Inbounds – Moving to the US
By Stafford Matthews
Technology companies in Europe or Asia often consider reincorporating in the United States and relocating their operations and employees to Silicon Valley or another US tech hub. The reasons for doing so can include greater access to venture funding, a larger pool of engineering and technical talent, more highly evolved markets, and increased opportunities to collaborate in the joint development and distribution of their intellectual property and products. The process of “inbounding” a foreign company in the US can be complex but there are a number of common factors that such companies must take into account, especially if privately held and more so if the company intends to move to a US jurisdiction like California. The following is a non-exhaustive summary of some key issues:
Form of entity
The entity of choice for technology companies in the US is the Delaware corporation. Delaware corporate law is highly developed with its own special judicial court [the Delaware Court of Chancery], and all else being equal tends to support the decision-making of corporate management and boards of directors. Physical presence of the company in the State of Delaware is not required. Venture funds also strongly favor Delaware law due to the extensive rights possible for preferred stockholders and the degree to which companies are free to negotiate such rights with investors.
Dealing with existing foreign corporate stockholders
The setting up of a new company in the US usually will include an exchange in some form of the existing equity capital of the foreign entity for new shares in the US corporation. This can include a straight stock exchange or a merger transaction.
In these situations existing stockholders of the foreign entity often will seek to precisely replicate in the structure of the new US entity all of the rights and remedies they may currently have as equity holders in the foreign company. These can take the form of historical or other rights and powers that are peculiar to the jurisdiction and incompatible with standard practices in the US; for example, multiple classes of existing common stock with active rights to intervene in the operations of the company. While it may be possible to replicate many or most of these rights in the new entity, it is not always advisable to do so. The company may consider using the one-time event of inbounding to negotiate a “reboot” and simplification of its capital stock structure [for example, by consolidating related classes of stock with similar rights] and otherwise conform the entity to US practices, especially if the company intends to obtain additional financing from venture and private equity funds in the US strongly favoring a clean and uncomplicated cap table.
It is also common in the US for technology companies to adopt a series of provisions in their governing documents to control the transfer of its shares and facilitate the eventual sale or other exit of the company if X percentage of the stockholders agrees. These can include provisions for “drag-along” and “tag-along” rights and rights of first refusal for sales by founders, employees and other common stockholders. In a company with continuing or new series of preferred stockholders, it similarly is typical in a Delaware corporation to include separate investor rights agreements [including registration rights for the shares and preemptive rights to any share offerings], voting rights agreements, right of first refusal and co-sale agreements, and indemnification agreements for the benefit of the preferred, some of which may not be part of the governing documentation of the foreign entity or common practice in the foreign jurisdiction.
In the case of foreign preferred stockholders, as would be the case of any new series of preferred stockholders generally, it is also essential for the preferred to conduct a careful review of applicable US laws and the proposed US governing documents to ensure that any liquidation preferences or other preferred rights being granted by the US company in the exchange are secure and in fact cannot be later revised or superseded by the unilateral action of the Board of Directors or others. Depending on the language of the governing documents, for example, it can be possible under Delaware law to strip the preferred stockholders of their rights, through use of a later merger transaction between the US company and a controlled subsidiary set up for this purpose [colloquially known as a “white-out merger”] requiring the forced exchange of the preferred for common stock or other less favorable class of shares.
Use of the existing foreign company as a subsidiary
Under various circumstances [such as the continuing existence of substantial operating assets or operations in the foreign jurisdiction such as a plant or factory or due to existing IP or contractual transfer issues below], it may be necessary or advisable to retain and use the existing foreign entity as a wholly owned or majority owned operating subsidiary of the new parent US company. If only a majority owned subsidiary it will be necessary to amend the existing articles of association and shareholder agreements to vest all necessary powers in the US parent.
Even if the subsidiary is wholly owned, it will be necessary to address possible rights of the preferred stockholders or other relevant parties to approve key operational and financial matters at the subsidiary level and the sale or other transfer of ownership of the foreign subsidiary, and the possible issuance of additional stock of the foreign subsidiary – to prevent liquidation or dilution of value at the subsidiary level by [for example] the transfer of subsidiary stock short of an outright sale to other investors.
