The Private Equity Review – Ninth Edition | Brazil Fundraising and Investing Chapters in Brazil
Source: The Law Reviews
I GENERAL OVERVIEW
The Brazilian private equity fundraising sector has consolidated in the past decade and shown significant growth since 2003, even compared with other BRIC countries.
This evolution can be attributed to Brazil’s economic development over this period and to the continuous improvement of the regulatory structures of the capital markets, chiefly regarding the main type of investment vehicle for the private equity segment, equity investment funds (FIPs).
As a result of this evolution, the Brazilian Securities and Exchange Commission (CVM) has been constantly concerned with regulating and updating specific rules for these funds, including the issuance of CVM Instruction No. 578/16 on 30 August 2016, which, as is discussed below, replaced CVM Instruction No. 391/03 and modernised the rules regarding the formation, operation and management of private equity funds.
More recently, the enactment of Law No. 13,874 of 20 September 2019, also known as the Brazilian Economic Freedom Law, represented important progress in the regulatory framework applicable to FIPs, as explained in Section II.i. According to recent studies published by the Brazilian Private Equity and Venture Capital Association (ABVCAP),2 between 2011 and 2018, despite the economic and political turmoil experienced in Brazil, investments by local and international investors in the private equity industry showed an upward trend, especially in 2018 when the total committed capital reached US$38 billion.3
2019 was marked by the beginning of the new right-wing administration and approval of important economic and legal measures, such as the Economic Freedom Law and the social security reform, which created a positive scenario for investment in Brazil. According to a report prepared by the Transactional Track Record, the total aggregate value of private equity transactions in 2019 represented an increase of more than 27 per cent compared with 2018, reaching a record volume of US$6.5 billion.4
Investments carried out in the oil and gas sector played an important role in the Brazilian private equity sector during 2019 and must be highlighted. In June, ENGIE, a French-based energy and solutions company, and the largest private power producer in Brazil, and Caisse de dépot et placement du Québec, a Canada-based fund, acquired a 90 per cent holding in Transportadora Associada de Gás SA, a major natural gas transmission company previously owned by Petrobras, for the amount of, approximately, US$8.1 billion.
Another important transaction in the oil and gas sector was the investment of a private equity fund managed by Starboard Asset in the oil company 3R Petroleum, aimed at acquiring an onshore oil field from Petrobras in the amount of approximately US$191.1 million. Upon the fulfilment of certain conditions precedent, the acquisition will mark the first time a private equity fund takes over the operation of an onshore oil field.
Petrobras’ divestment process shall attract more investors in the next few years. The management board has already approved its five-year strategic plan to continue such process, which aims to sell various assets for up to US$30 billion, including eight oil refineries. According to Petrobras, the main company goals of the plan are debt reduction and the focus on the pre-salt area.5
Other standout investments were those performed in the technology segment by the Japanese Softbank Group Corp. At the beginning of 2019, the group launched the SoftBank Innovation Fund, a technology fund focused exclusively in the Latin American market, which invested in at least 14 Latin American technology start-ups during the course of 2019.6 It has also announced the SoftBank Latin America Local Hub, a local group specifically created to manage SoftBank’s portfolio companies in Latin America.7
This growing tendency of investment in the private equity industry is directly related to the development of Brazilian start-up companies that have been attracting local and foreign investors, especially in the technology segment. During 2019, certain Brazilian companies, including Loggi, Gympass, QuintoAndar, Ebanx and Wildlife Studios, were added to the list of global ‘unicorns’ (start-ups valued at over US$1 billion).8 At the very beginning of 2020, another Brazilian start-up company, Loft, which focuses on the acquisition of real estate for refurbishment and subsequent sale, was also consolidated as a unicorn, after a new round of investment led by US funds Vulcan Capital and Andreesen Horowitz, in the amount of, approximately, US$175 million.9
Following this start-up movement, another type of investment that is progressively gaining strength in Brazil is corporate venture capital (CVC), which is the investment by well-established institutions in early stage companies (that are outside the investing company’s corporate chain). The main purpose of CVC investment is for the well-established company to develop a new product or specific market upon investment in an early stage company, rather than by setting up an internal research and development (R&D) department, as the R&D route may prove to be more costly, time-consuming and demanding than the alternative of investing in an early stage company.
Many Brazilian companies have embraced CVC investment for innovation purposes, including Embraer SA (the Brazilian business conglomerate that manufactures commercial and military aircraft, among other things), banks Banco de Brasil, Banco BMG, Itaú and Santander, manufacturers Gerdau, Votorantim and Natura (a cosmetics manufacturer), and retailers Pão de Açúcar and Magazine Luiza. Market experts forecast that the current economic landscape, the substantial devaluation of the Brazilian real against the US dollar, the UK pound and the euro, and the low interest rates – including the basic rate (Selic) that has been steadily lowered by the Brazilian Central Bank (BACEN) – will be incredibly positive for the private equity sector in 2020, especially with regard to foreign players.10
This scenario shall mean greater demand from foreign funds and banks for local portfolio managers, which have better knowledge of the internal market and, hence, greater capacity to identify the best investment opportunities. In this regard, according to the ranking by the Brazilian Association of Financial and Capital Market Entities (ANBIMA), the Brazilian portfolio managers responsible for most of the assets up to November 2019 were BB DTVM SA, Itaú Unibanco SA and Bradesco.11
II LEGAL FRAMEWORK FOR FUNDRAISING
To understand the fundraising industry in Brazil, it is first necessary to analyse the offshore structures adopted by local and foreign players before entering into a specific analysis.
i Vehicles for fundraising
The main offshore vehicles and jurisdictions used for fundraising are legal entities incorporated as holding companies in Luxembourg and Amsterdam, foreign securities holding entities in Spain and limited liability companies (LLCs) in Delaware, United States.
The above-mentioned countries stand out for investments in Brazil, and in most cases the investments are made directly into Brazilian companies or FIPs.
Even though FIPs are the main vehicle for investment in the industry, certain players do not use them, which at times makes it difficult to estimate the exact volume of funds raised for private equity investments in Brazil.
Many offshore fundraising entities end up entering Brazil by means of a holding company – an LLC or corporation – that acts as a vehicle for unifying and carrying out these investments. The main jurisdictions used for fundraising are those included on the Brazilian ‘grey list’ – countries that grant privileged tax regimes.12
In any event, FIPs are also a solid alternative for investors, to the extent they allow investments in public or private companies, as well as being a flexible vehicle when compared to other types of investment funds in Brazil.
The FIP is a communion of funds for the purchase of shares, subscription warrants, non-convertible debentures13 or other securities convertible into or exchangeable for shares of public or private companies, as well as titles and securities representing equity participation in LLCs, and it is required to maintain at least 90 per cent of its resources invested in assets of this nature. FIPs do not have separate legal personality; they are organised as closed-ended condominiums14 held by a pool of owners (individuals or legal entities), each being entitled to a portion (shares) of the total assets.
Due to the lack of specific federal legislation regarding investment funds, up until 2019 FIPs were subject to general provisions applicable to condominiums in the Brazilian Civil Code, as well as to specific rules issued by the CVM.
In 2019, a new regulatory framework was created upon the enactment of the Brazilian Economic Freedom Law. By adding an entire chapter regarding investment funds in the Brazilian Civil Code, such law introduced the legal grounds for the regulation of investment funds by the CVM.
Pursuant to the new provisions and subject to CVM regulation, the funds’ by-laws shall be allowed to establish limitation to the liability of the FIP’s shareholders to the value of their shares and also to the obligations attributable to the class of shares held by the shareholders, as well as limitation to the liability of the funds’ service providers (e.g., administrators and portfolio managers) to the obligations to be complied with by each of them (without being jointly liable), provided that the rules enacted by the CVM are also complied with.15 The Economic Freedom Law also allows the creation of segregated assets for each class of shares of the FIP. Such new rules play an important role in the development of the Brazilian private equity industry by bringing internal practices closer to international practices, and represent a safer, cost-effective and more attractive environment for investors and service providers.
The formation, operation and management of FIPs; and the accounting methods for the classification of assets and liabilities and the financial aspects related to FIPs are regulated, respectively, by CVM Instructions Nos. 578/16 and 579/16, both enacted on 30 August 2016, which modernised the former rules set forth by the revoked CVM Instruction No. 391/03.
As regards fund management, the current legislation requires that fund administrators be Brazilian legal entities authorised by the CVM to carry out the professional services of securities portfolio administration.
