After a remarkable 2020 for both private equity investments and exits in Brazil, with Brazil accounting for approximately 59% of the total number of investments and 62% of the total number of exits completed in Latin America in 2020 (according to data released by The Association for Private Capital Investment in Latin America – LAVCA), private equity deal flow looks bullish in 2021.

A combination of factors has been driving this spike in the number of M&A:

• with some more clarity brought by a slow, but ongoing, process of recovery from the COVID-19 pandemic, investors are now capable of modelling and forecasting returns on investments;
• Brazil’s local benchmark interest rates are currently at their lowest ever levels;
• during the past couple of years, Brazil’s legal and regulatory framework has undergone important enhancements, such as the Economic Freedom Law, the Social Security Reform and the Labour Reform (all detailed in the Brazil chapter of the previous edition of this guide), Brazil’s newly approved legal framework for start-ups and innovation companies, among other material changes; and
• IPOs gained traction again in 2020 as a realistic exit alternative (although the market in 2021 has become more selective than in 2020, in terms of asset profiles and valuation multiples, the pace of IPOs and follow-ons remained steady).

The pandemic brought some important takeaways in terms of trends on deal execution, as it demanded creativity and focus, without losing sight of caution.

Legal due diligence has become more efficient, with increased attention to sustainability, compliance and cybersecurity issues.

Local market practice has grown more receptive of pricing structures commonly adopted in other jurisdictions, such as the locked-box and earn-outs, in addition to traditional completion accounts arrangements.

Given the fierce competition for some of the best assets on the ground, M&A handled through competitive processes have somehow become the general rule. For obvious reasons, risk allocation has also shifted, with parties conceiving more detailed and carefully crafted “material adverse effects”, conduct of business and force majeure provisions.

Last, but not least, the possibility of executing documents electronically has brought a lot more efficiency to signing and closing procedures. In addition, despite some cons of social distancing (ie, difficulty in site visiting and doing the groundwork that is sometimes crucial in an M&A process), clients and other advisers seem to have adjusted well to the dynamic of video conferences and remote meetings, which has contributed to making M&A processes more efficient. 

Alternative investments in infrastructure, venture capital (VC), special situations, impact investing and private credit strategies have been particularly strong over 2020 and the first half of 2021. Traditional growth and development investment strategies in middle-market companies have remained steadily bullish (particularly where there is most competition for local assets).

In terms of sector focus, in addition to those that fared well during the pandemic, such as renewables, health, technology, financial services, education, agribusiness and life sciences, some other sectors, such as industrial facilities, retail, services’ outsourcing, utilities and real estate, are picking up again.

Social Security Reform

Constitutional Amendment No 103/2019, also known as the Social Security Reform (the "Reform"), changed the local social security system and may be seen as a step to organise the Brazilian government accounts. As an immediate consequence, it is expected that the new regulations will foster economic development through legal certainty, which will also help the country to attract new investments.

Almost two years after its approval in October 2019, the Reform is already well established. As part of the positive agenda to strengthen economic trust in the Brazilian government, the Reform is among the factors that have encouraged foreign investors to invest in Brazil.

Economic Freedom Law

In 2019, Law No 13,874/2019, known as the Economic Freedom Law (the "Law), came into force, the purpose of which is to create a more dynamic and liberal, and less bureaucratic, economic environment for doing business in Brazil.

The Law was conceived with the purpose of decreasing intervention in the economy. As a means of achieving this, the law is based on the following main principles:

• freedom in economic activities;
• assumption of individuals’ good faith before public authorities; and
• government intervention in economic activities must be secondary and exceptional.

The Law had a direct impact in the private equity marketplace, given the express provisions on limitation of liabilities afforded to onshore-fund shareholders. In December 2020, the Brazilian Securities and Exchange Commission (Comissão de Valores Mobiliários or CVM) submitted a resolution proposal to public hearing, based on the framework brought by the Economic Freedom Law. The purpose of these new regulations is to detail the limitations on liability of stakeholders of onshore funds. It is also intended to bring clearer definition to the issue of classes of shares by funds and design a clear set of attributions of local general partners (GPs) and so-called administrators.

The Legal Framework for Start-ups and Innovative Entrepreneurship

The Legal Framework for Start-ups and Innovative Entrepreneurship, also known as Marco Legal das Startups, was published in June 2021 and aims to simplify the ecosystem for innovative companies, foster investment in innovation and facilitate the contracting of innovative solutions by the public sector.

The law may serve as a first step for regulating the start-up market in the country. For example, the mechanisms introduced to incentivise investments, streamline business formation, simplify certain daily routines (exemption from publication of financial statements and the possibility for companies to use electronic corporate books for recording entries) and ease the process of contracting with government authorities/companies (with the introduction of regulatory sandboxes).

