There are, however, drawbacks to a Delaware flip which may in some circumstances make a ‘UK flip’ a more attractive option.

A Delaware flip will mean entering the remit of US taxation (state and federal), which may expose a company to a higher tax rate than in the UK or elsewhere, as well as potentially onerous US tax compliance obligations.  There is also the ‘US litigation risk’ to consider (which may well extend to the founders and senior management personally in a way that goes beyond what shareholders and directors in and of UK companies are familiar with).

And there is that awkward time difference between the UK (and Europe) and the US that gets progressively more problematic the further east you go across the globe.  Managing people and working with advisors can be challenging when they start work just as you are finishing.

The first step is to incorporate HoldCo, which will act as the buyer in the share for share transaction.  Company incorporation can be done inexpensively here in the UK, on a same day basis if required.

Typically, one of the founders or managers of the Target will, on incorporation, become the sole HoldCo director and the sole subscriber shareholder.

That sole subscriber will typically hold the single share issued by HoldCo on its incorporation.

HoldCo will then acquire the entire issued share capital of the Target from the Target shareholders. The principal transaction document will be an English-law share purchase agreement (SPA), usually short form with a simultaneous exchange and completion and title and capacity warranties given only.

In the UK the instruments of (share) transfer are stock transfer forms (STFs), which are signed by all the sellers/Target shareholders in favour of HoldCo as the buyer.  The requirement to sign the STFs will be a completion deliverable in the SPA. Shareholders that hold Target shares of different classes will need to sign a separate STF for each class.

HoldCo thereby acquires the entire issued share capital of the Target from its shareholders and in exchange, the Target shareholders are issued with shares in HoldCo that mirror their prior Target shareholdings.

The subscriber shareholder in HoldCo who was issued its one share on incorporation usually gets one share less though, to preserve the ‘mirror image’.

If both HoldCo and Target are UK companies, then  the ‘flip’ probably takes place under English law only.

If the Target is incorporated overseas, then local law advice should be sought regarding the transfer of the shares (since the share transfer regime will presumably be governed by the laws of the place of incorporation or registration of the Target and not by English law).

Even so, the SPA would remain under English law and the mechanics of the shares being issued by UK HoldCo in consideration will be governed by UK company law.

Share transfer mechanics will differ between jurisdictions; UK STFs are unlikely to be sufficient instruments of transfer, and the Target will have to consider local company law and its own constitutional documents. Overseas jurisdictions may not assign the same roles and responsibilities as regards management of the company.

For instance, from our understanding, private company law in Estonia (which has the most unicorns per capita in Europe at time of writing) does not appear to be written with the concepts of individual shares and number of shares in mind (although it does think that way in respect of public companies).  Instead (for private companies), it appears to look at the aggregate value of paid-up share capital per shareholder or investor; splitting that down into multiples of individual shares does not work in Estonia in exactly the same conceptual way as is the case in the UK.

As a result, the share transfer documentation that you might see on a transaction where an Estonian Target is flipped into the UK would not include STFs and various other key documents that would be required on a UK only deal, and would instead involve certain Estonian formalities that will be unfamiliar to UK lawyers.  And the SPA – even though under English law – will need to be tailored accordingly to factor in the local law share transfer mechanics.

A share for share exchange has a number of tax implications, which should be considered at the outset to ensure the flip can be properly structured so as to benefit from relevant tax reliefs and avoid pitfalls.  The intention is for the exchange to be tax neutral – if this cannot be achieved, the flip may not be viable.

What follows below is a high-level overview of certain UK tax aspects only; a full discussion of the relevant rules is well outside of the scope of this piece.  Detailed tax advice should always be obtained.  Where the Target and/or any of its shareholders are based in an overseas jurisdiction, overseas legal and tax advice should also be sought.

For the selling shareholders, it is essential that the transfer of the Target shares to HoldCo does not create a taxable disposal, which would give rise to capital gains tax (CGT) for individuals or corporation tax on chargeable gains for companies (or equivalent taxes in other jurisdictions).

In the UK, a share for share exchange is generally treated as a ‘reorganisation’ for tax purposes where the shares issued by HoldCo as consideration for the Target shares ‘stand in the shoes’ of those Target shares.  Accordingly, they are treated as one and the same asset, with the result that the ‘selling’ shareholders of the operating company are not considered to have any immediate chargeable gain. The HoldCo shares are instead treated as having been acquired by the selling shareholders at the same time and for the same amount as their original Target shares.

This tax treatment is automatic where it applies, meaning that is not necessary to make a claim for relief to HM Revenue & Customs (HMRC).  However, it should be noted that it only applies to shareholders with more than five per cent of the Target if the share exchange is carried out for “bona fide commercial reasons”.