The administration of a FIP comprises all the services directly or indirectly related to its representation, operation and maintenance, such as portfolio management; investment advising; treasury and assets processing control activities; placement of shares; and bookkeeping of the issuance and redemption of shares.
According to CVM Instruction No. 578/16, the FIP’s administrator may also, on behalf of the fund, engage third parties to render the following services:
- the FIP’s portfolio management;
- investment advising;
- treasury activities;
- assets processing control activities;
- placement of shares;
- bookkeeping of issuance and redemption of shares;
- custody of financial assets; and
- market maker for the FIP’s shares.
CVM Instruction No. 578/16 currently establishes that the FIP’s administrators and any other service providers hired are liable before the CVM and in accordance with the relevant charge, for the violation of any law, applicable rulings or the fund’s by-laws.
This CVM Instruction has also increased the duties and obligations of the portfolio management related to the hiring of services of investment or divestiture, as well as the role of the portfolio management on the pricing of the FIP’s investments. In this regard, according to CVM Instruction No. 578/16, the portfolio manager has powers to represent the FIP in certain acts, such as negotiation with and hiring of the assets and agents to conduct the FIP’s transactions, on behalf of the fund; negotiation with and hiring of third parties for the rendering of services of advising and consulting directly related to the investment and divestiture of the fund, as established in the FIP’s investment policy; and monitoring the assets of the FIP and exercising the voting right related to the assets, subject to the voting policy established by the portfolio manager. In the absence of a specific provision in the FIP’s by-laws or in the agreements entered into by the FIP’s administrator and portfolio manager, the latter shall send to the administrator, within five business days, the copies of all documents executed on behalf of the FIP.
CVM Instruction No. 558/15, as amended by CVM Instructions Nos. 593/1716 and 597/18,17 has introduced new rules on the activities related to securities portfolio administration in general. These rules include, among other things, two categories18 of registration of portfolio administration, as well as new requirements and procedures related to the registration of these categories:
- portfolio manager: individuals or legal entities that are authorised to manage the funds’ assets, including the application of financial resources in the securities market, on behalf of the investor; and
- fiduciary administrator: legal entities that are authorised to carry out all activities directly or indirectly related to the functioning and maintenance of the securities portfolio, including the custody, controlling of assets and debts, and, in general, the supervision of the management. The CVM Instruction mentioned above also establishes the possibility of a legal entity that is not a financial institution to require the registration as fiduciary administrator, as long as it complies with some requirements established by the CVM.
With the establishment of the two categories of registration mentioned above, the CVM has expressly established a separation of the activities of custody and controlling of assets and debts from those of portfolio management. An important amendment introduced by CVM Instruction No. 593/17 is that portfolio managers are no longer authorised to render securities consulting services unless they obtain CVM accreditation as a securities consultant and comply with the provisions of CVM Instruction No. 592/17.19
In addition, pursuant to CVM Instruction No. 558/15, as amended by CVM Instruction Nos. 593/17 and 597/18, to be granted registration for securities portfolio administration, a legal entity established in Brazil is, among other things, required to appoint:
- one or more officers (authorised by the CVM) responsible for the management activities;
- a compliance officer responsible for the implementation of the rules set out by CVM Instruction No. 558/15, as well as the procedures, policies and internal controls of the funds; and
- specifically for the category of portfolio manager, an officer responsible for the risk management (it is possible for the compliance officer to take on this duty as well).
The securities portfolio administration registered in both categories mentioned in items (a) and (b), above (portfolio manager and fiduciary administrator), shall also appoint an officer exclusively responsible for the activity of fiduciary administration. In addition, the above-mentioned CVM Instruction also establishes that the officers responsible for the management activities, the compliance officer, the officer responsible for the risk management and the officer responsible for the distribution of shares may also execute these roles in controlling companies, controlled companies, companies under common control or certain subsidiaries. The amendments introduced by CVM Instruction No. 597/18 have also established that the officers and the portfolio administrator (where the administrator is an individual) are not allowed to obtain or maintain enrolment as an autonomous investment agent.
Finally, it is also important to mention that upon the enactment of CVM Instruction No. 558/15, where the securities portfolio administrator is a legal entity, it is authorised to carry out the placement of shares issued by the investment funds managed by that entity, even if the latter is not a financial institution, subject to compliance with certain requirements established by the CVM.
ii Disclosure of information
The FIP’s administrator must disclose to all its investors, in the form established in the FIP’s by-laws, and through the CVM’s system of provision of documents, as well as to the organised market management entities where the FIP’s shares are placed, any material act or fact related to the fund or to the assets that comprise the FIP’s portfolio, except if the fund’s administrator understands that the disclosure of the information threatens the interests of the fund or of its invested companies.
In line with such duty, the CVM imposes on the administrators, by means of Article 46 of CVM Instruction No. 578/16, the obligation to periodically present to the CVM information on the accounting and financial status of the client FIPs through an electronic system on its website. The required information is as follows:
- within 15 days of the end of each quarter, the information established in Schedule 46-I of CVM Instruction No. 578/16 (i.e., the name of the FIP and its administrator, net equity of the fund, amount of subscribed capital and paid up shares, number of shareholders in each category, equity held by each category, etc.);
- on a semi-annual basis, and within 150 days of the end of this period, the portfolio composition, specifying the number and types of securities held;20 and
- annually, within 150 days of the end of the fiscal (calendar) year, the financial statements for the year with the independent auditor’s opinion and the administrator’s and portfolio manager’s opinion.21
iii Conduct and governance obligations
As well as the above-mentioned disclosure obligations, Article 16 of CVM Instruction No. 558/15 (which revoked CVM Instruction No. 306/99), as amended by CVM Instruction Nos. 593/17 and 597/18, provides that the administrator and portfolio manager are subject to the following strict conduct rules in the performance of their duties:
- to fulfil duties with good faith, transparency, diligence and loyalty to the interests of clients;
- to fulfil duties in such a way as to meet the investment goals of the holder or holders of the portfolio and avoiding practices that could breach their trust;
- to fulfil the provisions of the fund’s by-laws or the agreement executed with the client, which must contain the basic characteristics of the services to be rendered, including:
- the investment policy to be adopted;
- the detailed description of the compensation payable in exchange for the services;
- the risks inherent to the different types of transactions with securities in stock exchanges, over-the-counter markets, futures markets and share loan transactions that the manager intends to carry out using investors’ funds;
- the contents and periodicity of the information to be rendered by the manager to the client; and
- information about other activities that the manager itself may carry out in the market and any potential conflicts of interest existing between those activities and the management of the portfolio;
- to keep all documents relating to the transactions with securities that are part of the portfolios under management updated, in perfect order and available to the client, in the form and for the term set out in the internal rules and regulations;
- to hire custody services or to certify that the securities that are part of the portfolios under management are kept under the custody of a duly accredited entity and to take all actions as may be useful or necessary to protect the interests of its clients;22
- to transfer to the portfolio any benefit or advantage that may result from its standing as the manager of the portfolio, subject to the exception expressly set out in specific regulation of investment funds;
- as regards the portfolio under management, to contractually establish the information that will be rendered to the client, related to the investment policy and to the securities of the portfolio under management;
- to inform the CVM, whenever it verifies, in the performance of its duties, the occurrence or evidence of violation of any rule that the CVM monitors, within a maximum term of 10 business days counted from the occurrence or identification of the occurrence; and
- where an administrator is a legal entity, to establish the policy related to the negotiation of securities by officers, employees, collaborators, controlling partners and by the company itself.
CVM Instruction No. 593/17 has also included a new provision to CVM Instruction No. 558/15 establishing that the rendering of services of securities portfolio administration, by means of using automated systems or algorithms, is subject to the obligations and rules established in CVM Instruction No. 558/15, as amended by CVM Instruction No. 593/17, and does not mitigate the portfolio administrator’s liabilities. In addition, the source code of the automated system or algorithm shall be available for CVM inspection in the company’s headquarters, in a non-compiled version.
Pursuant to CVM Instruction No. 578/16, FIPs are required to take part in the decision-making process of the investee companies, exerting influence on the definition of their strategic policies and management. This participation may also be carried out by holding shares that are a part of the corresponding controlling block; entering into shareholder agreements; or entering into similar agreements or adopting procedures that guarantee the fund’s influence in the definition of the strategic policies and management of the investee companies, including by means of appointment of members of the board of directors. The requirement of participation of the FIP in the decision-making process of the investee companies does not apply if: (1) the investment by the FIP in the investee company is reduced to less than half of the percentage originally invested and, as a result, represents an amount lower than 15 per cent of the capital of the investee company; or (2) the book value of the investment is reduced to zero and is approved by a shareholders’ resolution by the majority of shareholders present at the meeting, if a higher quorum is not established in the FIP’s by-laws.