"Fiagro"

Law 14,130/21, enacted in 2021, has introduced a new onshore regulated fund type called Investment Funds in Agro-industrial Productive Chains (also known as "Fiagro"). It is a collective investment vehicle aimed at fostering private agribusiness financing.

There are three categories of Fiagros: Fiagro-Credit Rights; Fiagro-Real Estate; and Fiagro-Holdings. The CVM is still to rule on these new categories.

GovTech Law

The GovTech Law enacted this year (Law 14,129/2021) sets out principles, rules and legal instruments to the digital government. The purpose is to reduce red tape, increase public efficiency and bring civilians closer to the Brazilian government through digital initiatives.

Despite the absence of direct regulation for investment funds, the Law covers a wide range of aspects of digital government, such as digital provision of public services, platforms of public government, and core principles such as transparency and access to data. Like other reforms, this might increase trust in the Brazilian economy and, therefore, make the country more attractive to foreign investors.

Although private equity activities are not subject to any specific local regulations and/or restrictions – international private equity players with offshore structures can easily invest and exit from assets located in Brazil, subject only to registering their investments with the Brazilian Central Bank – several laws and regulations may influence the practice as a whole.

Brazilian Securities Exchange Commission (CVM) Regulations

Onshore regulated funds are subject to specific regulations enacted by the CVM such as Instructions No 578/16 and 579/16, which provide for the general framework, accounting and valuation rules for the so-called FIPs (Fundos de Investimento em Participações).

If anyone intends to act as a general partner in Brazil (eg, giving investment advice in respect of securities issued by Brazilian companies subject to management fees and carried interest), this person (either an individual or a legal entity) must abide by certain requirements brought by asset management regulations issued by the CVM.

Public offerings are also subject to the CVM’s scrutiny and applicable regulations.

In a nutshell, the CVM acts as a gatekeeper for certain activities that relate to the private equity environment in Brazil.

Other Regulations

As already indicated above, any foreign investors must register with the Brazilian Central Bank. In addition, they must enrol with the National Corporate Taxpayer Registry (CNPJ) and appoint a legal representative in Brazil upon remitting funds.

Depending on the sectors targeted by private equity players, industry restrictions or certain government controls may apply, such as in energy, telecoms, broadcasting, aviation, oil and gas, insurance, transportation, sanitation, pharmaceuticals and financial services. For some of these industries, there are government agencies responsible for inspecting and regulating the services. For instance, transactions involving change of control of companies operating in any segment of the local electrical energy market are subject to prior approval by the Brazilian National Electric Energy Agency (Agência Nacional de Energia Elétrica – ANEEL). 

CADE

If a transaction has effects in Brazil (ie, if the respective targeted investment derives, or is intended to derive, any turnover in Brazil) the respective parties involved in this transaction must assess if they meet the thresholds for mandatory clearance by the Brazilian antitrust authority (Conselho Administrativo de Defesa Econômica – CADE) prior to completion. This is a cumulative assessment if: (a) one of the economic groups, on one side, has a Brazilian turnover equal to or in excess of BRL750 million, and (b) the economic group, on the other side, has a Brazilian turnover equal to or in excess of BRL75 million. This assessment is run based on the analysis of the consolidated turnover of each economic group involved in opposite sides of the transaction and, pursuant to the rules issued by CADE, only investors with more than 50% private equity fund structure will be taken into account for the purposes of this assessment. In addition, parties must verify if the intended investment would represent an acquisition of a 20% stake or more of the targeted business’s total equity interest.

As in any other jurisdiction, due diligence is a key part of the process towards completing any investment. It serves the purpose of enabling the investor to make an informed decision about key commercial elements of the investment and potential pitfalls, as well as ensuring that both the investor and sell-side are assessing the investment in good faith.

Local private equity players generally split the process into two phases.

• The first phase is generally focused on key aspects of the underlying business that would substantiate the respective investment team’s decision about the feasibility of pursuing a given investment and placing an indicative offer (eg, if a company is heavily exposed to environmental issues, this phase would focus on potential red flags from an environmental law perspective).
• Phase two is generally a more extensive due diligence exercise that helps the private equity investor decide whether to place a final and binding offer. This phase should cover all areas of the law (to the extent applicable), namely:
1. corporate law;
2. financial obligations;
3. commercial agreements;
4. tax litigation (both in court and out of court);
5. employment litigation (both in court and out of court);
6. civil litigation (both in court and arbitrations);
7. social security litigation;
8. criminal law;
9. compliance;
10. intellectual property and information technology;
11. cybersecurity and data protection;
12. real estate;
13. environmental law;
14. regulatory;
15. insurance; and
16. antitrust.

Although the back-up materials prepared by a law firm are generally extensive, the output materials to a private equity investor consist of a summary/risk matrix focused on key findings. These findings are related to:

• factors that would affect or delay the ability of the parties to complete the transaction (eg, third-party consents, corporate reorganisation to carve out assets, etc);
• issues that may affect the price (eg, liabilities that are more than likely to result in an obligation on the part of the target company to make a payment); and
• matters to be addressed through contractual provisions, such as representations and warranties, indemnification provisions and respective guarantees/collateral.

