Private Equity 2020

Last Updated August 05, 2020

Brazil

Law and Practice

Authors



Machado Meyer Advogados has been building its history for more than 48 years, inspired by sound ethical principles, the technical skills of its professionals, and a close relationship with its clients. The firm is ranked as one of the major law firms in Brazil, with over 700 professionals. Machado Meyer provides innovative legal solutions, anticipates scenarios and makes business possible. Combining expertise in various areas of law, broad knowledge of legislation and a thorough understanding of the matter, the firm's professionals go beyond simple problem-solving to create and preserve value for companies. Because of the significant flow of today’s existing investment, the firm has organised professionals specialised in advising clients abroad, creating multidisciplinary groups, especially in Germany, Latin America, Iberia, and Asia, which have special desks.

The Brazilian private equity market started strong in the first quarter of 2020, with Brazilian private equity firms aiming at taking advantage of the capital markets boom at the time. However, due to the COVID-19 pandemic, private equity firms were forced to slow down both investments and divestitures during the second quarter in order to assess the impacts of the pandemic and provide full technical and financial support to their portfolio companies.

After the initial paralysis resulting from the pandemic, the private equity firms are now actively looking for investment opportunities and for divestitures.

In case of divestitures, due to the strong rebound of the global and Brazilian capital markets, they still tend to be made via initial public offerings or follow-on offerings.

From the investment side, Brazilian private equity funds have been focusing on investments in more resilient industries, such as tech and healthcare, which will continue to have attractive investment opportunities.

Other possible outcomes for 2020 are:

  • acquisition of the Brazilian business units of multinationals that are seeking to divest their subsidiaries to strengthen the financial health of their headquarters; and
  • investments in public companies with proven business models that need capitalisation (Private Investment in Public Equity – PIPE), considering the devaluation of many stocks.

In 2020 Brazilian private equity deals are spread across different sectors, with deals most concentrated in the tech, healthcare and financial industries. Investments in certain sectors that have stood out during the COVID-19 pandemic, such as remote healthcare, home entertainment and multi-channel retail, are also expected to excel in 2020.

A few legal developments have impacted the Brazilian private equity industry in the past three years, and more are expected to be approved in the second semester of 2020.

Economic Freedom Law

The Economic Freedom Law (Law No 13,874/2019), which was enacted in September 2019, has the purpose of promoting economic activity by reducing bureaucracy related to doing business in Brazil and increasing freedom within private relations and, thus, diminishing government intervention in private activity. This Economic Freedom Law also provides, among other matters:

  • the possibility of Brazilian limited liability companies having a single quotaholder;
  • a new chapter of the Brazilian Civil Code on investment funds, providing for the possibility of limiting the liability of investment fund shareholders and facilitating the incorporation of investment funds; and
  • simplification of the procedures for the obtaining of licences and permits.

Social Security Reform

The Social Security Reform, which was approved in October 2019, was considered by many people the first step to organise the Brazilian government accounts. Such reform, together with a major reduction of Brazilian interest rates, made traditional investment options based on fixed income less attractive to local investors, who took a bigger role on recent IPOs and follow-ons.

The Normative Rule No 606 of the Brazilian Securities and Exchange Commission (CVM), issued in March 2019, regulates incentive funds for investment in infrastructure, which grant to its shareholders a more favourable tax regime, provided certain requirements are met.

Labour Reform

The Labour Reform came into force in November 2017 and, since then, it has succeeded in significantly reducing labour disputes before courts. Great part of such reduction is due to the inclusion of a new article to the Brazilian Consolidation of Labour Laws, which states that the defeated party in a lawsuit must pay the prevailing party’s legal fees. As such, dismissed employees are now less impulsive in filing labour claims, which represents a reduction in labour litigation of Brazilian companies.

In addition to the above-mentioned legal developments, another future structural reform to monitor in 2020 is the Tax Reform. Aiming at simplifying and debureaucratising of the overly complex and burdensome Brazilian tax legislation, the Tax Reform will benefit both foreign and local investors.

The primary regulatory bodies for private equity funds and private equity transactions are as follows.

The Brazilian Securities and Exchange Commission (CVM)

The CVM regulates not only investment funds but also their administrators and portfolio managers, which must meet certain requirements in order to provide such services. CVM regulation must also be observed whenever the transaction involves public companies and/or offerings.

The Brazilian Antitrust Agency (CADE)

CADE approval is a condition precedent for the closing of transactions in which one economic group involved in the transaction had an annual gross turnover above BRL750 million in Brazil in the preceding fiscal year, and at least one other economic group involved in the transaction had an annual gross turnover above BRL75 million in Brazil in the preceding fiscal year.

Regulatory Agencies

Regulatory agencies are utilised whenever the target company develops activities in a regulated sector (eg, insurance, pharmaceuticals, energy, telecom, oil and gas, etc) and/or the transaction is likely to require the approval or notification of the transaction to the regulatory agency,

The Brazilian Central Bank

The Brazilian Central Bank is involved whenever the transaction involves direct foreign investments and/or local financial institutions.