The UK tax code also includes anti-avoidance rules known as the ‘transaction in securities rules’, which (if they were to apply to the share exchange) could give rise to income tax charges.  However, those provisions are unlikely to apply in the case of a transaction that is genuinely commercial.

It is possible (but not compulsory) to apply to HMRC for a pre-transaction clearance confirming that (a) HMRC accept that the share exchange will be carried out for bona fide commercial reasons (and the ‘no disposal’ treatment should therefore apply), and (b) that the transaction in securities rules are not in point.  As the preparation of a clearance application takes time and the HMRC turnaround time for a clearance application is usually a minimum of four weeks, it needs to be considered whether this can be accommodated within the transaction timetable.

Where shareholders are resident in jurisdictions other than the UK, tax advice in those jurisdictions should be obtained to ensure that tax neutrality for the shareholders can be achieved.

Where the Target is incorporated in the UK, getting the stock transfer forms stamped by HMRC will normally be necessary before the share transfers can be registered and the Target’s register of members can be updated to show HoldCo as the new owner.  This requires an application to HMRC which either accounts for any stamp duty that is due in respect of the transfers or demonstrates that the transfers are exempt from stamp duty owing to the availability of relief.

Unless relief is successfully claimed, the transfers will be subject to stamp duty at the rate of 0.5 per cent of the Target shares’ market value (broadly, being the price that the shares might reasonably be expected to fetch on a sale in the open market).  Where the Target has an established business, this could result in a significant tax liability.  Further, determining the value of shares in a private limited company is often not straightforward.  In practice, the availability of relief from stamp duty is usually a condition for a restructuring involving a share exchange to be viable.

The responsibility for accounting for stamp duty or claiming relief is on the buyer (here, HoldCo).  A successful claim for relief from stamp duty also prevents a liability of HoldCo for stamp duty reserve tax.

A share for share exchange usually qualifies for relief from UK stamp duty under section 77 of the Finance Act 1986 (FA 1986), subject to a number of conditions being met.  These are complex.  Among other things, they require that HoldCo’s shareholding following the share exchange mirrors that of the Target prior to the exchange.  Apart from the equity capital, this also takes into account certain types of debt obligations.  The share exchange generally must not involve a change of ownership or be undertaken in anticipation of a change of control.  Further, the share exchange must again be carried out for “bona fide commercial reasons”.

Where a pre-transaction clearance has been obtained under the chargeable gains rules (see above), HMRC (meaning the Stamp Office responsible for dealing with stamp duty applications) readily accept that the share exchange was carried out for “bona fide commercial reasons” for the purposes of the stamp duty relief application.  Where there has not been time to obtain a pre-transaction clearance, HMRC will subject the stamp duty relief application to further scrutiny, and it will take longer to process.

HMRC normally take a minimum of eight weeks to process a section 77 application, but it is not unusual for this to take significantly longer.  It is important to plan for this at the outset.  For example, where a share exchange is carried out for the purposes of a debt finance transaction (such as in the context explored further below), it will need to be explored whether the lender will be comfortable to complete before the Target’s share register has been updated to show HoldCo as the new owner.

Where Target shareholders include (current or former) employees or directors who are resident in the UK or otherwise subject to UK employment taxes, the application of the UK employment-related securities rules should be considered, to ensure that the share exchange does not give rise to unexpected liabilities for UK employment taxes on deemed earnings.

It is normally possible to structure a share exchange to achieve a tax neutral position under these rules; however, a detailed discussion and analysis is outside the scope of this piece.

In a different context, companies may be driven to establish a group structure through a share for share exchange as a condition to raising senior debt.

FinTechs in particular – needing to raise significant amounts of secured senior debt to meet prudential obligations as regards minimum capital and liquidity – may find themselves needing to restructure their group.

A lender will typically want to take a share charge – amongst other security – so that if the borrower company were to default, then the lender can effect a ‘clean’ enforcement through a sale of the shares of the relevant borrower/operating entities.

This approach avoids a debt investor having to sell a borrower’s assets piecemeal or through an insolvency practitioner appointed to the borrower/operating entities.

If the business is run through a single operating company (without a holding company), a lender may have to deal with a legion of founder, management and investor shareholders and ask for a share charge from each of them or those holding a large proportion of the share capital (and then ask for the same from future, incoming, shareholders on future funding rounds).

This may be impracticable if not commercially impossible, particularly for venture capital backed companies with a large shareholder base.

Where the business is run through an operating subsidiary that is wholly owned by a holding company, that holding company alone can grant the lender a share charge over the entire issued share capital of the operating subsidiary.  The shareholders in the holding company would not be involved (save as may be required to provide investor consent at the time).

And that is why some lenders will insist upon restructuring (and taking security) in that way prior to lending into the group.

