The Venture Capital Law Review: Argentina
Despite being known for its volatile macroeconomic environment, Argentina is still one of the leaders of the Latin American region when it comes to tech talent, start-up creation and attraction of capital to financing entrepreneurial activity.
Since 2016, investment in start-ups has multiplied more than 10 times. And in the last four years, through seed capital and venture capital funds in Argentina, more than 280 start-ups have been financed with almost US$740 million. Even though most of this investment came from foreign funds, when it comes to local funds, those that lead in terms of volume of money are Kaszek Ventures (regional), NXTP (regional), Draper Cygnus (Argentina) and Alaya Capital Partners (Argentina and Chile).
As known worldwide, in the field of traditional markets, livestock and agriculture have historically been two of Argentina's main industries. In fact, some of the largest meat and crop producing companies in the world are Argentinian. In this context, Argentina is one of the leading countries in the region in technology applied to both sectors: agtech and biotech. This, in addition to two other markets that have been growing steadily for the past few years – the fintech and commerce and enterprise software markets – and in which we have started to evidence (and will continue to see) a growing attraction and investment.
Notwithstanding the continuous growth seen in recent years, there is still a lack of institutional investors willing to invest in venture capital since it is still an unknown industry (in addition to the instability of the Argentinian economy and the lack of clarity of economic and legal rules). Therefore, as there are few local players in the investment ecosystem, fundraising by entrepreneurs becomes more complex.
Year in review
During 2019, US$14 million of seed capital and US$403 million of venture capital were invested. Only five start-ups captured 93 per cent of such funds invested: Ualá (US$150 million), Auth0 (US$103 million), Technisys (US$50 million), Statellogic (US$50 million) and Agrofy (US$23 million).2
During 2020, a year marked by the impact of covid-19 on the economy and on daily life in general, the companies that managed to raise capital were related to industries that grew exponentially since the pandemic, with technology as the protagonist of their business model. Some of these companies have to do with e-commerce, cybersecurity, business intelligence and the digital environment.
But there are also risky players who dare to invest in companies that have been more affected by the pandemic, but bet that once it is over, they will be able to reconvert and find an opportunity to shine in the market. In these cases, investors base their confidentiality almost exclusively on the talent of the team behind the venture, which is an invaluable asset of these incipient companies.
In a context of strong local economic crisis, the start-ups targeted by venture capital do not depend on the local market but are companies that are born with projection abroad and, therefore, are not so affected by local ups and downs. The most notable: L Catterton and Waha Capital's investment of US$200 million in Despegar, the leading online tourist agency in Latin America (originally Argentine).
The top 10 Argentine companies that raised capital in 2020 were: (1) Mural (US$118 million); (2) Onapsis (US$55 million); (3) Tienda Nube (US$30 million); (4) Checkars (US$10 million); (5) Nubimetrics (US$2.5 million); (6) VU Security (US$2 million); (7) Lemon Cash (US$1 million); (8) Agrofy (US$1 million); (9) Nawaiam (US$500,000); and (10) Plaza Logística (US$2 billion).3
Legal framework for fund formation
The legal entities used in the formation of venture capital funds in Argentina seek to bring investors together and also to separate the investment that entitles such investors to economic returns. The most common structure used in Argentina is the ordinary trust, which does not make public offering of its shares nor are they freely transferable.
Ordinary trusts have existed in Argentina since 1995, and are now regulated under Section 1666 et seq of the Civil and Commercial Code of Argentina.4 In the case of venture capital ordinary trusts, the investors will be trustors, beneficiaries and trustees at the same time and will be liable for making the committed capital contributions when requested by the fiduciary, which in most cases is also the fund manager. This structure provides legal protection to the investors, as the contingencies of one of the investors will not affect nor will be transferred to the others. The term of the ordinary trust is 30 years, which is more than sufficient considering the purposes of venture capital funds, which in most cases last between seven and 10 years.
Another structure worth mentioning is the financial trust. Although there is only one in Argentina, called CITES, the difference with this structure is that it has authorisation for the public offering of its trust securities by the National Securities Commission and its purpose is to finance or invest in venture capital.5 In this case, the fiduciary shall be a financial fiduciary who will be in charge of the issuance of trust securities, which in the case of CITES is the Banco de Valores. The purpose of CITES is to carry out investments in science-technology-based early-stage start-ups in the country, enabling a new option for qualified investors in alternative assets.
Another possible structure for venture capital funds from a theoretical perspective is the common fund. However, in practice there is no record of any common fund used for this purpose.