Private equity investors usually carry out a thorough due diligence, engaging local legal counsel and auditors (depending on the activities developed by the target company, a technical due diligence may also be carried out – eg, environmental, real estate, operational or IT). In general, this process involves the review of the documentation and information made available directly by the target company or by the financial advisors, who got the mandate of the project. Upon request, advisors may also carry out independent search about the target company on public records.

Even though the scope depends on the nature and industry of the target company, a legal due diligence typically involves the analysis of the target company’s:

  • corporate aspects;
  • civil, tax and labour materialised contingencies (please note that analyses of non-materialised contingencies are usually carried out by the auditors engaged by buyer);
  • commercial and financial contracts;
  • intellectual property;
  • real estate;
  • insurance;
  • regulatory aspects;
  • environmental aspects;
  • compliance; and
  • data protection.

Since the enactment of the Brazilian Anti-Corruption Law (Law No 12,846/2014) and of the Brazilian General Data Protection Law (Law No 13,709/2018), compliance and data protection have become focus areas in legal due diligences, specially to those involving target companies that hold close interactions with public authorities and store, transfer, process or otherwise have access to personal data.

Once the legal due diligence is finalised, a legal due diligence report is prepared (often in a “red-flag” format), summarising legal counsel’s main findings – notably any hurdles to the closing of the transaction (eg, third party and government notices and consents), relevant materialised contingencies that could lead to a price adjustment or indemnification, and other restrictions that could impact the valuation of the target (exclusivity, non-compete and early termination provisions, among others).

Although not a rule, there is a relevant number of transactions in which a vendor due diligence is prepared. When a private equity fund conducts a vendor due diligence, it normally focuses on selected matters, over whose narrative it desires to have a better control. Vendor due diligence reports are usually provided to potential buyers on a non-reliance basis. As for buy-side due diligence reports, they usually contain provisions stating that they may only be disclosed to third parties upon authorisation of legal counsel, who normally only provides reliance to its client.

Most Brazilian private equity transactions are carried by private sale and purchase agreements, involving either the acquisition of assets or of equity.

Even though most of the transactions do not involve a competitive process, auction sales are becoming increasingly common, as they, despite being more time consuming, tend to result in seller friendlier outcomes.

Courts do not usually participate in acquisition transactions, unless it involves:

  • the acquisition of equity/assets owned by minors or that comprise an instate estate;
  • parties that are under judicial reorganisation; or
  • the acquisition of assets of the bankrupt estate.

In the second and third cases, the acquisition must follow the specific procedures set forth in the Brazilian Bankruptcy Law (Law No 11,101/2005).

Finally, whenever the target company is a public company, the acquisition may be carried either by means of a privately negotiated agreement negotiated with controlling shareholders or a public tender offer (see 7.1 Public-to-Privates).

Private equity buyers are typically structured as Fundos de Investimento em Participações – FIPs, which are local funds regulated by the Brazilian Securities and Exchange Commission (CVM). FIPs are pools of assets, organised as non-personified condominiums.

The choice for the FIP structure is mostly based on its friendly tax regime (eg, FIPs are exempt from taxation over the gains and income from its portfolio, as a rule, such taxation is deferred to the time that the resources are distributed to the FIP quotaholders).

FIPs either invest in target companies directly or through a holding company. Note, however, that leveraged buyouts are usually carried out through holding companies, as FIPs have restrictions to debt financing.

Most of the Brazilian private equity transactions are equity financed. However, due to the recent lower interest rates trend in Brazil, it is likely that leveraged buyout transactions become more common (in most of these cases, the acquisition will be expected to be carried out through a holding company, as Brazilian private equity funds’ debt financing is limited to 30% of its assets). It is also not unusual for private equity buyers, in a mixed debt/equity financing structure, to raise debt overseas, and remit funds down to Brazil as capital for funding the acquisition.

Private equity buyers are usually reluctant to offer equity commitment letters or other types of comfort to sellers. Nevertheless, whenever such letters are offered, the shareholders of the private equity acquisition vehicle commit to fund the vehicle through equity subscription or loans.

Lastly, it is common for private equity funds to hold either controlling or minority stakes in their portfolio companies. Regardless of the structure, private equity funds usually negotiate strong shareholders’ agreements, as FIPs in general must effectively participate in the management and the decision-making process of their portfolio companies.

Deals involving a consortium of private equity sponsors are still rare in Brazil, since private equity sponsors, when investing in Brazil, are usually well capitalised and reluctant to reduce their equity ticket. Nevertheless, they are becoming more frequent in growth equity investments (ie, investments to back growing companies with proven business models) in the tech industry, which are usually led by foreign private equity investors.

Co-investments are also not so usual in Brazilian private equity transactions. However, whenever they occur, such co-investors may be either legal entities in the up streamline of the private equity sponsor or external co-investors. Whether such co-investor holds a passive or a more active stake in the invested company, depends on the terms and conditions agreed between the parties.

Frequently Used Transactions

The purchase price mechanism in most private equity transactions involves the parties agreeing to a base purchase price, jointly with a post-closing adjustment, considering the variation between the target company’s estimated closing accounts (eg, working capital, cash, indebtedness), and the actual closing accounts.

