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This analysis was provided by TozziniFreire Advogados
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The analysis for Brazil includes articles on Brazil Revenue Based Finance -Debt and Brazil Revenue Based Finance – Equity
Executive Summary
This research paper summarizes the main structures identified for revenue-based financings available in Brazil.
While Brazilian laws does not provide for concepts that are designed specifically for revenue-based financing1 , companies and investors may structure transactions by adjusting existing types of funding mechanisms available under existing regulations. For the purposes herein, we will suggest three types of structures, under equity, debt and receivables discount models:
Equity: investment by acquiring equity interest is one of the most common types of investment in Brazil. The acquisition of equity interest may occur by means of (i) execution of a share/quota purchase agreement, (ii) execution of a convertible loan, (iii) increasing the corporate capital by means of execution of an investment agreement, and (iv) incorporating a Brazilian subsidiary. Brazilian law provides for several types of legal entities, of which the Sociedade Limitada (limited liability company) and the Sociedade Anônima (corporation) are the most commonly used. Other company types are seldom used in practice, because most of them provide for unlimited liability of their partners. For limited liability companies and corporations, the partners liability is limited to their paid stake in the corporate capital and there are generally2 no minimum capital requirements. Moreover, dividends are currently tax exempt in Brazil, regardless of the status of the beneficiary. In this type of investment, it is possible to ensure a minimum return by means of (i) defining the interest in the convertible loan agreement; (ii) a put option, granted in an agreement between the partners and the company; or (iii) using redeemable shares.
Debt: issuance of debentures. A debenture is a security issued by a corporation (sociedade anônima), with mechanics that are similar to bonds governed by New York laws. The terms and conditions of the issuance of the debentures are regulated in an indenture executed by the issuing company. The debentures are essentially fixed-income debt instruments where the debenture holders are entitled to receive the repayment of the principal amount plus an accrued interest (fixed or floating). However, Brazilian laws allow the issuing company to stipulate that debenture holders may have the right to receive a share in the company’s profits or even an additional premium fee, which is based on income or profit variations of the company. The investors are usually represented by a fiduciary agent (similar in nature to a trustee). Debentures are one of the most relevant debt instruments used by companies in the Brazilian capital markets.
Receivables discount (securitization): funding granted by receivables investment funds (Fundos de Investimento em Direitos Creditórios – “FIDC”), which is a form of condominium regulated by the Brazilian Securities Commission (Comissão de Valores Mobiliários – “CVM”). The FIDC is a fund whose main purpose is to purchase receivables from Brazilian entities, and it benefits from technical and specialized services of administration, portfolio management and custody of the investments, provided by regulated entities. The FIDC is funded by investors, which in turn receives quotas issued by the FIDC. Although the FIDC (and investment funds in general) operate similarly to companies, it does not have a legal personality. Earnings from investments are distributed to FIDC’s quotaholders. On the other hand, the FIDC’s quotaholders also bear losses and other expenses that compose its liabilities. The FIDC is a viable way of ensuring that companies obtain cash by anticipating their receivables (revenues) without incurring in additional debt.
Members of TozziniFreire Advogados are qualified to practice law in the Federative Republic of Brazil. We do not express herein any answer concerning any law other than the law of the Federative Republic of Brazil.
Equity Interest
Investment Structure Summary
For investment in Brazilian companies, it is possible to (i) incorporate a Brazilian subsidiary or a joint-venture; (ii) acquire quotas/shares held by third parties in a Brazilian entity; (iii) subscribe new quotas or shares in a Brazilian company, by means of a capital increase; or (iv) execute a convertible loan with an existing company.
Category
Equity
Category for tax purposes
Equity investors are compensated either via dividends or gains on the sale of quotas/shares. Dividends are currently tax- exempt in Brazil, regardless of the status and location of the beneficiary. Capital gains are generally subject to progressive rates ranging from 15% to 22.5%, but actual rates vary depending on the shareholder’s status and location (see Critical Tax Considerations below).
Governance Rights
The owner of the equity interest in Brazilian companies is usually entitled to vote in quotaholders/shareholders resolutions and its voting rights will depend on the percentage held in the Brazilian entity and rights negotiated in the shareholders/quotaholders’ agreement. The lender of a convertible loan will acquire voting rights only after the conversion of the loan, but it is possible to protect the investor with early maturity of the debt.
Investor Qualification Requirements
In general, there are no restrictions on qualification of the investors of Brazilian companies. However, there are specific qualification requirements for investments in certain companies performing regulated activities (e.g., banking, energy, telecommunications, among others).
Also, the investor needs to be enrolled with the Brazilian tax authorities and the Brazilian Central Bank (in case of foreign investors).
