Built for Delaware: What U.S. Venture Capital Investors Really Expect from Your Company Structure
For non-U.S. founders looking to raise capital from U.S. venture funds, one piece of advice comes up repeatedly: If you want U.S. venture capital, be prepared to restructure as a Delaware C corporation.
The preference for Delaware is real, but it is not simply because venture capitalists or their lawyers like Delaware. VCs invest capital on behalf of a fund which has its own investment restrictions, tax considerations and regulatory requirements that are reflective of its investors’ needs. The fund manager is also thinking beyond the current investment—to future financing rounds and ultimately to how the fund will exit its investment.
For a non-U.S. company hoping to raise from U.S. VCs, understanding these perspectives can help you decide whether, and when, your corporate structure should change.
Why VCs Care About Your Corporate Structure
When a VC evaluates an investment, after it determines that there is a compelling business case for the investment, the fund manager focuses on another set of key questions. Can my fund invest in this type of entity and jurisdiction? Will doing so create tax or regulatory issues for the fund or its investors? Can I obtain the preferred stock, governance and other investor rights I expect? Will the structure work for the next financing? Will other U.S. investors be comfortable investing alongside me?
In many cases, the fund's governing documents limit how much it can invest outside the United States or restrict investments that could create negative tax consequences for its investors. That means a request for a Delaware C corporation may not simply be a negotiating preference. It may also reflect how the fund itself was designed and the composition of the fund’s investor base.
UBTI: Tax-Exempt Investors
Many venture funds have tax-exempt investors, including university endowments, foundations and pension plans. These investors generally seek to avoid unrelated business taxable income (UBTI). If a fund invests directly in a pass-through operating business, the fund can be allocated a share of that business’s operating income, which may flow through to its tax-exempt investors as UBTI, potentially resulting in additional U.S. tax and filing obligations for those investors.
Importantly, for non-U.S. companies, an entity’s classification under local law does not necessarily determine its classification for U.S. federal income tax purposes. A non-U.S. entity that is treated as a corporation or otherwise as tax-opaque in its home jurisdiction may nevertheless be classified as a partnership or disregarded entity for U.S. federal income tax purposes. The classification will depend on the type of entity, its ownership and whether an entity classification election has been made in the United States.
A Delaware C-corporation may be set up to act as a “blocker”—i.e., a corporation that will pay tax at the entity level, while the fund holds stock in the company rather than an interest through which the company’s operating income flows directly to the fund and its investors.
ECI: Non-U.S. Investors
A fund may also have non-U.S. investors that want to avoid effectively connected income (ECI) because it can subject such non-U.S. investor to U.S. tax and filing obligations. If a venture fund invests in a pass-through business that is engaged in a U.S. trade or business, the fund’s non-U.S. investors might be treated as engaged in that U.S. trade or business and such non-U.S. investors may be allocated ECI, even if the portfolio company is organized or headquartered outside the United States.
The relevant question here is the nature and location of the company’s business activities, not where the company is formed or headquartered. Similar to the action taken in connection with UBTI investors, the fund may invest through an entity treated as a corporation for U.S. federal income tax purposes which generally blocks the company’s operating activities and income from flowing through directly to the fund and its investors. A Delaware C-corporation here helps remove any doubt from the equation.
PFIC: Investing in a Foreign Corporation
Investing directly in a non-U.S. corporation can raise a different issue for U.S. taxable investors: the passive foreign investment company (PFIC) rules. A non-U.S. corporation may be a PFIC if at least 75% of its gross income is passive or at least 50% of its assets produce, or are held to produce, passive income. The analysis can be particularly relevant for early-stage companies holding significant cash from financing rounds relative to their other assets or revenues. PFIC status can result in unfavorable U.S. tax treatment and additional reporting obligations, making PFIC diligence and monitoring an important consideration for some U.S. venture funds.
CFC: U.S. Ownership of a Foreign Company
A non-U.S. portfolio company can also raise controlled foreign corporation (CFC) issues if U.S. shareholders collectively own more than 50% of the company, applying the applicable ownership and attribution rules. Certain U.S. shareholders of a CFC may be required to include specified categories of the company’s income in taxable income even without receiving a distribution, and additional reporting requirements may apply. Whether CFC status presents an issue depends heavily on the company’s ownership and the fund’s particular investment, but it is another reason investing directly in a non-U.S. corporation can require additional tax analysis.
These issues do not mean a U.S. VC cannot invest in a non-U.S. company. Venture funds in the United States make cross-border investments all the time, of course. But these issues help explain why the structure of the investment matters to a fund manager in ways that may not be apparent to the company.