Locked box consideration mechanisms are also frequently used, especially in acquisitions involving companies whose accounts suffer great variations thorough the year. In most of the cases where parties opt for locked box mechanisms, leakages to sellers and their related parties (except for permitted leakage) will be considered as purchase price reductions, and contributions by sellers and related parties (except if in the ordinary course of business) will be considered as purchase price increases.

Other Transactions

Private equity transactions with fixed price mechanisms are rare. However, when used, it usually is in transactions with simultaneous signing and closing.

Deferred purchase price payments upon the achievement of heavily negotiated milestones (ie, earn-out structures) are most common in transactions with private equity buyers where sellers remain in the invested company as part of its management team (usually in a C-level position) and, thus, are responsible for the achievement of such milestones.

It is usual for private equity buyers to holdback or hold in escrow part of the purchase price, in order to secure sellers’ payment obligations related not only to purchase price adjustments (either closing accounts adjustments or leakage adjustments) but also to indemnities. As for private equity sellers, they typically accept an escrow account structure, which provides for cleaner investment exists, since sellers are less likely to accept payment obligations that could delay the liquidation of the private equity investment vehicle.

Locked box structures are common in Brazilian private equity transactions, seconded to more usual closing accounts mechanism. Usually, interest is charged on the purchase price as from the date of the locked box accounts until the actual payment of the purchase price, but no interest is charged on leakage.

Upon the parties’ failure to amicably resolve any disputes regarding the closing accounts or leakage/contribution amounts within the timeframe set forth in the agreement, such disputes are usually submitted to an independent third-party, usually an audit firm, whose decision is binding on the parties.

Conditions precedent to the closing of private equity transactions vary according to the specific characteristics of the target company and the transaction itself. Nevertheless, common conditions precedent are the following:

  • approval of the transaction by the Brazilian Antitrust Agency (CADE), where applicable;
  • approval of the transaction or notice in this regard to regulatory agencies, where applicable;
  • absence of law or governmental order that prohibits, makes illegal or otherwise restricts the closing of the transaction;
  • representations and warranties of the target company, seller and buyer are true and correct at closing;
  • pre-closing covenants and obligations have been complied with;
  • specific third-party consents and/or waivers and/or delivery of specific third-party notices; and
  • absence of outstanding material adverse changes (whose definition is usually heavily negotiated).

Private equity-backed buyers are reluctant to accept "hell or high water" undertakings regarding the obtainment of regulatory approvals or of the Brazilian Antitrust Agency’s clearance. Whenever such undertakings are accepted, private equity buyers usually succeed in negotiating limits to the effects thereof (eg, restricting divestment obligations to a certain threshold).

Break-up fees may be negotiated in specific scenarios, but they are not common market practice.

In addition to the possibility of terminating the purchase agreement upon the parties’ mutual agreement, private equity sellers and buyers also have termination rights in the event:

  • closing has not occurred by the long-stop date (provided closing has not occurred due to the terminating party’s fault or because the terminating party has failed to fulfil the precedent conditions under its responsibility); or
  • the other party has materially breached its obligations under the purchase agreement.

It is also common for purchase agreements to provide for termination rights, prior to the long-stop date, whenever it is clear that conditions precedent, which cannot be waived, will not be fulfilled by the longstop date (eg, occurrence of an irreversible material adverse change).

Brazilian M&As, including those involving private equity investors, normally follow the “your watch/our watch” principle. Therefore, seller is often responsible for liabilities arising in connection with pre-closing triggering events, whereas buyer is responsible for liabilities arising in connection with post-closing triggering events. On the same note, and differently from many other jurisdictions, anti-sandbagging provisions are not market in Brazilian transactions and, thus, seller is usually responsible for indemnifying pre-closing liabilities, whether they are or not within buyer’s knowledge.

In view of the above, parties typically allocate risk by means of seller’s indemnity obligations. Private equity buyers will usually seek maximum legal protection, pushing for uncapped indemnification obligations and a broad definition of indemnifiable losses; whereas private equity sellers will seek to limit their indemnification obligations, pushing for caps, some of the main limitation on seller’s indemnification are the following:

  • time limitation for bringing claims;
  • financial limitations, such as caps, deductible or tipping baskets and de minimis;
  • narrow definitions of loss, excluding lost profits, indirect, incidental and consequential damages, moral damages, among others; and
  • restricting seller’s indemnification events (eg, seller will be responsible for indemnifying for losses arising in connection with pre-closing triggering events, provided such triggering events relate to breach of agreements or violation of applicable laws).

The scope and extent of the representations and warranties to be provided by private equity sellers depend on the private equity sellers’ involvement in the management of the target and the size of its equity stake. If the private equity seller is a passive minority shareholder, it will seek to limit its representations and warranties to basic representations and warranties. However, if seller is a controlling shareholder or otherwise have a significant level of influence over the target company, it will most likely provide a more robust set of representations and warranties as any other controlling shareholder and, then, seek to limit its indemnification obligations.

Usually sellers’ representations and warranties are carefully reviewed by sellers jointly with their legal counsel and the target company management team, in order to include the necessary carve-outs and materiality and knowledge qualifiers to guarantee that no misrepresentations are being made. The foregoing carve-outs are, many times, made through disclosure schedules, since a general disclosure against the data room is not usually accepted.

