There’s confusion around what legal structures make sense for Latin American startups. Founders, VCs and even lawyers can make decisions that can cost upwards of $100M if you get it wrong.
This post is the result of investing in 80+ startups from 15+ Latin American countries since 2014 via Magma Partners, and speaking to and working with countless lawyers across LatAm, US, UK, Europe and multiple offshore jurisdictions. I wrote a version of this that I’ve been sharing with Magma Partners founders internally and decided to open source it with the hope that founders save themselves time and money and make themselves more investable.
There are fairly clear outlines that most Latin American startups should likely follow. Every startup’s case is different, and each founder should get legal advice from a lawyer and tax advice from an accountant with relevant US and Latin American venture capital experience before following this guide or anyone else’s ideas.
To be clear, this is not legal or tax advice.You should always work with a lawyer and accountant when thinking about corporate structures. The money you’ll spend getting good advice will save hundreds of thousands or even hundreds of millions of dollars down the road. I can’t stress this enough. Don’t just follow thes guidelines. Your situation is unique. Talk to an experienced lawyer and accountant.
Let’s start with a story. Brian Requarth, cofounder of Vivareal and Latitud had a big exit in 2020.His structure cost him and his investors $100M:
In the early days of a startup, money is tight and it’s common to cut corners. I created a California LLC for my company because of my local accountant’s advice. He had zero experience with VC or Latin America.
Later, I hired a my hometown law firm that had no VC experience, which advised me to create a C-Corp, which seemed like good advice at the time.
We later realized that even tho our business had no operations in the US, we would be subject to US taxes upon an exit.We had raised VC money and at this point it was cost prohibitive to restructure.
We later merged with our competitors. We retained top lawyers & accountants to help us manage our extremely complex deal. The deal took an unnecessarily crazy amount of time and effort because of our original structure. But we finaly came up with a solution we thought worked.
When we ended up selling our combined business to OLX Brasil, we signed a term sheet, but during the due diligence they opted to buy our local entities as they saw our restructuring as a huge risk. We paid millions of dollars to lawyers & accountants to get this deal done.
We finally completed the transaction, but our company paid over $100M to the United States government despite our business having zero revenue in the US.
Via https://twitter.com/brianrequarth/status/1345063197146017798 Lightly edited for clarity.
Brian’s story is only unique in two aspects:
- The $100M in taxes his company paid is really high because he was so successful
- He’s willing to share it. Most founders don’t talk about these mistakes.
Delaware C Corps pay 21% corporate tax on profits, and then they can distribute the profits via dividends or stock redemptions. Investors will pay an additional tax when they receive their profits in their home countries. The 21% rate is today’s Corporate Tax rate and could go up in the future.
If a US company had bought the company, or it were structured as a Cayman holding company, this 21% would not be paid. To be clear, no matter what structure you choose, you are not avoiding taxes in your home countries or the countries where you operate. You continue to pay taxes operating your business in Chile, Colombia, Brazil, Mexico or anywhere you are operating, and entrepreneurs and investors will pay their own taxes in their home countries where they are tax residents.
A simplified exmaple on a $100M sale:
| Numbers in Millions | Delaware | Cayman |
| exit | $100 | $100 |
| Corporate Tax Rate | 21% | 0% |
| Corporate Tax Paid | $21 | $0 |
| Net Proceeds | $79 | $100 |
| Entrepreneur & Investor Tax Rate | 21% | 21% |
| Taxes Paid | $17 | $21 |
| Net Proceeds | $62 | $79 |
Hotel California: Why latin American startups should think twice before defaulting to a Delaware C Corp
Unlike other structures, if you start as a C Corp, it’s very hard to restructure. If you want to change your Delaware C Corp to another structure, the US will force you to pay 21% corporate tax on your paper profits. You can start with another structure and move to a C Corp easily, but not the other way around. A very simplified example of C Corp tax on leaving Delaware to restructure:
| Seed Valuation | $5,000,000 |
| delaware Tax Rate | 21% |
| Exit Tax paid | $1,050,000 |
No startup wants to pay 21% taxes on the paper upside in valuation that an investment created. Investors don’t want their money going to paying taxes to restructure a business, especially at early stage.
Founders often incorporate their startups as C corporations in the United States, but this structure can lead to unexpected tax implications down the road, especially for companies with international operations. Here’s what you need to know about navigating those challenges.
The Problem with C Corps
A C Corp is subject to corporate tax on its profits.When a C Corp is acquired, shareholders also pay taxes on the proceeds. For startups hoping for a speedy acquisition by a US company,this “double taxation” isn’t usually a problem. However, if a sale to a non-US buyer is more likely, the tax burden can become meaningful.
Cayman Islands: A Popular Alternative
Many startups choose to re-domicile to the Cayman Islands to avoid US corporate tax on the sale of the company. This involves creating a Cayman holding company that owns the C Corp. When the Cayman holding company is sold, the proceeds are generally not subject to US corporate tax.
However, Mexican founders should be aware of increased scrutiny of Cayman companies by Mexican authorities. While concerns about this scrutiny are frequently enough overstated, the United Kingdom offers a viable alternative.
The UK Option
The UK can be a good choice, notably if your company has corporate venture capital (CVC) or corporate investors. Some CVCs and corporations prohibit investing in Cayman-based companies.
Here’s how the UK compares to the Cayman Islands:
- UK companies are less common,which can make some VCs hesitant.
- Shareholder lists are public record in the UK, but private in the Cayman Islands.
- You’ll pay around $2,000 annually to file accounts in the UK. there are no such fees in the Cayman Islands.
- A 0.5% stamp duty applies to share transfers in the UK,but not in the Cayman Islands.
- Corporate share buybacks are more complex in the UK, and simpler in the Cayman Islands.
Avoiding the Dreaded Freeze
If you initially incorporate as a C Corp and later determine a US acquisition is unlikely, you might consider a ”Freeze” restructuring. This creates a parallel structure, typically with a Cayman holding company alongside your C Corp, to limit the proceeds subject to US corporate tax. These restructurings are complex and expensive, costing upwards of $250,000 to set up and over $1,000,000 to analyze at exit. You can find a more detailed overview of freezes for Latin American startups here.
Indirect Tax on Exits
Regardless of whether you structure as a C Corp, Cayman company, or UK company, you’ll likely face indirect tax on the sale if you have local subsidiaries.
This indirect tax can surprise investors unfamiliar with Latin American markets. When handled correctly, it generally doesn’t increase overall tax liability, but shifts tax payments across jurisdictions.Incorrectly managed,it can create problems for both founders and investors. read a more in-depth overview of Latin American indirect tax on exits here.
