Corporate Structures for Latin American Startups

By Luciana Jhon Urrunaga, Esq. and Anibal Manzano, Esq.

Given the challenges that startups tackle on a daily basis, it is understandable that LatAm founders don’t want to be bogged down by corporate structures or legal red-tape. However, choosing the wrong corporate structure for your LatAm startup at the outset can negate the hard work founders and their teams have put into their business. These losses can come in several forms: (i) taxes resulting from poor structuring decisions, (ii) loss of capital from investors who refuse to invest in your chosen corporate structure, and (iii) legal fees required to restructure your company or analyze an overcomplicated exit.

For LatAm startups looking to raise capital, it is important to choose a corporate structure that investors and venture capital funds (VCs) are familiar with and understand. Typically, VCs will not invest in your Latin American operating company because is governed by foreign legislation that they may not be familiar with, which could expose them to unknown risks. Investors are looking for predictability in governance and clearly defined rights as investors.

For LatAm tech startups looking to raise capital from United States (US) or international venture capital funds (VCs) or sophisticated angel investors, there are typically 3 corporate structures that startups can choose, each with its own advantages and disadvantages. This post outlines each of these options. Please note, however, that every startup is different; therefore, there is no one size fits all solution or substitute for professional advice from legal counsel and tax advisors.

I. “Cayman Sandwich”

The Cayman Islands holding company structure, commonly referred to as the “Cayman Sandwich,” consists of:

1. Top Holding Company: A Cayman Islands exempted company (HoldCo) limited by shares, at the top, which is where the company’s corporate governance, shareholding and equity incentive plans are housed. The HoldCo owns 100% of the membership interest (i.e., shares) of the intermediate Delaware LLC.

2. Intermediate Holding Company: A Delaware (DE) limited liability company (LLC). The intermediate DE LLC owns 100% (or 99.9%, depending on whether OpCos need to be owned by more than 1 shareholder) of the shares of the OpCos.

3. Operating Company(ies) (OpCos): A LatAm operating company (or companies), managing the startup’s entire local operation and isolating legal liabilities.

Cayman Sandwich Corporate Structure

In this structure, investment transactions are made at the Cayman level in exchange for Cayman shares or convertible instruments (e.g., convertible promissory notes, Safes), and capital contributions are usually made down the corporate structure (into the DE LLC and the OpCos) to provide working capital to the OpCos. From a US tax perspective, it is important to follow this procedure and to ensure all operating expenses are made from at the OpCo level to avoid negative US tax consequences.

The Cayman Sandwich is ideal for startups looking for maximum tax efficiency for larger or international fundraising and has become an industry standard for LatAm startups raising capital.

Investors prefer the Cayman Sandwich for multiple reasons, including: (1) the Cayman Islands do not charge corporate tax on income generated outside of the Cayman Islands and do not tax distributions paid from a Cayman HoldCo to its shareholders (though shareholders may be subject to taxes in the country where they are tax residents); and (2) the Cayman Islands is an internationally recognized corporate transactions venue, where holding companies for leading international companies are created for predictability in governance and familiarity for legal and tax counsel.

The primary advantage of the Cayman Sandwich is tax related; namely, that in an exit transaction shareholders can approve an asset sale of the DE LLC intermediate holding company, or of the local OpCos, and the proceeds of that sale transaction will flow up the corporate structure on a tax free basis (to the extent there is no "US effectively connected income" and subject, of course, to tax considerations at the OpCo jurisdiction level). The primary disadvantage of the Cayman Sandwich is cost, which requires startups to have legal teams in at least 3 jurisdictions (Cayman Islands, US, OpCo jurisdiction(s)) and comply with certain US tax obligations. It is not the simplest structure, but its increased popularity has lead to streamlining of many processes and specialization in the field, which have reduced costs considerably. Still, this structure may not be the best fit for pre-seed or seed stage startups or startups that have not closed (and do not intend to close in the short term) a priced round (equity financing). For those companies a "Delaware Tostada" may be more appropriate.

II. “Delaware Tostada”

The Delaware LLC holding company structure, commonly referred to as the “Delaware Tostada,” consists of:

1. Top Holding Company: A DE LLC, at the top. which is where the company’s corporate governance, shareholding and equity incentive plans (if any) are housed. The DE LLC owns 100% (or 99.9%, depending on whether OpCos need to be owned by more than 1 shareholder) of the shares of the OpCos.

2. Operating Company(ies) (OpCos): A LatAm operating company (or companies), managing the startup’s entire local operation and isolating legal liabilities.

Delaware Tostada Corporate Structure

A Delaware LLC holding company is a great intermediate option for startups in the earlier stages of capital raising (pre-seed and seed rounds). While it is true that most VCs will not invest by purchasing equity in an LLC, this intermediate structure gives startups two great benefits during early days of fundraising: flexibility and cost-savings. Still, startups should keep in mind that a Delaware LLC holding company structure is usually acceptable for VC’s looking to invest by way of a convertible instrument, such as a Simple Agreement for Future Equity (SAFE) or a convertible promissory note.

The Delaware Tostada can be considered a simpler version of the Cayman Sandwich that offers many of the same tax benefits and can help pre-priced round (usually seed stage) LatAm startups a lower cost alternative for their corporate structures.

An LLC is a type of organization consisting of members who own a membership interest in the company, as opposed to shareholders who own the company’s stock (as is the case with a C-Corp) or shares (as is the case with a Cayman Islands exempted company). Although an LLC organizes its equity in a fundamentally different way than a C-Corp, LLCs can still issue equity-based compensation and common convertible instruments like SAFEs and convertible notes.

