I GENERAL OVERVIEW
The Brazilian private equity fundraising sector has consolidated itself over the past decade and has shown significant growth since 2003, even compared with other BRIC countries.
In addition to Brazil’s economic development over this period, such evolution can also be attributed to the improvement of the regulatory structures of our capital market, mainly 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 Commission (CVM) has been constantly concerned in regulating and updating specific rules for such funds, as per the recent issuance of CVM Instruction 578/16, on 30 August 2016, which replaced CVM Instruction 391/03 and modernised the rules regarding the formation, operation and management of private equity funds, as will be further explored.
A study carried out by the Brazilian Private Equity and Venture Capital Association (ABVCAP)2 found that resources held by local investors increased only 10 per cent in 2015 over 2014, while those held by foreign investors increased by 12 per cent, evidencing still a growing interest in the Brazilian market by local and foreign players, despite the economic and political crisis. In 2016, the Brazilian Federal Police conducted an important investigation on fraudulent investments made by the four largest pension funds in Brazil using FIPs as vehicles of investment.
Despite the political scandals and change of government in 2016, which kept investors uncertain about committing capital in Brazil, significant transactions involving local and foreign private equity funds have occurred, as per the capital injection of US$125 million made by the North American fund Equity International in Estapar Estacionamentos, one of the largest parking infrastructure and service operators in Brazil.
It is also worth mentioning another transaction that took place in 2016 by the North American private equity fund General Atlantic, which increased its stake in Brazilian brokerage firm XP Investimentos from 33 per cent to 49 per cent, for US$130 million, through a capital injection and the acquisition of a 10 per cent stake held by Actis LLC. Before XP Investimentos, General Atlantic acquired 17 per cent stake in the drugstore chain Pague Menos in the end of 2015, and invested 200 million reais in Ouro Fino Saude Animal Participações SA in 2014.
In the first semester of 2016, ABVCAP coordinated a research project3 with private equity and venture capital foreign and local investors concerning the challenges and opportunities for investments in Brazil. According to the research, 88 per cent of the foreign investors intend to increase the allocation of private equity or venture capital in Brazil in the next three years. They attribute the leading factors to invest in the Brazilian market to portfolio diversification, qualified managers and lower risk versus return if compared with developed markets.
This scenario means 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.
According to the ranking by the Brazilian Association of Financial and Capital Market Entities (ANBIMA), the portfolio managers responsible for most of the assets until November 20164 were BB DTVM SA, Itaú Unibanco SA and Bradesco.
For 2017, specialists forecast that the conclusion of the former President Dilma Rousseff’s impeachment and the perception of economic and political stability can bolster investor confidence in the Brazilian market. Additionally, the substantial devaluation of the real against the dollar and the material demand for investment into several sectors of the economy, including infrastructure, hospitality, shopping centres, energy, services, technology and internet, healthcare and medical devices, and agribusiness can provide a favourable scenario for private equity investment.
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 such 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 such investments. The main jurisdictions used for fundraising are those included in the Brazilian ‘grey list’ – countries that grant privileged tax regimes.5
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 closed-ended (i.e., it does not allow for the redemption of its shares, except in the event of liquidation of the fund), and directs its funds to the purchase of shares, subscription warrants, non-convertible debentures,6 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, being required to maintain, at least, 90 per cent of its resources invested in such assets.
FIPs do not have separate legal personality, so the terms of the Brazilian Law of Corporations (Law 6,404/76, as amended) are not applicable to them. They are instead subject to the terms of the Civil Code and specific rules issued by the CVM. Hence, the FIP is an asset held by a pool of owners, where such owners hold a portion (shares) of the total assets.
It is important to mention that, on 30 August 2016, a new CVM Instruction 578/16 was enacted replacing the CVM Instruction 391/03 and creating new rules concerning the formation, operation and management of FIPs. The new rules brought by such CVM Instruction shall be adopted by the FIPs within 12 months counted from the publication of such rules, or immediately, in case the existing FIPs conduct a public offering of shares (registered or not) after the publication of CVM Instruction 578/16. Furthermore, on the same date, CVM Instruction 579/16 was issued creating new rules for the provision of financial statements of FIPs, outlining the accounting methods for the classification of assets and liabilities.