CFIUS and Other Regulatory Considerations
Tax is not, of course, the only cross-border consideration for your company. Depending on your company’s business and technology, a fund manager may also need to consider non-U.S. investment and export control rules.
A VC’s investment in a non-U.S. company may not itself trigger review by the Committee on Foreign Investment in the United States (CFIUS). But CFIUS considerations can arise if the non-U.S. company owns or acquires U.S. businesses, particularly businesses involving sensitive technologies, infrastructure or personal data. A fund manager investing in a global company may therefore need to understand not only where the parent company is organized, but also the location of its U.S. subsidiaries, operations, technology and ownership structure.
Here, it’s important to note that flipping to a Delaware corporation does not solve CFIUS. In fact, after a flip, the Delaware parent becomes a U.S. business, and foreign ownership of that parent can itself become relevant to CFIUS.
But be aware that, for companies in areas such as AI, semiconductors, defense and other sensitive technologies, these issues can affect diligence as well as the governance, information and technology-access rights associated with an investment.
Why Delaware Is Still the Familiar Path
Beyond these fund-level considerations, the Delaware C corporation remains the structure around which much of the U.S. venture ecosystem has developed.
Investors and their counsel are deeply familiar with Delaware corporate law. Preferred stock, liquidation preferences, protective provisions, board representation, equity incentive plans and future financing documents all fit within a framework U.S. investors have used for decades.
That familiarity has practical value. Fund managers prefer spending time negotiating valuation, governance and other issues that matter to the investment over determining how standard U.S. venture terms operate under an unfamiliar corporate regime.
There is also a network effect. Your current investor is thinking about your next investor. A Seed fund wants the company to be able to raise a Series A. The Series A investor is thinking about Series B and future growth rounds. Each investor benefits from a structure that the next investor already understands.
What If You Are Not a Delaware C Corporation?
A U.S. VC will not always walk away from a non-Delaware C corporation, but reorganizing as such an entity may become a condition to its investment. A typical “Delaware flip” places a new Delaware corporation above the existing non-U.S. company, with the existing shareholders becoming shareholders of the new U.S. parent.
The concept is straightforward, but the execution involves working with existing shareholders and addressing securities laws, tax considerations, local approvals and other regulatory concepts. For that reason, a non-U.S. company expecting to raise from U.S. institutional investors should understand what a flip would involve before it becomes a condition to closing.
For more information on the mechanics and longer-term implications of a Delaware flip, including intellectual property ownership, transfer pricing, equity compensation and cross-border tax considerations, see our colleagues’ insightful articles: “Beyond the Flip: Structuring Your U.S. Expansion for Scale, Not Just Speed” and “Money Moves Matter: Financing Your U.S. Expansion Without Slowing Your Growth.”
Think About the Exit, Not Just the Investment
Another key reason fund managers think about structure differently from founders is that a venture fund ultimately wants to return capital to its investors. That means a fund manager is thinking about exit pathways from the time it invests.
The renewed activity in the U.S. IPO market is a useful reminder that the path from venture financing to the public markets is not merely theoretical. But that does not mean a company needs to be incorporated in Delaware to list in the United States. Non-U.S. companies can and do access U.S. public markets, and there may be good tax, regulatory or commercial reasons to maintain a non-U.S. parent.
Instead, founders should think about a broader question: Where are you building your company's capital markets home?
If you expect your investors, future financing rounds and eventual exit to become increasingly centered in the United States, adopting a corporate structure familiar to U.S. institutional capital may make sense earlier in the company's lifecycle. If your business and capital strategy will remain principally outside the United States, the answer may be different.
Takeaway for Non-U.S. Founders Seeking U.S. Venture Capital
If U.S. venture capital is important to your growth strategy, you do not necessarily need to flip your company tomorrow. But you should know what you would do if a U.S. VC wanted to invest tomorrow.
Understand whether your target investors typically invest directly in companies from your jurisdiction. Know what a Delaware flip would require and whether waiting could make the tax or execution issues more difficult. Keep your capitalization and corporate records clean so that existing equity and convertible securities can be dealt with efficiently. And coordinate U.S. and local legal and tax advice before—not during—the rush to close a financing.
From the VC fund manager's side of the table, asking for a Delaware corporation may be one line in a term sheet. For a non-U.S. company, satisfying that request may involve shareholders, employees, existing investors and advisers in several jurisdictions.
The goal should not be to become a Delaware C corporation simply because U.S. VCs expect one. It is, instead, to understand why your target investors care about your structure and to be prepared to meet those expectations when the right financing opportunity arrives.
