Private equity in Brazil: market and regulatory overview

A Q&A guide to private equity law in Brazil.

The Q&A gives a high level overview of the key practical issues including the level of activity and recent trends in the market; investment incentives for institutional and private investors; the mechanics involved in establishing a private equity fund; equity and debt finance issues in a private equity transaction; issues surrounding buyouts and the relationship between the portfolio company's managers and the private equity funds; management incentives; and exit routes from investments. Details on national private equity and venture capital associations are also included.

To compare answers across multiple jurisdictions visit the Private Equity Country Q&A Tool.

This Q&A is part of the global guide to private equity. For a full list of jurisdictional Q&As visit www.practicallaw.com/privateequity-guide.

Rodrigo Menezes, Carlos Derraik and Juliene Piniano, Derraik & Menezes Advogados
Contents

Market overview

1. How do private equity funds typically obtain their funding?

Brazilian private equity funds (PE funds) receive funding from several different sources. The main investors in private equity and venture capital vehicles are pension funds and financial institutions (Second Brazilian Private Equity and Venture Capital Census, published by GVCepe (Brazilian PE Census)). Other important investors include family offices, corporate ventures and public institutions. In 2013, 55% of the capital committed for venture capital and private equity investments came from foreign investors (www.abvcap.com.br/Download/Estudos/2716.pdf).

 
2. What are the current major trends in the private equity market?

The Brazilian private equity market is currently experiencing a period of expansion due to the growth of the Brazilian economy and the increase in flow of fundraising to Latin America.

 
3. What has been the level of private equity activity in recent years?

Fundraising

The private equity industry in Brazil has developed substantially in the past five years, particularly in the level of fundraising. The total capital committed for private equity (PE) and venture capital (VC) investments in 2013 was BLR$100.2 billion according to the Brazilian Venture Capital and Private Equity Association (ABVCAP). The amount increased BLR$17.1 billion, or 21% if compared to 2012 (www.abvcap.com.br/Download/Estudos/2716.pdf).

Investment

Investments in Brazilian companies are usually based on innovation, technology and business models that have a fast growth potential, although private equity may also invest in more consolidated businesses that require investment to support fast growth.

According to the ABVCAP research, the General Partners of private equity and venture capital funds in Brazil indicated a multi sectorial investment trend for the years of 2014 and 2015. However, 21% of the General Partners of PE and VC funds also indicate interest in investing in the clean tech and renewable energy sectors (see above, Fundraising).

Sectors currently receiving attention from PE funds include:

  • Clean Tech and renewable energy.

  • Agribusiness.

  • Energy.

  • Technology.

  • Infrastructure.

  • Health.

  • Oil and gas.

  • Food and beverage.

  • Consumer and retail.

  • Education.

Transactions

Most of the transactions in Brazil are typical private equity transactions, such as management buyout (MBO) and public to private transactions. However, after the subprime crisis, there has been a substantial increase in the use of mezzanine vehicles as well as private investments in public or private equities (PIPES). All types of private equity investments are seen, with the exception of leveraged buyouts, which are very rare.

Exits

Since 2004, with increasing capital market activity, initial public offerings (IPOs) have increasingly been seen as a possible exit for PE funds. From 1999 to 2003 there were no IPOs in Brazil (Brazilian PE Census). In 2004 there were seven IPOs and this number increased over the years until its peak of 64 IPOs in 2007. However, this number drastically decreased in 2008 due to the credit crisis to four IPOs. There were five IPOs in 2009, 11 in 2010, 11 in 2011, three in 2012, 11 in 2013 and just one IPO in 2014 (www.bmfbovespa.com.br/pt-br/mercados/acoes/ofertas-publicas/ofertas-publicas.aspx?idioma=pt-br).

The main form of divestment in the period of 2005 to 2008 was the secondary private sale, which represented 32% of private equity exits. In 2009 trade sales increased and became the main form of investment exit in the private equity sector.

 

Reform

4. What recent reforms or proposals for reform affect private equity in your jurisdiction?

There are currently no plans for reform that will affect private equity in Brazil.

 

Tax incentive schemes

5. What tax incentive or other schemes exist to encourage investment in unlisted companies? At whom are the incentives or schemes directed? What conditions must be met?

