Five things to know before starting a company in Latin America

So you want to build a startup in Latin America. Maybe you grew up in our corner of the continent, or maybe you feel a calling to the region.

If you've had any experience with established tech ecosystems like Silicon Valley, you'll soon learn that things can be a little different on this side of the globe. 

I'll be straight with you: you may be carrying one too many assumptions in your baggage. If there's one thing you should know, it's that the incorporation advice widely spread in the U.S. does NOT directly translate to Latin American companies. Let's unpack that, shall we?

In Hustle Fund's latest webinar, two of the brightest minds in the LatAm tech scene were invited to answer your burning questions.

Whomst, you may ask?

Brian Requarth is the co-founder and CEO of Latitud, home to a community of over 1,000 tech founders from all parts of Latin America. His $600 million dollar exit in LatAm happened when these were few and far between, and he wrote the book "Viva the Entrepreneur: Founding, Scaling, and Raising Venture Capital in Latin America" to tell the story.

Andres Barreto is the Managing Director of Techstars Miami, one of the driving forces behind the strengthening of the LatAm ecosystem in Florida. He's invested in over 120 startups and co-founded 8 companies himself, and his track record earned him mentions as BusinessWeek’s top 25 under 25 and MIT Tech Review Top 10 Innovators under 35.

Below is what we learned from these experts.

Disclaimer: CAUTION! None of us are lawyers, so please check with your own lawyer about what you think is best for your company. We are just sharing war stories and opinions of our own.

What we'll cover:

How should I incorporate my Latin American startup?

Why do investors care about where I incorporate?

Does my corporate structure impact my exit strategy?

Who can help me with international incorporation?

Can I get a TL;DR?

How should I incorporate my Latin American startup?

I'll say it again: what you know about incorporation in the U.S. does NOT directly translate to Latin American companies. Abandon all conjecture, ye who enter here.

Brian Requarth is the co-founder and CEO of Latitud. He built a product to help LatAm startups incorporate, so he knows a thing or two about the topic.

As a first-time founder in 2009, Brian made an incorporation mistake that cost his company $100 million in capital gains taxes

Being from the U.S., Brian was advised to set up his company as a Delaware C Corp. It didn't take long before his decision would come back to bite him, and he learned what not to do the hard way.

When asked about the best corporate structure for LatAm businesses, Brian's answer began with a classic: "it depends". There's no one-size-fits-all formula for incorporation, and different startups have different needs.

According to Brian, there are three things you should ask yourself before deciding where and how to incorporate:

  • Who do I want to raise capital from?
  • What's the size of the round I want to raise?
  • Where will my company operate?

With these answers, your legal counsel will be able to help you figure out the 'when' and the 'how'.

Picture this: If you're raising $120,000, does it really make sense to spend 1/4 of that money on legal fees? If you're only raising from local investors, do you really need a sophisticated international structure? 

From Brian's experience, the most common and tax-efficient international structure for Brazilian startups is the Cayman Sandwich, which consists of:

  • A Cayman holding company, with investors and individuals holding shares at the top
  • A Delaware LLC intermediary, optimizing for exits and adding disclosure advantages
  • And one or more local operating companies, gating all of the liabilities

This structure is spreading across Latin America as a whole as the ecosystem matures, with over 47% of the region's unicorns having a legal entity in Cayman.

But we'd be delusional to say that a Cayman sandwich would be right for every early-stage startup.

"If there's someone who can raise $2 million dollars on a PowerPoint from a top VC like a16z or Sequoia, or $5 million dollars in Cayman from day one, that's great! That's typically not most founders that I work with."  – Andres Barreto

As Managing Director of Techstars Miami, Andres Barreto has mentored hundreds of LatAm startups over the course of the years, and he's seen plenty of incorporation mistakes too.

Latin American founders are constantly challenged by how hard it can be to do business in the region.

Andres's two cents on the topic speak to his lessons as a U.S. investor. His key takeaways are:

  • Always talk to your investors before setting up offshore
  • Pick a corporate structure that is widely accepted by international VCs
  • Optimize for your company's survival over anything else

Incorporating in the U.S. makes sense from Andres's perspective because there are thousands of VCs in the country, meaning you'd be able to raise from a bigger pool of investors.

But realistically and regardless of where, spending over $30,000 dollars on international incorporation won't make sense until you have a solid capital runway. 

There are ways to change your company's corporate structure later, but you should only cross that bridge when the occasion calls for it.