As regards the funds 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 an FIP comprises all of the services directly or indirectly related to its representation, operation and maintenance, such as portfolio management; investment advising; treasury and share processing control activities; placement of shares; and bookkeeping of the issuance and redemption of shares.
According to the recently enacted CVM Instruction 578/16, the FIP’s administrator may also engage, on behalf of the fund, third parties to render the following services: (1) the 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. Such new 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 FIPs investments. In this regard, according to the CVM Instruction 578/16, the portfolio manager has powers to represent the FIP in certain acts such as (1) negotiation and hiring, on behalf of the fund, of the assets and agents to conduct the FIP’s transactions; (2) to negotiate and hire 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 (3) to monitor the assets of the FIP and to exercise the voting right related to such 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 days, the copies of all documents executed on behalf of the FIP.
It is also worth mentioning that CVM Instruction 558/15, which came into force on 4 January 2016,7 has brought new rules on the activities related to the securities portfolio administration in general. Among those rules, two categories8 of registration of portfolio administration have been established, as well as new requirements and procedures related to the registration of such categories:
a 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, as well as to render securities consulting services; and
b 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 new CVM Instruction mentioned above has also established the possibility of a legal entity that is not a financial institution to require the registration as fiduciary administrator, as long as it continually maintains a minimum capital defined by 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.
In addition, CVM Instruction 558/15 has established, as a requirement for the granting, to a legal entity, of registration of securities portfolio administration, that such entity appoints a compliance officer responsible for the implementation of the rules set forth by the CVM Instruction 558/15, as well as the procedures, policies and internal controls of the funds, and, specifically for the category of portfolio manager, that the entity also appoints an officer responsible for the risk management (the compliance officer has the possibility to take on this duty as well).
Finally, it is also important to mention that upon the enactment of CVM Instruction 558/15, the securities portfolio administrator that is a legal entity is authorised to carry out the placement of shares issued by the investment funds which are managed by such entity, even if the latter is not a financial institution, and upon the compliance with some 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 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:
a within 15 days after the end of each quarter, the information established in Schedule 46-I of CVM Instruction 578/16 (i.e., name of the FIP and its administrator, net equity of the fund, amount of subscribed capital and paid up shares, number of shareholders per each category, equity held by each of such category, etc.);
b on a semi-annual basis, within 150 days after the end of such period, the portfolio composition, specifying the number and types of securities held;9 and
c 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.10
iii Conduct and governance obligations
As well as the above-mentioned disclosure obligations, Article 16 of the CVM Instruction 558/15 (which revoked CVM Instruction 306/99), provides that the administrator and portfolio manager are subject to the following strict conduct rules in the performance of their duties:
a to fulfil duties with good faith, transparency, diligence and loyalty to the interests of clients;
b 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;
c 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 such activities and the management of the portfolio;
d 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 term set forth in the internal rules and regulation;
e 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;11
f 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 forth in specific regulation of investment funds;
g 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;
h to inform CVM, when it verifies, in the performance of its duties, the occurrence or evidences of violation of any rule that CVM monitors, within the maximum term of 10 business days counted from said occurrence or identification; and
i in case of an administrator that is a legal entity, to establish the policy related to the purchase and sale of securities by officers, employees, collaborators, controlling partners, and by the company itself.
It is also worth mentioning that the CVM Instruction 578/16 establishes that, in case the FIP’s administrator hires third parties to render the services of treasury, activities of controlling and processing of portfolio assets or bookkeeping of the issuance or redemption of shares, the services agreement shall contain a provision establishing that the FIP’s administrator and the respective third party is jointly liable for eventual damages caused to the FIP’s shareholders due to the violation of any law, the FIP’s by-laws or CVM rulings. In addition, without prejudice to the above mentioned, the FIP’s administrators and any other renderers of services hired, are liable, before the CVM and in accordance with the respective attribution, for the violation of any law, applicable rulings or the fund’s by-laws.
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. Such 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, in case a higher quorum is not established in the FIP’s by-laws.