Incentive schemes

To encourage direct investment from foreign limited partners (LPs) in Brazil-based funds, the Brazilian tax authorities have granted a tax incentive to foreign investors by exempting from capital gains tax the sale of shares on the Brazilian stock exchange in (Law 11,312/06):

  • Private equity investment funds (fundo de investimento em participações) (FIPs).

  • Emerging companies investment funds (fundos mútuos de investimento em empresas emergentes) (FMIEEs).

This tax benefit is not available to foreign investors that are domiciled in low-tax jurisdictions (tax havens), that is, a country or jurisdiction that:

  • Does not impose tax on income, or in which the applicable income tax rate is between zero and 20%.

  • Has legislation that does not allow access to information on the capital stock structure or ownership of the legal entities organised under its laws.

As a general rule, where investments are not made through FIPs and FMIEEs, the withholding income tax rates applicable to foreign investors are the same as those applicable to Brazilian residents and vary (usually from 15% to 25%) depending on the nature of the funds that are remitted abroad.

No tax is payable on dividends from entities located in Brazil, whether paid in the country or abroad.

At whom directed

The tax incentive provided by Law 11,312/06 (see above) is directed to foreign LPs investing in:

  • FIPs.

  • FMIEEs.

Conditions

To receive the tax benefit for foreign investors in FIPs and FMIEEs, they must comply with the National Monetary Council (Conselho Monetário Nacional) (CMN) rules, meaning that:

  • None of the investors can be located or resident in tax havens.

  • One single investor cannot, alone or in conjunction with its related parties, own more than 40% of the total quotas issued by the fund.

  • One single investor cannot, solely or along with its related parties, have the right to receive 40% or more of the fund's income.

  • The fund cannot have more than 5% of its net equity related to debt securities.

 

Fund structuring

6. What legal structure(s) are most commonly used as a vehicle for private equity funds in your jurisdiction?

The Brazilian Security Exchange Commission (CVM) created the FIP and FMIEE investment fund structures to regulate private equity and venture capital investments. Each is commonly used as a vehicle for both private equity and venture capital investments. The FIP structure has certain advantages in comparison to the FMIEE:

  • Investments by FMIEE are limited to companies that have an annual income up to BRL150 million. FIPs do not have this limitation.

  • The law is unclear in relation to the ability of the investors and/or manager to have board representation in an FMIEE, but this right is clearly established for FIPs.

  • The FIP has a substantial level of transparency for investors (including corporate governance and disclosure information). This is not given by the FMIEE's regulatory framework.

In 2009, from the 239 existing private equity vehicles (97% of the total) (Brazilian PE Census):

  • 67 were FIPs.

  • 63 were limited partnerships.

  • 34 were FIMEEs.

  • 31 were holding companies.

  • 16 were direct investments.

The remaining vehicles used other legal structures, such as investments made by non-financial private companies.

 
7. Are these structures subject to entity level taxation, tax exempt or tax transparent (flow through structures) for domestic and foreign investors?

FIPs and FIMEEs are tax transparent and therefore not themselves subject to taxation. The regular investment income they pay to investors is subject to withholding tax. The applicable withholding income tax rate is generally 15%, but may vary depending on:

  • The nature of the fund.

  • The nature of the income received.

  • The place where the investor is located.

  • Whether the fund's portfolio complies with the rule that they must invest at least 67% of the investment in any of the following to receive full tax benefits:

    • public company shares;

    • company shares (other than limited liability companies);

    • convertible debentures; and

    • commercial paper.

FIPs and FIMEEs are not themselves subject to taxation on the acquisition and disposal of investments. Instead a gain on a sale of quotas on the Brazilian stock exchange realised by local individual investors in FIPs and FMIEEs is deemed a net profit, and is subject to a 15% withholding income tax.

Local investors that are commercial entities are subject to a 15% withholding income tax on gains both inside and outside the Brazilian stock exchange, which are considered to be net income.

Investors (whether individuals or entities) located or domiciled abroad have the same income tax treatment as Brazilian investors in relation to regular income payments and gains from FIPs and FMIEEs, unless they qualify for favourable tax treatment under the CMN provisions (see Question 5).

