Note: Since the date of this article’s publication the Cayman Islands have been removed from the EU’s blacklist.
The headline was bit jarring for hundreds of entrepreneurs in Latin America whose holding companies are in the Cayman Islands:
The EU Council (comprising the finance ministers of the 27 EU Member States) announced on 18 February 2020 that the Cayman Islands, alongside Palau, Panama and the Seychelles, has been added to the EU’s list of non-cooperative jurisdictions in tax matters, known as the EU’s tax haven “blacklist”
Ten years ago Latin entrepreneurs looking to raise capital from international VC funds had almost no choice but to form their holding company in Delaware. Non-US entrepreneurs realized that Delaware is highly tax-inefficient, but a Delaware Flip was a “mal necesario” (a necessary evil) to raise capital. That changed a decade ago due to one smallish M&A transaction out of Argentina with an unexpected result.
As was the custom in the early 2010s, a well-known accelerator required each of its LatAm founders to create a Delaware C-Corp as a condition to get the accelerator’s funding and support. One of the accelerator’s portfolio companies from Argentina did a quick US$2M exit after only raising the less than US$15,000 the accelerator invested.
You can only imagine the surprise for the Argentine founder (who had never been to the US and who didn’t even have a visa to travel to the US) and his five non-US angel investors when we explained to them they would have to pay US$600K+ in US taxes because the European buyer was not willing to buy their shiny, new Delaware company, but rather insisted on buying their Mexican and Argentine operating subsidiaries.
We leveraged this terrible situation to convince the always founder friendly Kaszek Ventures to allow one of our Mexican tech clients to create a Cayman Islands holding company (rather than a Delaware holding company) for the Series B round Kaszek Ventures was leading.
Kaszek Ventures suggested putting an LLC below the Cayman Islands holding company to appease the local corporate regulator in Mexico, and thus the “Cayman/LLC sandwich” was born–or at least began to be used for LatAm venture deals. Once Kaszek Ventures validated the Cayman/LLC structure, the other venture capital funds active in the region quickly followed suit. NTXP and their attorney, Manuel Tanoira, were also early adopters.
Over the past 5 years approximately 25% of our Latin American based entrepreneurs from Spanish speaking countries have raised capital using the “Cayman/LLC Sandwich”. In Brazil, a majority of entrepreneurs raising capital offshore have used the “Cayman/LLC Sandwich”. That is well over 100 entrepreneurs using a Cayman Islands holding company just from our firm.
Given the wide adoption of the Cayman/LLC structure of venture investments throughout Latin America, what does it mean that the Cayman Islands (a UK overseas territory) is now on the EU blacklist?
Some commentators have argued that this was really a political move the EU took to punish the UK for exiting the EU. Whether a jurisdiction should be on the blacklist is subject to “continuing review”, as said by the EU. Bermuda is an example of just how fluid (and arguably political) this blacklisting process can be. Bermuda moved from the blacklist to the EU’s “grey list” after a number of weeks of being blacklisted in 2019. A short time later, Bermuda was removed altogether on the same day that the Cayman Islands was moved to the EU blacklist.
Many attorneys in the Cayman Islands expect that Cayman will successfully negotiate with the EU a resolution in 2021 that takes the Cayman Islands off the EU blacklist.
That said, the consequence of being on the EU Blacklist actually isn’t very draconian. The inclusion of a jurisdiction on the blacklist does not trigger material sanctions by the EU or even amount to a prohibition on marketing a Cayman Islands fund (under national private placement regimes) in the EU. Some EU investors perceive there will be an increased risk of local tax audits on investments in Cayman structures.
Based on anecdotal evidence since February when Cayman was put on the EU Blacklist, it does not appear there has been a significant number of VC or PE funds leaving the island and re-domiciling elsewhere (at least for now). Certainly, the addition of the Cayman Islands to the blacklist is likely to make EU institutional investors increasingly averse to Cayman Islands funds for a number of reasons. And it is clear that EU institutional investors with connections to EU governments (such as state pension plans) will likely be dissuaded from investing in Cayman Islands funds as a matter of policy or government pressure. Not many of those investors are doing venture deals out of LatAm.
As is usually the case with venture capital, the “Golden Rule” will likely prevail—those who have the gold set the rules.
Ultimately it will be the venture capital funds active in Latin America who will decide whether they are comfortable with their portfolio companies continuing to use Cayman holding companies as an alternative to Delaware for non-US founders. For now, our entrepreneurial clients from Latin America have not received pressure from their institutional investors to redomicile. Only time will tell.
Many of us are hoping the Cayman Islands, like Bermuda, is able to get itself off the EU blacklist. If not, we may start seeing “Canada/LLC” and “Bermuda/LLC” sandwiches as both Canada and Bermuda share the distinction with the Caymans that they are centers for various types of funds.
Is the “Cayman/LLC” stale? We would say it has gotten a little soggy, but still edible.
This post is also available in: Español (Spanish)