The most frequent question I am asked by Latin founders is “What is so bad about a Delaware holding company? And why do I keep hearing about the Cayman/LLC Sandwich?”
Being the oldest person in the room, my instinct is to start with a history lesson. Where did this tasty “Cayman/LLC Sandwich” come from?
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 $2M exit after only raising the less than $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 at PAG Law explained to him the company would have to pay $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.
At PAG law 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 countries have raised capital using the “Cayman/LLC Sandwich”. That is well over 100 entrepreneurs using a Cayman Islands holding company just from our firm.
Here’s a little secret– US lawyers don’t make as much money when a non-US founder creates its holding company in the Cayman Islands.
At PAG Law we regularly see US lawyers pushing their non-US clients away from a Cayman Islands holding company structure and towards a Delaware holding company structure by noting that in 2020 the Cayman Islands was put on the EU “Blacklist”. These lawyers often fail to mention that the Cayman Islands were subsequently taken off this Blacklist. Today the Cayman Islands is as popular as it has ever been.
The Cayman Islands are preferred by many international entrepreneurs because they do not charge corporate tax on income generated outside of Cayman. There is also no tax on distributions paid from a Cayman holding company to its owners. However, each recipient of any distributions needs to see if it needs to pay taxes on that income in their home country. (For a more expansive discussion of the pros/cons of Caymans vs Delaware see this article).
The reason most VC funds will not object to a Cayman Islands holding company is that many large funds have operations in the Caymans. It is hard to object to a jurisdiction that many funds rely on. It’s worth noting that as venture-backed companies raise $100M+ rounds their VCs start to apply pressure to move the holding company from the Caymans to Delaware in anticipation of an exit. That day of reckoning is years down, if ever, for most venture-backed companies.
For these reasons, the Cayman/LLC Sandwich continues to be the structure of choice for Latin founders looking for a more efficient tax structure for their holding company, while needing to choose a “VC friendly” jurisdiction.