On January 1st, 2017, rules applicable to investments made on “micro-enterprises” (companies with annual gross revenue lower than R$360,000.00) and “small-enterprises” (companies with annual gross revenue lower than R$4,800,000.00) by angel-investors, became effective for the first time in our country’s legal system, through Supplementary Law # 155 dated as of October 27th, 2016 (Sections 61-A, 61-B, 61-C and 61-D).
In short, the aforementioned Sections of Supplementary Law # 155 determine: (i) the possibility of investing in the company without allocating the resources as corporate capital; (ii) the creation of a bidding agreement designated “participation agreement” (Contrato de Participação), where all the transaction details will be determined; (iii) that the angel-investor: (a) will not be considered an equity holder nor shall have managing or voting power; (b) shall not be liable for any company’s debt; (c) shall be compensated for its investments for the maximum term of 5 years and such compensation shall not exceed 50% of the company’s profit; (d) may only withdraw its investment after, at least, 2 years of the investment date; (e) shall have preference rights on the acquisition of equity in case of sale of the company and tag-along rights of the investment.
Supplementary Law # 155 is an inspiring measure that seeks, among other purposes, to increase angel investors’ legal certainty regarding the concern of potential liability for the company’s debt and other contingencies; and preference and tag-along rights.
Currently, we see a clear conflict of corporate law, civil law and legal studies in these fields (that provide the investors independency, individualization and liability limitation) against lato sensu definitions of “economic group” and “piercing the corporate veil” inserted in paternalist case laws of labor and tax courts. The challenge here will be the consolidation of the legislator’s position and the success of its original purpose against current opposing case law.
It should also be highlighted that the legislator lacked to clarify many other important matters, imperative to the sector’s growth, and creates doubts related to the so called “participation agreement” about which it failed to unfold. Additionally, Section 61-A is redundant, since it states that the investment allocated by the angel-investor will not be considered as corporate capital (equity investment). Well, if the investment is structured as a debt investment it obviously will not be allocated as corporate capital until it is converted to equity.
It is common for Startups in Brazil to use Convertible Debt (in case of Brazilian limitadas) or Convertible Bonds (in case of Brazilian corporations) as fundraising tools to angel-investors. Alternatively, some use a more complex structure, chosen when there is a potential to raise funds abroad, where a U.S. LLC will be formed and becomes majority shareholder of the Startup and a convertible note is issued to investors. Although all these structures are valid and legally possible, the lack of Brazilian case law as for the Convertible Debt structure creates uncertainty to investors.
Besides the important attempt brought by Supplementary Law # 155 to protect angel-investors in regards to the company’s debts and liabilities, safeguard preference rights and tag-along rights, the legislator could have broaden the matter to legally consolidate fundraising methods, which are crucial to the development of innovation and productivity brought by Startups in Brazil and thus raising the chances of solidifying case law towards a pro-investor position.
Gustavo de Lima Palhares – Furriela Advogados
1701 Pennsylvania Avenue NW
Phone: +1 (202) 580-6641
Av. das Nações Unidas, 10.989
Phone: +55 (11) 3040-4900