The due diligence exercise is generally handled through the analysis of documents, available on virtual platforms, by several specialists led by a core legal team that concentrates the flow of information, Q&As and interactions with other advisers and parties involved in the transaction. There are certain checkpoints, however, where the legal team is afforded access to key personnel of the target business, either to interview them based on their respective expertise or to gather information through management presentations.

Reviews done by law firms in Brazil are typically focused on legal issues that have already been reflected in investigations or claims, or which lack required documents and licences. Routine procedures and contingent liabilities are usually assessed by auditing/accounting firms, technical environmental experts, and/or compliance experts. The law firms are also in charge of assessing the risks in respect of findings identified in reports prepared by such technical experts. Therefore, a key element for a successful exercise is regular interface between all the advisers involved in the due diligence process. 

Vendor due diligence has become more common in Brazil as transactions are increasingly organised through private auctions, due to the fierce competition for local assets (which, in turn, offers a reasonably interesting way for a private equity investor to maximise returns and gain momentum on the sell side). The respective report generally contains a high-level review by external counsel to sell-side regarding specific critical matters and works as a shortcut for the review conducted by participants of the process. Depending on whether these vendor due diligence reports are issued on a non-reliance or a reliance basis, external counsel to the potential buyer would use its own due diligence exercise in order to validate, cross-check and go into deeper detail on the information included in these vendor due diligence reports, or proceed to the so-called “top-up” due diligence.

The vast majority of transactions carried out by private equity funds in Brazil are equity transactions, completed upon execution of a private investment or stock purchase agreements, either through a private auction sale or privately negotiated transaction (over the past couple of years, Brazil has entered a “sellers’ market”, which has resulted in a substantial increase in the number of M&A run under auction).

Convertible debt arrangements are also starting to pick up in practice with Brazil’s VC space gaining traction.

With Brazil’s recent IPO spike, public M&A may also become more frequent within the next few years.

In addition, the Brazilian congress passed some material improvements to Brazil’s insolvency and recovery laws in 2020, which may bring additional incentive for private credit/special situation funds to acquire the so-called “separate business unit” (unidades produtivas isoladas) in the context of an auction run by the respective court handing the insolvency case. The winning bidder is afforded a clean break on succession liabilities and this has become clearer with the changes that were approved by the congress.

As a general rule, private equity-backed buyers are either structured as cross-border offshore funds (with the underlying vehicle that invests directly in Brazil domiciled in a jurisdiction that is not considered, for the purposes of Brazilian law, to be a tax haven, ie, jurisdictions that charge income tax at rates that are lower than 20%) or onshore regulated fund vehicles such as FIPs, FII (Fundos de Investimento Imobiliário), FIMs (Fundos de Investimento Multimercado), FIDICs (Fundos de Investimento em Direitos Creditórios) and the brand-new Fiagro.

Each of these onshore-regulated fund vehicles serves a specific purpose and offers some tax breaks and protections provided that certain concentrations and other conditions are met. FIIs are intended for investments in real estate. FIMs are intended for investments in multiple classes of assets (including debt securities, equity securities, bonds, options, etc). FIDICs are aimed at investing in credit rights. The purpose of the recently conceived Fiagros is to invest in agricultural assets and businesses. Finally, the vast majority of purely private equity onshore vehicles are structured as FIPs, which can invest in shares of privately or publicly owned corporations, shares of limited liability companies (subject to certain conditions/thresholds), debt securities that are convertible into equity, and debentures (either convertible or not), both in Brazil and abroad.

It is fairly common for private equity funds to be directly involved in the execution of each respective deal documentation, unless there are any other particular strategic reasons for these players to invest through a local company.

For instance, if the investment thesis of a certain fund is based on consolidation of local fragmented markets on acquisitions and add-ons, they would typically have a company underneath the fund to operate as the consolidating platform, either formed from the outset by the sponsor or acquired from a third party.

Private equity deals executed in Brazil are typically funded through equity investment commitments.

Leveraged Buyouts

Leverage buyouts are scarce in Brazil, firstly because of the scarcity of a sophisticated debt market (historically there has been little incentive for development of products locally for a number of reasons, such as hyper-inflation in the 1990s, volatility, risk aversion, financial markets heavily concentrated in a few local sponsors, etc) and secondly, because of historically high interest rates (although this has been shifting over the past few years). However, some international sponsors raise debt in other jurisdictions scattered across their fund structure, bringing the proceeds into Brazil as committed equity.

