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Preparing Brazilian Businesses for
Venture Capital Financing
November 2014
Why taking care of the legal stuff matters
• Before investing, most investors perform legal due diligence
• Perceived legal risks may lead to:
– Reduced valuation
– Delays in financing process
– Indemnification from the company and founders
– Decline in investors’ trust and confidence
• U.S. investors generally have a lower risk tolerance for aggressive tax, labor and IP
positions
• KISS - Be creative with your business, not your legal structure
Forming a company
• Form a company early, i.e., as soon as you decide to pursue the business idea
• Sociedade Limitada
– Commonly used by businesses that raise funding through an offshore holding company
– Unlike S.A.s, limitadas are not required to publish financial statements until they reach
significant size
• Sociedade Anonima
– Better choice when venture capital firms are expected to invest directly in the Brazilian
company
– Shares can be publicly traded on an exchange
– Managed by a board of directors
– Can create an employee equity compensation plan
Offshore holding companies
• Be flexible
– Wait to form an offshore company until you sign a term sheet for the first round of
funding
– Investors have different requirements and capabilities
• Reasons investors prefer offshore holding companies
– Familiar corporate law
– Perceived risks of being a director of a Brazilian company
• Delaware vs. tax neutral countries
– Delaware corporations are usually tax inefficient unless the company plans to have
significant business activities in the U.S.
• Conduct all business activities through the Brazilian subsidiary (or other local
subsidiaries), not the holding company
• Brazil subsidiary should be 100% owned by the holding company, except for
qualifying shares
Capitalization and equity
• Founders receive common shares
– Ownership percentages should reflect relative contributions and importance to the
company
• Employees, advisors and consultants receive options
– Typically join the company at later point in time, when value has been created
• Put everything in writing, in agreements reviewed by legal counsel
– Board approval (including number of shares, price, vesting schedule, vesting start date
and location of recipient)
– Share purchase agreement or option agreement
• ROFR
• Vesting / right of repurchase
• IPO Lock-up
Vesting
• Essential when there is more than one co-founder
– Protection when a co-founder or employee leaves the company
– Investors will insist upon vesting
• Founder shares typically vest over 4 years, sometimes with credit for time
previously spent on the business
– Company has right to buy back unvested shares at cost if the founder leaves
• Employee options typically vest over 4 years with a one-year “cliff” probationary
period
– Options may not be exercised until they have vested
• Founder shares may include change of control acceleration
– Double trigger: Acceleration occurs if the founder is terminated without cause within 6 –
12 months after the sale (i.e., founder must agree to stay with the acquirer after a sale)
– Single trigger: Acceleration occurs immediately upon the sale
– Single trigger is more likely to be renegotiated by an investor or acquirer
Obligations to former employers
• Non-compete and non-solicitation agreements
– Check the duration and scope of agreements with former employers
– Assess your co-founders’ agreements, too
• Intellectual property
– Avoid using technology that was created in the scope of previous employment
– Pursue the new business idea entirely outside of working hours and on personal
computers and equipment (i.e., not belonging to employer)
– Use personal (not work) email and communications
Protecting the company’s IP
• Document the company’s ownership of intellectual property from the start
– Technology assignment agreements with founders for technology created before the
company’s incorporation
– Proprietary Information and Invention Agreement (PIIA) with every founder and
employee for technology created after the company’s incorporation
• Make PIIA a part of “new hire” paperwork
• Typically includes non-solicitation and non-compete provisions
• Enforceability of non-compete provisions may be limited under Brazilian law
– Consulting agreements for other service providers
– Licenses from university or third parties for intellectual property owned by others
• Protect trade secrets
– Use confidentiality agreements in discussions with third parties
– Mark company documents “confidential”
Labor and employment
• Properly classify all workers and service providers
– May be more expensive, but . . .