Despite participating in the review of the representations and warranties, the management team (except for sellers that are management shareholders) does not have any contractual liability in connection with the violation of such representation and warranties, which is fully allocated to sellers. Sellers, on the other hand, usually have the obligation to indemnify for the violation or breach of the representations and warranties given in the purchase agreement. However, as mentioned above, sellers will seek to limit such indemnification obligations.

Warranty and indemnity insurances are still a novelty in the Brazilian market and, as such, sellers continue to be the sole responsible for indemnifying buyer in most of the Brazilian private equity transactions.

Due to the incipient adoption of warranty and indemnity insurances, buyers usually resort to other types of protection to secure sellers’ indemnification obligations, such as escrow accounts and holdbacks, parent company guarantees, bank guarantees, pledge over target company shares that are still held by sellers, among others.

Litigation is generally rare and confidential in private equity transactions, as Brazilian parties to an investment agreement or stock purchase agreement tend to choose settling disputes through arbitration. Nevertheless, post-closing disputes usually revolve around purchase price adjustments, earn-out payments and indemnification for third party claims.

Public-to-private transactions, especially private equity transactions, are not common in Brazil. Whenever such a transaction takes place, the rules of the Brazilian Securities and Exchange Commission (CVM) must apply.

Material shareholding disclosures are applicable to public companies. Shareholding disclosure thresholds as well as filing requirements are set forth in the rules of the Brazilian Securities and Exchange Commission (CVM), which provide as follows:

  • any shareholder or group of shareholders, acting jointly or representing the same interests, must notify the company of any transaction or group of transactions by means of which the shareholding held by such shareholder or group of shareholders surpasses or falls below 5%, 10%, 15% and so on of a same type or class of shares of the company;
  • during a mandatory tender offer for acquisition of control, any shareholder or group of shareholders, representing the same interests, that hold more than 2.5% of a type or class of shares shall disclose any 1% variation to the holding of its shares; and
  • in order to acquire shares of a Brazilian company via a public takeover, bidder must launch its public tender offer by publishing the tender offer notice and instrument in the mass circulation newspaper usually used by the public company and in the Official Gazette. Such notice and instrument will also be sent to the public company’s investor relations executive officer, so that they may immediately disclose the notice to the market.

MTOs apply to public companies only. According to the Brazilian Corporations Law (Law No 6,404/1976) and the Brazilian Securities and Exchange Commission (CVM) rules, the obligation to launch a mandatory offer is triggered whenever:

  • the controlling shareholders or a person related to them acquire shares representing more than one third of all outstanding shares of each type and class of shares; and
  • there is a sale of the public company’s control.

Cash is more commonly used as consideration. However, other securities or a combination of cash and other securities are also used as consideration in sparse cases.

Brazilian tender offers are subject to the Normative Rule No 361/2002 of the Brazilian Securities and Exchange Commission (CVM), among other terms and conditions, such Normative Rule establishes that the tender offer must:

  • be directed indistinctly to all shareholders of the same type and class of shares that are the object of the tender offers;
  • guarantee the equal treatment of its recipients;
  • furnish the recipients of sufficient information about the company and the bidder so the recipients have sufficient information for their decision making; and
  • be intermediated by a brokerage firm, securities dealer, or a financial institution with a portfolio investment.

The tender offer may also be subject to condition established by the bidder on the tender offer notice and instrument, provided the fulfilment of such condition does not depend, directly or indirectly, on action to be carried out by the bidder or any of its related parties.

In the event a competing tender offer is launched, the initial bidder as well as the competing bidder are entitled to raise the price of their offers by any amounts and as many times they deem necessary, provided the required formalities are observed.

If a bidder does not seek or obtain 100% ownership of the company following the completion of its tender offer, it may still have significant control over the target company depending on the shareholding percentage it holds. For example, the Brazilian Corporations Law (Law No 6,404/1976) provides that: (i) the general quorum for approval of resolution in general shareholders’ meetings is the majority of the voting capital stock present at the meeting (please note that the company’s by-laws may establish higher approval quorums, as well as there are specific provision with higher approval quorums established by law); and (ii) if the multiple voting system for the election of members of the Board of Directors (ie, each share will hold as many votes as Board members positions, and the shareholders will be able to distribute their votes among the Board candidates as they deem fit) is required by shareholders representing 10% of the company’s voting capital stock, the shareholder or groups of shareholders bound by a voting agreement, holding more than 50% of the company’s voting capital stock, will be able to elect equal number of Board members elected by the other shareholders plus one Board member.

Additionally, if following the completion of a delisting tender offer, less than 5% of the company’s shares remain outstanding, the company shareholders’ meeting may approve the redemption of such outstanding shares (squeeze out), based on the same price per share paid in the tender offer.

Because dispersed ownership companies are still unusual in Brazil, it is more common for a bidder to first negotiate a private purchase agreement with the company’s controlling shareholders or relevant shareholders and, following such acquisition, launch a public tender offer for the acquisition of the shares of the remaining shareholders, in which it must guarantee to such remaining shareholders a purchase price per share of 80% or 100% of the purchase price per share paid to the controlling shareholder, depending on the listing level of the public company with the Brazilian stock exchange.