On 17 November, 2020, the National Security Commission issued General Resolution No. 868, which regulates financial trusts and common funds. The most relevant remarks of the Resolution include:
- the obligation to inform the valuation methodologies and selection mechanisms of the eligible companies to be used by the fund and the follow-up and divestment policies;
- the limits to investment in the same eligible company, in which case 20 per cent of the equity of the funds may not be exceeded, nor more than 35 per cent in the case of investments in companies of the same economic group;
- the requirement to have a professional manager – which shall be a legal person – for the selection and management of the invested assets, and a control committee aimed at monitoring investment management and compliance with the respective investment policies; and
- that the issuance of negotiable securities is limited to sharing certificates and condominium shares.6
When it comes to ordinary trusts, it is possible for them to create a committee, composed by key persons responsible for the fund management, or it is also possible for the ordinary trust to hire a third person to be responsible for this role. Fund managers serve as the investment advisers of the investee companies of the venture capital fund, and therefore are the ones in charge of searching for prospective opportunities to invest, selecting the start-ups in which the fund will invest and follow up on them once the investment is done, typically through the minor participation in the board of directors of the companies or as syndics.
Regarding tax matters, financial trusts7 are not deemed to be subject to income tax concerning local investments. This is not the case regarding investments done offshore. On the contrary, financial trusts under Federal Law 27,440 would be considered as a special type of pass-through trusts, and the income should be attributed to the investor (trustors or beneficiaries), who must determine and pay the pertaining tax in their personal tax return.
When it comes to ordinary trusts, two different alternatives shall be mentioned:
- Those cases in which (1) the trustors and beneficiaries of the trust are the same; (2) the trust could not be deemed as a financial trust;8 (3) there are no foreign investors (funders or beneficiaries); and (4) the option for the trust to pay as a limited company has not been exercised;9 the trust could be deemed as pass-through. Since the trust does not pay, but determines and attributes the income, investors (trustors or beneficiaries) must consider the attributed income in their tax return as income and pay the due tax.
- In the case of the ordinary trust as a company or ordinary trusts that do not comply with the requirements listed above in points (1) to (3), the trust shall be considered as subject to income tax. Argentine companies (including SA, SAU, SAS and SRL) are taxed at a rate ranging from 25 to 35 per cent, minus the dividends they collect that are not computable.10
Notwithstanding the aforementioned, given the rules and complexities of Argentine regulation, venture capital funds are typically set up abroad due to the industry structures to receive the investment, and leave them in a position to expand regionally.
As established in the Civil and Commercial Code of Argentina, the ordinary trust agreement must contain:
- the individualisation of the goods that are the object of the agreement and if such individualisation is not possible on the date of the execution of the trust, the description of the requirements and characteristics that the goods must meet shall be included;
- the determination of the way in which other assets can be incorporated into the trust, if applicable;
- the term or condition to which the fiduciary property is subject;
- the identification of the beneficiary, or the way to determine it;
- the destination of the assets at the end of the trust, with an indication of the trustee to whom they should be transferred or the way to determine it or the way of exit; and
- the rights and obligations of the fiduciary and how to replace him them, if they cease their functions.11
In the case of financial trusts, the agreement shall contain all the above-mentioned conditions as well as the terms and conditions of issuance of the securities, the rules for the adoption of decisions by the beneficiaries, including the provisions for the case of insufficiency or insolvency of the trust assets, and the name or particular identification of the financial trust.12
The work done by the fund managers is retributed and said retribution is most commonly agreed in the trust agreement between the parties, which could be either a fixed or variable fee, or subject to success.
The retribution could be made through a management fee, which is usually 2 per cent of the committed contributions of the investors; a carried interest, which could be up to 20 per cent of the results; and a subscription or purchase fee, equalling the sum of 1 per cent of each acquisition made by the fund.13
Financial trusts are regulated by the National Securities Commission (and the aforementioned Resolution No. 868 applies) whereas ordinary trusts are not specifically regulated, their parties having full discretion when it comes to their functioning.
Local companies (whether SA, SAS or SRL as chosen by the start-up) are regulated by the Registry of Commerce (IGJ).
Raising capital by start-ups
In Argentina, many start-ups seek financing abroad (after friends and family have invested in the project). It is very common for them to do so through a company incorporated in a foreign jurisdiction (generally Delaware) to facilitate the investment of their foreign investors and avoid undesirable currency exchange rates and foreign exchange entry and exit problems that unfortunately must be analysed when doing business in Argentina.
The first steps to raise capital when starting a company is through equity financing. At this stage, friends, family – and those who trust the project very much typically referred to as 'fools' – dare to invest. Angel investors, incubators and venture capital funds, depending on if the start-up is in a pre-seed (average investment amount US$25,000–US$200,000) or seed (average investment amount US$200,000–US$1 million) round are also key players at this stage. When an equity investor agrees to invest in a start-up, they invest in exchange for ownership in that business. This financial arrangement is different from debt transactions where lenders are repaid according to the terms that they agreed.