The requirement to exert influence on the strategic policies and management of the investee companies does not apply to investment in companies listed in special trading segments created by stock exchanges or over-the-counter markets aimed at the access market, and that ensures, contractually, corporate governance standards stricter than those required by law, provided that the investment corresponds to up to 35 per cent23 of the FIP’s subscribed capital.
Furthermore, except for companies that meet the above-mentioned conditions, closely held companies that receive FIP investments must adopt the following governance practices, guaranteeing greater protection to investors:
- a prohibition on issuing founders’ shares, with measures taken to ensure the absence of securities of this type in the market;
- establishment of a unified term of office of up to two years for all the members of the board of directors, if such a board exists in the company;
- to make available to the shareholders, agreements with related parties, shareholders’ agreements and option plans for the acquisition of shares or other securities issued by the investee company;
- to resolve corporate disputes through arbitration;
- in the event that the investee company goes public through category A,24 it must undertake to the fund to join a special listing segment of a stock exchange or of an organised over-the-counter market management entity that guarantees at least the differentiated levels of corporate governance practices provided in the items above; and
- an annual audit of their financial statements by an independent auditor registered with the CVM.
iv FIP portfolios
According to the new CVM Instruction No. 578/16, FIPs are classified into the following categories, as regards the portfolio composition:
- seed capital;
- emerging companies;
- infrastructure (FIP-IE);
- intensive economic production in research development and innovation (FIP-PD&I); and
Each category of FIP as described above is allowed its own investment policy, subject to the applicable rules established by the CVM. Seed capital, emerging company and multi-strategy FIPs, for instance, are allowed to invest in limited liability companies, which was a significant change introduced by CVM Instruction No. 578/16, compared with CVM Instruction No. 391/03, and represents an important step for the development of new investments in Brazil, facilitating the funding of early stage companies. The corporations or limited liability companies that comprise the portfolio of seed capital FIPs shall have an annual gross revenue of up to 16 million reais as accrued in the fiscal year ending prior to the first payment of the fund, and shall not have presented a revenue greater than this limit in the past three fiscal years. Such corporations and limited liability companies are exempt from compliance with the corporate governance requirements set out in CVM Instruction No. 578/16 (and expressly mentioned in Section II.iii), including exemption from the obligation to provide independent auditing of those companies. In the case of an increase of the annual gross revenues of the invested companies after the investment by the seed capital FIP, in such a way that it supersedes the above-mentioned limit, CVM Instruction No. 578/16 establishes certain transition rules related to the compliance by this category of FIP with corporate governance requirements.
In addition, and among other rules, corporations or limited liability companies that comprise the portfolio of seed capital FIPs shall not be controlled, directly or indirectly, by a company or group of companies that has total assets in an amount greater than 80 million reais or annual gross revenue higher than 100 million reais in the end of the fiscal year ending prior to the first payment of the fund.
Another important development introduced by CVM Instruction No. 578/16 was the establishment of the possibility for all FIPs to invest up to 20 per cent of the subscribed capital abroad, as long as the foreign assets have the same economic nature of the assets that may be part of a FIP’s portfolio in Brazil, as described in Article 5 of CVM Instruction No. 578/16.25
Multi-strategy FIPs are allowed to combine investments across several categories and are intended exclusively for professional investors. Multi-strategy FIPs may invest up to 100 per cent of their subscribed capital abroad provided that: (1) their by-laws expressly include the possibility of investment in assets abroad as well as the maximum percentage of such investment; (2) their by-laws expressly set out the exclusive participation of professional investors; and (3) the term ‘investment in foreign assets’ is expressly mentioned in the FIP’s name.
As regards emerging company FIPs,26 they may invest in corporations and limited liability companies with an annual gross revenue of up to 300 million Brazilian reais as accrued in the fiscal year ending prior to the first capital contribution of the fund, and shall not have presented a revenue greater than this limit in the past three fiscal years, and the invested companies are exempt from compliance with some of corporate governance requirements set out in CVM Instruction No. 578/16 (discussed in Section II.iii). However, if gross revenue is increased in such a way that it supersedes the above-mentioned limit after the FIP’s investment, the emerging company shall comply with the corporate governance rules established in CVM Instruction No. 578/16 (discussed in Section II.iii), within two years of the end of the fiscal year in which the gross revenue supersedes the above-mentioned limit (300 million reais). It is also important to mention that the emerging companies invested in by emerging company FIPs may not be directly or indirectly controlled by a company or group of companies with total assets greater than 240 million reais or gross revenues greater than 300 million reais as accrued in the fiscal year ending prior to the first payment of the fund.
FIP-IEs and FIP-PD&Is are not permitted to invest in limited liability companies and are restricted to investments in shares, subscription warrants, debentures (convertible or non-convertible into shares) or other securities issued by public or private corporations with investments in new27 projects of infrastructure or intensive economic production in research, development and innovation in Brazil in the energy, transport, water and basic sanitation, and irrigation sectors, among other areas deemed as priorities by the federal government. These categories of FIPs shall have at least five shareholders, provided that none of them hold more than 40 per cent of the shares issued by the FIP or earn an amount greater than 40 per cent of the FIP’s revenue.
Notably, among the developments introduced by CVM Instruction No. 578/16, FIPs are now allowed to advance funds for future capital increases of an invested corporation, whether a private or public corporation, as long as:
- the FIP holds shares in the invested corporation as at the date of the anticipation of funds;
- this option is expressly set out in the FIP’s by-laws, including the limit of the subscribed capital that may be subject to the anticipation of funds;
- the anticipation of funds is irrevocable and the anticipated funds shall be converted into capital; and
- the advanced funds are converted into capital increase of the invested company within 12 months.
Pursuant to Article 4 of CVM Instruction No. 578/16, FIPs can only be the target of investment by qualified investors,28 and public offerings are the most suitable mechanism to raise such investments.29
Pursuant to Article 19, Paragraph 3 of Law No. 6,385/76 (the Brazilian Securities Market Law), a public offering is one that is carried out by means of the use of sale or subscription lists or bulletins, flyers, prospectuses or advertisements aimed at the public; where the search for subscribers or purchasers is carried out by means of employees, agents or brokers; and where the negotiation is conducted in a store, office or venue open to the general public, or by means of public communication services.
In addition to the terms of the Brazilian Securities Market Law and CVM Instruction No. 400/03, as amended by CVM Instruction No. 584/17 and CVM Instruction No. 588/17, which sets out the objective requirements for an offering to be considered public, it is also necessary to observe subjective requirements that relate to the characteristics of the investors to which the offer is being made.
Information on the recipients of the offer and the availability of information on the fund and the securities issued are characteristics that must be observed for an offering to be defined as being public. Regarding information on the recipients, their degree of sophistication as investors must be analysed to verify that they possess enough knowledge and experience in financial and business issues and are able to assess the risks and merit of the investment. In relation to the availability of information on the fund and the shares issued, it must be shown that the target party had access to the information that the fund would have presented when registering the offering, so as to allow full evaluation of the risks.
The application for registration of the public offering shall be made to the CVM by the FIP together with the intermediary financial institution. The application shall be accompanied by the documents and information required under CVM Instruction No. 400/03, so as to allow full disclosure of the information on the offering, such as characteristics, volume and price of the offered shares, and the method and place of issuance.
Among these documents is the prospectus, set out under Article 38 of CVM Instruction No. 400/03, which is the main informative document to be presented by the fund. The prospectus must contain full information on the offering; the shares subject to the offering and the rights inherent therein; the offering party; the issuing fund and its economic and financial situation; third-party guarantors of obligations related to the shares being offered; and the types of companies that may receive the funds raised by the offering.
In this context, it is important to highlight that upon the enactment of CVM Instruction No. 578/16, the CVM has clarified an understanding that had already been adopted by Brazilian FIPs: the issuance of shares destined to the shareholders of the FIP is not considered a public offering, as long as the shares issued by the FIP are not admitted for trading in organised markets and the shares not placed for the shareholders are automatically cancelled.
The CVM also provides, by means of Instruction 476/09, for a different kind of public offering called a ‘public offering distributed with restricted efforts’. This type of offering is not subject to the registration rules set out by CVM Instruction No. 400/03. The offerings under the terms of this instruction may have as targets, among other securities, closed investment fund shares (such as FIPs) and may only be directed to professional investors, as defined in specific regulation.