 
8. What (if any) structures commonly used for private equity funds in other jurisdictions are regarded in your jurisdiction as being tax inefficient (whether by not being recognised as tax transparent or otherwise)? What alternative structures are typically used in these circumstances?

Only FIPs and FMIEEs are tax transparent. All other structures used by private equity funds in Brazil are treated as taxable entities.

 

Investment objectives

9. What are the most common investment objectives of private equity funds?

Private equity investments are generally long-term investments. The average life of an investment is about eight years. The typical average rates of return are 20% per year. Some funds also include the inflation rate of 6% per year in this 20% return rate.

 

Fund regulation and licensing

10. Do a private equity fund's promoter, principals and manager require authorisation or other licences?

The management and general partners (GPs) of a PE fund must be registered and authorised by the CVM.

 
11. Are private equity funds regulated as investment companies or otherwise and, if so, what are the consequences? Are there any exemptions?

Regulation

The CVM is responsible for issuing rules and controlling investment funds in Brazil, which are strongly regulated.

FIPs and FMIEEs have specific regulations issued by the CVM (Normative Instructions 301/2003 and 209/94) and only qualified or institutional investors can invest in such funds. The management of such funds is required to disclose and provide information related to the fund's financial statements to the CVM on a regular basis.

Quotas of funds that have been distributed in a public offering can only be traded on the stock market or on the over-the-counter market, except for private placements to qualified investors whose status has been confirmed by a licensed broker.

The CVM allows flexibility for the regulation and control of investment funds, depending on the category of placement of quotas. The general rule is that the fund must prepare and register with CVM all relevant documents for the fundraising (placement agreement, prospectus, fund bye-laws, fund status and so on). However, if the fund is marketed or advertised to no more than 50 institutional investors, and no more than 20 of those investors actually invest in the fund, the registration process is relaxed, and certain documents such as the prospectus do not need to be registered with the CVM.

Exemptions

There is no need for registration with CVM if the private equity funds are established, as holding companies, which are not subject to a CVM authorisation.

Certain exemptions to the registration of a prospectus apply (see above, Regulation).

 
12. Are there any restrictions on investors in private equity funds?

Only qualified investors or institutional investors can invest in FIPs. The rules for investing in FIMEEs are less restrictive, but the rules of such funds must be pre-approved by CVM.

 
13. Are there any statutory or other maximum or minimum investment periods, amounts or transfers of investments in private equity funds?

There are no limits on investment periods or transfers. FMIEEs are limited to companies that have an annual income up to BRL150 million. FIPs have no such limitation (see Question 6).

 

Investor protection

14. How is the relationship between the investor and the fund governed? What protections do investors in the fund typically seek?

The main instrument that governs the relationship between the investors and the fund are the fund's regulations (regulamento). They provide the rules applicable to the fund's activities, such as its term and its investment policy to be followed by the fund's manager, and accounting methodology.

As protection, investors (LPs) normally seek:

  • Disclosure of the fund's activities, including investment overviews and analysis of management decisions.

  • Voting rights in the fund, including over important changes to the fund's structure (for example, approving the administrator's accounts or amending the fund's regulatinos) and creation of investment committees.

  • Periodic meetings or notices to keep investors informed regarding the performance of the fund and its portfolio.

Another typical characteristic of Brazilian funds is a request by Brazilian institutional investors (in particular, state-owned companies and pension funds) to have a seat on the fund's investment committee.

 

Interests in portfolio companies

15. What forms of equity and debt interest are commonly taken by a private equity fund in a portfolio company? Are there any restrictions on the issue or transfer of shares by law? Do any withholding taxes or capital gains taxes apply?

Most common form

PE funds commonly invest in equity through acquisition or issuance of new shares in a portfolio company. Funds may also invest in debentures, warrants or other securities convertible into or exchangeable for shares of the portfolio companies.

Only 29% of the investments made by PE funds are through debt instruments and from these investments, 65% are made through convertible debentures (Brazilian PE Census).

The main advantage of investing directly in equity is the right to receive dividends (if the company is profitable) and have voting rights in the portfolio company.

For investments in preferred shares, the PE fund may have priority in the distribution of dividends (fixed or minimum dividends) and/or priority in the reimbursement of capital, with or without premium. The risks associated with this structure are limited to the capital invested in the company.