As regards the requirement of exerting influence on the definition of the strategic policies and management of the investee companies, it does not apply to the investment in companies listed in special trading segments created by stock exchanges or over-the-counter market, destined to access market, which ensures, by means of contractual relation, corporate governance standards stricter than those required by law, provided that such investment corresponds to up to 35 per cent12 of the FIP’s subscribed capital.
Furthermore, except for the companies that fall under the above-mentioned scenarios, closely held companies that receive FIP investments must adopt the following governance practices, guaranteeing greater protection to investors:
a prohibition on issuing founders’ shares and the absence of such securities in the market;
b establishment of a unified term of office of up to two years for all the members of the board of directors, in case such board exists in the company;
c 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;
d to resolve corporate disputes through arbitration;
e in the event that the investee company goes public through category A,13 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
f an annual audit of its financial statements by an independent auditor registered with the CVM.
iv FIPs portfolio
According to the recently enacted CVM Instruction 578/16, the FIPs are classified into one of the following categories, as regards the portfolio composition:
a seed capital;
b emerging companies;
c infrastructure (FIP-IE);
d intensive economic production in research development and innovation (FIP-PD&I); and
Each category of FIP as described above shall be allowed its own investment policy. The seed capital and the emerging companies FIPs, for instance, are now allowed to invest in limited liability companies, which was a significant change brought by CVM Instruction 578/16 if compared to CVM Instruction 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 ended prior to the first payment of the fund, and shall not have presented a revenue greater than such limit in the past three fiscal years. Such corporations and limited liability companies are exempt from the compliance with the corporate governance requirements set forth in CVM Instruction 578/16 (and expressly mentioned in Section II.iii, supra), including from the obligation of providing independent auditing of such companies, however, in case of an increase of the annual gross revenues of the invested companies in such a way that it supersedes the above-mentioned limit, the CVM Instruction 578/16 establishes certain transition rules related to the compliance by such category of FIP with corporate governance requirements.
In addition, and among other rules, such corporations or limited liability companies 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 immediately prior to the first payment of the fund.
Another important development brought by CVM Instruction 578/16 is that all FIPs can now 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 578/16.14 Multi-strategy FIPs are allowed to combine investments across several categories and may invest up to 100 per cent of their subscribed capital abroad, provided that the by-laws of such FIPs expressly include the possibility of investment in assets abroad as well as the respective percentage of such investment; the by-laws of such FIPs expressly set forth the exclusive participation of professional investors; and the term ‘investment in foreign assets’ is expressly mentioned in the FIP’s name.
As regards the emerging companies FIPs,15 they may invest in corporations and limited liability companies with an annual gross revenue of up to 300 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 such limit in the past three fiscal years, and the invested companies are exempt from compliance with some of corporate governance requirements set forth in CVM Instruction 578/16 (discussed in Section II.iii, supra). However, if gross revenue is increased in such a way that it supersedes the above-mentioned limit, some transition rules set forth in CVM Instruction 578/16 shall be complied with.
The Infrastructure FIPs (FIP-IE) and Intensive Economic Production in Research Development and Innovation FIPs (FIP-PD&I) 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 infrastructure projects or intensive economic production in research, development and innovation in Brazil in the energy, transport, water and basic sanitation, irrigation sectors, among other areas deemed as priorities by the federal government. Such categories of FIPs shall have at least five quotaholders, provided that none of them may hold more than 40 per cent of the shares issued by the FIP or earn an amount greater than 40 per cent of the FIPs revenue.
Among the developments brought by CVM Instruction 578/16, it is also important to mention that FIPs are now allowed to advance funds for future capital increases of an invested company, whether private or public corporations, as long as (1) the FIP holds shares of the invested company as of the date of the anticipation of funds; (2) such possibility is expressly set forth in the FIP’s by-laws, including the limit of the subscribed capital that may be subject to the anticipation of funds; (3) the anticipation of funds is irrevocable and the anticipated funds shall be converted into capital; and (4) the advanced funds are converted into capital increase of the invested company within 12 months.