Furthermore, for a public offering to be considered an offering with restricted efforts, it is also necessary that the number of investors pursued is limited to 75 professional investors, and that the securities are subscribed or acquired by no more than 50 of those targeted investors.30 This is the Brazilian version of the American private placement, when an offer is made directly to qualified investors with no purchase efforts being made to the public in general.
With the enactment of CVM Instruction No. 551/14, the CVM has increased the list of securities that may be distributed with restricted efforts, which now includes, inter alia, the following securities: certificates of structured transactions, shares, debentures convertible into or exchangeable for shares and subscription warrants issued by certain companies. This measure aims to meet a proposal by some capital market entities to facilitate small and medium-sized companies’ access to capital markets funding.
Another important characteristic of FIPs is that they are allowed, upon approval by a qualified majority of the investors, to post sureties, guarantees, acceptance, co-obligations or in rem guarantees (collaterals). The provision to this effect was initially included in CVM Instruction No. 391/03 (by means of the enactment of CVM Instruction No. 535/13) and kept in the wording of CVM Instruction No. 578/16 (which revoked CVM Instruction No. 391/03),31 and had as one of its goals to increase the participation of FIPs in leveraged buyouts.
Finally, it is also worth mentioning the development of equity crowdfunding regulation in Brazil, upon the enactment of CVM Instruction No. 588/17. The main goal of equity crowdfunding, by means of online platforms, is to give access to the investors to invest in start-up companies, which still suffer from a shortage of resources, particularly in light of the recent economic crisis in Brazil. Investment through equity crowdfunding is an important financing instrument for early stage companies and is crucial for enhancing employment and generating income in the Brazilian economy.
The main purpose of CVM Instruction No. 588/17 is to allow companies with annual revenues of up to 10 million Brazilian reais to carry out offerings by means of online platforms of collective financing, without registration of the public offerings. For purposes of protecting the investors, the CVM has established as a condition to this type of offering that it occurs by means of online platforms that are submitted to the authorisation process before the CVM.
It is also important to mention that even before the enactment of CVM Instruction No. 588/17, the issuance of securities by means of equity crowdfunding in Brazil was already permitted and had been carried out by some start-ups upon the application of CVM Instruction No. 400/03, which allows the public offering of securities issued by small companies in Brazil (MEs and EPPs)32 to be carried out without registration. Despite the recent enactment of the crowdfunding regulation, crowdfunding is not yet common practice in Brazil, mainly because of the economic and political crisis experienced in Brazil over recent years, which makes investors sceptical about taking risks of this nature.
III REGULATORY DEVELOPMENTS
The Brazilian Securities Market Law determines that the CVM shall, among other obligations, supervise the issuance and distribution of securities in the market, portfolio management and safekeeping of securities, as well as the services provided by securities consultants and analysts. Since investment fund shares are considered securities for all purposes, they are subject to the provisions of this Law.
In this way, without prejudice to the above-mentioned registration procedures for public offerings, and pursuant to Article 2 of CVM Instruction No. 578/16, the mere existence of a FIP depends on previous registration with the CVM, which shall be automatically granted upon delivery of the following documents and information:
- incorporation documents and the full text of the by-laws;33
- the administrator’s statement that it has executed the applicable agreements whenever the FIP’s administrator hires, on behalf of the FIP, third parties to render the services set out in Article 33, Paragraph 2 of CVM Instruction No. 578/16,34 and that the agreements are available to the CVM;
- a statement specifying the name of the independent auditor;
- information on the maximum and minimum numbers of shares to be placed, their issue price, all costs incurred in the placement and other relevant information concerning the placement;
- marketing material used in the placement of the fund’s shares, including the prospectus, if any;
- any additional information that may be provided to potential investors; and
- the number of the FIP’s enrolment with the National Registry of Legal Entities (CNPJ).
As well as the rules issued by the CVM, entities associated with the ABVCAP and ANBIMA must also observe the terms of the Code for Regulation and Best Practices (the Code), which was drafted by both associations and determines certain general parameters related to the establishment and operation of FIPs and other investment vehicles. The activities of administration, portfolio management and distribution of FIP shares are subject to the provisions of the Code. The Code mainly aims to:
- allow for greater transparency in the performance of the activities of FIPs (and other investment vehicles governed by the Code), allowing better quantification and supervision of the sector’s development;
- promote the standardisation of practices and procedures of FIPs (and other investment vehicles);
- promote the adequate functioning and credibility of FIPs (and that of other investment vehicles);
- maintain the highest ethical standards and consolidate the institutionalisation of fair practices;
- raise the fiduciary standards and promote best practices; and
- allow for, as the case may be, the compatibility and gradual integration of the Brazilian FIP market with the international private equity and venture capital market.
As regards fundraising carried out in other jurisdictions, the terms of Law No. 4,131/62 must be observed regarding the definition of foreign capital, and the inflow of funds directly into Brazil, and the terms of National Monetary Council (CMN) Resolution No. 4,373/14 must also be observed whenever such funds enter Brazil through the capital markets.35
In cases of direct investment, every foreign investor and every Brazilian company in which the foreign investor participates must be registered with the Brazilian Central Bank. Additionally, every inflow or outflow of money arising out of such investment must also be registered, including for transactions involving acquisition or sale of equity interests.
Recent amendments introduced by the Brazilian Federal Revenue (RFB) by means of Rule No. 1,634 (IN 1,634/2016), further replaced by Rule No. 1,863 (IN 1,863/2018), as amended,36 governing the registration of national and foreign entities with the CNPJ have established the obligation for foreign shareholders of Brazilian entities, and also for Brazilian entities, to provide the RFB with information on the relevant corporate chain, including trusts and foundations, up to the individuals deemed the ultimate beneficial owners, with a few exceptions, defined as (1) the individual or individuals who either directly or indirectly own, control or significantly influence37 the legal entity; or (2) the individual under whose name a given transaction is performed. This obligation must be complied with during any update of any of the Brazilian or foreign entity’s RFB registry data or, in the case of a new entity, up to 90 days from the date of registration before the RFB.38
This Rule also permits some exceptions to compliance with the above-mentioned obligation, such as in the case of (1) a publicly held corporation incorporated in Brazil or in another jurisdiction that requires public disclosure of all shareholders considered relevant and that are not located in a jurisdiction with favourable taxation or under a privileged tax regime; and (2) Brazilian investment funds regulated by the CVM, provided that the Brazilian taxpayer’s number of all the shareholders of the funds are duly provided to the RFB by the portfolio administrators. Note that this is a recent obligation and even the authorities remain uncertain in their requests for documents and information.
Investments made in the Brazilian financial and capital markets through CMN Resolution No. 4,373/14 are subject to favourable income tax treatment.39 Concerning FIPs specifically, the income arising from investment in these funds and gains arising from the sale or amortisation of FIP shares by non-resident investors40 that are not resident or domiciled in a favourable tax jurisdiction41 are currently taxed at zero per cent, provided the following requirements are met (the FIP Requirements):
- the non-resident investor does not hold, individually or with related parties (as defined by applicable legislation),42 40 per cent or more of all shares issued by the fund (shareholding test) nor does it have the right to receive 40 per cent or more of the total income generated by the fund (economic test), and the ultimate beneficial owners must be identified to the CNPJ in accordance with the RFB beneficial-owner requirement (see above);43
- the fund does not have in its portfolio, at any time, debt securities in an amount exceeding 5 per cent of its net worth, unless the securities correspond to convertible debentures, subscription warrants or public bonds;
- the fund is compliant with additional portfolio requirements provided by CVM regulations, which currently require at least 90 per cent of FIP portfolios to be composed of shares, subscription warrants, simple debentures, other convertible securities or securities exchangeable into shares that are issued by corporations (either closely held companies or publicly held companies), as well as securities representing equity participation in limited liability companies, provided that the FIP participates in the decision-making process of the investee companies, with effective influence on the definition of their strategic policies and management; and
- in addition to the provision mentioned in item (c) above, at least 67 per cent of the FIP’s portfolio is composed of shares of corporations, debentures that are convertible into shares and subscription warrants (allowed assets).44
Additionally, under another tax incentive regime45 and provided that all shareholders are exclusively non-residents, all gains, including capital gains paid, credited, delivered or remitted to beneficiaries resident or domiciled outside Brazil (except if situated in a favourable tax jurisdiction) that are produced by investment funds are exempt from income tax if the following general cumulative requirements are met (but an analysis per asset to be invested is advisable):
- all the shareholders must be exclusively non-residents, with the RFB now requiring beneficial-owner information to be provided to the CNPJ to avoid structures with individuals resident in Brazil for tax purposes as the ultimate beneficial owner, as defined above; and
- the fund regulations must provide that its fund application is made exclusively in:
- assets required by tax legislation;
- cash deposits;
- assets that are also exempt from income tax, or taxed at a zero per cent rate, when the beneficiaries of the gains derived from the assets are residents or are domiciled outside Brazil (except if situated in a favourable tax jurisdiction);46 or
- assets traded in financial and capital markets that are exempt from taxation, provided that they are negotiated by the funds under the same terms and conditions set out by law for the enjoyment of the tax exemption.
