BRAZIL: An Introduction to Venture Capital

Navigating the Brazilian Venture Capital Landscape: An Outlook on Growth, Innovation and Regulations

The outlook for venture capital (VC) transactions in Brazil reflects a dynamic landscape that has been evolving with the country’s economic growth and increasing interest in entrepreneurship. Brazil has emerged as a key player in the global venture capital scene, attracting both domestic and international investors. The nation’s diverse market and growing tech ecosystem contribute to an optimistic outlook for VC transactions.

The global recognition of the country’s potential, combined with successful exits and unicorn stories, draws increased attention from foreign investors. This international interest not only brings additional capital, but also facilitates knowledge transfer and the integration of global best practices, contributing to the overall development and sophistication of the local VC landscape. Brazil had a very successful first VC fund cycle, has several active second-time entrepreneurs and a market extremely underpenetrated by VC funds (with 0.12% of the GDP in VC, versus 0.60% in the US and 0.33% in China). All this with an impressive population of 220 million people in a geopolitically neutral country. According to recent research from the Brazilian Association of Private Equity and Venture Capital (ABVCAP), Spectra Investments and Insper, it is not only VC funds that actually outperform private equity (PE) funds in Brazil; during the analysed period, PE and VC funds outperformed public equivalent alternatives, such as IBOVESPA , CDI and MSCI EM. As pointed out by Valor Capital, Brazil is the beta market of the world.

Brazil counts on a diverse and growing talent pool, particularly in the fields of technology, engineering and innovation in general. In this sense, investors in the Brazilian VC scenario have increasingly recognised the value of founder-driven investments. The dynamic nature of Brazil’s start-up ecosystem encourages the formation of agile and talented teams. The Brazilian VC landscape benefits from a young and skilled workforce, making it an attractive market for acqui-hire transactions, where acquiring specialised talent is a priority.

Brazilian legal and regulatory framework

Brazil has established a regulatory framework that supports and encourages VC investments. For instance, the Brazilian Securities and Exchange Commission (Comissão de Valores Mobiliários or CVM) regulates the operation of investment funds, providing a clear legal structure for funds used as VC/PE vehicles (such as FIPs) and ensuring transparency and investor protection. Brazilian law also accommodates cross-border transactions. Foreign investors can participate in Brazilian VC funds, and regulations are in place to facilitate international collaboration.

The Brazilian government has taken steps to simplify regulatory procedures for new, innovative businesses, directly benefiting VC investments. These include streamlined registration processes and reduced administrative burdens, making it easier for start-ups to operate and attract investors.

Brazilian law facilitates exit mechanisms, a sensitive point of attention for VC investors. While initial public offerings (IPOs) are one option, the legal framework also supports very diversified M&A structures as viable exit strategies, providing investors with flexibility in realising returns on their investments. Brazilian law also sets forth provisions aimed at protecting minority investors. These provisions ensure that minority shareholders, including VC investors, have certain minimum rights and protections, contributing to a fair and transparent investment environment.

A significant recent development is the enactment of a new regulatory framework for investment funds by the CVM, aimed at reshaping the investment funds industry in Brazil. This regulatory modernisation, brought about by the Economic Freedom Law (Law No 13,874/2019), consolidates important rulings and introduces substantial changes through CVM Ruling 175.

CVM Ruling 175 consists of a general section encompassing rules applicable to all investment funds, alongside distinct schedules, each meticulously regulating various types of funds. Amongst its major changes, the ruling allows for the creation of different classes of quotas with distinct rights and obligations. Each class of quotas can have a segregated portfolio of assets, providing flexibility and potential cost reductions for both service providers and investors. It also allows funds to issue multiple classes of quotas and introduces the concept of subclasses of quotas, allowing for customisation of characteristics such as amortisation, redemption, fees and profits distribution.

The ruling also introduces a definition for crypto assets, expanding the list of eligible assets for investment funds. However, it specifies that crypto assets must be traded in regulated environments, either in Brazil or abroad, through institutions authorised by financial regulators. In addition to crypto assets, carbon credits were also included in the list of eligible assets for investment funds, but the ruling currently limits investments to carbon credits existing under Brazilian regulation, such as Decarbonisation Credits (Créditos de Descarbonização or CBIO).

The CVM Ruling 175 also aims at streamlining the decision-making process for investment funds, allowing for more flexibility in fund by-laws to address new matters. This includes provisions for payment in kind, issuance of new quotas for closed-end funds, preferred rights on quota issuance, and the creation of a reserve for managing exceptional illiquidity circumstances (additionally, it introduces insolvency rules, allowing quotaholders to decide on actions if the net asset value becomes negative). CVM Ruling 175 also enhances flexibility for local investment funds to invest abroad, raising the limit from 20% to 100% of their net asset value.

Conclusion  

Several Brazilian agents acknowledge the importance of nurturing the start-up ecosystem and this view has a direct impact on the local VC landscape: in addition to all the private and legal landscapes, development banks in Brazil often collaborate with VC initiatives, including through credit lines for innovation provided by the Brazilian Development Bank (BNDES), the main financing agent for development in Brazil, and through several initiatives from the Brazilian Trade and Investment Promotion Agency (Apex-Brasil), a non-profit body that actively promotes exports, the internationalisation of Brazilian companies and foreign direct investment, in support of national public policies and strategies, in order to contribute to the sustainable growth of the Brazilian economy. By providing financial support and incentives, these institutions further enhance the attractiveness of VC investments, especially in sectors crucial for economic development.

While the outlook is positive, challenges persist. Market volatility, regulatory uncertainties and macroeconomic factors can greatly impact investment decisions. However, proactive measures such as diversification of portfolios, robust due diligence and strategic partnerships can mitigate these risks. The resilience and adaptability of venture capitalists in navigating challenges, paired with a landscape that has shown flexibility in deal structures, allowing for creative and tailored arrangements, contribute to the overall strength of the sector.

As the country’s entrepreneurial ecosystem continues to mature, the VC landscape is likely to play a pivotal role in shaping the future of innovation and business growth in Brazil. These factors most likely indicate a favourable environment for increased investment activity.