Delaware LLC: what's a Delaware Tostada and why your startup might need it

We come to you with a truth that's hard to swallow 💊: 8 out of the 15 biggest VC firms in the world are based in the United States of America. These funds set the best practices even for LatAm angels and VC firms.

If you want your startup to raise early-stage capital from top-tier investors, the odds are high that you'll run into requirements commonly seen in the US. Having an international corporate structure can make these investment talks go much, much smoother.

That's when the Delaware LLC comes into the scene for Brazilian startups. We even have a cute nickname for when a startup combines their local operation with a Delaware LLC: Delaware Tostada. We'll shortly explain why, Fernanda, hold on tight.

Internacional company formation is still a black box for most Latin American startups.

Just between us founder friends, I can make things a little less opaque for you.

Here's a comprehensive guide on how Brazilian founders can set up their companies through a combination of their local structure and a Delaware LLC (Delaware Tostada).

Why do LatAm startups even need to incorporate in the US?

We've talked about this before in our startup incorporation guide: most entrepreneurs want to get rid of company formation as quickly as possible to focus on more interesting tasks, like getting revenue into your business.

But all this work to create value can go down the drain due to a lack of interest in having the best legal framework. A little dedication right from the start can save you not only a lot of headaches but also millions of dollars in losses.

These losses don't just come from taxes but also from investors who just won't put money into your business.

When you raise larger rounds or when you raise with international investors, having only one local operation can worry them about unexpected financial and legal obligations. Corporate law in most LatAm countries is not as robust and established as in the US. VCs are very keen on doing their due diligence, and they can't anticipate risks and liabilities with legislation they don't know.

For example: in the case of a labor lawsuit, investors would not be able to know with 100% certainty whether or not they could be held liable. They also cannot predict whether some local authority will knock on their door demanding some information or even a full audit.

VCs can't possibly know the laws and taxations of every country they are active in – come on, João, even you had trouble figuring out the difference between Lucro Real and Lucro Presumido. And hiring legal counsel in every country they've ever invested in is just not practical, now, is it?

If everything is not clear at least in the basics of regulation, it's difficult to assess other potential risks. And startups are risky enough. Sorry, but you've lost the deal.

It's not just us saying this. Dan Green, partner at the startup-focused law firm Gunderson Dettmer, shared the same reasoning during an episode of our Latitud Podcast. Gunderson assisted in famous transactions such as Uber's acquisition of Cornershop and Kavak's Series D round.

This is also the view of investors in international and renowned venture capital firms. For example, the first global VC firm that should come to your mind: Andreessen Horowitz (a16z).

“When we are investing in a Brazilian company, having the right governance and corporate structure has significant impacts. Not only in tax terms but in possible obligations on the part of investors", David Haber, a16z general partner, said during the event Launchpad by Latitud + a16z.‍

Lawyers and Investors aren't enough: you'd rather hear this truth from other startup founders in Latin America. We understand, and here they are.

"We are starting to raise our Seed round right now. And the first thing they ask us is which country our legal structure is in", João Pirola, co-founder of fintech AmFi, said at the event. “Founders see this greater access to international capital, but at the same time it's not an easy task for first-time entrepreneurs to incorporate the right way to raise these funds", Ruben Guerrero, creator of Sproutfi, agreed.

Delwaware Tostada: a good choice for Brazilian startups

Ok, now we all know the importance of having an international corporate structure on top of your local company – if you want to have any hope of attracting top-tier investors to your early-stage Brazilian startup, that is.

The best structure for that? We like to call it a Delaware Tostada:

But among all possible incorporations, why should your Brazilian startup choose a Delaware LLC + Local operating company? Why choose this delicious Delaware Tostada instead of just bland bread?

Let's go down memory lane for a bit. Some years ago, most Latin American startups looking for an international corporate structure had both their local operation and a C-Corp in Delaware.

But there was a catch: a C-Corp incurs double taxation. The owners are responsible for paying personal income taxes on earnings from dividends or the sale of C-Corp shares, and the C-Corp is accountable for paying yearly corporate income taxes.

Looking for an alternative, entrepreneurs got to the Limited Liability Company (LLC). In this type of corporate structure, each member pays taxes on a portion of their personal income in their country of tax residency. The company owes no corporate taxes – fiscal responsibility is passed on to the individuals behind the business.