In addition, foreign exchange transactions carried out in Brazil are subject to the tax on financial operations regarding exchange agreements (IOF) for inflow and outflow. The standard rate is currently 0.38 per cent for most foreign exchange transactions. IOF is levied at a zero per cent rate on the inflow and outflow of remittances into related investments made by non-Brazilian residents in the Brazilian financial and capital markets. There are other specific rates or exemptions that may apply to certain transactions. Although unlikely in the current economic scenario, the IOF rate, because of its regulatory purpose rather than budgetary, may be increased at any time to a maximum of 25 per cent by the government.
The tax aspects can be summarised as follows.
|Transaction||Taxes involved||Additional details|
|Inflow of funds as investment in a FIP||IOF: zero per cent||Registration of the investor under CMN Resolution No. 4,373/14. Financial institutions are required to represent the investor and comply with regulatory and tax requirements.|
|Amortisation or redemption of FIP shares||IOF: zero per cent Withholding tax (WHT) on capital gains: in general, progressive table from 15 per cent and 22.5 per cent;* but zero per cent if certain of the FIP Requirements are met.||Capital gain is the difference of the amortised value and the corresponding cost of the shares amortised (calculated in reais).|
|Sale of shares||IOF: zero per cent WHT on capital gains: in general progressive table from 15 per cent and 22.5 per cent;† but zero per cent if certain of the FIP Requirements are met.‡||WHT of zero per cent applies on the trading of shares through a stock exchange, even though this is not a common exit strategy for private equity funds; or if the FIP Requirements are met.|
|Dividends from lower-tier companies held by the FIP||IOF: zero per cent WHT: exemption (but taxed when further distributed to the FIP holders as WHT on capital gains).||It is possible to argue that dividends paid by the lower-tier company to the FIP and immediately transferred to the investor are exempt from WHT. However, tax authorities have expressed a contrary position and sought taxation of these dividends as an amortisation or redemption of FIP shares.|
|* If the FIP does not follow the investment requirements established by the CVM, as mentioned above, and at least 67 per cent (Section 11 of Bill No. 10,638/2018 intends to revoke this requirement (see below)) of its net worth refers to shares, convertible debentures or subscription bonuses (tax law investment requirement), then the applicable tax rates range between 15 per cent and 22.5 per cent. If only those requirements are met (CVM and tax law investment requirements), the tax rate is 15 per cent. If the CVM and tax law investment requirements and the FIP Requirements are met (see (a) to (d) of the FIP Requirements, above), the tax rate is zero per cent.
† As above.
‡ As of 2017, in the case of transactions out of the stock market, progressive tax rates of 15 per cent for gains up to 5 million reais, 17.5 per cent for gains above 5 million reais and lower than 10 reais, 20 per cent for gains above 10 million reais and lower than 30 million reais and 22.5 per cent for gains above 30 million reais will be applicable (Law No. 13,259/2016).
Companies can distribute profits in the form of either dividends or ‘interest on stockholders’ equity’. Dividends are tax-exempt to the beneficiary but cannot be deducted by the company, while interest on stockholders’ equity is tax-deductible by the company but subject to a flat 15 per cent income withholding tax when paid to the beneficiary (not subject to adjustment on the beneficiary’s tax return).
However, under Michel Temer’s presidency,47 the federal government tried to change the tax regime mentioned above by enacting Provisional Measure No. 806 (MP No. 806/2017) on 30 October 2017, which introduced substantial changes that entered into force in January 2018, on the procedures related to applicability of income tax due on certain financial investments and the tax treatment of certain Brazilian investments funds. The RFB did not enact any regulations regarding MP No. 806/2017.
To enact provisional measures requires urgency on the part of the executive branch and such measures must be approved by Congress within a period of up to 120 days (suspended during Congress’ recess). During this period, the provisional measure is converted into law (although its provisions may be changed or others included), otherwise it will no longer be valid. The provisional measure may also be rejected.
However, MP No. 806/2017 was not even voted on by the Brazilian Congress during its 120-day term and therefore it became invalid on 8 April 2018.
The federal government then introduced Bill No. 10,638/2018 in the Chamber of Deputies, regarding the same matter and using almost the same wording as MP No. 806/2017 in relation to the procedures related to the applicability of income tax due on certain financial investments and the tax treatment of certain Brazilian investments funds. In addition, Senator José Serra introduced Senate Bill No. 336/2018 (using the same wording of MP No. 806/2017) regarding the same matter. Both bills are still under discussion in the Brazilian Congress and, therefore, have not been (and may not be) converted into law.
It is important to mention that any legislation that establishes new taxation or increases the income tax due will only be in force in the next calendar year of its conversion in law because of a constitutional rule48 in this regard. In our opinion (although some provisions seem to refer only to the moment of taxation), even if converted during 2020, the provisions upon conversion into law will only be in force as of 1 January 2021, so the provisions requiring the taxation on this new basis since 2019 are not applicable yet (note, however, that in our analysis below, we kept the dates as determined under Bill No. 10,638/2018).
Under Bill No. 10,638/2018, it became clear that the new rules aimed at closing a loophole allowing investors to use FIPs as if they were holding companies (property funds) just for tax deferral purposes. To close this tax-planning loophole, Bill No. 10,638/2018 focused on qualifying FIPs according to CVM regulations to establish their tax treatment with the following conditions:
- FIPs qualified as investment entities shall not be taxed as a legal entity, but the sale of any investment shall be considered as a distribution to the shareholders, regardless of effective distribution, being subject to a 15 per cent withholding tax (WHT) based on the amount that exceeds the portion paid in by the investors in the FIP’s capital49 (deferral will no longer be an option); and
- FIPs not qualified as investment entities but known as property funds shall be taxed as legal entities and subject to corporate income tax of 34 per cent and social contributions of between zero and 9.25 per cent on gross revenues50 (effective taxation depends on the tax regime and the kind of revenue or gain), in which case the fund administrator is liable for the fulfilment of all tax obligations (including ancillary obligations). However, earnings accrued by such FIPs prior to 2 January 2019 will be considered as paid and subject to a 15 per cent WHT at the investor level.51
It seems that the rationale of these new rules is, in the case of property fund FIPs, to tax only the FIP, and in the case of investment entity FIPs, to tax only the investor, but not both the FIP and the investor. However, that is not so clear in the legislation (i.e., it is unclear whether property fund FIP distributions will still be considered tax-exempted dividends) and we await changes in the legislation or RFB regulations for further clarification.
Also, the earnings from FIPs organised and held exclusively by non-resident investors not located in favourable tax jurisdictions and investing under CMN Resolution No. 4,373/14 in FIPs that follows the FIP Requirements remain subject to the tax-exemption rules mentioned above,52 but it is unclear whether a FIP that qualifies as a property fund FIP according to CVM regulations will actually be taxed as a legal entity.
In summary, as provided under CVM Instructions Nos. 578/16 and 579/16, FIPs shall be classified as investment entities if the following cumulative requirements are met:
- the fund has a qualified manager, empowered to take discretionary decisions and not required to appoint shareholders as representatives of the invested entities;
- the purpose of the fund is to offer returns through the appreciation of the invested capital;
- the fund evaluates its investments based on the assets’ fair market values; and
- the fund’s by-laws establish clear and objective strategies in relation to divestment.
Moreover, funds classified as investment entities must also have some of the following characteristics (not necessarily all of them):
- more than one direct or indirect investment;
- more than one direct or indirect shareholder;
- shareholders with no influence in the management of the invested entities and not related to the fund’s administrators; and
- investment in entities with which the shareholders had no previous corporate relationship.
Note also that, as of 1 January 2019, the WHT imposition shall be anticipated when funds classified as investment entities are either transformed, merged or spun off. Furthermore, although Bill No. 10,638/2018 was not converted into law in 2018, and its provisions are not yet in force, reorganisations of investment structures may be considered during 2020, to be prepared for the enactment of new RFB regulations once the Bill is converted into law.