Conversely, investing through a debt structure does not create any shareholders' liability (except if debt instruments are converted into equity). However, in this case the risks are associated with the investee entity's credit health and ability to pay.

Restrictions

There are statutory rights of first refusal, under which a shareholder that sells (directly or indirectly) or transfers company shares must give to the other shareholders the option to acquire the shares. Any other specific restrictions may be imposed by a shareholders' agreement and/or the company's bye-laws.

Taxes

The transfer of quotas will generally be subject to capital gain taxation at 15%. This rate will be increased to 25% if the payment is to a country listed as a tax haven by the Brazilian tax authorities. In addition, in the event of payments abroad, the Financial Transactions Tax (IOF) will apply at 0.38%.

 

Buyouts

16. Is it common for buyouts of private companies to take place by auction? If so, which legislation and rules apply?

It is not common for buyouts of private companies to take place by auction.

 
17. Are buyouts of listed companies (public -to -private transactions) common? If so, which legislation and rules apply?

Buyouts of listed companies are not as common in Brazil as, for example, in the US. However, several rules apply to tender offers to acquire control. When a public to private transaction occurs, the buyer must respect tag-along provisions in the company's bye-laws and shareholders agreements, as well as CVM rules.

 

Principal documentation

18. What are the principal documents produced in a buyout?

The main documents produced in a buyout are the share purchase agreement, investment agreements and shareholders' agreements, followed by the required corporate documents to give publicity to the buyout.

 

Buyer protection

19. What forms of contractual buyer protection do private equity funds commonly request from sellers and/or management? Are these contractual protections different for buyouts of listed companies (public-to-private transactions)?

It is common to see provisions such as:

  • Anti-dilution mechanisms.

  • Non-compete clauses for founders of the portfolio company.

  • Affirmative votes.

  • Earn-outs, where management or sellers remain in the company after investment.

  • Tag/drag-along and liquidation preference rights.

In addition, the agreements typically provide for a complete set of representations and warranties from the sellers or founders of the company to the investor. It is also common to see provisions in the investment transaction on the investor's approval or veto powers over major decisions affecting the portfolio company. The investor's right of first refusal is provided by statute.

In addition, with the current level of corruption existing in Brazil, typical protection provisions under the US Foreign Corrupt Practices Act are also recommended.

 
20. What non-contractual duties do the portfolio company managers owe and to whom?

The Brazilian legal system establishes a series of duties that managers of a company owe. Officers and directors have general duties of loyalty and trustfulness to the company and are strictly bound by the company's bye-laws. The managers must not use any commercial opportunity offered to the company for their own benefit and must not compete with the company in any way. The company's interests must prevail over the officers' and directors' interests. These duties are inherent in the management position and therefore, in an MBO, officers and directors that remain in the company must still observe and comply with these duties. MBOs are still uncommon in Brazil and are usually made with the full consent of the selling shareholder.

 
21. What terms of employment are typically imposed on management by the private equity investor in an MBO?

MBOs are still uncommon in Brazil. On the rare occasions when an MBO happens, PE funds generally impose management employment agreements with provisions covering matters such as confidentiality, non-compete and non-solicitation of employees. There are restrictions on managers' non-compete agreements under which they must receive compensation during the non-compete period.

 
22. What measures are commonly used to give a private equity fund a level of management control over the activities of the portfolio company? Are such protections more likely to be given in the shareholders' agreement or company governance documents?

PE funds usually negotiate the right to appoint:

  • One or more members of the portfolio company's board of directors.

  • The chief financial officer.

It is also common to agree in a shareholders' agreement strategic matters for which an affirmative vote of the member of the board appointed by the fund is required (such as capital increases, changes to dividend policies, and amendments to the company's formation documents).

 

Debt financing

23. What percentage of finance is typically provided by debt and what form does that debt financing usually take?

Debt financing is an uncommon form of finance for private equity activity in Brazil and it is therefore not possible to describe the typical market practice.

 

Lender protection

24. What forms of protection do debt providers typically use to protect their investments?
 

Financial assistance

25. Are there rules preventing a company from giving financial assistance for the purpose of assisting a purchase of shares in the company? If so, how does this affect the ability of a target company in a buyout to give security to lenders? Are there exemptions and, if so, which are most commonly used in the context of private equity transactions?