Hostile takeovers, although permitted, are still rare in Brazil. Despite that, a few Brazilian public companies have implemented defences against hostile takeovers, such as poison pills. The “Brazilian poison pills” provided in the bylaws of the certain public companies provide that the acquisition of a certain percentage of shares triggers the acquirer’s obligation to launch a mandatory tender offer, which makes the hostile takeover more expensive.

Equity incentivisation of the management team is a common feature in Brazilian private equity transaction, especially when founding shareholders remain in the management of the target company.

The level of equity ownership held by management varies from transaction to transaction, depending on the private equity fund’s philosophy and on how essential are certain members of the management team.

Whenever sellers remain in the target company as part of its management team, it is common for such sellers to continue holding equity directly in the target company or have such equity rolled over to a holding company. The nature of such equity may either be the same as or different from the equity of the private equity shareholder. In any case, management team members holding equity in the target company and the private equity shareholder will execute a shareholders’ agreement regulating governance rights, if management team holds a relevant stake in the company, and share transfer rights.

In the event the members of the management team do not already hold equity in the target company prior to the transaction, management incentive plans may also be structured as stock option plans or phantom stock plans.

Vesting of management equity depends on the type of equity. The equity the management shareholders already hold in the company as well as rollover equity and cash investments are vested upon issuance. Stock option plans, on the other hand, usually have vesting provisions that are part time-based and part returned-based.

Leaver provisions are usually a given in stock option plans, but more negotiated in shareholders’ agreements as such negotiations are usually tied to the negotiations of the purchase/investment agreement regulating the entry of the new shareholder into the target company. It is common for such leaver provisions provide for the repurchase of the equity management at market value or less than market value, depending on whether it is a “good” or “bad” leaver situation.

Customary restrictive covenants assumed by management shareholders are confidentiality, non-disparagement, non-solicitation and non-compete obligations. In order to non-compete obligations be enforceable, they must observe a few requirements:

  • proper compensation is paid for the leaving shareholder (ie, a portion of the purchase price);
  • the geographical limitation thereto cannot be greater than the entire country; and
  • the term does not exceed five years.

Management shareholders usually hold a minority stake in the company and, thus, may enjoy tag rights (see 10.3 Tag Rights) and the minority rights provided by law, such as:

  • pre-emption rights for the subscription of shares in future capital increases;
  • withdrawal rights, in the event the shareholder does not agree with the approval of certain provisions, such as amalgamation or merger of the company or its shares, split up of the company, change of the corporate purpose of the company, among other matters;
  • right to minimum mandatory dividends (which consist of 25% of the net profits of the company, in case the by-laws do not set forth a specific percentage);
  • veto on the transformation of the company’s corporate type; and
  • certain information rights.

Management shareholders’ control will typically be restricted to the actions within the competence and threshold limits of the positions they hold in the management of the company (usually C-level positions). However, depending of the percentage of the equity stake held by them, management shareholders may be able to indicate members to the company’s Board of Directors and prevent the approval of resolutions that require higher approval quorums.

Usually management shareholders’ have little or no influence over the private equity investor’s exit. Nevertheless, management shareholders may be involved in the discussions regarding the exit and the shareholders’ agreement of the company may include the management shareholders’ obligation to cooperate with the private equity investor’s exit.

Brazilian Securities and Exchange Commission (CVM) rules regarding Brazilian investment funds establish that Brazilian funds must, as a rule, participate in the decision-making process of their portfolio companies, with effective influence over the definition of their strategic policies and management. Exception to such rule are if:

  • the Brazilian fund’s investment in the company is reduced to less than half of its original percentage and represents less than 15% of the portfolio company’s capital stock;
  • the book value of the Brazilian fund’s investment is reduced to zero, subject to the approval of the Brazilian fund’s general quotaholders’ meeting; and
  • the investment is in public companies listed in a special listing segment, whose governance standards are higher than those required by law, provided such investment corresponds to up to 35% of the Brazilian fund’s subscribed capital.

In view of the above, Brazilian funds usually negotiate strong shareholders’ agreements with corporate governance rules, which provide for:

  • right to appoint Board members;
  • right to appoint executive officers;
  • information rights; and
  • veto rights over certain reserved matters (eg, capital increase and issuance of convertible securities; changes to by-laws/articles of association; corporate restructurings; acquisition and divestures; formation of joint ventures; approval of the business plan and annual budget; capex investments; incurrence of new indebtedness; execution of related-parties transactions); among other matters.

As a rule, shareholders are not liable for the contingencies of their invested companies. A few exceptions to this rule are the following:

  • certain cases of violation of law (eg, fraud to harm third parties, commingling of assets), in which there is the piercing of the company’s corporate veil;
  • labour liabilities, since the member of the same economic group are jointly liable for any amounts due to the employees of other companies belonging to the same economic group;
  • corruption liabilities, since the Brazilian Anti-Corruption Law (Law No 12,846/2013) provides for the joint liability of controlled and controlling companies, affiliates and members of a consortium; and
  • if the legal entity is an obstacle for the redressing or compensation of environmental damages.