There are certain difficulties in bringing fundraising into Brazil when compared with the existing offshore fundraising possibilities, mainly because of the slowness and bureaucracy regarding offerings, the difficulty for foreigners to understand the Brazilian tax system and the need for the relaxation of certain rules for the private equity industry.
The relaxation of rules begins when the offering is carried out in accordance with CVM Instruction No. 476/09. As previously mentioned, the CVM has amended this regulation to increase the types of securities that it is possible to offer (such as shares and debentures convertible into or exchangeable for shares issued by certain companies), as well as to facilitate access by other companies to this kind of fundraising. Currently, there is a drive in Brazil to increase the funding possibilities for small and medium-sized companies, which typically do not have easy access to the capital markets, making funding more costly to such companies.
To this end, in 2017, the CVM enacted rules applicable to crowdfunding investments for purposes of allowing companies with annual revenues of up to 10 million reais to carry out offerings by means of online platforms of collective financing, without registration of the public offerings.
In addition, the CVM has amended CVM Instruction No. 409/0453 (which was subsequently revoked by CVM Instruction No. 555/14, as mentioned below), and created a new investment vehicle – the stock investment fund – access market (FMA), which is able to participate more easily in the transition of companies from the pre-public offering to the post-public offering stage.
Pursuant to the terms of CVM Instruction No. 555/14, the FMA shall adopt an investment policy under which at least two-thirds of the net assets are invested in shares of companies listed in an access market securities trading segment of a stock exchange or over-the-counter entity, which guarantee, by means of a contractual relationship, enhanced corporate governance practices.
This CVM Instruction also allows FMAs, when incorporated as closed funds, to invest up to one-third of their net assets in shares, debentures, subscription warrants, or other titles or securities convertible into or exchangeable for shares issued by closely held companies, provided that they participate in the decision process of the investee companies and the closely held companies adopt certain corporate governance practices as established in CVM Instruction No. 555/14.
In addition, FMAs, when incorporated as closed funds, may invest in companies with lower liquidity,54 and also repurchase the shares issued by the funds in the organised markets where the shares are admitted for trading, provided that certain requirements regarding the price and amount of shares to be repurchased, established by CVM Instruction No. 555/14, are also complied with.
Through the above-mentioned amendments, the CVM has created a fund with mechanisms that enable investors to participate in the maturing process of private companies by purchasing their shares when they are private companies and accompanying them during the initial public offering and their first years in the market.
Another important example of the relaxation of the Brazilian regulation applicable to investment funds is the enactment of CVM Instruction No. 555/14, which replaced CVM Instruction No. 409/04 on 1 October 2015, establishing new provisions on investment funds, which provided, among other amendments, the valorisation of electronic means of communication, the modernisation of information disclosure and the relaxation of the limits of investment in certain assets, especially financial foreign assets, as well as the creation of a ‘simple fund’, for which the CVM does not require compliance with the procedure to verify the investment suitability of the client’s profile, provided that more than 95 per cent of its net equity is invested in government bonds or bonds with equivalent risk.
As regards investments in foreign assets, a type of fund exclusively directed to qualified investors is now authorised to invest 100 per cent of its portfolio in foreign assets, provided that some other rules established in CVM Instruction No. 555/14 are complied with. In addition, with the creation of the simple fund mentioned above, the CVM intends to incentivise newer and safer opportunities for local players to invest in investment funds. The main goal of establishing the simple fund was to provide a new vehicle type directed at initial investors and formed by low-risk assets, and whose portfolio managers shall have the duty to protect against volatility.
Regarding FIPs, it is important to highlight CVM Instruction No. 578/16, which, as mentioned above, replaced CVM Instruction No. 391/03, and created new rules concerning the formation, operation and management of FIPs. Among the new rules, it is important to mention the creation of seed capital FIPs, emerging company FIPs and multi-strategy FIPs, which are allowed to invest in limited liability companies. The creation of these types of FIPs represented an important step for the development of new investments in Brazil, facilitating the funding of start-ups and early stage companies. In addition, general FIPs may now invest up to 20 per cent of their portfolio in foreign assets, provided that the foreign assets have the same economic nature as the assets permitted for investment by FIPs, and multi-strategy FIPs (exclusively directed to professional investors) may invest up to 100 per cent of their subscribed capital abroad, as long as certain other requirements are complied with (see Section II.iv).
Another important development introduced by CVM Instruction No. 578/16 is that FIPs are now allowed to contract loans directly from entities classified as incentive entities, provided that the amounts are limited to 30 per cent of the FIP assets. Such loans may now also be used for the payment of pending shares subscribed and not paid by shareholders.
Furthermore, CVM Instruction No. 578/16 allows FIPs exclusively aimed at professional investors to have classes of shares with different financial and economic rights (in addition to those rights already established in Article 19, Paragraph 2 of CVM Instruction No. 578/16).55 The shares of the same type may also be divided into different categories, with the specific purposes of establishing, for each category, different payment dates and forms of amortisation and compensation. In this regard, the recently enacted Brazilian Economic Freedom Law has also allowed the creation of segregated assets for each class of shares of the FIP. Such new law reflects another example of the relaxation of the Brazilian regulation on the private equity industry, and, among other important provisions, has established the possibility of funds’ by-laws to establish limitation to the liability of FIP shareholders to the value of their shares and also to the obligations attributable to the class of shares held by the shareholders, as well as limitation to the liability of funds’ service providers (e.g., administrators and portfolio managers) to the obligations to be complied with by each of them (without being jointly liable), provided that the rules enacted by the CVM are also complied with.
As mentioned above, the option for FIPs to grant guarantees (initially introduced by the enactment of CVM Instruction No. 535/13, amending CVM Instruction No. 391/03, and retained by CVM Instruction No. 578/16, which revoked CVM Instruction No. 391/03) should, in principle, improve access to debt funding by the private equity industry, allowing financing entities such as the National Bank for Economic and Social Development to become more involved in the expansion of local industry. As previously mentioned, this would facilitate the use of leveraged buyout mechanisms; however, because of the economic crisis and political uncertainty experienced in Brazil over the past years, Brazilian banks have not demonstrated an appetite to provide financing for leveraged buyouts. The scenario is expected to be different for 2020 and the following years. The economic policies drawn up by the new right-wing government have shown signs of economic recovery and development in many ways.
The Brazilian government is promoting the transition to an open and competitive market. In this regard, 2019 was marked by the beginning of a divestment process conducted by the federal government, by means of divestments and privatisations of companies and their subsidiaries previously controlled by the federal government.
In addition, the recent enactment of Resolution No. 16/19 of the National Council for Energy Policy, which promotes principles, guidelines and recommendations for the transitioning to the ‘new gas market’ has also shown the tendency of the Brazilian government to enhance a competitive and open market. Although there are many regulatory and economic issues to tackle, specialists of the oil and gas industry are certain that the natural gas supply will grow over the next decade, accompanied by investments related to the integration of this sector with the electric and industrial sectors. In relation to the aviation market, recent amendments to Rule No. 7,565/1986 (the Brazilian Aeronautical Code), introduced by means of Rule No. 13,842/2019, have increased the equity participation that may be held by foreign entities in the capital stock of Brazilian airline companies from 20 per cent to 100 per cent. With the opening of the aviation market, Brazil expects to have an increase in foreign investments in local airline companies, which, in its turn will represent an increase of the airline services offered in Brazil, the creation of new employment opportunities and growing competition in the airline sector.
This new landscape is very promising for the private equity industry.
Also, there is still a material demand for investment into several sectors of the economy, including infrastructure, energy, services, technology and the internet, healthcare and medical devices, education and agribusiness, which shows a variety of segments available for private equity investments.
Owing to the relaxation of Brazilian regulation of the healthcare system in 2015 – in particular, allowing foreign investment – there has been an increase in private equity fund investments in this sector since then, especially into hospitals and medical laboratories. In addition, the healthcare system is considered an essential segment, and so, even in periods of economic crisis there is scope for development. Likewise, the innovation of medical devices in Brazil has been attracting the interest of foreign investors. The investment in start-up companies (mainly focused in internet and technology sectors) has also been attracting the interest of foreign investors, especially through corporate venture capital and alternative fundraising mechanisms such as equity crowdfunding. The Brazilian healthcare market has also experienced a verticalisation process in recent years and healthcare operators are building their own hospital network. Many of the highest-valued transactions of 2019 were backed by private equity funds, as was the case in the sale of São Francisco Saúde Group (which had a private equity fund managed by Gavea Investimentos as one of its shareholders) to Hapvida, one of Brazil’s largest healthcare operators, for over US$1.2 billion.56
Given the above, we believe that the Brazilian market is very promising for local and global players, especially considering the recent and upcoming reforms, relaxation of CVM instructions related to investment funds (i.e., the creation of simple funds, the new rules for FIPs, especially the possibility of investing in limited liability companies), the equity crowdfunding regulation that has been enacted by the CVM in 2017, the recent enactment of the Brazilian Economic Freedom Law and the reduction of interest rates, as well as of exchange rates that are favourable to foreign investors and that also create a favourable scenario for exporting Brazilian products. In addition, because of the current lack of attractive financing mechanisms for Brazilian companies, private equity funds have become an important capital-raising alternative for Brazilian companies, which are more open to negotiating their assets.