Brazil has not yet created a set of rules preventing a company from giving financial assistance for the purpose of assisting a purchase of shares in the company. However the practice is not recommended, and investors and the CVM may note that a conflict of interest arose, and require an insertion in the prospectus stating that a loan was given by the lead financial adviser.

 

Insolvent liquidation

26. What is the order of priority on insolvent liquidation?

Creditors are given the following order of priority (Bankruptcy Law (Law no. 11,105/2005)):

  • Debts that are not subject to the bankruptcy:

    • employees' salaries for the three months before confirmation of the bankruptcy by the judge, limited to the amount equivalent to five Brazilian national minimum salaries;

    • creditors of advances on exchange agreements;

    • credits related to the expenses incurred in the bankruptcy proceeding, such as amounts due to the trustee and its assistants, amounts spent in the management of the bankruptcy, judicial costs, obligations resulting from legal acts practised during the judicial reorganisation and tax debts that originated after the bankruptcy was confirmed by the judge.

  • Debts subject to the bankruptcy, in the order of payment as provided by the Bankruptcy Law:

    • employees' salaries (limited to the equivalent of 150 Brazilian national minimum salaries) and credits related to labour accidents and/or labour injuries indemnifications;

    • creditors secured by real estate property (such as a mortgage);

    • taxes due, except fines applied by tax authorities;

    • debts with special privileges as determined by law (such as debts over agricultural produce);

    • debts with general privileges as determined by law (such as expenses incurred in the debtor's funeral);

    • unsecured debts, such as employees' salaries exceeding the 150 minimum salaries threshold;

    • contractual, tax, criminal and administrative fines; and

    • subordinated credits as determined by law, such as debts owed to shareholders or to managers without an employment bond.

 

Equity appreciation

27. Can a debt holder achieve equity appreciation through conversion features such as rights, warrants or options?

A debt holder can have its right convertible into equity by the issuance of convertible debentures or through debt security such as pledge of shares or quotas.

 

Portfolio company management

28. What management incentives are most commonly used to encourage portfolio company management to produce healthy income returns and facilitate a successful exit from a private equity transaction?

The most common incentives granted to management to encourage portfolio company management to produce healthy income returns are:

  • Share option plans, vested on the occurrence of certain events or after a certain period of time.

  • Bonuses on achievement of pre-established goals or objectives.

 
29. Are any tax reliefs or incentives available to portfolio company managers investing in their company?

There are no specific tax reliefs or incentives for managers investing in their company. However, if they receive a portion of their compensation as dividends, there will be no tax due (see Question 5, Incentive schemes).

 
30. Are there any restrictions on dividends, interest payments and other payments by a portfolio company to its investors?

There are no restrictions on dividends, interest payments or other payments by a portfolio company to its investors. Dividends are tax free and interest payments to shareholders are subject to a 15% withholding tax (the tax rate on interest paid to tax havens increases to 25%) (see Question 5).

 
31. What anti-corruption/anti-bribery protections are typically included in investment documents? What local law penalties apply to fund executives who are directors if the portfolio company or its agents are found guilty under applicable anti-corruption or anti-bribery laws?

The protection provisions for anti-corruption/ anti-bribery practices are generally included in the representations and warranties of the investments documents, and impose penalties and indemnification in cases of breach of such representations and warranties. The US Foreign Corrupt Practices Act recommends the performance of due diligence.

A recent law issued on 1 August 2013 (Law no. 12.846 of 1 August 2014) has been in force since January 2014. It provides for the civil and administrative punishment of both a company and its executives in cases of corruption or bribery practices. However, such law is only clear regarding the penalties to be imposed to the legal entity. These vary from 0.1% to 20% of the total revenue of the company in its last fiscal year or, if this figure is not available, the penalties can vary from BLR$6000 to BLR$60 million, depending on the breach.

Companies are always strictly liable for corruption/bribery practices and the executives will be limited to liability of their own culpability (www.planalto.gov.br/ccivil_03/_ato2011-2014/2013/lei/l12846.htm).

 

Exit strategies

32. What forms of exit are typically used to realise a private equity fund's investment in a successful company? What are the relative advantages and disadvantages of each?