Compliance with corporate and securities laws
It also is essential to ensure full compliance with both foreign and US corporate and securities laws so that any merger or share exchange is lawful and not subject to challenge or unwinding in all relevant jurisdictions. This may require for example a formal share exchange offering document in the case of an inbound UK company, and in any case can require the inclusion of a series of express restrictions in the exchange agreement to qualify the issuance of the US shares to the exchanging parties under US securities laws.
Transfer of intellectual property and contract rights
The reincorporation of the foreign entity in the US may require the transfer of intellectual property (IP) and contract rights to the new US corporation. Issues to watch out for include (1) any prohibition on transfer or assignment in any relevant contracts which may be triggered by the transaction, including any “change of control” provisions; (2) any missing assignments by employees or contractors for IP in the foreign entity that will need to be rectified as part of the reincorporation; (3) any foreign laws involving rights of third parties [in particular but not only so-called “moral rights” laws in EU or other non-US jurisdictions for the benefit of employees or contractors] which could restrict or complicate the transfer of IP rights to the new corporation, especially in the case of software or other copyrightable works; and (4) completion of any formalities with the US Patent and Trademark Office and the US Copyright Office as required to vest of record the required rights of ownership. In addition the existing licenses or development agreements for the IP of the company may be not sufficient for US law purposes and may need to be supplemented or amended.
In addition, a proper structuring of these transactions may involve (i) the transfer of all IP ownership or transfer of all non-US IP to a new entity set up in a tax beneficial or bankruptcy remote jurisdiction prior to entry of the business and the IP into the United States, and (ii) a proper license regime for the US entity, in order to prevent repatriation and taxation of non-US revenues within the US and to maximize the potential protection of the ownership of the IP if the US entity becomes insolvent or is otherwise subjected to substantial liabilities that would put the ownership of the underlying technologies of the enterprise at risk. These subjects are beyond the scope of this discussion but should be considered with appropriate professional assistance.
Transfer of employees
The transfer of employees or contractors of the foreign company to the US requires obvious attention to US visa and immigration laws. US visa requirements often impose very specific legal requirements for the structure of the ownership and control relationship between the foreign company and the US company, as well as the employment relationship of the employees. When determining how the US venture will be funded, issuing stock and appointing officers, it is important to integrate the visa requirements with other business needs. Less obvious related issues include the following:
- Persons relocating to the US will need new or revised employment and consulting agreements and proprietary invention agreements with the new US corporation that conform to applicable US and state laws and practices and ensure among other matters that the know-how and other IP generated by the employee belong to the US corporation.
In this connection and by means of example: (i) in many civil law jurisdictions the rules can be different regarding the ownership of work performed by an employee, and rights of ownership may be covered by the civil code of the jurisdiction but are not set forth in the agreement with the employee or contractor per se; and (ii) in the case of California and potentially other applicable state jurisdictions, it is unlawful to require that all inventions made by an employee are the property of the employer, if the invention is made on his or her own time and equipment and does not relate to the current or anticipated business of the employer.
- It also is not uncommon for some employees of a transitioning enterprise to already be working in the US under an existing visa or immigration status which may be under the aegis of the existing foreign entity or an existing subsidiary but will not be part of the new US corporation. The timing of the reincorporation can be affected by the additional steps necessary to sort this out.
- In California, noncompetition clauses for employees are unlawful and unenforceable; and there further is no concept of “inevitable disclosure” of trade secrets to delay the move of an employee to work for or start a competing company under California law. These laws are designed to promote high turnover and split offs of engineers and others who start new companies. In this sense foreign companies relocating to Silicon Valley or other California locations benefit from the velocity of the labor market accelerated by these rules even if by the same token they are generally unable to restrict employee movement from the company other than through generally applicable trade secrets laws.
It is very common for the inbound foreign company to have highly restrictive employment contracts containing noncompetition provisions, and even outside of California you must review existing agreements to conform to local law to avoid invalidation of the contract and other material legal problems.