Pursuant to Article 19, Paragraph 3 of Law 6,385/76 (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 400/03, which sets forth 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 in order 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 by the FIP to the CVM together with the intermediary financial institution. Such request shall be accompanied by the documents and information required under CVM Instruction 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 forth under Article 38 of Instruction 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 the recently enacted CVM Instruction 578/16 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 forth by CVM Instruction 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 (which definition was already mentioned herein), and that the securities are acquired by no more than 50 of those targeted investors.18 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 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 of a qualified majority of the investors, to post sureties, guarantees, acceptance, co-obligations or in rem guarantees (collaterals). Such provision was initially included in CVM Instruction 391/03 (by means of the enactment of CVM Instruction 535/13) and kept in the wording of CVM Instruction 578/16 (which revoked CVM Instruction 391/03),19 and has as one of its goals the increase of the participation of FIPs in leveraged buyouts.
Finally, it is also worth mentioning the development of equity crowdfunding regulation in Brazil, which is currently under discussion before the CVM. The main goal of the equity crowdfunding, by means of online platforms, is to give access to the investors to invest in start-up companies, which still suffer the shortage of resources, especially considering the current economic crisis in Brazil. The expected regulation of equity crowdfunding by the CVM shall set forth clearer rules, especially duties and obligations, and set limits for the exemption from registration of the public offerings, which are currently linked to the company size and have a maximum amount of funding per year, according to the provisions of CVM Instruction 400/03.
Despite the lack of specific regulation, the issuance of securities by means of equity crowdfunding in Brazil is already permitted and has been carried out by some start-ups upon the application of CVM Instruction 400/03, which allows the public offering of securities issued by small-sized companies in Brazil (MEs and EPPs)20 to be carried out without registration. However, crowdfunding is not yet common practice in Brazil mainly because of the legal uncertainty. Due to the lack of regulation by the CVM and the current economic and political crisis, investors are still sceptical about taking such risks.
In this regard, the CVM has issued the public hearing to discuss the above-mentioned regulation with a term until 6 December 2016 to receive comments by the public on the suggested regulation, and such comments are currently under analysis by the CVM.
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 such law.
In this way, without prejudice to the above-mentioned registration procedures for public offerings, and pursuant to Articles 2 of CVM Instruction 578/16, the mere existence of an FIP depends on previous registration with the CVM, which shall be automatically granted upon delivery of the following documents and information:
a incorporation documents and the full text of the by-laws, with a certificate proving its registration with a registry of instruments and documents;
b 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 forth in Article 33 Paragraph 221 of CVM Instruction 578/16, and that such agreements are available to CVM;
c a statement specifying the name of the independent auditor;
d 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;
e marketing material used in the placement of the fund’s shares, including the prospectus, if any;
f any additional information that may be provided to potential investors; and
g the number of the FIP’s enrolment with the Brazilian Taxpayer’s Registry (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 (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:
a 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;
b promote the standardisation of FIPs’ (and other investment vehicles) practices and procedures;
c promote FIPs’ (and other investment vehicles) credibility and adequate functioning;
d maintain the highest ethical standards and consolidate the institutionalisation of fair practices;
e raise the fiduciary standards and promote best practices; and
f 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 4,131/62 must be observed regarding the definition of ‘foreign capital’ and inflow of funds directly into Brazil, and the terms of the National Monetary Council (CMN) Resolution 4,373/14 must also be observed whenever such funds enter Brazil through the capital market.22
In cases of direct investment, every foreign investor and every Brazilian company in which such 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.
Investments made in the Brazilian financial and capital markets through CMN Resolution 4,373/14 are subject to favourable income tax treatment. Concerning FIPs specifically, the income arising from investment in such funds and gains arising from the sale or amortisation of FIP quotas by non-resident investors that are not resident or domiciled in a favourable tax jurisdiction23 are currently taxed at zero per cent, provided the following requirements are met (the FIP Requirements):
a the non-resident investor does not hold, individually or with related parties (as defined by applicable legislation24), 40 per cent or more of all shares issued by the fund (shareholding test) or does not have the right to receive 40 per cent or more of the total income generated by the fund (economic test);25
b the fund does not have in its portfolio, at any time, debt securities in an amount exceeding 5 per cent of its net worth, except if such securities correspond to convertible debentures, subscription warrants or public bonds;
c at least 67 per cent of the portfolio is composed of shares of corporations, debentures that are convertible into shares and subscription warrants (allowed assets); and
d 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 allowed assets.