Advantages and disadvantages of a Delaware LLC

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An LLC has advantages and disadvantages in relation to a C-Corp. Here's a quick overview of the differences between a C-Corp and an LLC:

As we've seen, one of the biggest advantages of an LLC is avoiding double taxation.

Say you're building a company based in Brazil, but need a United States entity to receive investments. Having a C-Corp as a holding company will make your startup subject to taxes in the US even if you haven't made a single dollar there.

With an LLC as a holding company and a legal entity in your own country, you'll only pay taxes where they're really due: where you're operating, managing payroll, and making profits. A.k.a. in your own corner of Latin America.

On the other hand, the most commonly cited disadvantage of an LLC is the different equity structure.

But get this: LLCs can still provide equity-based compensation and liquidation preferences even when they lack stock or shares to distribute. It will demand more effort, but there are several configurable and versatile alternatives for doing so with the help of a trusty lawyer.

Startup founders often use a C-Corp structure to prepare for an IPO. But unless you're planning to go public in the next 12 months, that might be a bit of an overkill at the current stage.

In Brazil, an LLC can be easily converted to a corporation later on without necessarily having tax implications. But the opposite conversion would be much more complex in case an IPO is not in the cards for you.

Still, it's important to remember: not all investors would be comfortable with or able to invest in an LLC. It's crucial to check with yours before committing to a corporate structure.

‍When should you set up a Delaware Tostada?

Founders will typically need to add a Delaware LLC to their local company, and cook themselves a Delaware Tostada, when they're ready to raise angel investment, a pre-Seed, or a Seed round.

These founders also have already discussed the possibility of incorporating an LLC with investors and gotten their green light. They are open to the idea of changing their corporate structure down the road if needed, but they want to stay cost-effective for now.

Still not sure if you're suited for a Delaware Tostada? Here's a quick decision tree about the right corporate structure for your startup:

Which investors accept a Delaware LLC/Tostadas?‍

As we've seen, the "Delaware LLC + Local operating company" corporate structure is geared towards the earlier stages of investment. Once again, it's always good to check with your potential investors before committing to a structure.

Some investors are open about writing checks for companies with a Delaware Tostadas structure. Examples are 500 Startups, Canary, Maya Capital, Norte Capital, ONEVC, and yours truly Latitud Ventures!

What comes after a Delaware LLC/Tostada?

The first model of corporate structure is to only have a local company. Since your entire operation exists in the country you are in, it makes sense to open a company in this country and that's all right, right?

If you want to raise more significant rounds with global investors, wrong. Okay, we just learned that. Then came the second model of corporate structure: having the local company, but also a C-Corp in Delaware. We know how that turned out too.

So you have your local company and a Delaware LLC. The Delaware Tostada is in the toaster. Could it get even tastier?

We finally arrived at the current standard of high-end corporate structure. It was created by the venture capital firm Kaszek and the law office PAG LAW back in the early 2010s. They called it the Cayman Sandwich. Yum!

With a Cayman Sandwich, a startup has this structure:

• A holding created in the Cayman Islands, with investors and founders as shareholders and with no obligation to pay taxes (learn more about tax neutrality in the Cayman Islands);
• An LLC in Delaware as an intermediary, with the objective of avoiding the double taxation of C-Corps in liquidity events and, in general, optimizing the tax structure for startups that do not have operations in the United States;‍
• A local corporate structure, focused on managing the startup's entire local operation. This framework is necessary when hiring local employees and protecting your in-country intellectual property, for example.

This is the ideal model to create your startup looking for tax efficiency and larger or international funding. Why don't all startups just do this from the get-go then? Well, there are some caveats.

In addition to the costs of starting a company abroad, maintaining the Cayman Sandwich international legal structure can cost more than US$ 6,000 a year.

If that amount is going to leave a hole in your startup's budget, maybe it is too soon. You're better off starting with a Delaware Tostada. There's no problem in adding another layer later on and getting yourself a Cayman Sandwich – that's a common process known as a flip.

Our rec as your friend: as we've said before, every investor has their preferences. So talk to your investors and, if they agree, start small but correctly. Then, expand when another investor requires a more robust corporate structure down the line.