Equity Commitment Letters

Equity commitment letters are common, especially in the context of cross-border deals, where the underlying international investment fund decides to channel the funds required to pay the purchase price through a newly incorporated local vehicle, or if there is a portion of the respective consideration that is deferred. It is not unusual for these equity commitment letters to also be backed up by some type of collateral in Brazil (ie, in the context of payment of the purchase price in instalments, the respective equity commitment letter may be backed by a pledge on the target’s shares acquired by a PE fund to the benefit of the sell-side).

Private Equity Players

The majority of local private equity players generally invest upon acquisition of substantial minority stakes in Brazilian businesses (25–49% stakes), with rights that effectively afford them a high level of influence in the respective companies invested in, in addition to strong exit/liquidity rights. Some of these also tend to negotiate options to buy control within a certain timeframe.

There are also a few more robust private equity players, including funds of international well-established private equity houses (such as Carlyle, Advent and others) and of Brazilian champions (eg, Patria and Vinci) that usually focus on buyouts, although there is more competition, given the scarcity of assets with this development profile in Brazil.

Deals involving a consortium of private sponsors are becoming increasingly popular, especially for VC. Brazil is following the same investment model for a series of investments that is typical in jurisdictions such as the United States. A more-seasoned VC sponsor in Brazil generally takes the lead in a mix comprised of a range of international and local sponsors and angel investors that would have a passive stake.

Co-investments are also becoming a trend for private equity, especially in the case of companies at later development stages, with two or more active private equity sponsors sharing leadership/control. These are generally backed up by a separate relationship agreement establishing governance among co-investors.

Completion accounts are by far the most common pricing mechanism used in private equity transactions in Brazil. They are probably associated with a traditional buy-side aversion to taking risk before stepping into the cap table/management company, as the basis for the adjustment are generally financials drawn up closer to the completion date. Effective adjustments generally occur within a certain timeframe after completion.

Locked box has also become reasonably common over the years, especially in deals involving exits by private equity players, entailing more predictability for the sell-side, as the price of locked-box mechanisms is usually only adjusted for post-closing disbursements qualified as leakage (pursuant to a clear definition under the respective transaction). Parties also negotiate items that would generally be expected to take place, which are defined as permitted leakage.

Deferred payments structured upon earn-out arrangements are also a useful tool for a private equity buyer, as they address uncertainties about future performance. This type of arrangement entails carefully crafted protections for both parties, especially on definitions of the metrics used for the purposes of assessing if the earn-out performance thresholds are triggered, causing the buy-side to pay the respective deferred consideration. On the flipside, the sell-side would need to ensure that achieving the goal is a feasible task, upon inclusion of certain protective covenants and normalisation items.

Locked-box is becoming more popular within private equity transactions, especially if the buyer is a private equity seller. Leakage is generally adjusted for a pre-determined ticker fee or inflation index.

Except for transactions where parties agree upon a fixed price, there is always a dispute resolution procedure intended for sorting out parties’ different views in respect of the elements that may adjust the price. Usually one of the parties is responsible for sending out an initial calculation, while the other party is afforded the right to review and dispute the items that comprise the calculation. If parties enter a deadlock, the dispute should be submitted to a third-party expert (a neutral lawyer, auditor or appraiser, depending on how the pricing is structured). Names can be included in a list that parties negotiate and include in the respective transaction documents from the outset. This has the effect of avoiding lengthy and cumbersome discussions around the choice of an expert.

Some more complex arrangements provide for the possibility of each party electing its own expert and then a third (neutral) one being appointed if the deadlock persists. However, these complex mechanisms have proved inefficient and time consuming, generally achieving the same end result as a mechanism where parties appoint an expert from a pre-agreed list.

Conditionality is generally based on the requirement to submit a transaction to government authority approval (such as, the local antitrust authority, if parties to the transaction fall in any of the thresholds described in 3.1 Primary Regulators and Regulatory Issues, or a regulator, depending on the sector). Third-party approval is also common, especially considering that most financing arrangements provide for change-of-control provisions – going ahead with a transaction without waiver by the respective sponsor may result in early maturity and cross-default of financings. Other conditions, such as a reorganisation for carving out certain business/assets, may apply. For instance, as mentioned before, there are still several family-owned businesses in Brazil and, therefore, title to some assets may need to change hands prior to completing a transaction (eg, the intellectual property that is required to operate a business that is unduly registered in the name of a shareholder).

If a deal is subject to conditions for completion (ie, there is a delay between signing and closing), the parties would usually negotiate the terms and conditions of a material adverse change condition, especially if the respective delay is material. Although these provisions may be as broad as the parties agree upon, it is generally better to include certain tangible boundaries in order to provide deal certainty, such as the ability of a material adverse change to cause a loss that is substantially higher than the normal course (above a certain percentage or even absolute number).

“Hell or high water” is generally acceptable up to a certain degree if: (a) the only condition to completion of a deal is antitrust clearance in Brazil that is eligible to the so-called “fast track” procedure (rito sumario) and (b) the respective private equity buyer has no prior investments in companies exercising dominant positions in a given market. This is because private equity investors executing deals in Brazil focus on deal certainty. Nonetheless, parties generally agree upon certain tangible boundaries, such as commitments imposed on any of them by the authorities for selling non-core businesses or businesses representing less than a certain percentage of their revenues.

