The beginning of a dream: you want to build a successful startup in Latin America. It all worked out: after a decade of hard work and financial (and emotional) investments, one day you get a different email in your inbox.
It's from a big tech company: they've realized how amazing your startup is, and they want to buy it for hundreds of millions of dollars.
Sounds interesting, right?
That's what happened to Brian Requarth, co-founder of Latitud, when he was still at Grupo ZAP Viva Real. You may already know that the company was in fact acquired by OLX for $640 million.
But what you may not know is that $100 million was lost.
Yes, all of it. In taxes. Because of a wrong legal structure.
We don't want you to make the same mistake. In this guide, we'll give you even more reasons to have the right legal framework for your startup. Then, we'll show you the right way to incorporate a startup, with the best corporate structure for every moment of your business.
We will also reveal the corporate structure that unicorns in Latin America use, so you know what you have to do when you get there. If you already have your startup in operation and just realized that your incorporation wasn't the right one, we will show you how to change your corporate structure through a flip.
Finally, we'll have the ultimate startup incorporation checklist, for you to mark your options and make the best decision for your startup's corporare structure.
In the beginning of a startup, talking to potential clients, creating an MVP, attracting talent, and opening doors with future investors are some of the concerns that populate your daily to-do list.
Most entrepreneurs want to get rid of incorporation as quickly as possible to focus on the operation. But all this work to create value can go down the drain due to a lack of interest in having the best legal framework.
A little dedication right from the start can save you not only a lot of headaches, but also the loss of millions of dollars. These losses don't just come from taxes, as we've seen, but also from investors who won't put money into your business.
When you raise larger rounds or when you raise with international investors, having only one local operation can worry them about unexpected financial and legal obligations.
In the case of a labor suit, for example, investors would not be able to know with 100% certainty whether or not they could be held liable. They also cannot predict whether some local authority will knock on their door demanding some information or even a full audit.
For a global VC, putting his money in Brazilian companies with an unknown legal model, and with unpredictable future regulatory changes, is an additional risk. And startups are risky enough.
An example: SoftBank is headquartered in Japan, and it will dive headfirst into Brazilian corporate legislation. And it's not out of laziness. It may be due to the lack of trust, stability, and transparency of our institutions, or simply because it is virtually impossible to delve into the laws of every country in the world. If everything is not clear at least in the basics of regulation, it's difficult to assess other potential risks.
It's not just us saying this. This is also the view of investors in international and renowed venture capital firms. Like the first global VC firm that should come to your mind: Andreessen Horowitz (a16z).
“When we are investing in a Brazilian company, having the right governance and corporate structure has significant impacts. Not only in tax terms, but in possible obligations on the part of investors," said David Haber, a16z general partner, during the Launchpad by Latitud + a16z event, in São Paulo.
"There is friction when international funds do not see an international entity to deal with. It is very important for Latin American founders to be able to attract capital from abroad, and it can be the turning point for the region's ecosystem," agreed Itali Collini, a principal at international impact fund Potencia Ventures and an angel investor in the Latitud Angel Fellowship. also during the event.
Still not convinced? Dan Green, a partner at the startup-focused law firm Gunderson Dettmer, also shares this reasoning.
"An international investor will not be comfortable investing in a Limitada [local corporate structure for Brazilian startups]. They are looking for predictability in governance, to know that their rights as an investor are protected and that their obligations as a board member are well-defined," Dan said during an episode of our Latitud Podcast. Gunderson assisted in famous transactions such as Uber's acquisition of Cornershop and Kavak's Series D round.
Investors and lawyers are not enough. You'd rather hear this truth from other startup founders. We understand – so we collected some real-life examples from startup founders in Latin America, just like you.
Ruben Guerrero, founder of Sproutfi, arrived in Brazil in 2008. The entrepreneur shared that, at that time, if you were building a startup in Brazil or any other country in Latin America, you could only talk to local investors. So a startup founder didn't have to worry about having a legal structure in the United States or on neutral ground such as the Cayman Islands.
But with the development of the startup ecosystem in the region, international investors have taken a genuine interest in the region. “And they don't feel comfortable or understand local structures. One of the biggest frictions I see among entrepreneurs is that they see this greater access to international capital, but at the same time it's not an easy task for first-time entrepreneurs to incorporate the right way. to raise these funds", stated Ruben also during the Launchpad by a16z + Latitud.
João Pirola, co-founder of fintech AmFi, highlighted how the issue of incorporation weighs during negotiations with international investors. "We are starting to raise our Seed round right now. And the first thing they ask us is which country our legal structure is in."
It is worth doing a little retrospective on how startups begin their incorporation, and how they arrive at corporate structures that are more suitable for international investments. (I promise we'll be brief. Nobody likes law classes.)
The first model of corporate structure is to only have a local company.