1 Marcus Vinicius Bitencourt and Alex Jorge are partners, Renata Amorim and Marcelo Siqueira are senior associates and Tatiana Pasqualette is an associate at Campos Mello Advogados in cooperation with DLA Piper.
2 ABVCAP and KMPG. Consolidação de Dados da Indústria de Private Equity e Venture Capital no Brasil: 2011–2018. Estudos ABVCAP, 2018, available at https://abvlink.abvcap.com.br/cl/PHEbn/Fat/3a58/LBGybi3rzyu/BJx2/GSb5M_9DSfp/1/; ABVCAP. Inside PE – Private Equity in Brazil. Estudos ABVCAP, 2019. Available at www.abvcap.com.br/pesquisas/estudos.aspx?c=pt=br. Both accessed on 9 January 2020.
3 Conversion from Brazilian reais into US dollars is according to the exchange rate announced by the Brazilian Central Bank on 31 December 2019.
4 Available at https://www.ttrecord.com/en/publications/market-reports/monthly-report-brazil/Brazil-4Q-2019/1918/. Accessed on 9 January 2020.
5 Available at https://www1.folha.uol.com.br/mercado/2019/12/petrobras-podera-adicionar-bilhoes-de-dolares-ao-plano-de-desinvestimentos.shtml. Accessed on 9 January 2020.
6 Among the Brazilian start-ups that received investments from Softbank fund are Rappi (delivery platform), Loggi (delivery platform), Creditas (credit fintech), QuintoAndar (real estate platform), Gympass (wellness platform), Buser (bus platform), Olist (e-commerce platform), Vtex (e-commerce platform), MadeiraMadeira (home goods platform), Volanty (car platform) and Banco Inter (digital bank).
7 Available at https://group.softbank/en/corp/news/press/sb/2019/20190307_02/. Accessed on 10 January 2020.
8 Available at https://www.cbinsights.com/research-unicorn-companies. Accessed on 10 January 2020.
9 Available at https://link.estadao.com.br/noticias/inovacao,startup-loft-se-torna-11-unicornio-do-pais-apos-nova-rodada-de-investimento,70003142555. Accessed on 10 January 2020.
10 Available at https://www.seudinheiro.com/2019/fundos/e-hora-de-investir-no-brasil-mas-nao-de-captar-recursos-diz-fundo-carlyle/. Accessed on 10 January 2020.
11 ANBIMA. Ranking de Gestão de Fundos de Investimento, November 2018, available at https://www.anbima.com.br/pt_br/informar/ranking/fundos-de-investimento/gestores.htm. Accessed on 10 January 2020.
12 Pursuant to the terms of Law No. 11,727/08, a country is considered to grant a privileged tax regime if it: does not tax income or taxes it at a maximum rate of less than 20 per cent; grants tax benefits to non-resident individuals or legal entities without requiring that a substantial economic activity be carried out in the country and conditional on the non-exercise of a substantial economic activity in the country; does not tax – or taxes at a maximum rate of less than 20 per cent – income earned outside its territory; or does not allow access to information related to shareholding, ownership of assets or rights or to the economic transactions performed. The standard tax rate of 20 per cent to identify privileged tax regimes is reduced to 17 per cent if the country and its privileged tax regime follows the international standards of tax transparency (Ordinance MF 488/14), as established by the Brazilian Federal Tax Authorities.
13 An important development introduced by CVM Instruction No. 578/16 was the permission for FIPs to invest, in addition to the convertible debentures that were already authorised by the rules in effect, in non-convertible debentures, up to the limit of 33 per cent of the total subscribed capital of the fund, except for infrastructure FIPs and intensive economic production in research development and innovation FIPs, which can invest in any amount of debentures that are convertible or non-convertible into shares.
14 FIPs do not allow for the redemption of shares, except in the event of liquidation of the fund.
15 According to the current wording of CVM Instruction No. 578/16, if the FIP’s administrator hires third parties to render treasury services, activities of controlling and processing of portfolio assets or bookkeeping for the issuance or redemption of shares, the services agreement shall contain a provision establishing that the FIP’s administrator and the relevant third party are jointly liable for any damage ultimately caused to the FIP’s shareholders resulting from the violation of any law, the FIP’s by-laws or CVM rulings. In view of the contradiction with the recently enacted Brazilian Economic Freedom Law, the CVM has stated that a public hearing will be submitted to issue new Instructions that will reflect, on the current regulation, the innovations brought by the Economic Freedom Law, thus, reviewing the joint liability of the administrator and relevant third parties. Available at www.cvm.gov.br/noticias/arquivos/2019/20190923-3.html. Accessed on 9 January 2020.
16 CVM Instruction No. 593/17 was enacted on 17 November 2017.
17 CVM Instruction No. 593/18 was enacted on 26 April 2018.
18 According to CVM Instruction No. 558/15, the portfolio administrator can request registration in only one or in both categories and is also able to request the CVM to change its category.
19 CVM Instruction No. 592/17 was enacted on 17 November 2017.
20 This information shall be sent to the CVM based on the fiscal year of the FIP.
21 CVM Instruction No. 578/16 has waived the necessity of provision of the non-audited financial statements on a semi-annual basis, as previously provided by CVM Instruction No. 391/03 (revoked by CVM Instruction No. 578/16), and has increased the term for the provision of the audited financial statements from 120 to 150 days.
22 The portfolio administrator registered exclusively in the category of portfolio manager, and exercising its duties in investments funds, does not have to comply with items (d) and (e).
23 This limit will be of 100 per cent during the term of allocation of the resources, established in up to six months counted from each event of payment of shares set out in the instrument of investment commitment. If, at the end of the relevant month, the fund supersedes the limit of 35 per cent mentioned above, for reasons beyond the control of the portfolio manager, and this non-compliance continues until the end of the following month, the FIP’s administrator shall immediately inform the CVM of the non-compliance and the related reasons, as well as the expected term for compliance, and inform the CVM about the effective compliance, when it occurs.
24 Pursuant to CVM Instruction No. 480/09, the registration of corporations with the CVM may be made within the following categories: Category A, which authorises the trading of any securities by the corporation in regulated securities market; or Category B, which authorises the trading of securities by the corporation in regulated securities market, except for (1) shares or certificates of share deposits; or (2) securities that grant to their holder the right to acquire the securities mentioned in item (1) as a consequence of their conversion or of the exercise of rights attributed to them, provided that they are issued by the issuer of the securities mentioned in item (1) or by a corporation of the same group of that issuer.
25 According to Article 5 of CVM Instruction No. 578/16, FIPs shall direct their funds to the purchase of shares, subscription warrants, non-convertible debentures or other securities convertible into or exchangeable for shares of public or private companies, as well as titles and securities representing equity participation in limited liability companies.
26 CVM Instruction No. 578/16, which has created Emerging Company FIPs, has revoked CVM Instruction No. 209/94, which previously established the provisions for the establishment and development of the Mutual Fund for Investment in Emerging Companies (FMIEE). This fund was created in 1994 with the main purpose of investing in private corporations that had annual gross revenue up to 150 million Brazilian reais, as accrued in the fiscal year ended prior to the first payment of the fund. Another difference between FMIEEs and FIPs for emerging companies, is that FMIEEs did not have to comply with the same corporate governance requirements as currently established for the emerging company FIPs. According to CVM Instruction No. 578/16, the FMIEEs should have a term of either 12 months counted from the publication of the Instruction, or immediately if the existing FMIEEs conduct a public offering of shares (registered or not) after the publication of CVM Instruction No. 578/16, to be adapted to the rules of emerging company FIPs.
27 Pursuant to Section 1 of Article 17 of CVM Instruction No. 578/16, the new projects are considered those implemented after 22 January 2007.