Forms of exit

The most common form of exits used to realise a PE fund's investment in a successful company are sales to strategic investors and IPOs.

Advantages and disadvantages

An IPO's success depends on the capital market conditions. For example, in 2007, IPOs were one of the main ways to exit investments for PE funds. However, after the subprime crisis in 2008, the number of IPOs in Brazil decreased substantially.

Exits through sale to strategic investors are more traditional, especially when the company is in a sector under consolidation.

 
33. What forms of exit are typically used to end the private equity fund's investment in an unsuccessful/distressed company? What are the relative advantages and disadvantages of each?

In unsuccessful/distressed companies, the main form of exit is a sale back to the original owner or an MBO exit.

Another alternative if the company is not performing and is on its way to bankruptcy is to simply sell-back to the founders for a nominal sum. The fund then assumes the loss of the investment, but stays out of future problems arising from a typical bankruptcy procedure.

 

Private equity/venture capital associations

Brazilian Private Equity and Venture Capital Association (Associação Brasileira de Private Equity & Venture Capital) (ABVCAP)

W www.abvcap.org.br

Status. ABVCAP is a non-profit institution.

Membership. ABVCAP has over 100 members consisting of institutional or individual participants in the Brazilian private equity and venture capital investment community.

Principal activities. The basic objectives of ABVCAP are to:

  • Represent the Brazilian private equity and venture capital investment community and defend its interests.

  • Develop the private equity and venture capital industry in Brazil.

  • Facilitate relationships between private equity and venture capital players in Brazil.

  • Collect, process, and spread knowledge and data related to private equity and venture capital in Brazil.

  • Monitor the ethics and best practices of private equity and venture capital investments in Brazil.

  • Co-operate with allied international institutions.

Latin American Venture Capital Association (LAVCA)

W www.lavca.org

Status. LAVCA is a not-for-profit membership organisation.

Membership. Members include international, regional and national private equity and venture capital fund managers, institutional investors and corporate investors active in Latin America and the Caribbean. Associate membership is open to development finance organisations, academic institutions, trade associations and reputable service providers.

Principal activities. LAVCA aims to spur regional economic growth by advancing venture capital and private equity investment. This is accomplished through programmes of research, networking, investor education, the promotion of best investment practices, and the advocacy of sound public policy.



Online resources

Brazilian Security Exchange Commission

W www.cvm.gov.br/legislacao/inst.html

Description. Web site of the Brazilian Security Exchange Commission.

Brazilian Federal Government

W www2.planalto.gov.br/acervo/legislacao

Description. Web site of the Brazilian Federal Government where it is possible to find updated wording of the federal legislation.

Brazilian Stock Exchange, BM&F Bovespa

W www.bmfbovespa.com.br

Description. Web site of the main Brazilian Stock Exchange, BM&F Bovespa.

Brazilian Venture Capital and Private Equity Association

W www.abvcap.com.br/pesquisas/estudos.aspx?c=pt-br

Description. Web site of the Brazilian Venture Capital and Private Equity Association containing the result of the last researches performed by such entity regarding the Brazilian venture capital and private equity market.



Contributor profiles

Rodrigo Menezes

Partner, Derraik & Menezes Advogados

T +55 11 3046 4414
F +55 11 3046 4401
E rodrigo.menezes@derraik.com.br
W www.derraik.com.br

Professional qualifications. Brazil, 2000; Portugal, 2006

Areas of practice. Private equity and venture capital; corporate transactions; finance and governance; M&A.

Carlos Derraik

Partner, Derraik & Menezes Advogados

T +55 11 3046 4404
F +55 11 3046 4401
E carlos.derraik@derraik.com.br
W www.derraik.com.br

Professional qualifications. Brazil, 1996

Areas of practice. Private equity and venture capital; corporate transactions; finance and governance; M&A.

Juliene Piniano

Senior Associate, Derraik & Menezes Advogados

T +55 11 3046 4404
F +55 11 3046 4401
E juliene.piniano@derraik.com.br
W www.derraik.com.br

Professional qualifications. Brazil, 2005

Areas of practice. Private equity and venture capital; corporate transactions; finance and governance; M&A.


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