Why some Venture Capital Firms require Startups to incorporate an Offshore Holding Company as a Condition Precedent to Funding

As a Startup seeking to raise finance through equity investments, you will find that a common request of Venture Capital Firms (VCs) and a condition precedent to funding (as contained in Term sheets) is that you incorporate an offshore holding company in a jurisdiction that is investor friendly. This offshore holding company then serves as the VC’s investment vehicle for your Startup.

In this newsletter, we have highlighted reasons for this request by VCs; investor friendly locations; and useful consideration to help determine the appropriate time for such an incorporation.

Why do VCs require Startups to incorporate an Offshore Holding Entity?

  • The offshore entities benefits from a favourable tax climate: For example in Mauritius and Delaware, there is no capital gains tax on the sale or transfer of shares and  also, there is no corporate tax on dividends.
  • Reduced foreign exchange exposure and risks: Most investments by VCs are made in foreign currency and for this reason, they need to limit their foreign exchange exposure. The offshore entities provide these benefits with limited foreign exchange controls.                                                                        
  • Minimal regulatory oversight: Reduced regulatory interference in the conduct of business.

What Jurisdiction are considered to be Investor Friendly?

The jurisdictions that have been known to be investor friendly include:

  • Delaware
  • Mauritius
  • Singapore
  • Cyprus
  • Hong Kong
  • Cayman Islands
  • British Virgin Island

Should a Startup incorporate an Offshore Holding Company before raising funds from VCs

VCs have their preferences depending on where their funds are located. If the funds are in Africa, VCs would typically encourage incorporating an offshore holding entity in Mauritius. On the other hand, a VC with funds in the US would tend to encourage incorporating an offshore holding entity in Delaware.

Although the decision to incorporate is entirely that of the Startup, it may be wise for a Startup to be clear on the direction investments will come from or which VC will be investing prior to incorporating its offshore entity, so as not to incur unnecessary expenses.