Break fees have become common, especially in the context of a seller deciding to run a private auction to dispose of the target. These provisions can be structured with a compensatory nature for direct and indirect losses, but they are generally intended to cover parties’ expenses with external advisers and costs incurred with the analysis of a given transaction.

A private equity buyer would typically have the right to terminate an acquisition agreement if:

• closing has not occurred within a certain timeframe agreed by the parties in the transaction documents, setting out a maximum time limit for closing (the so-called “long-stop date”);
• on closing, sell-side is not capable of bringing down the representations and warranties given on signing;
• any conditions precedent are not fulfilled within the pre-established timeframe; and
• there is a material adverse change in the business.

In transactions where a private equity fund is the seller, the desirable outcome is to achieve a clean break, meaning that substantially all liabilities associated with the acquired business would be transferred to the buyer, regardless of whether they relate to the period preceding or following closing. This is because private equity funds often try to ensure certainty on amounts of return distributions across the waterfall, for both limited partners (LPs) and carry payments to GPs. Therefore, the structure put forward (at least as an initial position) is to offer buyer-limited indemnification rights, primarily focused on the breach of fundamental warranties and contractual provisions, with no indemnification for issues disclosed during the due diligence or under the representations and warranties given in the respective transaction documents.

However, considering some of the risks typically involved in Brazilian businesses (chief danger zones are generally tax and labour issues, and environmental matters, if the target is exposed to activities that may influence the environment), the general clean-break approach might be tempered by exceptions. This is probably among the main reasons why most funds dedicated to invest in Brazil provide for an additional term of three years for drawdowns by LPs, with the purpose of making the sell-side whole for any indemnification obligations.

The customary risk allocation structure, however, is the so-called “your watch, our watch”, considering the limitations imposed by the asymmetry of information between buyer and seller prior to completion of a transaction, and also taking into account time constraints imposed by fierce competition for the best assets. Based on this structure, a buyer gets full indemnity for all matters preceding closing, regardless of their disclosure, based on an assumption that the deal value was established assuming that the target business had no exposure to liabilities with the potential to generate losses. This also helps to maximise gains for the sell-side, as potential matters would generate an obligation to make a payment (hence reducing consideration) upon materialisation. These obligations are generally subject to some limitations, such as:

• indemnification cap amount;
• time limitations for placing a claim for indemnification, which generally vary depending on the statute of limitation of each matter;
• de minimis, which is an exclusion of minor amounts related to matters that are part of the recurring business (eg, employment liabilities up to a certain amount);
• deductible, which is a “cushion” or a discount on sell-side obligations to indemnify;
• exclusion of loss of profits, moral damages, loss of business opportunities and other indirect losses from the concept of what should be construed as an indemnifiable loss;
• tipping basket, which is a management account where potential losses may be recorded and subject to indemnification (from dollar one), when it exceeds a certain threshold;
• no double recovery for a same loss;
• duty of the buyer to mitigate losses;
• exclusion of matters that are already forecast and provided for in the financial statements, based on records in certain reserves (generally not funded); and
• exclusion of losses covered by insurance.

These indemnification obligations are generally backed up by some type of guarantee/collateral, as better detailed in 6.10 Other Protections in Acquisition Documentation.

In the VC space, local practice is constantly aligning to international standards, with investors seeking less aggressive indemnification rights. It is a shifting landscape, despite investors’ traditional risk-aversion pattern when it comes to investments in Brazil.

Usually, private equity sellers try to limit to their representation and warranties to typical fundamental warranties (ownership of shares, capacity, authority, etc). On the flipside, if the private equity seller is a buyout fund (ie, with a greater level of influence on the business), it is common practice that the fund gives substantially the same warranties given by other shareholders, tending to rely upon warranties given by management shareholders. However, under no circumstance will the fund accept to be bound by joint and several liability with other shareholders, as this may be construed as a means of giving collateral to the benefit of third parties. As better described in 6.8 Allocation of Risk, if a private equity fund is the seller, it has become acceptable in Brazil for the parties to agree on a clean break, with full (fair) disclosure of the data room against the warranties. Limitations are substantially the same as detailed above, including potential qualifications on warranties (knowledge, ordinary course, materiality, etc). However, in the context of a deal structured under a clean-break arrangement, a buyer would seek to include anti-sandbagging protections in the transaction documents.

Additional protections include collateral (pledge, fiduciary transfer, etc), personal/parent guarantees and other types of liquid guarantees such as escrow accounts and hold-backs. Warranty and indemnity (W&I) insurance has been used in only a few deals in Brazil (especially in the context of acquisitions of assets operated under concession to public services). Brazil’s insurance market is small and only a few operators actually offer W&I insurance.