For the average LatAm startup, it's more practical to incorporate locally first and then add international layers when and as needed with the help of legal advisors. You'll typically only need to incorporate offshore when you're gearing up to raise investment from an international VC. 

Andres's ultimate recommendation is that early-stage startups should stay cost-efficient when incorporating so that they can make it in the long run.

Don't just start with an international corporate structure without knowing who you'll be raising from. You'll thank us later.

Why do investors care about where I incorporate?

You're in the world of startups, so you've probably heard the expression "due diligence" thrown around a few times.

Investors care about your company setup because it impacts their ability to anticipate and mitigate risks. 

If you've incorporated in a country your investors are not familiar with, they don't know what liabilities they're signing up for. They don't have legal counsel in the jurisdiction, so they might wonder: if the company I'm considering investing in gets sued, can I get in trouble with the law?

On top of that, where and how you incorporate can also impact their own taxation treatment, especially if they're U.S.-based.

The United States has strict policies to prevent money laundering. U.S. funds investing in non-U.S. companies are subject to more scrutiny, and will sometimes have to make additional filings with the IRS. 

Andres points out that U.S. investors care a lot about a tax benefit called Qualified Small Business Stock (QSBS). With this perk, investors backing U.S.-based small and medium businesses (SMBs) are eligible for tax exemption so long as they hold on to their shares for 5 or more years.

By investing in non-U.S. legal entities, they essentially have to give up that benefit, which can be a challenging point for negotiations.

Does my corporate structure impact my exit strategy?

Very much so.

Different corporate structures will have their own set of advantages and disadvantages for potential exit scenarios. Here are a few examples.

  1. IPOs

Say you're a Delaware C Corp looking to have an Initial Public Offering in the U.S.. That would work wonderfully – in fact, it's the traditional way to do it, what lawyers are accustomed to, and how titans like Mercado Libre went about it.

If you're a Cayman Holding wanting to IPO, that's still possible, and you can benefit from something called Foreign Private Issuer rules and more lax mandatory disclosures with the SEC. That was Nubank's path of choice.

  1. U.S. acquisitions

Some of the biggest tech companies in the world are based in the U.S., so you may or may not have daydreamed about this scenario before.

If your buyer is U.S.-based, they'll be perfectly fine with buying a U.S. legal entity since that's their bread and butter. 

C Corps would be ideal, but a Delaware LLC would not necessarily be a dealbreaker when they can just buy it and convert it after.

  1. Local acquisitions

It's also common that LatAm companies get offers from local players in their markets. This buyer persona is rarely ever interested in buying C Corps, and they'll be looking to buy you out at the local operating level.

In this scenario, having a C Corp would result in capital gains taxes in the U.S., making the Cayman sandwich a better fit.

  1. International acquisitions

Put simply, most European and Asian buyers won't want to touch a U.S. C Corp with a 10-foot pole.

For international acquisitions outside of the U.S., the Cayman sandwich adds the benefit of disclosure advantages.

In countries like Mexico for instance, antitrust authorities are known to be ruthless and make it mandatory for every shareholder to disclose their financials before an M&A deal can be approved, which would be a dealbreaker for most VC firms.

With a three-layer structure, selling at the local level means investors won't ever have to disclose their financials, because the intermediary layer (Delaware LLC) is the local entity's sole shareholder.

  1. Mergers

The ideal scenario for mergers would be two companies incorporated in the same jurisdiction, whichever one that may be.

But lawyers don't live in a fairytale world, so they'll be prepared to coach you through more complex solutions if that's not your case.

One note: merger transactions in the U.S. are subject to a lot more regulations than in the Cayman Islands, and typically take longer to be approved.

Who can help me with international incorporation?

How meta is it that there are startups solving this problem for other startups?

In the last 5 or so years, more and more solutions have popped up to help founders incorporate, especially in the US.

Hustle Fund invested in and partnered with Doola, which covers both Delaware C Corp and LLC incorporations at an affordable price. 

If your startup is based in Brazil or Mexico and looking to incorporate in the Cayman Islands or as a Delaware LLC, Latitud Go can get you set up.

And if you want to go with an OG, Stripe Atlas offers a reliable Delaware C Corp structure that Techstars knows and loves.

Can I get a TL;DR?

Of course. Here are three main things to remember from this article:

  • Don't spend thousands of dollars in company setup before you have to
  • Balance your need for tax efficiency with optimizing for a big investor pool
  • Prioritize your company's survival over anything else