Additionally, 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):
a the quotaholders must be exclusively non-residents; and
b the fund regulations must provide that its fund application is made exclusively in:26
- 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 such assets are residents or are domiciled outside Brazil (except if situated in a favourable tax jurisdiction); 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 forth 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, due to 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:
Inflow of funds as investment in a FIP
IOF: zero per cent
Registration of the investor under CMN Resolution 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 capital gains tax (WHT): in general, progressive table from 15 per cent and 22.5 per cent;1 but zero per cent if certain FIP requirements are met
Capital gain is the difference of the amortised value and the corresponding cost of the shares amortised (calculated in Brazilian reais)
Sale of shares
IOF: zero per cent
WHT capital gains: in general progressive table from 15 per cent and 22.5 per cent,2 but zero percent if certain FIP requirements are met1
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 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 has sought taxation of these dividends as an amortisation or redemption of FIP shares.
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). The government tried to increase the tax rate of ‘interest on stockholders’ equity’ to 18 per cent through a provisional measure, but the Congress did not approve it in due time, with the tax rate being kept at 15 per cent.
1 If the FIP does not follow the investment requirements established by the CVM and at least 67 per cent of its net worth refers to shares, convertible debentures or subscription bonuses, then the applicable tax rates range between 15 and 22.5 per cent. If only those requirements are met, the tax rate is 15 per cent. If the FIP requirements are met, the tax rate is zero per cent.
2 Same as above.
3 Since 2017, in 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 million 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 13,259/2016).
There are certain difficulties in bringing fundraising into Brazil when compared with the existing offshore fundraising possibilities. This is largely due to 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 476/09. As previously mentioned, the CVM has amended this regulation in order 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 this end, the CVM has amended CVM Instruction 409/0427 (which was, afterwards, revoked by CVM Instruction 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 the CVM Instruction 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.
Such CVM Instruction also allows FMAs, when incorporated as closed funds, to invest up to one-third of their net assets in shares, debentures, subscription bonus, or other titles or securities convertible into shares issued by closely held companies, provided that they participate in the decision process of the investee companies, and that such closely held companies adopt some corporate governance practices as established in the CVM Instruction 555/14.
Another important amendment to CVM Instruction 409/04 (which was kept by the CVM Instruction 555/14, that replaced CVM Instruction 409/04) has created rules to enable investment in companies with lower liquidity, authorising FMAs,28 when incorporated as closed funds, to repurchase the shares issued by the funds, in the organised markets where the shares are admitted for trading, provided that (1) the repurchase price is lower than the book value of the share as of the day immediately prior to the repurchase, (2) the repurchased shares are cancelled; and (3) the amount of repurchased shares does not supersede, in a period of 12 months, 10 per cent of the total number of shares issued by the fund.
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.
As mentioned above, on 17 December 2014, the CVM enacted CVM Instruction 555/14, which has replaced CVM Instruction 409/04 on 1 October 2015, establishing new provisions on the investment funds.
Amendments brought about by CVM Instruction 555/14 regard, inter alia, the valorisation of electronic means of communication, modernisation of information disclosure, as well as the relaxation of the limits of investment in certain assets, especially financial foreign assets.
Furthermore, the new CVM Instruction has set forth provisions on the following:
a 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 their net equity is invested in government bonds or bonds with equivalent risk;
b a prohibition on receiving remuneration that threatens the independence of a fund’s portfolio management;
c additional transparency in relation to the distribution policy;
d improvement of the rules related to the performance fee; and
e safer rules for investments in foreign assets.
As regards item (e), 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 555/14 are complied with. In addition, with the creation of the simple fund mentioned in item (a) 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 is to provide a new vehicle type directed to initial investors and formed by low-risk assets, and whose portfolio managers shall have the duty to protect against volatility.
As regards FIPs, it is important to highlight the recently enacted CVM Instruction 578/16, which, as mentioned above, replaced CVM Instruction 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 and emerging companies FIPs, which are allowed to invest in limited liability companies. The creation of such types of FIPs represents 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 its portfolio in foreign assets, provided that such foreign assets have the same economic nature of the assets permitted to be invested by the 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 some other requirements are complied with (as mentioned in Section II.iv, supra).