In most cases, disputes in connection with private equity transactions relate to earn-out consideration payments, indemnification payments/assessments, enforcement of collateral, material adverse change provisions and conduct of business in the ordinary course between signing and closing (which has become particularly common during the COVID-19 pandemic). These disputes are generally resolved under arbitration based in Brazil and governed by Brazilian law if the asset is located inside the country because enforcement of court decisions and arbitral awards issued overseas depends on confirmation by the Brazilian Superior Court of Justice (Superior Tribunal de Justiça). This confirmation process is subject to certain legal requirements and it is not possible to ensure that confirmation will be achieved, or to provide timing estimates for conclusion.

Public-to-private transactions account for a minor portion of the local deal flow (especially within the local private equity environment), considering the relatively small size of the local public equities market as compared to jurisdictions like the United States and the United Kingdom. Brazil is now entering a cycle that probably precedes these types of deals, where private equity players start performing exits via IPOs.

Material shareholding positions in public companies are subject to the disclosure and filing obligations established by the CVM, as summarised below: 

• any shareholder or group of shareholders acting together or representing the same interest must notify the public company immediately after any transaction that causes such shareholder or group of shareholders to cross, upwards or downwards, the thresholds of 5%, 10%, 15%, and so on, of a type or class of shares of such public company; and
• during a mandatory tender offer for the acquisition of control of a public company, any shareholder or group of shareholders acting together (or representing the same interest) holding 2.5% or more of a certain type or class of shares must inform the market of any direct or indirect 1% variation (upwards or downwards) in its shareholding.

Mandatory tender offers are applicable to public companies only and are triggered in the following cases:

• after the controlling shareholder of the public company or a person related to it acquires shares representing more than one third of the total shares of each type and class;
• by the sale of the public company’s control, in which case, the tender offer is a condition precedent to the completion of such sale; or
• for delisting the shares of the company, in which case, the tender offer is a condition precedent to delisting.

Cash is by far the most typical type of consideration, although share deals are common where the intention is to consolidate fragmented markets, in which case, sellers receive shares of the consolidating entity as consideration for their stake. Other types of arrangement may apply, especially in the VC space, where Brazilian entities are flipped over to Delaware/Cayman entities and sellers receive convertible notes or other types of securities of these entities as consideration.

Voluntary or mandatory tender offers to acquire shares of public companies in Brazil are subject to Normative Ruling No 361/2002 which, among other things, establishes that the tender offer shall:

• be directed to all the holders of shares of the same type and class as those that are the object of the offer without distinction;
• ensure the equitable treatment of all recipients of the offer, furnishing them with adequate information about the company and the bidder;
• be intermediated by a brokerage firm, securities dealer or financial institution with an investment portfolio;
• be launched at a sole price, except for the possibility of setting different prices according to the class and type of shares subject to the tender offer; and
• be carried out in an auction on a stock exchange or over-the-counter market.

Furthermore, the bidder can subject the tender offer to conditions, provided that such conditions do not, direct or indirectly, depend on any action by the bidder or its related parties. Takeover offers in connection with privately held companies are not subject to specific regulation and may be more freely negotiated.

Even if a bidder does not seek or obtain 100% ownership of a target, it might have vast governance rights over a Brazilian corporation depending on its interest ownership. Such governance rights arise from the fact that, in general, resolutions are approved by majority votes cast in the shareholders’ meeting. However, certain resolutions depend on a higher approval quorum, as established by the corporations law. The by-laws can also establish higher quorums.

Additionally, in a case where shareholders representing at least 10% of the voting stock request multiple voting right for the election of the members of the board of directors (ie, a system by which each share will hold as many votes as a director's position and the shareholders will be entitled to allocate their votes among candidates as they choose), the shareholder (or group of shareholders) holding more than 50% of the voting stock will have the right to elect the number of directors elected by other shareholders, plus one.

Squeeze-Out Mechanisms

Brazilian law does not provide many possibilities to squeeze out minority shareholders, except in the case of a tender offer to delist the company. In this case, if less than 5% of the total shares issued by the company remain outstanding after the completion of the tender offer, such shares may be redeemed (squeezed out) for the same price per share as the tender offer, provided that the bidder deposits the amount in a financial institution authorised by the CVM, which amount shall be at the disposal of the remaining shareholders.

As opposed to other jurisdictions with consolidated equities markets such as the United States and the United Kingdom, where unconditional undertakings are common and even regulated to some extent (eg, by the UK Takeover Code), this is unusual in the context of Brazilian public M&A, especially because there are very few Brazilian listed companies with dispersed control (which is where these undertakings generally come into play). On the flipside, in the context of private M&A, any investment by a private equity player is negotiated with other shareholders in advance, who then undertake to cast their votes in a manner that ensures the transaction will be completed, at least from a corporate governance standpoint.

