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When founders and entrepreneurs in Latin America start to prepare their Latam-based company to receive an investment from U.S.-based venture capital funds, one of the first tasks to consider is restructuring the company in a way that makes these funds comfortable to invest. For companies formed in any jurisdiction in Latam and without a parent company in the Cayman Islands or Delaware, this corporate restructuring process is known as a “flip.” This post describes how flips work, why U.S.-based venture capital and other institutional funds often request a flip and discusses key issues to pay attention to in a flip transaction.
How does a flip work?
In a flip, shareholders of an existing company exchange their shares in the existing company for shares in a new company. In Latam, the existing company is usually a Latam-based entity formed and organized under the laws of a Latam country. The new entity is usually a company formed in the Cayman Islands or Delaware. As a result of the “flip,” the existing Latam company—or companies, if there is more than one—becomes a wholly-owned subsidiary of the new Cayman Islands or Delaware entity.
Why do Latam companies sometimes pursue flips?
U.S.-based venture capital funds generally don’t invest directly in Latam companies, with very few and rare exceptions. One of the main reasons is that these funds generally see corporate law and governance regime in Latam countries as less predictable than that of Delaware or the Cayman Islands. In Delaware, the predictability is due to the development of the judiciary and both statutory and common law, and in the Cayman Islands, it’s due to the corporate law regime there generally mirroring that of Delaware while remaining neutral from a tax-perspective. The predictability factor also applies to issues like taxes, reporting requirements, permanent establishment, employment and labor regimes, freedom of contract, as well as politics at a more macro level, among other issues.
While these funds don’t typically invest directly in Latam companies, they have in recent years gotten increasingly comfortable investing indirectly through a parent entity organized in the Cayman Islands or Delaware. U.S.-based venture capital investors will generally require that any Latam-based existing entities “flip” to the Cayman Islands or Delaware as a condition before committing to close a financing. This is why founders, entrepreneurs and executives typically hear about a “flip” in the context of fundraising with U.S.-based venture capital or other institutional investors. Accordingly, with the increase in attention received by Latam companies from U.S.-based venture funds, flips have become more and more common in Latam.
Issues to consider when doing a flip.
Below are 5 of the main issues that—in our experience—you should pay attention to and try to solve for if you’re considering flipping your Latam business entity (or entities) to a Cayman Islands or Delaware-based holding company structure. The insights below would apply whether you are flipping an entity out of Brazil, Mexico, Chile, Colombia or any other Latam country.
- Tax considerations. You will want to consult with local tax advisors early to determine whether the flip might trigger tax obligations for some of the shareholders, or if there is a more tax-efficient manner to complete the transaction. For example, flipping an entity from Mexico will be different than one from Chile or Brazil due to the different tax regimes. The stage of the company at the time of the flip may also affect the tax consequences. If the flip would be a taxable event, you may want to consider other alternatives and potential liquidity transactions for some of the shareholders that would be impacted, especially founders.
- Timing. All things considered, the sooner you complete the flip, then the easier, more efficient and simpler that it will probably be. Generalities aside, there are a few practical guidelines that you might find helpful. For example, flipping after a priced equity round in which the company sold shares will usually be more complicated and time-consuming, and it may ultimately not be feasible at all. On the other hand, flipping after having raised capital via Safes or convertible promissory notes is usually more straightforward as long as the holders are in agreement. There are also other factors that might make it more complicated to flip with time, particularly after years of operating, such as revenue, profitability and capitalization issues as discussed below.
- Capitalization. What does your company’s cap table look like? Typically, the more equityholders on your cap table and the more types of equity the company has issued (i.e., common / ordinary shares plus preferred, debt, etc.), then the more complicated the flip will be. Usually you’ll want 100% of your equityholders to agree not only to the flip itself but also the jurisdiction to which you would be flipping. Therefore, the more shareholders on your cap table, the higher the risk of governance issues or dissenting shareholders. If you have an equity incentive plan in place or have otherwise granted stock options, you will probably need to have a conversation with your optionholders about terminating and/or replacing those options with options in the new parent entity. If they aren’t already, your local tax advisors and attorneys will become your close advisors during the flip process.
- Governance. Special shareholders’ agreements (SHAs, pactos) and side letters with investors or early co-founders, service providers, suppliers, etc. can often lead to complications during the flip process because they tend to make it more challenging to steer towards consensus. Generally, the simpler your governance structure, then the simpler your flip. Sometimes a flip can offer an opportunity to reset your governance through a negotiated outcome.
- Flip jurisdiction / destination. There’s no one-size-fits-all approach. Tax considerations have driven many Latam companies to flip to the Cayman Islands in recent years. However, there are other considerations to take into account when deciding where to flip, for example: What kind of business are you building? Where do you plan to operate your business, conduct sales or otherwise generate revenue? Who are you pitching to? Some investors are prohibited from investing in companies in the Cayman Islands; similarly, anti-tax haven laws and regulations in some Latam countries make it very expensive (and tax-inefficient) to flip to the Cayman Islands. So it’s important to know your investors’ position and what the tax, legal and regulatory landscapes look like in the jurisdictions in which you plan to operate.
[Last reviewed: May 24th, 2023. Please consult with local legal and tax advisors in connection with any flip transaction.]
Last reviewed: May 24, 2023