OpinionDespite challenges, majority of VC funds are against Delaware flip for Israeli startups
Opinion
Despite challenges, majority of VC funds are against Delaware flip for Israeli startups
Only 13% of investors recommend their portfolio companies to perform a Delaware Flip in order to mitigate the current situation in Israel
As Israel's tech landscape grapples with uncertainty, the Delaware Flip emerges as a tantalizing prospect for companies seeking refuge from geopolitical turmoil. However, results from a recent survey which polled over 100 Israeli and foreign VC investors who have invested in Israeli tech, revealed that only 13% of investors recommend their portfolio companies to perform a Delaware Flip in order to mitigate the current situation in Israel.
At its core, the flip represents a structural transformation—a change in legal status, but not necessarily a change in essence or culture. After the flip, the main asset of the company remains rooted in its Israeli identity, with the American parent company serving as a legal framework rather than a transformative force.
Despite its appeal, the flip entails tax considerations. While it constitutes a taxable event, savvy entrepreneurs can navigate this hurdle through special taxation decisions, allowing for deferred tax payment until the sale of shares in the new foreign company. However, such arrangements come with strings attached, including requirements to hold certain shares in trust and restrictions on future dilution—factors that should be carefully considered before proceeding. For instance, entrepreneurs planning to relocate post-flip may inadvertently trigger tax liabilities, underscoring the importance of meticulous planning and foresight.
In addition to tax implications, the flip may also impact exit scenarios—a critical consideration for both entrepreneurs and investors. Potential buyers may show little interest in purchasing the American entity, preferring instead to acquire the Israeli company with its intellectual property intact. Such scenarios can lead to increased tax burdens for entrepreneurs and investors, highlighting again the need for strategic foresight.
Moreover, the transfer of intellectual property outside of Israel represents a distinct event with its own set of tax implications. In the eyes of Israeli income tax authorities, such transfers constitute a taxable event, necessitating careful valuation and planning. To mitigate tax liabilities, many entrepreneurs opt to establish Delaware parent companies early on, thereby centralizing intellectual property ownership while maintaining Israeli operations.
However, this approach comes with its own set of challenges. Companies operating under this structure may be required to declare theoretical profits from Israeli operations, triggering tax liabilities despite limited cash flow. Furthermore, the granting of employee stock options—common practice in startup culture can further exacerbate tax burdens, creating a paradoxical situation where success breeds tax liabilities.
Considering these complexities, the Delaware Flip emerges as a topic of fervent discussion among Israeli tech entrepreneurs. Yet, despite widespread discourse, the actual number of flips remains relatively low—a testament to the myriad challenges and considerations at play. Consistent with our survey results, the allure of the flip is tempered by practical realities and long-term implications, prompting entrepreneurs to approach this decision with caution and deliberation.
The author is Moran Massad Hadar, Hi-Tech & Startups Partner at Deloitte Catalyst