Hostile takeovers are feasible pursuant to Brazilian law, although they happen very seldom because most public companies in Brazil still have controlling shareholders. Besides, most Brazilian listed companies provide for statutory protections that increase the hurdle for a potential buyer to pursue a hostile takeover, such as the so-called "poison pills". The first hostile takeover attempt in Brasil took place in June 2006, when Sadia (one of the biggest refrigerated foods companies in Brazil) announced that it would carry out a public tender offer to acquire control of its main competitor (Perdigão), but ended up withdrawing the offer after shareholders’ opposition. More recently, as the number of companies without defined control has increased, hostile takeovers or attempts at them have become somewhat more common, for example, the hostile acquisition of Eletropaulo by Enel in 2018, Eneva’s proposal to merge with AES Tiete in March 2020 and, also in 2020, Gafisa’s hostile offer to acquire Tecnisa.

Equity incentive plans are a key element to any private equity transaction executed in Brazil. These incentive plans can be structured as profit-sharing arrangements, stock option plans or phantom stock plans, in addition to traditional earn-out arrangements where the selling founders of a business are ahead of the business operations as C-level executives. Normal dilution in the private equity space would be up to 5%, while in seed/VC stage, this can be higher (up to 10%).

Management is usually key in the context of a private equity transaction and incentive arrangements are one of the fundamental portions of an investment package offered by a private equity investor. These incentives can either be based upon the right to receive additional upside in a liquidity event, shares given from the outset or other types of arrangements. Types of securities taken up by management also vary. Preferred instruments can be a feasible solution, such as preferred stock affording the respective beneficial owners a larger chunk of the economics (through preferred/minimum dividends), liquidation preference (which is junior to the liquidation preference given to the private equity investor), and/or redemption rights.

Vesting is generally based on both retention for a minimum period of time and certain performance goals, which may include ramp-up triggers over time, provided that certain goals are achieved. All these mechanisms are generally backed up by "good leaver/bad leaver" provisions.

"Good leaver" provisions relate to situations where the respective management shareholder leaves their office in management for circumstances that are not under their control (death, disability or dismissal with no reasonable grounds).

"Bad leaver" provisions are the opposite, where there is a just cause for dismissal, such as wilful misconduct, or where the manager shareholder leaves before the agreed-upon minimum retention/lock-up term, or if the manager shareholder decides to move to a competitor. 

Typical key restrictive provisions for manager shareholders, provided that there is reasonable consideration for them, are non-compete and non-solicitation provisions within a limited territory, scope and term (maximum of five years). Non-disparagement, “key-person” and confidentiality provisions are also common, although assessment of compliance by manager shareholders with these obligations can prove difficult in practice, as enforcement is incumbent upon strong evidence. All these obligations are generally backed up by non-compensatory penalties.

Manager shareholders generally benefit from certain restrictions on:

• transfers of shares (typically pro rata tag-along rights, although in some circumstances where they remain as “material” manager shareholders, they can benefit from rights of first offer/first refusal);
• on the issue of shares (pre-emptive rights, which are statutory pursuant to Brazilian law);
• information rights;
• veto on transformation of the corporate type;
• minimum mandatory dividend; and
• some other rights that may result in them exiting the company with proper compensation pursuant to the law – the so-called “withdrawal right” – if certain decisions related to the structure, purpose and existence of the company are passed without their favourable vote.

A private equity buyer generally exercises some level of control in their investments in Brazil, especially if the respective investment vehicle is structured as an FIP, where there is a statutory obligation for the investor to exercise effective influence (influencia efetiva) on the portfolio companies’ decision-making process. In addition to protections against value destruction (such as vetoes, negative covenants and reserved matters that require a super-majority in order to be approved), a private equity buyer would generally require that all shareholders enter into a shareholders’ agreement that ensures the private equity investor:

• rights to appoint at least a board member, and, in some cases, an observer too;
• clear process for appointing other officers, based on goals and support by external experts for choosing professionals in the market (such as a head-hunter firm) and, in the case of higher interest ownership, the right to appoint a “c-level” officer, generally the CFO; and
• information rights within pre-established seasonality and level of detail.

In addition, the shareholders' agreement would include clear governance provisions, such as rules for convening board and shareholders’ meetings, requirement that the financial statements are audited by an authorised external firm, clear process for scrutiny of related party transactions, prohibition of the issue of founders’ shares (partes beneficiárias), and jurisdiction of an arbitration panel for the resolution of disputes among the shareholders, among other provisions.

