The Cayman Sandwich: A Potential Corporate Structure Solution for LatAm Startups?

With special thanks to Xander Lee and Tamim Bazzi for their contributions.

For founders, choosing the right entity structure is a key decision point in the formation of the company (a process we discussed in more detail here). Historically, almost all Latin American startups seeking venture funding would incorporate in the US regardless of where the founding team was located, as venture investors would shy away from unfamiliar corporate structures in other Latin American jurisdictions. However, the “Cayman sandwich” has grown in popularity as a solution to address potential tax consequences for non-US founders of Latin American startups and has become increasingly appealing to investors as well. This three-tier company structure emerged as a popular alternative to the typical Delaware C corporation for predominantly non-US companies (which usually have non-US operations), offering a combination of investor friendliness and potential tax optimization, including avoiding the standard corporate tax on the earnings of Delaware corporations. If you are considering starting a company based out of Latin America and seeking venture backing in the future, the Cayman sandwich may be an avenue worth exploring, but should be considered with all its nuance and on a case-by-case basis.

What is the ‘Cayman sandwich’?

The Cayman sandwich involves a three-tier structure with at least three corporate entities. At the top level, a Cayman holding company (the TopCo) is where investments are made and the equity ownership and governance of the company is represented. In other words, this is where you, your co-founders, your employees and your investors would own shares and make corporate decisions. Having ownership in this tier also makes it easy to implement a US-style equity incentive plan (i.e., option pool).

The TopCo wholly owns a Delaware LLC, which forms the middle layer of the Cayman sandwich. The LLC is a purely pass-through entity, and its purpose is to provide a buffer between the TopCo and local entities and offer some flexibility for potential exit structuring.

The Delaware LLC then wholly owns the local operating company at the ground level (the OpCo), or multiple OpCos if the company does business in multiple countries. This is where the core business takes place – the company’s employees, intellectual property, customers, revenues, etc. typically exist at this level.

Why is the Cayman sandwich popular?

The main draw of the Cayman sandwich is simple: It can offer preferential tax outcomes on company exits with more flexibility than standard Delaware structure. The Cayman sandwich has emerged for several reasons:

1. Tax treatment

Compared to Delaware corporations, Cayman companies may have more favorable tax outcomes, especially for non-US investors. If a non-US investor wishes to buy your company but only wants to acquire the local OpCo, the Cayman sandwich allows them to bypass the 21% US corporate tax the buyer would otherwise be made to pay if your company was owned by a Delaware corporation instead. It may also avoid the local country’s capital gains tax. This makes your company more appealing to a wider range of suitors.

• Important: Keep in mind that founders may still have to pay local taxes on exit; this structure merely avoids the 21% US corporate tax.
• If you are unsure about the exact exit plans for your company, the Cayman sandwich may provide more flexibility for considering different exit options depending on the circumstances.
• Different tax considerations may apply to you depending on your company’s circumstances, such as who you are selling to, where your OpCo is based out of, etc.
• Another point to consider (in addition to your own company’s circumstances) is the nature of the company’s future buyer/investor. Will they be US-based, and are they open to acquiring the Cayman TopCo? It is difficult to say with any degree of certainty, but unless the answers to both of these questions is likely “yes,” then the additional 21% US corporate tax will not apply, which may make your company more appealing for future investments and exits.

2. Predictable corporate law

Cayman Islands corporate law closely mirrors that of Delaware and has a well-developed and consistent body of law.

3. Corporate flexibility

It is easier to flip a Cayman company into a Delaware one than vice versa.

• To learn more about flips, read this Cooley GO article.

Drawbacks to consider

1. Increased corporate costs

Because the Cayman sandwich covers three types of entities across three jurisdictions, it bears increased costs for incorporation, operations and at significant corporate actions – such as equity financings, option grants, share transfers, etc. Additionally, you may need to place more reliance on tax advisors across the jurisdictions involved, especially as your company grows and potentially enters into more cross-border intercompany agreements or agreements relating to intellectual property ownership. If you are not looking to scale aggressively or receive the kind of venture-based or institutional backing that eclipses these increased operational requirements, the sandwich may not be worth the added cost.

• One important example: When using the Cayman sandwich, you should work with your company’s legal and tax advisors to determine the appropriate US tax elections for the various entities in the structure.

2. Lower appeal to local investors

Local investors should be familiar with their own jurisdiction’s corporate and tax laws and likely will not mind investing in local entities – in these cases, the added costs to the Cayman sandwich are likely not worthwhile.

• However, the flexibility of the Cayman sandwich allows companies to spin off the lower-tier OpCos and sell them directly to investors, which mitigates the above drawback to some extent.

3. Lower appeal to European investors

Although the Cayman Islands has been removed from the European Union’s list of high-risk countries for strategic deficiencies in their anti-money laundering regimes, in our experience, the potential for future regulations has led certain European investors to occasionally shy away from investing in Cayman entities. However, this is an evolving area, and it may be difficult to optimize for all potential investors’ sensitivities.

Key takeaways

In light of the above, the Cayman sandwich may be a compelling structure for Latin American startups in the following situations:

• You want or expect to receive substantial funding from institutional investors (whether from the US or elsewhere).
• Your main exit strategy is not from a US-based buyer (as those buyers would be subject to the US corporate tax regardless of the Cayman sandwich structure).
• The vast majority of your company’s team/operations are located outside the US.

Conversely, the Cayman sandwich may be less suitable if:

• You expect or are targeting an acquisition from a US-based buyer as your company’s exit.
• Your operations are based out of the US.
• You expect heavy investment from funds in your home country or from European investors.

While the Cayman sandwich has become a popular entity structure for many venture-backed LatAm companies, it is not the only one, and you should consult with your legal counsel and tax advisors to determine if any alternatives may be better for your situation. The answers to the questions we’ve laid out above are key to determining if the Cayman sandwich is right for you. Of course, these guidelines are applicable as of the date of this article. Please note that tax laws are constantly changing, and several countries have proposed legislation to limit the ability to lower tax rates by incorporating entities in low-tax or no-tax jurisdictions. Thus, we urge you to check with local counsel about the current state of the tax law at the time of your transaction.