Foreign investors must also appoint a Brazilian resident representative as its corporate attorney-in-fact, with powers to receive summons, and also a legal representative before the Brazilian Internal Revenue Service, as required by Law No. 6404 of December 15, 1976.
Currency Considerations
The payment of the corporate capital of the Brazilian entity must be in Brazilian reais. Also, any capital increase of the Brazilian entity made by foreign entities in other currency will need to be converted into Brazilian reais, by means of a foreign exchange agreement, registered with the Brazilian Central Bank.
In case of acquisition from third parties, the payment can be made in another currency.
Collateral
Not applicable
Priority Payment Rights
It is possible to issue preferred shares or quotas in Brazilian entities, with priority in the distribution of dividends or priority in case of liquidation of the company. The issuance of preferred shares is limited to 50% of the company’s voting corporate capital.
Distribution and Redemption Limitations
In order to distribute dividends to its shareholders/quotaholders, the Brazilian entity must have accrued profits in its financial statements sufficient to offset any losses from previous fiscal years, so that the positive difference may be distributed.
Therefore, prior to any distribution, the dividends received in the current fiscal year must be used to reduce the losses from the previous fiscal years and then the balance could be remitted to the shareholders/quotaholders.
It is possible to set a fixed percentage of profits to a partner in a shareholders/quotaholders’ agreement, in order to ensure a minimum capital return.
The payment of the convertible loan is not subject to the existence of profits by the company.
Legal limitations to pricing or total return
Not applicable to limited liability companies. For joint-stock corporations, the issuance price of the shares shall be established without any unjustified dilution of the interests of previous shareholders, even if they have a right of first refusal to subscribe to the shares, taking into account, either alternatively or jointly (i) the profit expectation of the corporation, (ii) the net worth of shares, (iii) the quotation on the stock exchange or organized over-the-counter market, taking into account the premium or discount value due resulting from market conditions, according to Law No. 6404 of December 15, 1976.
For accommodating revenue-based financing, for closely-held companies, it is possible to provide in an investment agreement the schedule of payments of the investor and grant a put option against the invested company or the current partners, in which the put option price will be calculated in accordance with financial indexes, such as revenue, EBITDA, or any other formula to calculate the repayment, using thresholds and payment in installments. In addition, for both closely held and public companies, it is possible to issue common or preferred redeemable shares, provided that the bylaws provide the redemption price, conditions and if the corporate capital will be reduced or not. The redemption price should be calculated using the same criteria as the issuance price mentioned above and the company shall use its profits, its reserves or its corporate capital to pay such price.
Status in Insolvency Proceedings
In case of insolvency of a Brazilian entity, the shareholders/quotaholders are not considered creditors and will only receive any amounts if there outstanding balance after the payment of all creditors.
The lender of a convertible loan, on the other hand, is considered a creditor and an early maturity of the debt in case of insolvency, judicial/extrajudicial recovery or bankruptcy is used to protect the investor.
Limitation of Liability
The investors’ liability is limited to the amount of the corporate capital of the Brazilian entity.
If the corporate capital of the limited liability company is not paid-in, all quotaholders are jointly liable, limited to the amount of the corporate capital.
The lender of a convertible loan is not exposed to the company’s liabilities.
Transfer Restrictions
There are no general transfer restrictions of shares/quotas provided in Brazilian law. Transfer restrictions are usually provided in the shareholders/quotaholders’ agreement of the Brazilian entity. The most common provisions are:
- Right of first offer;
- Right of first refusal;
- Lock-up
Critical Tax Considerations
Dividends are currently tax exempt in Brazil, regardless of the status and location of the beneficiary.
Taxation of capital gain on the sale of shares/quotas may vary depending on the shareholder status and location. Brazilian individuals and foreign investors not located in a tax haven jurisdiction will usually be subject to progressive rates ranging from 15% to 22.5%, depending on the size of the gain. The rate is 25% for foreign investor located in a tax haven jurisdiction. Taxation of Brazilian legal entities will vary according to the legal entity’s tax regime. A foreign investor duly registered with Brazilian Central Bank as portfolio investor (Resolution 4.373) and not located in a tax haven jurisdiction will be afforded with capital gain exemption if the sale is carried out in the stock exchange.
- For the purposes of this research, as instructed, “revenue-based finance” means a funding/finance arrangement under which the investor has a priority right to receive repayment/distributions up to an agreed portion of “gross revenues” or “free cash flow”, until an agreed return on the investment is reached (whether or not the investor continues to participate in the equity upside after that)..
↩︎ - Certain regulated sectors, such as the banking and insurance sectors, do impose minimum capital requirements. Therefore, it is recommended to double-checked this aspect from a regulatory standpoint. ↩︎