Building the Equity Incentive Framework in the U.S. Post Delaware Flip
Following a Delaware flip, founders need to consider how the new U.S. parent company will use equity to attract and retain talent across borders. That means choosing a plan structure that supports the company’s hiring ambitions while accommodating the different tax and legal requirements applicable to its workforce. This article explores the available approaches, from adopting a U.S.-style plan with UK arrangements to retaining a UK-focused scheme, and explains the principal types of U.S. stock options.
TopCo often, but not always, adopts a new equity incentive plan in connection with the flip. The right structure depends less on where TopCo is incorporated than on where award recipients work and whether the group remains eligible to grant EMI options (if applicable).
To Adopt or Not to Adopt a U.S.-Style Equity Plan
Many companies that complete a Delaware flip also build a U.S. presence and hire U.S.-based service providers. In that case, TopCo will generally adopt a U.S.-style equity incentive plan pursuant to which the company may issue a variety of compensatory equity awards, such as stock options, restricted stock and restricted stock units (RSUs), to employees, directors, consultants and advisors going forward. A U.S.-style plan helps the company comply with U.S. federal and state securities laws and the ISO requirements, and offers flexibility consistent with U.S. market practice.
A UK sub-plan or UK-specific schedule can sit beneath that plan to satisfy HMRC requirements for EMI or CSOP options, while the core plan remains governed by U.S. law; alternatively, a separate UK plan can be adopted. For service providers in jurisdictions without a tax-qualified award regime, a “global” form of option agreement with country-specific appendices addressing local tax, securities and employment law requirements is usually sufficient.
Not every flip leads to U.S. hiring, however. If the workforce will remain entirely UK-based for the foreseeable future, TopCo may instead assume the UK company’s existing share option scheme (or adopt a new UK-style share option scheme). The share option scheme must still comply with U.S. corporate and securities laws as well as U.K. requirements, so input from counsel in both jurisdictions is important.
Types of U.S. Options
There are two types of U.S. stock options: ISOs and non-qualified stock options (NSOs). (While an ISO is sometimes described as the U.S. analogue to an EMI option, the regimes are not interchangeable. They have different company and employee eligibility rules, limits, holding periods and tax consequences.)
The key differences are summarized in this chart. (For a more detailed discussion, see our article Equity Compensation Primer: ISOs v. NSOs.)
Which type of option is “better” depends on the individual’s circumstances, but most early-stage startups default to granting ISOs to U.S. employees given the potential tax advantages.
Note that ISO tax benefits are available only to individuals subject to U.S. federal income tax. A UK employee who is not a U.S. taxpayer will be taxed under UK rules regardless of ISO status, so granting an ISO would offer no benefit while still subjecting the award to ISO restrictions.
(For a checklist of steps to take before and after the flip, click here.)
This is the second in a series of three articles that walks through how stock options are treated in a Delaware flip—what a UK startup founder needs to know about granting stock options in the new U.S. TopCo, and how the U.S. approach differs from the U.K. framework. For the first article, see Equity Isn’t Equal: How Stock Options Work Differently After a Delaware Flip.