Brazilian law generally provides for separation of liability between shareholders and the respective Brazilian invested companies, with a few exceptions brought by:

• the Brazilian Civil Code, which provides the general framework for piercing the corporate veil in the case of fraud or abuses;
• the Consolidated Labour Act, which brings a notion of liability of all entities belonging to an “economic group” for the labour debts of the underlying entity that is in default;
• the Brazilian Consumers’ Code, which is also based on evidence of conduct, similarly to the mechanism of piercing the corporate veil set out in the Brazilian Civil Code;
• the Brazilian Environmental Crimes Act (if there’s evidence that a given company serves as an obstacle for the reparation of damages caused to the quality of the environment); and
• the National Tax Code, which provides that personal liability for tax debts can reach the shareholders, officers, managers and administrators of the company that act with excess powers or in violation of the law.

However, there are several ways of mitigating these risks depending on how the investments are structured.

It has become common practice for private equity fund shareholders to require that their portfolio companies abide by a compliance programme. It can either be a programme that is consistent with the fund’s already existing policies, subject to a few adjustments in order to enable enforcement in Brazil, or it can be programmes that are tailored to the respective portfolio companies. This trend increased after Brazil enacted its anti-corruption law in 2013 (Law No 12,846/13), which was deeply inspired by the Foreign Corrupt Practices Act (FCPA) and the UK Anti-bribery Act.

The holding period depends on the type of strategy of the private equity fund, the maturity and sector of the invested companies, and the level of returns accrued by these companies vis-à-vis the fund’s hurdle. As a general rule, pure private equity funds generally tend to hold their investments between five and ten years.

Common Private Equity Exits

Sales to strategic buyers or institutional investors, and/or secondary buyouts to private equity funds continue to account for the vast majority of the exits executed in Brazil, although IPOs have come back strongly as a realistic means of exiting too, offering promising returns to private equity investors. With Brazil’s benchmark interest rate at its lowest-ever level, investors have sought to diversify their traditional fixed-income strategies, turning to the Brazilian capital markets. According to data released by LAVCA in 2020, 13 Brazilian companies backed by private equity funds made their debut in the public markets. Although the market has grown more selective in 2021, the pace of IPOs remains steady.

Dual tracks

Dual tracks are also becoming increasingly popular. Despite the spike in the number of exits through IPOs, Brazil’s capital markets continue to be shakier if compared to developed jurisdictions, given the country’s exposure to global markets. A means of streamlining uncertainties around the IPO process is to conduct an IPO while also pursuing a possible M&A through a private auction process. This was especially noticeable during a relative downturn in the Brazilian capital market in Q4 of 2020 and Q1 of 2021, among companies that started their IPO processes and were unable to capture their desired market caps. Some companies that had made their first IPO filings with the CVM eventually cancelled their offer requests and reportedly turned to private buyers.

Drawdowns

Private equity investors typically do not reinvest in the same asset after performing an exit. However, most onshore funds or offshore funds with a Brazil-focused strategy, provide for an additional term of up to three years after an exit for drawdowns for making buyers whole under indemnification obligations.

Regardless of the equity stake that they wish to acquire, private equity investors always request to be backed-up by exit/liquidity mechanisms and protections, including drag-along rights. There is neither a particular threshold that would entitle a private equity investor to a drag right, nor a limitation on co-investors that could also benefit from it (although generally there is some definition on who could call a drag if there is a clear leading investor in a series round, club deal or co-investment). It is common practice, however, that the possibility of a private equity investor exercising its drag rights is subject to certain boundaries, such as:

• a minimum time for this right to become effective (generally matching the expected holding period and mirroring manager shareholders’ lock-up obligations); and/or
• a trigger at a minimum pre-established valuation (based on a determined multiple of EBITDA, the target Internal Rate of Return, etc). 

Private equity players generally use this mechanism as a “stick” for seeking alignment by other shareholders towards a liquidity event. It turns out that it has been little enforced in practice, as parties eventually settle upon performing the exit desired by the private equity investor or the exercise of rights of first offer/first refusal by the other shareholders. It serves more as a protective provision than as an effective means of exiting.

The most common tag-along mechanics provide that (i) in the case of sale of control by the manager shareholder, the private equity investor would have a tag-along right in relation to the totality of its stake, and (ii) in the case of a partial sale by the manager shareholder, the private equity investor would have pro rata tag-along rights. However, in VC investments and sectors where some liquidity needs to be afforded to the founding shareholders, it is not unusual for the manager shareholder to have pro rata tag-along rights on a sale by the private equity investor.

CVM Instruction No 480/2003 establishes a lock-up for the controlling shareholders, the selling shareholders, company management, underwriters and other persons involved in the offer until the IPO closing announcement (anúncio de encerramento) is published. However, it is common practice in Brazil for underwriters to request that the controlling and selling shareholders be bound to a lock-up for at least 180 days counted from the date of the IPO. This may vary from a more restrictive covenant, where underwriters, for instance, demand longer lock-up periods and establish certain milestones for releasing shareholders over time, to a more flexible covenant, where certain types of shareholders can be released from such obligation, including, in a few cases, funds of private equity sponsors that held minority stakes pre-IPO.

The execution of “relationship agreements” is not unusual in the Brazilian IPO environment.