Once a company has developed a track record and understands how to monetise the business by having a concrete business plan, consistent revenue figures and expectancy for long-term profits, that company may opt for Series A funding. Typically, well-known venture capital firms participate in these rounds. Afterwards, if companies are prepared for success at a larger scale (i.e., if the companies have potential, and after Series A funding has been successfully finished), Series B and even Series C funding are typically used. In these cases, as the business has proved to be successful and consequently the investment gets less risky, more investors are willing to enter. In Series C, groups such as hedge funds, investment banks and private equity firms are also involved.
The legal documents to instrument equity financing are the following:
- Term sheets: set the framework and main terms of the investment, which may be binding or non-binding depending on each case. They expedite the entry of funds while negotiating the entry of investors that complete the round.
- Subscription agreements: set out the conditions for the subscription of shares and the methods of disbursement of the investment. They include, in a more detailed way, the terms already agreed in the term sheet.
- Shareholder agreements: regulate rights and obligations of the investor (now shareholder) in the decision-making process in order to take care of his investment and the relationship towards other investors and sponsors or founders.
There are also other ways of raising capital through debt. Bridge financing takes place when investors invest in a start-up business with a short-term loan to help it reach the next round of funding, on the basis that they will receive their money back. Start-ups use bridge financing or a 'bridge round' to help them get to a significant round of funding such as equity funding. In general, they are instrumented through loans convertible into shares.
The different alternatives that are being used when seeking debt financing are discussed below.
i Convertible debt security
This is basically a loan convertible into shares if certain events occur (i.e., change of control or maturity date). Thus, if the venture fails, the investor is in a better position by having a debt security than by having equity in the company.
The convertible debt security allows the discussion regarding the valuation of the company to be deferred to the moment when a new investment round is closed. Additionally, by having (1) a valuation cap (the maximum valuation of the company at which the investor may convert its loan into shares) and (2) discount clauses (set to be applied on the valuation reached by the company at the time of converting the investment in those cases in which the start-up does not reach the cap), the founders or early investors suffering a dilution of their participation in the company can be avoided.
Some disadvantages are that it will burden the company with debt, and it is always unknown whether its balance sheet will support it. Also, to the extent that the conversion is not exercised, interest will accrue. It also does not grant political rights (votes) to the extent that the option is not exercised (it can be exercised until maturity); and investors do not participate in the distribution of dividends until the option is exercised. Another disadvantage is the very high transaction cost involved in negotiating the clauses of this document.
ii Simple agreement for future equity (SAFE)
Created by the start-up incubator 'Y Combinator' in 2013, the SAFE is a subscription agreement for future shares of the company.
Unlike the convertible debt security, the SAFE has no maturity date and only triggers its conversion into shares if certain events are met.
Thus, in the event of conversion, it is capitalised in the company and will entitle the holder to shares, which will be calculated taking as reference valuation the negotiated cap or the actual market valuation applying the discount (depending on the negotiated value).
The SAFE does not accrue interest or pay capital, so it can be assimilated to equity and not to debt. It will be automatically converted into equity in the event of an investment, it does not grant political rights (votes) if the conversion does not occur, and the investors participate in the distribution of dividends even before the conversion. This document is intended to be short, clear and to reduce the negotiation and drafting time, as well as the expenses in professional fees of the corresponding legal advisers.
In all cases it is important that the bridge financing is approved by the company's board of directors, and to verify that no special authorisations are required (e.g., from the shareholders, if there is a signed shareholders' agreement).
iii Keep it simple security (KISS)
KISS is an alternative to the SAFE and was created for the main purpose of allowing an investor to invest money in the company and receive the right to purchase shares in a future equity round when it occurs.
KISS includes a maturity date, like the convertible note, but does not accrue interest to the investor. There is also an 'equity version' of the KISS, without a maturity date and interest, which is seen as a middle ground between the convertible note and the SAFE.
Different from the SAFE, KISS contains a 'most favoured nation' clause, which allows the investor to get better securities in the future if issued by the company.
As mentioned, these ways of financing are commonly used abroad. When it comes to Argentina, it is advisable to understand the venture capital operation to evaluate which is the preferred structure for financing to try to receive any of the above-mentioned alternatives in accordance with local laws.
From a different perspective, with the enactment of the Entrepreneurial Capital Support Law No. 27,349 in 2017 (the Entrepreneurial Law) and the establishment of the Entrepreneurial Capital Development Fund, great possibilities have been opened up for the development of Argentine projects, from tax benefits and credits for venture capital institutions, granting of loans to ventures, and the implementation of crowdfunding platforms.