That preparation can be the difference between corporate structure being a routine closing item and becoming an obstacle to the investment.
The preference for Delaware is real, but it is not simply because venture capitalists or their lawyers like Delaware. VCs invest capital on behalf of a fund which has its own investment restrictions, tax considerations and regulatory requirements that are reflective of its investors’ needs. The fund manager is also thinking beyond the current investment—to future financing rounds and ultimately to how the fund will exit its investment.
For a non-U.S. company hoping to raise from U.S. VCs, understanding these perspectives can help you decide whether, and when, your corporate structure should change.
Why VCs Care About Your Corporate Structure
When a VC evaluates an investment, after it determines that there is a compelling business case for the investment, the fund manager focuses on another set of key questions. Can my fund invest in this type of entity and jurisdiction? Will doing so create tax or regulatory issues for the fund or its investors? Can I obtain the preferred stock, governance and other investor rights I expect? Will the structure work for the next financing? Will other U.S. investors be comfortable investing alongside me?
In many cases, the fund's governing documents limit how much it can invest outside the United States or restrict investments that could create negative tax consequences for its investors. That means a request for a Delaware C corporation may not simply be a negotiating preference. It may also reflect how the fund itself was designed and the composition of the fund’s investor base.
UBTI: Tax-Exempt Investors
Many venture funds have tax-exempt investors, including university endowments, foundations and pension plans. These investors generally seek to avoid unrelated business taxable income (UBTI). If a fund invests directly in a pass-through operating business, the fund can be allocated a share of that business’s operating income, which may flow through to its tax-exempt investors as UBTI, potentially resulting in additional U.S. tax and filing obligations for those investors.
Importantly, for non-U.S. companies, an entity’s classification under local law does not necessarily determine its classification for U.S. federal income tax purposes. A non-U.S. entity that is treated as a corporation or otherwise as tax-opaque in its home jurisdiction may nevertheless be classified as a partnership or disregarded entity for U.S. federal income tax purposes. The classification will depend on the type of entity, its ownership and whether an entity classification election has been made in the United States.
A Delaware C-corporation may be set up to act as a “blocker”—i.e., a corporation that will pay tax at the entity level, while the fund holds stock in the company rather than an interest through which the company’s operating income flows directly to the fund and its investors.
ECI: Non-U.S. Investors
A fund may also have non-U.S. investors that want to avoid effectively connected income (ECI) because it can subject such non-U.S. investor to U.S. tax and filing obligations. If a venture fund invests in a pass-through business that is engaged in a U.S. trade or business, the fund’s non-U.S. investors might be treated as engaged in that U.S. trade or business and such non-U.S. investors may be allocated ECI, even if the portfolio company is organized or headquartered outside the United States.
The relevant question here is the nature and location of the company’s business activities, not where the company is formed or headquartered. Similar to the action taken in connection with UBTI investors, the fund may invest through an entity treated as a corporation for U.S. federal income tax purposes which generally blocks the company’s operating activities and income from flowing through directly to the fund and its investors. A Delaware C-corporation here helps remove any doubt from the equation.
PFIC: Investing in a Foreign Corporation
Investing directly in a non-U.S. corporation can raise a different issue for U.S. taxable investors: the passive foreign investment company (PFIC) rules. A non-U.S. corporation may be a PFIC if at least 75% of its gross income is passive or at least 50% of its assets produce, or are held to produce, passive income. The analysis can be particularly relevant for early-stage companies holding significant cash from financing rounds relative to their other assets or revenues. PFIC status can result in unfavorable U.S. tax treatment and additional reporting obligations, making PFIC diligence and monitoring an important consideration for some U.S. venture funds.
CFC: U.S. Ownership of a Foreign Company
A non-U.S. portfolio company can also raise controlled foreign corporation (CFC) issues if U.S. shareholders collectively own more than 50% of the company, applying the applicable ownership and attribution rules. Certain U.S. shareholders of a CFC may be required to include specified categories of the company’s income in taxable income even without receiving a distribution, and additional reporting requirements may apply. Whether CFC status presents an issue depends heavily on the company’s ownership and the fund’s particular investment, but it is another reason investing directly in a non-U.S. corporation can require additional tax analysis.
These issues do not mean a U.S. VC cannot invest in a non-U.S. company. Venture funds in the United States make cross-border investments all the time, of course. But these issues help explain why the structure of the investment matters to a fund manager in ways that may not be apparent to the company.