Because the adoption of compliance programs may assist companies in mitigating risks and lowering fines they might face regarding breaches of compliance obligations (provided the compliance program was already in force at the time of the wrongdoing); it has become common for private equity fund shareholders to push their Brazilian portfolio companies into adopting compliance programs, which not necessarily are the same ones as of the private equity fund itself.

Private equity investors typically hold their investments for five to ten years. It is rare for private equity funds to reinvest upon exit, as in many cases the exit date will be close to the end of the private equity fund’s life itself and, thus, the private equity fund would not have enough time to liquidate the reinvestment prior to its wound-up.

Despite the increasing number of Brazilian companies’ IPOs in the past years (including 2020), private sales to strategic buyers or other private equity funds continue to the most common way of exiting private equity investments in Brazil. It is not unusual for the exit to be conducted as a “dual track” process, since it offers the private equity fund the opportunity to better assess which route (ie, private sale or IPO) is more advantageous and, thus, mitigate the risks of an aborted IPO.

Private equity investors usually are entitled to drag along rights in the event of the sale of the company’s corporate control. Drag rights are usually applicable to management shareholders and institutional co-investors alike.

Drag rights are rarely used by private equity investors as they represent a more aggressive approach whereby one shareholder obliges the other shareholders to sell their shares at a pre-agreed price to a third party. Negotiated amicable exits are more common in the Brazilian market.

It is common for all shareholders of an invested company to be entitled to tag along rights. The tag threshold is usually the sale of the invested company’s corporate control, and the tag right may comprise all the shares of the other shareholders. However, it is not unusual for shareholders’ agreements to provide for lower tag thresholds, where other shareholder may exercise only a pro rata tag right.

The lock-up period for controlling shareholders and management in Brazilian IPOs is of 180 days counted as from the IPO date, followed by an additional 180 day-period in which controlling shareholders and management cannot sell more than 40% of the shares they held immediately after the completion of the IPO. Relationship agreements are not a common in Brazilian IPOs.

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Trends and Developments


Authors



Baptista Luz Advogados (B/Luz) is well known for its expertise in transactions involving tech companies, VC and PE funds. As a full-service firm, B/Luz supports its clients with international-level quality standards and is used to carry out large cross-border PE and VC deals. All practices and teams are well versed in the issues that regularly come up in VC and PE investments in Brazil, notably tax, labour, IP, regulatory and data protection issues. International transactions are part of the firm's routine and start-ups are part of its culture. B/Luz has offices in Brazil’s most prominent innovation hubs, such as São Paulo, Porto Alegre and Florianopolis (and it is also present in Londrina, an important agribusiness hub). Among its most prominent clients are Grupo Pão-de-Açúcar (a leading retail company in Brazil), Havas, Movile (a leading Brazilian tech conglomerate), and Accenture. The firm has a strong 16-year track record in private equity transactions and is well known for advising large corporations in their investments in, and acquisitions of, innovative companies. The firm would like to thank Erico Lopes Tonussi, Sergio Alberich, Marina Polli, Fabio Salmoni, Jessica Ann Bernstein Heumann and Marcelo Lerch Hoffmann for their contribution to this article.

Introduction

The past couple of years have been a period of unprecedented change to the Brazilian legal and economic landscape.

After two decades of socialist presidencies, the country started to lean towards a less interventionist and more liberal government. In 2017, a milestone of the new trend was the extensive labor reform promoted by President Michel Temer. In 2018, President Jair Bolsonaro was elected after a campaign based on promises of free-market-oriented policies. In fact, led by its minister of finance (free-market economist Paulo Guedes), the federal Government has proposed relevant legal measures to reduce the intervention in the economy and simplify bureaucracy, along with comprehensive tax and social security reforms.

Concurrently, the Brazilian Central Bank has been continuously reducing the official interest rate, currently set at 2.25%, a historical minimum which may represent negative rates in real terms (depending on inflation).

COVID-19

The COVID-19 crisis has accelerated several market trends that had been struggling to take off before the pandemic. The Brazilian Private Equity and Venture Capital Association (ABVCAP) pointed out that, whilst many industries have been substantially impaired by the COVID-19 crisis, others are actually thriving during the crisis. E-commerce, healthtech, fintech and information technology in general have been positively affected by the consequences of the pandemic.

After a natural initial dread, the COVID-19 months have been busy for the PE and VC communities. As indicated by the volume of deals since March 2020, the Brazilian equity market seems to have recovered a great deal of its vibrant facet, following-up on the promises of 2019. More importantly, PE and VC investments have proven to be a great force that can boost the reconstruction of the Brazilian economy.

Deal Activity

The past couple of years were very positive to venture capital (VC) and private equity (PE) in Brazil. Some of the most prominent international players entered Brazil’s Venture Capital market, a trend that naturally took the investment tickets to record-high amounts.

In 2019, VC investments reached USD10 billion and PE investments reached USD12.8 billion (ABVCAP/KPMG Report 2019).

New unicorns arose in that landscape, such as Loggi (logistics/delivery), Gympass (health/fitness), Quinto Andar (proptech), Ebanx (fintech) and Wildlife (games).

Deals during COVID-19

Due to the COVID-19 crisis, Brazil has faced social isolation and lockdown measures, but despite this, deal activity during the pandemic did not stop, so the negotiation, signing and closing of transactions had to be adapted and become digital.

