Venture Capital in Brazil

Editor’s note: Venture Capital in Brazil is rapidly evolving as a number of highly innovative new enterprises take central stage in the technology, insurance and financial fields. Frequently seen on top of economic and legislative innovation, Pinheiro Neto Advogados is a leading player in this area. It has developed a highly specialised practice in which several of the most prominent investors have relied upon as they target and boost the most promising startups in Brazil. With international experience and continuous dedication to the area, Pinheiro Neto partner Álvaro Silas Uliani Martins dos Santos spearheads the practice. He authors the overview below.

Venture Capital in Brazil

The debut of the Brazilian venture capital sector in Chambers and Partners results from a swift development of a sector that has been sparkling the interest of local and international investors. Increasing numbers of venture capital players have been attracted by the unique set of growth opportunities that Brazil presents to them, which is primarily supported by strong internal consumer market, solid economic and regulatory framework, one of the most diversified ecosystems with some of the keenest start-ups when it comes to scaling internationally, and large number of start-ups that require far more capital than is available in the domestic market.

With respect to the size of the industry, over the year of 2020, venture capital funds with allocation to Brazil raised around BRL 1.4 billion, and total venture capital investments in Brazilian start-ups amounted to approximately BRL 14.6 billion, distributed among 200 invested companies. It is important to stress that those numbers result from a challenging pandemic scenario. In the first quarter of 2021, investments in Brazilian start-ups amounted to approximately BRL 8.8 billion vis-a-vis BRL 2.4 billion invested in the same period of 2020, and the expectations are high for the remainder of the year.

At the end of February 2020, when covid-19 pandemic arrived in the country, the venture capital sector optimism found in early 2020 was replaced by the prospect of a year with scarcer and more selective investments. But now, looking back, many venture capital players mention that 2020 has proven to be the year of consolidation of the venture capital practice in Brazil, with Brazilian investors showing their good eye and well-known resilience.

Relevant investments in Brazilian start-ups were made in a variety of sectors, but without a doubt, the leading has been the FinTech & InsurTech industry. More recently, Healthtech, Edtech and Retailtech industries have also been seen as key sectors for start-ups, drawing relevant investors’ attention.

In light of the above, the venture capital sector has been drawing the attention of regulators and legislators in Brazil. The most notable and recent development directly affecting the venture capital markets and start-ups was the approval, on June 1, 2021, of Law No. 182, known as the “Start-ups Legal Framework” (Marco Legal das Startups).

Perhaps the most important change brought by the Start-ups Legal Framework to venture capital investors is the clear liability limitation set in relation to these investors, however, only specifically when the investment is not carried out directly via equity (i.e., when investments are in fact made via convertible-into-equity titles, such as convertible loans, debentures, options, warrants and any other instrument not involving the direct subscription or purchase of equity). In these cases, the Start-ups Legal Framework is clear in the sense that investors should not be held liable for any debts and liabilities of the invested company, except in cases of fraud or wilful misconduct in which the investor is involved. Such provision is relevant because when it comes to investor liability in Brazil, there is an existing legal uncertainty as to the extent investors can be held liable for invested companies’ liabilities, mostly related to labor and consumer rights matters.

Start-ups Legal Framework also created a special type of public bidding that authorizes the public administration to present a certain technological challenge that should be resolved by respective participants. This measure is intended to encourage start-ups to join public biddings and to make such biddings more approachable and accessible, given that participants are not required to have a service or product ready when of their application to the public bidding.

Another relevant outcome of the Start-ups Legal Framework is the creation of experimental regulatory programs (called regulatory sandbox), in which public authorities responsible for sectorial regulation may dismiss certain requirements and rules of its own concern to selected start-ups. The purpose of this provision is to provide start-ups with freedom to experiment and reduce bureaucracy to create products and services.

Besides the noteworthy innovations mentioned above, there were also changes to the Brazilian Corporations’ Law (Law No. 6.404/1976) brought by the Start-ups Legal Framework, such as the decrease of the mandatory number of officers from two to one and the flexibility of not having to publish certain corporate documents, including corporate books that can now be digital. These rules are currently applicable to start-ups incorporated as a Brazilian joint-stock company (sociedade anônima) that do not surpass a certain annual income.

In the upcoming months, it is expected to have updates and activity on the Brazilian special purpose acquisition company (SPAC) regulatory framework and market. In light of the spiking interest from global investors as an alternative exit strategy for venture capital investments, with record year for SPAC IPOs in the United States in 2020 and some of those new SPACs raising money in Nasdaq with a mandate to buy Latin American private growth companies, the Brazilian Securities and Exchange Commission (CVM) has recently turned its attention to this matter.

In March 2021, CVM launched a public consultation, with a proposal to reformulate the regulatory framework for securities public offerings, and in this consultation the Brazilian regulator formally (i) recognized growing popularity of SPAC IPOs in the USA; (ii) confirmed that those offerings are not prohibited by Brazilian regulations; (iii) indicated that the Brazilian private equity investment funds, in certain aspects resemble SPACs, with regard to their object; and (iv) called the market agents to speak out about the target audience of SPAC offerings in Brazil.

Although SPAC structures have not been implemented in Brazil yet, there are three potential structures that could be explored in the near future: (i) using a Brazilian private equity investment fund as a SPAC; (ii) using a Brazilian joint-stock company (sociedade anônima) as a SPAC; or (iii) carrying out an offer, in Brazil, of Brazilian Depositary Receipts – BDRs of a foreign SPAC.

It is expected that this industry continues to grow in the future mainly due to: (i) general economic drivers; (ii) recent reforms on labor and social security matters; (iii) diversified ecosystems; (iv) dropping interest rates; and (v) recent regulatory and law changes that demonstrate the attention of the Brazilian regulators and Legislative Power to the ecosystem. However, there is still room for improvement in relevant topics, such as the tax treatment of stock option plan and the SPAC potential structures in Brazil.

Finally, it is worth mentioning that there is an ongoing Tax Reform in the National Congress, that, if approved by the Senate, would cause material to the venture capital investment structures. Among the most relevant proposals of the Tax Reform are changes to (i) profits and dividends taxation (currently the general rule is that dividends in Brazil are exempt from income tax); (ii) capital gain on indirect disposal of Brazilian assets; (iii) tax treatment of stock option plans; (iv) the contribution of assets in foreign companies (that according to the bill shall be made at effective market value, so that the capital gain is also taxed); (v) amortization of goodwill; and (vi) controlled foreign corporation rules and individual income tax.