CFIUS and Other Regulatory Considerations
Tax is not, of course, the only cross-border consideration for your company. Depending on your company’s business and technology, a fund manager may also need to consider non-U.S. investment and export control rules.
A VC’s investment in a non-U.S. company may not itself trigger review by the Committee on Foreign Investment in the United States (CFIUS). But CFIUS considerations can arise if the non-U.S. company owns or acquires U.S. businesses, particularly businesses involving sensitive technologies, infrastructure or personal data. A fund manager investing in a global company may therefore need to understand not only where the parent company is organized, but also the location of its U.S. subsidiaries, operations, technology and ownership structure.
Here, it’s important to note that flipping to a Delaware corporation does not solve CFIUS. In fact, after a flip, the Delaware parent becomes a U.S. business, and foreign ownership of that parent can itself become relevant to CFIUS.
But be aware that, for companies in areas such as AI, semiconductors, defense and other sensitive technologies, these issues can affect diligence as well as the governance, information and technology-access rights associated with an investment.
Why Delaware Is Still the Familiar Path
Beyond these fund-level considerations, the Delaware C corporation remains the structure around which much of the U.S. venture ecosystem has developed.
Investors and their counsel are deeply familiar with Delaware corporate law. Preferred stock, liquidation preferences, protective provisions, board representation, equity incentive plans and future financing documents all fit within a framework U.S. investors have used for decades.
That familiarity has practical value. Fund managers prefer spending time negotiating valuation, governance and other issues that matter to the investment over determining how standard U.S. venture terms operate under an unfamiliar corporate regime.
There is also a network effect. Your current investor is thinking about your next investor. A Seed fund wants the company to be able to raise a Series A. The Series A investor is thinking about Series B and future growth rounds. Each investor benefits from a structure that the next investor already understands.
What If You Are Not a Delaware C Corporation?
A U.S. VC will not always walk away from a non-Delaware C corporation, but reorganizing as such an entity may become a condition to its investment. A typical “Delaware flip” places a new Delaware corporation above the existing non-U.S. company, with the existing shareholders becoming shareholders of the new U.S. parent.
The concept is straightforward, but the execution involves working with existing shareholders and addressing securities laws, tax considerations, local approvals and other regulatory concepts. For that reason, a non-U.S. company expecting to raise from U.S. institutional investors should understand what a flip would involve before it becomes a condition to closing.
For more information on the mechanics and longer-term implications of a Delaware flip, including intellectual property ownership, transfer pricing, equity compensation and cross-border tax considerations, see our colleagues’ insightful articles: “Beyond the Flip: Structuring Your U.S. Expansion for Scale, Not Just Speed” and “Money Moves Matter: Financing Your U.S. Expansion Without Slowing Your Growth.”
Think About the Exit, Not Just the Investment
Another key reason fund managers think about structure differently from founders is that a venture fund ultimately wants to return capital to its investors. That means a fund manager is thinking about exit pathways from the time it invests.
The renewed activity in the U.S. IPO market is a useful reminder that the path from venture financing to the public markets is not merely theoretical. But that does not mean a company needs to be incorporated in Delaware to list in the United States. Non-U.S. companies can and do access U.S. public markets, and there may be good tax, regulatory or commercial reasons to maintain a non-U.S. parent.
Instead, founders should think about a broader question: Where are you building your company's capital markets home?
If you expect your investors, future financing rounds and eventual exit to become increasingly centered in the United States, adopting a corporate structure familiar to U.S. institutional capital may make sense earlier in the company's lifecycle. If your business and capital strategy will remain principally outside the United States, the answer may be different.
Takeaway for Non-U.S. Founders Seeking U.S. Venture Capital
If U.S. venture capital is important to your growth strategy, you do not necessarily need to flip your company tomorrow. But you should know what you would do if a U.S. VC wanted to invest tomorrow.
Understand whether your target investors typically invest directly in companies from your jurisdiction. Know what a Delaware flip would require and whether waiting could make the tax or execution issues more difficult. Keep your capitalization and corporate records clean so that existing equity and convertible securities can be dealt with efficiently. And coordinate U.S. and local legal and tax advice before—not during—the rush to close a financing.
From the VC fund manager's side of the table, asking for a Delaware corporation may be one line in a term sheet. For a non-U.S. company, satisfying that request may involve shareholders, employees, existing investors and advisers in several jurisdictions.
The goal should not be to become a Delaware C corporation simply because U.S. VCs expect one. It is, instead, to understand why your target investors care about your structure and to be prepared to meet those expectations when the right financing opportunity arrives.
That preparation can be the difference between corporate structure being a routine closing item and becoming an obstacle to the investment.