Since your entire operation exists in the country you are in, it makes sense to open a company in this country and that's all right, right? If you want to raise more significant rounds with global investors, wrong. Okay, we just learned that.
A second model of corporate structure then emerges: having the local company, but also a C-Corp in Delaware (United States).
This C-Corp holds 100% of the shares of the Brazilian company. This allows the American investor to invest in the company in his own country, where he already understands all the regulations and thus avoids unnecessary financial and legal risks.
It sounds perfect, but even a C-Corp has its flaws. A famous defect is double taxation: not only companies pay taxes on the profit generated, but individual shareholders also pay taxes on dividends or liquidations of their shares. Investors were soon unhappy with the C-Corps' high tax burden, which ended up diminishing the return on their investments.
We arrive at the third and so far final model of corporate structure: the delicious Cayman Sandwich.
Let's go back to the early 2010s, when you still weren't sick of Adele's music. Our Latin American friends from the venture capital firm Kaszek and the law firm PAG Law rethought the legal structure of startups and, seeking to increase the tax efficiency of their investments, designed the "Cayman Islands Sandwich."
With a Cayman Sandwich, a startup has this structure:
This is the ideal model to create your startup looking for tax efficiency and larger or international funding. It's the global standard generally expected by VCs around the world – but it's worth mentioning that some family offices and European VCs may not like the format.
Another important point is that the capital you have raised or are raising needs to be enough to cover the cost of keeping your business operating for the next 24 months.
In addition to the costs of starting a company abroad, maintaining this international legal structure can cost more than US$ 6,000 a year. If that amount is going to leave a hole in your startup's budget, maybe it is too soon.
If you're raising a smaller check, a Cayman Sandwich might be too big of a financial and legal step. And that's why we suggest another structure for Brazilian startups in that stage: a Delaware Tostada.
Having a Delaware Tostada means adding a Delaware LLC on top of your local operating company in Brazil. It's the Cayman Sandwich without the top bun.
Brazilian founders will typically need to add a Delaware LLC to their local company and cook themselves a Delaware Tostada when they're ready to raise angel investment, a pre-Seed, or a Seed round.
These founders also have already discussed the possibility of incorporating an LLC with investors and gotten their green light. Some investors are open about writing checks for companies with a Delaware Tostadas structure. Examples are 500 Startups, Canary, Maya Capital, Norte Capital, ONEVC, and yours truly Latitud Fund!
Finally, these founders are open to the idea of changing their corporate structure down the road if needed, but they want to stay cost-effective for now. In Brazil, an LLC can be easily converted to a corporation later on without necessarily having tax implications – that's what we're going to talk about now.
"Building an international corporate structure without dissolving the existing company and incorporating a new legal entity from scratch" might sound too specific. But we'll share a secret: many other startup founders have had the same problem.
The solution actually has a very simple and well-known name: flip (learn more about all the steps to transform your startup's legal structure).
When a flip is done correctly, your intellectual property and ownership interest in the company will be protected. So it's important to point out one more time: you will definitely need legal advice to change your corporate structure.
The time for the flip to be completed depends on the complexity of your specific case, your cap table, and the corporate structure you would like to adopt. But a flip might take at least 6 weeks from start to finish.
The sooner you think about your startup's legal structure, the sooner you can see the need to flip and the easier that transition will be, according to Dan from Gunderson Dettmer. That's because your startup is probably not that mature yet and doesn't have as many people on the cap table and as much revenue or profit.
That way, you will position yourself early in the best way possible to capture investments and ensure the maintenance of the value created by your startup.
It would be easy (and irresponsible) for us to recommend something that has never been tested before. That's not the case with the Cayman Sandwich.
Almost half of Latin American unicorns have an entity in the Cayman Islands as part of their structure (47.7%). That's an impressive percentage, considering that this format only became popular in the last decade.
Brazilian unicorns like 99, Stone, Creditas, QuintoAndar, and Loft use this recommended structure.
Let's use QuintoAndar's story as an example. The real estate startup was founded in 2012. It started its operation with a Limitada + LLC model in Delaware.
That was enough until 2015. When the startup started preparing for its Series A, it saw the need to open a holding company in the Cayman Islands. The merger took place before Kaszek's investment of US$ 7 million. QuintoAndar has received many more rounds since then, raising another US$ 700 million. Today, its valuation exceeds US$ 5 billion.
Want to understand more about the path unicorns have taken as they navigate their own embeds? Download the ebook "The Path of the Unicorns" in Portuguese. The material was written by Latitud Go, together with the law firms Gunderson Dettmer and Pinheiro Neto.
Local operating company only, Delaware Tostada, or Cayman Sandwich? See the decision tree for your startup’s legal structure below:
Easy, right? Even so, always talk to your investors and seek out local tax advisors and specialist international law firms and make sure that the structure you choose is accepted by everyone involved in the round before deciding on what your legal structure will be.
Now, you are sooo prepared to have this conversation. Everyone will be impressed.