Another important development brought by CVM Instruction 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 FIPs assets. Such loans may now also be used for the payment of pending shares subscribed and not paid by the shareholders.
Furthermore, such CVM Instruction now allows the FIPs exclusively destined to professional investors to have classes of shares with different political and economic rights (in addition to those rights already established in Article 19, Section 229 of CVM Instruction 578/16 also enables the establishment of different investment conditions for each class of shares. 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.
As mentioned above, the possibility of the FIPs granting guarantees (initially brought by the enactment of CVM Instruction 535/13, which amended CVM Instruction 391/03, and kept by CVM Instruction 578/16 that revoked CVM Instruction 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 and other development banks to become more involved in the expansion of local industry. As previously mentioned, this would facilitate the use of leveraged buyout mechanisms, however, due to the current scenario of economic crisis, Brazilian banks are not demonstrating an appetite to provide financing for leveraged buyouts. On the other hand, in periods of recession, new opportunities may arise and investment banks may gather forces with controlling shareholders or strategic investors to advance this type of transaction.
The worsening of the political and economic crisis in Brazil, which culminated in the devaluation of the Brazilian real, along with the capital markets slowdown that reduced IPOs, influenced private equity investors to postpone their exit process. Compared to 2015, which was a year of political instability due to several political scandals, which culminated with the president’s impeachment in August 2016, this year has shown that the capital markets slowdown will continue longer than expected.
Despite the current economic, political and financial crisis in Brazil, as well as a continued tax increases, which has already caused a decrease in the growth of investments from local players, we believe that the market is still promising for local and global players, especially considering the recent 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 is currently under analysis by CVM, as well as exchange rates that are favourable to foreign investors and that also creates a favourable scenario for exporting Brazilian products. In addition, due to the current lack of 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.
Furthermore, there is still a material demand for investment into several sectors of the economy, including infrastructure, hospitality, shopping centres, energy, services, technology and the internet, healthcare and medical devices, and agribusiness. Due to the recent relaxation of Brazilian regulation of the healthcare system, in particular allowing foreign investment, there has been an increase in private equity fund investments in this sector, 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. Finally, the investment in start-up companies (mainly focused in internet and technology sectors), have also been attracting the interest of foreign investors, especially through alternative fundraising mechanisms such as equity crowdfunding.
1 Marcus Vinicius Bitencourt and Alex Jorge are partners, Renata Amorim and Marcelo Siqueira are senior associates, and Tatiana Martins is associate at Campos Mello Advogados.
2 Associação Brasileira de Private Equity & Venture Capital. Consolidação de Dados da Indústria de Private Equity e Venture Capital no Brasil: 2011, 2012, 2013, 2014 e 2015. Estudos ABVCAP, 2016. Available at: www.abvcap.com.br/pesquisas/estudos.aspx?c=pt-br. Accessed on: 10 January 2017.
3 Associação Brasileira de Private Equity & Venture Capital. Perspectiva dos investidores sobre Private Equity e Venture Capital 2016. Estudos ABVCAP, 2016. Available at: www.abvcap.com.br/Download/Estudos/3586.pdf. Accessed on: 10 January 2017.
4 Associação Brasileira das Entidades dos Mercados Financeiro e de Capitais. Ranking de Administradores de Fundos de Investimento, November 2016. Available at: www.anbima.com.br/pt_br/informar/ranking/fundos-de-investimento/administradores.htm. Accessed on: 10 January 2017.
5 Pursuant to the terms of Law 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 of 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 (RFB).
6 An important development brought by CVM Instruction 578/16 is that FIPs can now invest in non-convertible debentures, up to the limit of 33 per cent of the total subscribed capital of the fund, except for Infrastructure FIPs (FIP-IE) and Intensive Economic Production in Research Development and Innovation FIPs (FIP-PD&I), which can invest in debentures that are convertible or non-convertible into shares.
7 Although such instruction was already in force since 4 January 2016, the securities portfolio administrators that had already obtained their registration with CVM before 4 January 2016 had until 30 June 2016 to comply with the new rules brought by CVM Instruction 558/15.
8 According to the CVM Instruction 558/15, the portfolio administrator can request the registration in only one or both categories, being also able to request to CVM the change of its category.