– Failure to properly classify employees creates labor liabilities that investors will factor
into valuation
– Also increases the risk of labor lawsuits
• Persons who work exclusively for the company should be treated as CLT
employees
• Founders and officers of the company may qualify as pro labore workers
• Ensure non-Brazilian founders have necessary work or investor visas
Foreign currency exchanges
• Venture financing that is raised through an offshore holding company will often be
in a currency other than Reais
• Transfer funds from the holding company to the Brazilian operating company on a
periodic basis to hedge against exchange rate fluctuations
• Holding company can use funds to pay its non-Brazilian legal, accounting and
professional advisers
• All other business expenses should be paid by the Brazilian company
– Register all funds transfers to the Brazilian company with the Brazilian Central Bank to
reduce future taxes if the holding company sells the Brazilian company
Financing structures
• Purchase of common shares
– Typically not a good idea as it places value on the common shares, setting a floor on the exercise price of
employee stock options
• Convertible notes
– Does not place an enterprise value on the company
– Provides investors with a liquidation preference ahead of common shareholders
– Notes convert at a future date at a valuation set by a future investor, with a discount to reward note holders for
the risks of investing earlier
– Usually can be executed more quickly and less expensively than other financings
• Purchase of preferred shares
– Places an enterprise value on the company and therefore locks in the investors’ and founders’ ownership
percentages
– Amount invested is usually greater than with convertible notes
– Generally costs more in legal fees (because of the greater number of documents to negotiate)
– Investors gain greater control rights, such as a board seat and protective protections
– Founders stock will likely be subjected to transfer restrictions, such as rights of first refusal and co-sale
Financing structures – Special considerations
• When negotiating valuation (including conversion price caps in convertible notes),
consider the effect on founder ownership after future rounds
– Most Series A and Series B investors will want the founders to continue to own a majority of
the company following their investment
– Series C and later investors will want the founders to own a substantial minority interest
– Giving away too much equity to early angel investors can turn off later investors or require a
three-part negotiation with the angels
• The conversion price discount of convertible notes may result in a “gift” of additional
liquidation preference for the note holders.
– The liquidation preference of the preferred shares received by note holders will be 100% of
their face value, even though the note holders pay 70 - 80%
– In large convertible note financings, the company may want to honor the discount by
substituting common shares
• In all financing structures, investors should be limited to persons who meet the
“accredited investor” standard under U.S. securities laws

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Dia2 11 keynote_brian hutchings_gunder_preparando sua startup para investimento internacional

  • 1. Preparing Brazilian Businesses for Venture Capital Financing November 2014
  • 2. Why taking care of the legal stuff matters • Before investing, most investors perform legal due diligence • Perceived legal risks may lead to: – Reduced valuation – Delays in financing process – Indemnification from the company and founders – Decline in investors’ trust and confidence • U.S. investors generally have a lower risk tolerance for aggressive tax, labor and IP positions • KISS - Be creative with your business, not your legal structure
  • 3. Forming a company • Form a company early, i.e., as soon as you decide to pursue the business idea • Sociedade Limitada – Commonly used by businesses that raise funding through an offshore holding company – Unlike S.A.s, limitadas are not required to publish financial statements until they reach significant size • Sociedade Anonima – Better choice when venture capital firms are expected to invest directly in the Brazilian company – Shares can be publicly traded on an exchange – Managed by a board of directors – Can create an employee equity compensation plan
  • 4. Offshore holding companies • Be flexible – Wait to form an offshore company until you sign a term sheet for the first round of funding – Investors have different requirements and capabilities • Reasons investors prefer offshore holding companies – Familiar corporate law – Perceived risks of being a director of a Brazilian company • Delaware vs. tax neutral countries – Delaware corporations are usually tax inefficient unless the company plans to have significant business activities in the U.S. • Conduct all business activities through the Brazilian subsidiary (or other local subsidiaries), not the holding company • Brazil subsidiary should be 100% owned by the holding company, except for qualifying shares
  • 5. Capitalization and equity • Founders receive common shares – Ownership percentages should reflect relative contributions and importance to the company • Employees, advisors and consultants receive options – Typically join the company at later point in time, when value has been created • Put everything in writing, in agreements reviewed by legal counsel – Board approval (including number of shares, price, vesting schedule, vesting start date and location of recipient) – Share purchase agreement or option agreement • ROFR • Vesting / right of repurchase • IPO Lock-up