Crowdfunding was born as an alternative to traditional methods of financing that do not always consider the realities experienced by local entrepreneurs. What is new and advantageous of this way of financing for entrepreneurs is that, on the one hand, interest rates are usually lower than in traditional financing and, on the other hand, it allows investors to be repaid not only in money, but also in shares, products or other forms of remuneration.
There are three main types of crowdfunding that depend on the type of reward obtained by the investor:
- Reward crowdfunding: investors will receive a product or service in return for the money invested.
- Crowdfunding by donation: the investor does not expect a return in exchange for the money (often related to non-profit companies or social actions).
- Crowdfunding for shares (also called 'equity'): investors receive shares of the company in exchange for their financing.
Crowdfunding platforms in Argentina are regulated by the National Securities Commission, which operates under the Ministry of Economy. There is no specific crowdfunding law, but it is regulated by the Entrepreneurial Law.
The Entrepreneurial Law also implemented the FONDCE – a trust fund for the development of entrepreneurial capital to facilitate the financing of entrepreneurs in Argentina. Credit of up to 250,000 pesos at no interest rate to be paid in up to six years can be requested. However, since these initiatives are relatively new, we will continue to see their impact in the upcoming years.
The capital markets in Argentina are not as established as they may be in other more developed and economically stable countries. Consequently, the exit of start-ups, meaning the sale of its equity – or part of it – either by going public or by being acquired by another company, has its nuances.
IPO as itself is not a common exit for start-ups in Argentina. Consequently, this exit is commonly used in foreign jurisdictions, especially in the United States.
We have seen one case of an Argentine (in its inception) company – Satellogic14 – that merged with SPACs to go public. We shall note that as mentioned above it was not in the Argentine stock exchange, but nothing prohibits a dual listing from a legal perspective.
When it comes to M&A, the aforementioned uncertainty about political and economic path that characterises Argentina has caused investors to look at the country with higher distrust, which has resulted in a significant decrease in M&A transactions in the jurisdiction. Ongoing transactions actually involve foreign investors wishing to exit the companies in which they have invested through the sale of their shares or stock capital, or in lesser cases, speculative investors seeking distressed companies to achieve higher profitability in the future. However, as mentioned above, there always are risk-taking investors who take advantage of economic downturns to invest on especially those sectors that are deemed to blossom down the road, such as the tech sector. In this respect, we can conclude that M&A is the exit that is mostly used nowadays in Argentina.
As described in this chapter, Argentinian start-ups are pretty much created with a regional approach in order to raise foreign investment.
Despite local economic and regulatory difficulties, in the next few years we are likely to see a lot of investment in areas such as agtech, biotech, fintech and commerce. As mentioned, one of the main attractions for investors is the Argentine talent, which has proven to be fruitful on many occasions, as in the cases of the start-ups mentioned throughout this chapter.
While there has been a slowdown in activity due to the pandemic and the economic conditions, we do not anticipate any regulatory changes in the near future. However, we expect a recovery in the sector led by the tech sector.
1 Tomas Allende is a partner and Maria Lucila Seco and Marina Heinrich are associates at Beccar Varela. The authors wish to thank Lucía Aldanondo for her contribution.
4 Section 1666 of the Civil and Commercial Code of Argentina establishes that 'there is a trust contract when a party, called the trustor, transmits or undertakes to transmit ownership of goods to another person called the fiduciary, who is obliged to exercise it for the benefit of another party called beneficiary, which is designated in the contract, and to transmit it to the trustee upon expiration of a term or fullfilment of a condition.'
7 Please note that we are referring to financial trusts that could be framed under the Productive Funding Law No. 27,440 and Decree 382/2019. Although this regulation comprises most of the financial trusts approved for public offering by the National Security Commission, it would be advisable to review each specific case, as the tax impact could change otherwise.
8 Including financial trusts that cannot be framed under the Productive Funding Law.
9 Pursuant to Section 73(a)8 of the Income Tax Law, ordinary trusts can choose to be deemed as subject to income tax instead of being considered as pass-through.
10 'Vehículos legales de venture capital y private equity en la Argentina y los Estados Unidos' by Nicolás Malumian, published on April 2021.
11 Section 1667 of the Civil and Commercial Code of Argentina. http://servicios.infoleg.gob.ar/infolegInternet/anexos/235000-239999/235975/norma.htm.
12 Section 1692 of the Civil and Commercial Code of Argentina. http://servicios.infoleg.gob.ar/infolegInternet/anexos/235000-239999/235975/norma.htm.
13 'Vehículos legales de venture capital y private equity en la Argentina y los Estados Unidos' by Nicolás Malumian, published in April 2021.