9 The information mentioned in this item b shall be sent to CVM based on the fiscal year of the FIP.
10 As regards item (b) above, it is important to mention that the recently enacted CVM Instruction 578/16 has waived the necessity of provision of the non-audited financial statements on a semi-annual basis, as provided on CVM Instruction 391/03 (revoked by CVM Instruction 578/16), and has increased from 120 to 150 days the term for the provision of the audited financial statements.
11 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) above.
12 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 forth in the instrument of investment commitment. In case the fund supersedes the limit mentioned above (of 35 per cent) due to reasons beyond the control of the portfolio manager, at the end of the respective month and such non-compliance endures until the end of the following month, the FIP’s administrator shall immediately inform CVM about such non-compliance and the related reasons, as well as the expected term for compliance, and inform CVM about the effective compliance, when it occurs.
13 Pursuant to CVM Instruction 480/09, the registration of corporations with 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 (a) shares or certificates of share deposits; or (b) securities that grant to its holder the right to acquire the securities mentioned in item (a) as a consequence of its conversion or of the exercise of rights attributed to them, provided that they are issued by the issuer of the securities mentioned in item (a) or by a corporation of the same group of such issuer.
14 According to Article 5 of CVM Instruction 578/16, FIPs shall direct its 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.
15 CVM Instruction 578/16, which has created the Emerging Companies FIPs, has revoked CVM Instruction 209/94 which used to set forth 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 reais, as accrued in the fiscal year ended prior to the first payment of the fund. Another difference of the FMIEEs if compared with the FIPs for emerging companies, is that they did not have to comply with the same corporate governance requirements as currently established for the emerging companies FIPs. According to the CVM Instruction 578/16, the FMIEEs shall have a term of (1) 12 months counted from the publication of such instruction; or (2) immediately, in case the existing FMIEEs conduct a public offering of shares (registered or not) after the publication of CVM Instruction 578/16, to be adapted to the rules of emerging companies FIPs.
16 Pursuant to CVM Instruction 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 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.
17 Article 19 of Law 6,385/76 sets forth that ‘no public securities offering shall be distributed in the market without prior registry with the CVM’.
18 Upon the enactment of CVM Instruction 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 554/14, the reference to ‘qualified investors’ in Articles 3, I and II of CVM Instruction 476/09 was replaced by ‘professional investors’.
19 CVM Instruction 578/16 kept the wording of CVM Instruction 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.
20 According to the Brazilian Law LC No. 123106, as recently amended by the Brazilian Law LC No. 155106, an ME (microempresa) is considered a company (under the types established in such law or a businessperson) which has in each fiscal year, a gross revenue equal to or lower than 360,000 reais, and an EPP (empresa de pequeno porte) is considered a company (under the types established in such law or a businessperson) that has a gross revenue greater than 360,000 reais and equal to or lower than 4.8 million reais in each fiscal year. In addition, the recently enacted Brazilian Law No. 155/16 has created the possibility of ‘angel investors’ whether individuals or legal entities, to invest in MEs and EPPs without having to hold equity in such 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.
21 According to Article 33, Paragraph 2 of CVM Instruction 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.
22 Pursuant to Article 1 of CMN Resolution 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 such 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.
23 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 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 such list as being a numerus clausus list, namely, any jurisdiction not appearing on the list will not be deemed as a favourable tax jurisdiction. Ireland was the last inclusion in the end of 2016.
24 Such 40 per cent ceiling considers the following related parties of the investor of the FIP: (a) regarding individuals, (1) its relatives up to the second degree, (2) company controlled by the investor or by any of its relatives up to the second degree and (3) partners or managers of the company controlled by the investor or its relatives up to the second degree; and (b) regarding legal entities, the one which is its controller, controlled or affiliated.
25 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 such 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 quotas of the FIP.
26 If the fund regulations restrict its quotaholders 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 11,033/2004 (e.g., certificates of real estate receivables (CRIs), real estate investment funds (FIIs)).
27 Such amendments were made by the enactment of CVM Instruction 549 as of 24 June 2014.
28 The provisions related to the FMA mentioned herein have remained in force under CVM Instruction 555/14, which came into force on 1 October 2015.
29 According to Article 19, Paragraph 2 of CVM Instruction 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.