  • 6. Vesting • Essential when there is more than one co-founder – Protection when a co-founder or employee leaves the company – Investors will insist upon vesting • Founder shares typically vest over 4 years, sometimes with credit for time previously spent on the business – Company has right to buy back unvested shares at cost if the founder leaves • Employee options typically vest over 4 years with a one-year “cliff” probationary period – Options may not be exercised until they have vested • Founder shares may include change of control acceleration – Double trigger: Acceleration occurs if the founder is terminated without cause within 6 – 12 months after the sale (i.e., founder must agree to stay with the acquirer after a sale) – Single trigger: Acceleration occurs immediately upon the sale – Single trigger is more likely to be renegotiated by an investor or acquirer
  • 7. Obligations to former employers • Non-compete and non-solicitation agreements – Check the duration and scope of agreements with former employers – Assess your co-founders’ agreements, too • Intellectual property – Avoid using technology that was created in the scope of previous employment – Pursue the new business idea entirely outside of working hours and on personal computers and equipment (i.e., not belonging to employer) – Use personal (not work) email and communications
  • 8. Protecting the company’s IP • Document the company’s ownership of intellectual property from the start – Technology assignment agreements with founders for technology created before the company’s incorporation – Proprietary Information and Invention Agreement (PIIA) with every founder and employee for technology created after the company’s incorporation • Make PIIA a part of “new hire” paperwork • Typically includes non-solicitation and non-compete provisions • Enforceability of non-compete provisions may be limited under Brazilian law – Consulting agreements for other service providers – Licenses from university or third parties for intellectual property owned by others • Protect trade secrets – Use confidentiality agreements in discussions with third parties – Mark company documents “confidential”
  • 9. Labor and employment • Properly classify all workers and service providers – May be more expensive, but . . . – Failure to properly classify employees creates labor liabilities that investors will factor into valuation – Also increases the risk of labor lawsuits • Persons who work exclusively for the company should be treated as CLT employees • Founders and officers of the company may qualify as pro labore workers • Ensure non-Brazilian founders have necessary work or investor visas
  • 10. Foreign currency exchanges • Venture financing that is raised through an offshore holding company will often be in a currency other than Reais • Transfer funds from the holding company to the Brazilian operating company on a periodic basis to hedge against exchange rate fluctuations • Holding company can use funds to pay its non-Brazilian legal, accounting and professional advisers • All other business expenses should be paid by the Brazilian company – Register all funds transfers to the Brazilian company with the Brazilian Central Bank to reduce future taxes if the holding company sells the Brazilian company
  • 11. Financing structures • Purchase of common shares – Typically not a good idea as it places value on the common shares, setting a floor on the exercise price of employee stock options • Convertible notes – Does not place an enterprise value on the company – Provides investors with a liquidation preference ahead of common shareholders – Notes convert at a future date at a valuation set by a future investor, with a discount to reward note holders for the risks of investing earlier – Usually can be executed more quickly and less expensively than other financings • Purchase of preferred shares – Places an enterprise value on the company and therefore locks in the investors’ and founders’ ownership percentages – Amount invested is usually greater than with convertible notes – Generally costs more in legal fees (because of the greater number of documents to negotiate) – Investors gain greater control rights, such as a board seat and protective protections – Founders stock will likely be subjected to transfer restrictions, such as rights of first refusal and co-sale
  • 12. Financing structures – Special considerations • When negotiating valuation (including conversion price caps in convertible notes), consider the effect on founder ownership after future rounds – Most Series A and Series B investors will want the founders to continue to own a majority of the company following their investment – Series C and later investors will want the founders to own a substantial minority interest – Giving away too much equity to early angel investors can turn off later investors or require a three-part negotiation with the angels • The conversion price discount of convertible notes may result in a “gift” of additional liquidation preference for the note holders. – The liquidation preference of the preferred shares received by note holders will be 100% of their face value, even though the note holders pay 70 - 80% – In large convertible note financings, the company may want to honor the discount by substituting common shares • In all financing structures, investors should be limited to persons who meet the “accredited investor” standard under U.S. securities laws