Luckily, Brazil has outstanding legal digital infrastructure. Although the initial drivers of such transformation are not to be celebrated (unmanageable number of judicial proceedings and one of the world’s heaviest bureaucratic burdens), digital signatures are now widely used and accepted by Brazilian courts, judicial filings and commercial registers can be digitally made, and good standing certificates may be issued online. Brazilian banking system is one of the most modern and reliable in the world. Payments can be made and received almost instantaneously.

These factors have helped sustain VC and PE deal activity at surprisingly high levels during the pandemic. The first five months saw an increase of approximately 2.6% in the number of VC deals (from 113 in 2019 to 116 in 2020) and an increase in the total investments amount of almost 20% (from USD431 million in 2019 to USD516 million in 2020). May 2020 alone saw an 80% growth in the total VC investments compared to the same month of 2019 (from USD20 million in 2019 to USD36 million in 2020).

VC investors may have changed their targets a little bit. Some seem to have started to look for “camel” companies, more resilient businesses, better prepared to handle the post-crisis “desert” scenario. Further, the pandemic may have caused a “reality check” on the valuations and GPs are seizing this opportunity to acquire cheaper assets and investors are excited on the perspective of a digital turning point in Brazil’s economy. In fact, the initial pessimistic outlook slowly turned into realistic optimism that will likely keep the PE and VC activity at record-high levels through the remainder of 2020.

Regulatory Framework

Brazil’s regulatory framework regarding businesses, especially those usually targeted by PE and VC firms, had many positive developments during 2019 and 2020.

The new Federal Government introduced an agenda of reforms comprising topics such as tax, labor, social security, legal certainty, deregulation and reduction of the Federal Administrative structure. A few of those reforms are worth highlighting:

“Economic Freedom” Act

In September 2019, the Brazilian Congress passed the “Economic Freedom” Act (Lei No 13.874/2019) which promotes a general liberalisation in the Brazilian legal and administrative system. Some of those changes will bring positive consequences for PE and VC, such as the introduction of limited liability to LPs, single-shareholder companies and partnerships, limited liability of shareholders, and debureaucratisation in general.

Social security reform

In November 2019, Brazilian Congress enacted a long-anticipated Social Security Reform (“Emenda Constitutional No 103/2019”), which should provide a much necessary relief to the Federal Budget in the next decade.

Corporations Law COVID-related amendments

Soon after the pandemic outbreak, Federal Government enacted “MP 931/2020” (recently converted into a law – “Lei No 14.030/2020”), which allowed virtual shareholders’ meetings and the digital register of corporate documents.

Commercial registry reform

In June 2020, the Brazilian Federal Commercial Registry Agency (DREI) published an important new regulation (IN 81). It simplifies the registration process of all commercial and corporate documents, whilst promoting digital filing of acts. Moreover, IN 81 adapts the commercial registry regulation in view of the provisions of the above-mentioned Economic Freedom Act and MP 931. Among the most relevant innovations are mergers of companies with a negative net equity, introduction of preferred quotas in Brazilian LLCs, and conversion of civil associations into companies.

Minority shareholders’ rights

In June 2020, Brazilian SEC (CVM) published IN 627 which regulates Article 291 of the Corporations Law (Lei No 6.404/1976) reducing the minimum stock that shareholders must own in order to file a lawsuit against the company. This minimum stock requirement now varies between 1% and 5% depending on the corporate capital amount.

Trends

Market trends

Corporate ventures

In the last five years, corporate venture capital (CVC) has become a relevant force in the Brazilian VC scene. Due to the pandemic, certain traditional investors have been more cautious in funding cash-burning startups, which led to a scarcity of capital, especially for startups in their early stages. However, the COVID-19 crisis made it crystal clear, to both large and traditional Brazilian corporations, that they cannot stall digital transformation and innovation. These corporations are now moving fast to boost their CVC initiatives and this will likely create a wave of new investments in, and acquisitions of, startups and innovative businesses in general.

Venture debt

The past couple of years also saw the rise of venture debt in Brazil. With the lowest interest rates ever, venture debt is likely to become a relevant alternative for startups that need fast access to funds whilst avoiding dilution of founders.

Distressed assets

Brazil presents a very interesting scenario for distressed assets investors. After a long period of economic downturn, many Brazilian companies were already struggling prior to COVID-19. Now, they may not be able to resist to the effects of the crisis. A relevant volume of bankruptcies and judicial reorganizations (analogous to US Chapter 11 bankruptcy proceeding) is expected for the coming months. Some will turn into full bankruptcies (in US Chapter 7 style). This landscape may provide auspicious opportunities to players engaged in distressed assets transactions.

IPO boost

The Brazilian stock exchange has an extensive waiting list of several companies intending to make IPOs in the second half of 2020. The combination of diminishing returns to investors in traditional investments (due to record-low interest rates) with the capital constraints that companies have been facing due to the pandemic creates the perfect scenario for IPOs. This is good news to PE and VC players as it creates an excellent (and not so common in Brazil) exit opportunity for investors.