An LLC taxed as a partnership (which would usually be the case for this holding company structure) does not owe corporate taxes, instead its profits and losses are assigned to its members, who then include these profits and losses in their personal tax returns. This makes the LLC a “pass‑through” entity because the fiscal responsibility is passed on to the individual members of the company. This avoids the dreaded double taxation of a C-Corp by the US Internal Revenue Service (IRS), which can be extremely disadvantageous for LatAm startups with little or no operations or income coming from the US.

However, this is also the main reason that VCs will not invest in LLCs. Because both profits and losses flow through to the members of the LLC, the LLC must assign these profits and losses via the issuance of K-1 tax forms to all members listing their pro-rata share of profits and losses (including VC funds, which must then assign those profits and losses to its limited partners).

Still, early-stage founders might want to use an LLC as their initial holding company to preserve flexibility. If down the line a VC wants to invest in your startup via a priced round but refuses to do so in an LLC, you can easily convert your LLC into a C-Corp or add a Cayman holding company over your LLC (to complete the Cayman Sandwich), as opposed to being stuck in the inflexible (and difficult to restructure) C-Corp (below).

If your current investors are comfortable with investing in an LLC and you do not plan to close a priced equity round in the short term, a startup might be better off initially opting for a Delaware Tostada. There is typically no issue with adding a Cayman holding company on top of your existing LLC simultaneously with your next priced round financing, this process is commonly referred to as a “flip” (similar to the initial restructuring transaction by which founders (and investors, if any) contribute their OpCo shares to a DE LLC for DE LLC units or Cayman shares). However, because not all investors are comfortable with or able to invest in an LLC, it’s always important to check with your investors prior to choosing a corporate structure.

III. Delaware C-Corporation (C-Corp) Holding Company

Some background is appropriate here. Delaware corporations are the preferred corporate structure for many US companies for many reasons. Their dominance is uncontested. There are also many tax advantages for founders and investors of Delaware corporations (taxed as C-Corps) if the company is a technology company — namely, the qualified small business stock (QSBS) exemption for capital gains and research and development (R&D) tax credits. This has resulted in a strong preference to invest in Delaware C-Corps in the US technology sector, which has influenced tech company funding on a global basis (because of the US’s leading role in VC investments). Therefore, the following Delaware C-Corp holding company structure has resulted:

1. Top Holding Company: A Delaware C-Corporation, at the top. which is where the company’s corporate governance, shareholding and equity incentive plans (if any) are housed. The DE C-Corp owns 100% (or 99.9%, depending on whether OpCos need to be owned by more than 1 shareholder) of the shares of the OpCos.

2. Operating Company(ies) (OpCos): A LatAm operating company (or companies), managing the startup’s entire local operation and isolating legal liabilities.

Delaware C-Corporation (C-Corp) Holding Company Corporate Structure

A Delaware C-Corp holding company structure is best suited for you if your startup targets the US market, most of your clients are in the US, the main shareholders are US persons, and there’s a high probability your startup will be acquired by a US company. If this is not the case, then incorporating a C-Corp as your US holding company can be extremely unfavorable for an international startup (such as a LatAm startup), its founders, and its investors. A C-Corp holding company will subject your startup to taxes in the US even if you have no operations there.

Unlike an LLC, which can be converted into a C-Corp relatively easily, a C-Corp is very difficult and expensive to restructure and move to a more tax efficient jurisdiction, such as the Cayman Islands. Also, if a non-US acquirer agrees to buy your business, they will likely be interested in (1) purchasing the assets of your US company and/or (2) purchasing your local operating companies. They will likely not be interested in purchasing your US holding company if they do not intend to operate in the US.

If your local operating companies are owned by a C-Corp, the proceeds of the local sales will flow up to the C-Corp and the profits will be subject to tax at the C-Corp level (even if there is no US nexus aside from the fact that the holding company is a Delaware C-Corp). This means that (1) the C‑Corp pays corporate income tax on these profits, after offsetting income with losses, deductions, and credits (the current corporate tax rate is 21%) and (2) a second level of taxation may apply, where either (a) the shareholders then pay personal income taxes on their dividends at their personal income tax rate (which ranges from 10% to 37%) or (b) the Delaware C-Corp must withhold 25% of the dividend payable to non-US shareholders. Therefore, the "federal US exit tax" in the context of an asset sale could be range between 21% and 48%, none of which would apply if your holding structure were a Cayman Sandwich or a Delaware Tostada.

For clarity, no corporate structure will help you avoid taxes in your operating countries or in countries where shareholders or investors are tax residents. Avoiding a C-Corp structure (in the appropriate situations) will simply prevent your startup from paying taxes to a country where it had no operations (i.e., the US).

A C-Corp holding company typically only makes sense for LatAm startups that are certain they will be acquired by a US company or if a strong US nexus applies.

While the C-Corp can provide several considerable advantages—like a familiar equity structure and separation from its owners—it can be extremely costly for LatAm startups and their founders in connection with an exit.

This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.

About the EDITOR

Anibal Manzano is a corporate lawyer who specializes in venture capital and startup law, mergers and acquisitions, and cross-border transactions connected to the United States and Latin America. He is based in Boca Raton, Florida and regularly represents startups and investors in connection with venture capital financing transactions and related corporate and securities matters.
Mobile: (561) 440-8242