28 Pursuant to CVM Instruction No. 554, enacted by the CVM on 17 December 2014, which came into force on 1 October 2015, qualified investors are: professional investors; individuals or legal entities that hold financial investments in an amount greater than 1 million reais and that furthermore attest in writing their qualified-investor status according to a specific instrument; individuals that have been approved in technical qualification tests or hold certifications approved by the CVM as requirements for their registration as independent investment agents, portfolio administrators, analysts and securities consultants, in relation to their own resources; and investment clubs, provided that they have the portfolio managed by one or more shareholders who are qualified investors.
In addition to the new concept of qualified investors, CVM Instruction No. 554/14 has also created a definition of professional investors, considered as those investors that are: financial institutions and other institutions authorised to function by the Central Bank of Brazil; insurance companies and capitalisation companies; closed or open pension plans entities; individuals or legal entities that hold financial investments in an amount greater than 10 million reais and that furthermore attest in writing their professional-investor status according to a specific instrument; investment funds; investment clubs, provided that they have their portfolio managed by portfolio administrators authorised by the CVM; independent investment agents, portfolio administrators, analysts and securities consultants authorised by the CVM, in relation to their own resources; and non-resident investors.
29 Article 19 of Law No. 6,385/76 sets out that ‘no public securities offering shall be distributed in the market without prior registry with the CVM’.
30 Upon the enactment of CVM Instruction No. 551, as of 25 September 2014, the limitation of the number of qualified investors that can be pursued was increased from 50 to 75 qualified investors, and the maximum number of securities that can be acquired by qualified investors was increased from 20 to 50. Upon the enactment of CVM Instruction No. 554/14, the reference to ‘qualified investors’ in Articles 3, I and II of CVM Instruction No. 476/09 was replaced by ‘professional investors’.
31 CVM Instruction No. 578/16 kept the wording of CVM Instruction No. 391/03 related to the possibility of granting guarantees by the FIPs, upon the approval of the shareholders’ meeting, and included in rem guarantees (collaterals) in the list of guarantees.
32 According to Brazilian Complementary Law (LC) No. 123/06, as amended by Brazilian LC No. 155/16, a microbusiness (ME) is a company (under the types established in this LC), or a businessperson, that has in each fiscal year a gross revenue equal to or lower than 360,000 Brazilian reais, and a small business (EPP) is a company (under the types established in this LC), or a businessperson, that has a gross revenue greater than 360,000 Brazilian reais and equal to or lower than 4.8 million Brazilian reais in each fiscal year. In addition, Brazilian Law No. 155/16 has created the option for ‘angel investors’, whether individuals or legal entities, to invest in MEs and EPPs for purposes of enhancing innovation and productive investments without having to hold equity in the companies or being liable for any of the company’s debts or insolvencies. In addition, angel investors shall not have any voting right nor influence on the company’s management. The funds granted by the angel investors to the companies shall not be considered as part of the companies’ capital and the angel investors shall be compensated for the investments made, according to the terms of the investment agreement, during a term of up to five years, provided that the compensation shall not be greater than 50 per cent of the profits of the MEs or EPPs.
33 Recently enacted CVM Instruction No. 615/19, of 2 October 2019, has waived the necessity of registration of the by-laws before a registry of instruments and documents, as previously established in CVM Instruction No. 578/16, which, in other words, means that the registration of the by-laws before the CVM is now sufficient to ensure its effects before third parties.
34 According to Article 33, Paragraph 2 of CVM Instruction No. 578/16, the FIP’s administrator may hire, on behalf of the fund, the following services: (1) FIP’s portfolio management; (2) investment advising; (3) treasury activities; (4) assets processing control activities; (5) placement of shares; (6) bookkeeping of issuance and redemption of shares; (7) custody of financial assets; and (8) market maker for the FIP’s shares.
35 Pursuant to Article 1 of CMN Resolution No. 4,373/14, the provision mentioned aims to determine the guidelines for application of external resources entering Brazil by non-resident investors in the financial and capital markets, and the transfer of funds from and to abroad, in national or foreign currency. According to Article 5, I of this Resolution, non-resident individual or collective investors are defined as individuals or legal entities, funds or other collective investment entities resident, domiciled or headquartered abroad.
36 IN 1,863/2018 was amended by Rules Nos. 1,895 of 27 May 2019, 1,897 of 27 June 2019 and 1,914 of 26 November 2019, and also by COCAD Declaratory Executive Act No. 2 of 30 December 2019, issued by the RFB.
37 Pursuant to IN 1,863/2018, a significant control or influence is presumed whenever the individual (1) holds, directly or indirectly, more than 25 per cent of the entity’s corporate capital, or (2) holds, directly or indirectly, the power to control the entity’s corporate decisions and to appoint the majority of its managers.
38 IN 1,634/2016 initially established the deadline for the submission of information on ultimate beneficial owners as 31 December 2018. However, IN 1,863/2018 (which revoked IN 1,634/2016) extended the deadline to 26 June 2019 (180 days from the publication of IN 1,863/2018).
39 Section 3 of Law No. 11,312/2006.
40 The FIP may also have Brazilian resident investors, but they will not benefit from this tax incentive.
41 Brazilian law defines more than one concept of favourable tax jurisdiction. However, the concept that matters for this particular analysis refers to foreign investments in the Brazilian financial and capital markets pursuant to CMN Resolution No. 4,373/14. Accordingly, the applicable concept of favourable tax jurisdiction refers to a country that does not tax income or that taxes income at a rate lower than 20 per cent or does not provide information regarding the equity partners of legal entities, its owners or the beneficial owner of the income paid to non-residents. The standard tax rate of 20 per cent to identify privileged tax regimes is reduced to 17 per cent if the country follows the international standards of tax transparency (Ordinance MF 488/14), as established by the RFB. The Brazilian tax authorities have listed some jurisdictions as favourable tax jurisdictions. Historically the tax authorities have viewed this list as being a numerus clausus list, namely any jurisdiction not appearing on the list will not be deemed a favourable tax jurisdiction. Ireland was the most recent inclusion, at the end of 2016.
42 The 40 per cent ceiling applies to the following parties related to individual FIP investors: (1) relatives up to the second degree, (2) companies controlled by the investor or by any of the investor’s relatives up to the second degree, and (3) partners or managers of companies controlled by the investor or the investor’s relatives up to the second degree. Where the investor is a legal entity, the ceiling applies to any entities that are the investor’s controller or are controlled by or affiliated to the investor.
43 Based on the literal wording of the law, one could conclude that the 40 per cent test for fulfilling the FIP Requirements is to be observed solely by the direct investors of the FIP, and not by their shareholders, partners or members (except where the shareholders, partners or members are also direct investors of the FIP), and that there is no need to account for any indirect interests. However, any analysis of the shareholding test and the economic test may be controversial, and one should consider an indirect approach and a ‘substance-over-form’ analysis. The rationale is to avoid using related parties (close individuals and group companies) to circumvent the ceiling of not having 40 per cent or more shares of the FIP.
44 Section 11 of Bill No. 10,638/2018 intends to revoke this requirement (see below).
45 Section 97 of Law No. 12,973/2014.
46 If the fund regulations restrict its shareholders to non-resident individuals only, the fund is also allowed to invest in assets whose gains will be exempt from individual income tax under Section 3 of Law No. 11,033/2004 (e.g., certificates of real estate receivables, real estate investment funds).
47 Michel Temer was the vice president who assumed the presidency after the Senate approved the proceeding to impeach and remove President Dilma Rousseff from the presidency in 2016.
48 Section 62, § 2 of the Brazilian Constitution.
49 Sections 5, VI and 7 of Bill No. 10,638/2018 and Section 2, § 6, 7 and 8 of Law No. 11.312/06.
50 Corporate income tax (IRPJ/CSLL) and social contributions on gross revenues (PIS/COFINS) will be due by the FIP.
51 Sections 5, VII, 8 and 9 of Bill No. 10,638/2018.
52 Section 5, IV of Bill No. 10,638/2018.
53 The amendments were made by the enactment of CVM Instruction No. 549 of 24 June 2014.
54 The provisions related to the FMA mentioned herein have remained in force under CVM Instruction No. 555/14, which came into force on 1 October 2015.
55 According to Article 19, Paragraph 2 of CVM Instruction No. 578/16, the FIP’s by-laws may establish different financial and economic rights to one or more classes of shares exclusively in relation to (1) the establishment of administration and portfolio management fees; and (2) the priority in relation to the payment of revenues, amortisation or liquidation balance of the fund.
56 Available at https://www.ttrecord.com/en/exclusive-area/transactions/private-equity/GSFRP-Participacoes/272039/. Accessed on 14 January 2020.