Infrastructure public concessions and state-owned companies privatisation

Federal and state governments are expected to soon resume the privatization of state-owned companies that have been put on hold after COVID-19 outbreak. This will probably be a great opportunity for the acquisition of undervalued assets and Project Finance investments.

ESG (environmental, social and governance) investing

Following a global trend, Brazil may witness the surge of investments in ESG-related businesses. After 2019 Business Roundtable Statement and Larry Fink’s Letter to Shareholder, ESG commitment was put under spotlight globally, and there is no reason to think differently in regard to Brazil, especially in the post-crisis period.

Escrow vs R&W insurance

Traditionally, M&A transactions in Brazil use escrow accounts to secure payment of liabilities by sellers. With reduced liquidity after the pandemic, representations and warranties (R&W) insurance may become an important tool in more complex M&A deals to make cash available for investors and entrepreneurs in exit events.

Regulatory trends

Tax reform

Federal Government has recently presented a first proposal for a much-needed tax reform. It aims to simplify the Brazilian tax system by replacing federal taxes on revenues by a VAT-style single tax. Whilst the proposal is still in its very early stage and will likely go through relevant amendments before being approved by the Congress, once approved, it will probably reduce the so-called “cost of doing business in Brazil”, hence fostering private businesses and PE and VC investments.

Bankruptcy law reform

Due to the experience acquired as a result of the economic downturn of the past five years, several discussions related to the Bankruptcy Act of 2005 (Lei No 11.101/2005) have been led by important jurists, with a reform draft already filed before the National Congress. Once enacted, these amendments will undoubtedly help in new judicial reorganizations as well as spur distressed assets investments.

Startups legal framework (Marco Legal das Startups)

Since 2019, a group of specialists have been working with the Ministry of Economy in drafts aiming to support startups and VC investments by amending several provisions of Brazilian laws, including: stock options plans, a simplified type of corporation, protection for investors against liabilities of invested startups, and a regulatory sandbox for innovative new businesses.

Brazilian SEC (CVM) regulatory agenda

The CVM has proposed a regulatory agenda for 2020, comprising relevant legal aspects that will affect PE and VC firms such as:

  • adapting investment funds regulation to the Economic Freedom Act;
  • regulatory Sandbox for innovative capital market structures; and
  • crowdfunding act reform.

Open banking

The Brazilian Central Bank and several entities of Brazilian financial markets are putting forward an ambitious agenda to increase competition in the banking industry, mainly in consumer banking. To achieve such goal, the Central Bank is issuing several rules to boost fintech as well as introducing an open banking regulation, which allows data sharing between financial institutions in order to facilitate credit to consumers.

Final Considerations

COVID-19 will be a reality for an uncertain, and relatively long, period.

Investors may expect Brazilian Federal Government to continue to promote reforms to boost a free-market economy and reduce state intervention and bureaucracy. 

Brazil is a thriving landscape for venture capitalists lacking opportunities in more mature markets, and for PE, the COVID-19 scenario may offer unique opportunities for the acquisition of cheap assets.

Both VC and PE will consolidate their status of powerful forces working for the reconstruction of Brazilian (and global) economy. As Marc Andreessen said earlier this year, in a statement that perfectly fits Brazil’s reality, “it’s time to build”.

Baptista Luz Advogados

Rua Ramos Batista 444
2º Andar, 04552-020
São Paulo, SP

+55 11 3040 7050

contato@baptistaluz.com.br www.baptistaluz.com.br
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Law and Practice

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Machado Meyer Advogados has been building its history for more than 48 years, inspired by sound ethical principles, the technical skills of its professionals, and a close relationship with its clients. The firm is ranked as one of the major law firms in Brazil, with over 700 professionals. Machado Meyer provides innovative legal solutions, anticipates scenarios and makes business possible. Combining expertise in various areas of law, broad knowledge of legislation and a thorough understanding of the matter, the firm's professionals go beyond simple problem-solving to create and preserve value for companies. Because of the significant flow of today’s existing investment, the firm has organised professionals specialised in advising clients abroad, creating multidisciplinary groups, especially in Germany, Latin America, Iberia, and Asia, which have special desks.

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Authors



Baptista Luz Advogados (B/Luz) is well known for its expertise in transactions involving tech companies, VC and PE funds. As a full-service firm, B/Luz supports its clients with international-level quality standards and is used to carry out large cross-border PE and VC deals. All practices and teams are well versed in the issues that regularly come up in VC and PE investments in Brazil, notably tax, labour, IP, regulatory and data protection issues. International transactions are part of the firm's routine and start-ups are part of its culture. B/Luz has offices in Brazil’s most prominent innovation hubs, such as São Paulo, Porto Alegre and Florianopolis (and it is also present in Londrina, an important agribusiness hub). Among its most prominent clients are Grupo Pão-de-Açúcar (a leading retail company in Brazil), Havas, Movile (a leading Brazilian tech conglomerate), and Accenture. The firm has a strong 16-year track record in private equity transactions and is well known for advising large corporations in their investments in, and acquisitions of, innovative companies. The firm would like to thank Erico Lopes Tonussi, Sergio Alberich, Marina Polli, Fabio Salmoni, Jessica Ann Bernstein Heumann and Marcelo Lerch Hoffmann for their contribution to this article.

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