Given the cost and practicalities of executing a share for share exchange, FinTechs might think about incorporating from the outset as a ‘DualCo’ structure, with a holding company that is the 100% shareholder in a subsidiary operating company.

There are then two rather than one companies to administer from the outset, but those administrative costs are likely to appear de minimis when compared to the costs of properly executing a share for share exchange.  Further, the structure is then set up in advance for when or if the management team go to speak to senior lenders.

Other areas to consider when executing a UK flip include dealing with the Target’s existing constitutional documents.  For example, the Target becomes a subsidiary of HoldCo and should replace its articles of association with a set of new articles suitable for a wholly owned subsidiary (or just the Model Articles for private companies limited by shares).  If there is a stack of share classes and the associated preferences, then these would typically be collapsed into a single class of ordinary shares (and the preference stack replicated at HoldCo level).

Caution is required when mirroring the historic or existing preference stack or waterfall at HoldCo level.  Venture capital-type investors usually receive a 1x non-participating preferred convertible return on their share class.  What that means is that investors at exit have a choice between 1x their money back or a pro rata return along with the holders of the ordinary shares.  (See here the HLaw analysis of how those work.)

The wording for those waterfalls usually sees the mechanic for the 1x return refer to the ‘Issue Price’ of the shares, which is the price paid for them (their nominal value and the premium paid up).  When a UK company issues shares at a premium, section 610 of the Companies Act 2006 says that the premium goes into the share premium account.

1x the ‘Issue Price’ per share at exit is then a return of the nominal value and what is in the share premium account for the relevant class of shares.

The new shares issued by HoldCo on completion of a true share for share exchange will, however, be issued at nominal value because ‘merger relief’ under section 612 of the Companies Act 2006 will apply.  Essentially, the HoldCo shares will be issued in consideration for the transfer of the Target shares, but the difference in value between the Target shares’ market value at the time of of transfer and the HoldCo shares’ nominal value will be credited to a ‘merger reserve’ instead of HoldCo’s share premium account.  This is considered a ‘relief’ as funds credited as a ‘merger reserve’ can be used more flexibly than share capital.  However, it means that the amounts originally paid by historic investors do not track through from the Target’s share capital into HoldCo’s share capital. As merger relief is considered to be compulsory where it applies,  it is not possible to disapply it and credit the share premium account instead.

If the drafting in the preference stack included in the new articles for HoldCo refers back to the ‘Issue Price’, then this could be nominal value only for the historic preferred share classes unless that definition specifically refers to the ‘hard coded’ values.

Note that in the BVCA model documents at time of issue, this issue is not present as the preference works by reference to a ‘hard coded’ ‘Preference Amount’.  However, the language is frequently amended on transactions and not all transactions will follow the BVCA model documents.

Further, an existing shareholders’ agreement (SHA) may be in place for the Target, particularly if that company has raised funds through previous funding rounds. That existing SHA will need to be terminated and replaced at the HoldCo level – if the Target was incorporated overseas, the document doing the termination may need to be local-law governed.  Thought should also be given as always to any relevant investor consent rights that need approval before the restructuring process can take place.

Option schemes will also need amending so that they operate over the HoldCo shares, and tax advice should be taken, and careful consideration given to the mechanics.

If there are other equity-type arrangements giving persons or entities the right to subscribe for Target shares in the future, thought should be given to having them terminated at close and re-stated such that it is HoldCo and not Target giving the obligation to issue those shares.  As an alternative to termination, a novation might be possible; much will depend on what the underlying documents say.

Further attention should also be given to warrant instruments, convertible loan notes, subscriptions for future equity and the like.

If the Target is regulated by the UK Financial Conduct Authority or other regulatory body (whether UK or overseas) then you will need to think about what consents will need obtaining as a condition to completion. If consents are required, then usually the SPA would not be amended to build in a split exchange and completion as this creates unnecessary complexity in a transaction where there is no change of beneficial ownership. Instead, the parties would usually prepare the SPA in advance and wait for the consent to be provided.

Share for share exchange transactions invariably have unique and fact-dependent characteristics.  There will undoubtedly be features of any one particular transaction that are not explored above or that require further in-depth exploration of some of the issues we have covered.  If you have any real-world questions or queries about anything written above, then please do reach out to a member of the HLaw team.

This Insight piece was written by Jamie Crocker and Henry Humphreys.  Annette Beresford wrote the sections on tax.  Alistair Hill helped write the sections covering the possible approach of senior lenders asking for share charges.

All the thoughts and commentary that HLaw publishes on this website, including those set out above, are subject to the terms and conditions of use of this website.  None of the above constitutes legal advice and is not to be relied upon.  Much of the above will no doubt fall out of date and conflict with future law and practice one day.  None of the above should be relied upon.  Always seek your own independent professional advice.

Humphreys Law