M&A / Private Equity Newsletter
Conflict of Interests in Secondary Buyout Transactions ISSUE No 5
Applicable regulation and how to handle the risk of conflict of interest in M&A transactions involving two different PE funds
March 2015 Brazilian FIA-MAs: a New Option for Investments in Mid-Market Companies and Private Equity A look into the regulation of the new type of fund available to both accredited and retail investors for investments in mid-market listed and unlisted companies.
R&W Insurance: a Useful Tool for Private Equity & Venture Capital Transactions Advantages and disadvantages of the Representations and Warranties Insurance.
Brazilian Healthcare Industry Now Open for Foreign Investment With the enactment of Law 13,097, a long-lasting ban on foreign investment in the healthcare industry has been lifted.
Tax Advantages of Brazilian Real Estate Funds The contents of this newsletter are intended to convey general information on mergers & acquisitions and private equity in Brazil and do not necessarily express the opinion of law firm Lobo & Ibeas on the matters presented. This newsletter should not be relied upon as legal advice.
An overview on taxation of investments made through FII-Fundos de Investimento Imobiliário in the Brazilian real estate market.
M&A / Private Equity
Conflict of Interests in Secondary Buyout Transactions
ISSUE No 5 MARCH 2015
preferred vehicle for PE funds in Brazil, provides that, unless the majority at a quota-holders meeting authorizes otherwise, a FIP is not allowed to invest in securities where: (1) the FIP investment or administrative manager 1; members of the FIP investment
Last year the private equity (PE) behemoth KKR acquired the
committee; holders of quotas in the FIP representing more than 5%
Brazilian technology company Aceco TI from the PE fund
of its net worth; or their partners or spouses: (A) severally or jointly
General Atlantic and other shareholders. A sale to another
hold more than 10% of the voting shares of the issuer company; (B)
PE fund was also GP Investimentos’ exit strategy from its
are members of the board of directors, the oversight committee or
investment in the restaurant chain Fogo de Chão. Transactions
any other special committees of the issuer company; (C) are directly
like these, known as secondary buyouts, are becoming more
or indirectly involved with the issuance of such securities; or (D) are
and more common in Brazil.
the seller of these securities; or (2) the seller of such securities is another FIP run by the same administrative or investment manager.
The classic exit strategy for a PE fund is taking its invested companies public through initial public offerings (IPOs). However,
Additionally, Instrução 391 requires that documents related to
given the lingering weak performance of the Brazilian stock market
the FIP, such as prospectuses and bylaws, disclose the risk of
(IBOVESPA, which is the local main stock index, is currently at
potential conflicts of interest, and imposes on investment and
the same level it was in 2009), the environment for IPOs has been
administrative managers, as well as on committee members a
unfavorable. Thus Brazilian PE funds need to resort to different exit
duty to disclose any concrete situation of conflict of interest.
strategies. And in this strained scenario secondary buyouts are
Failure to comply with such rules exposes the wrongdoer to
proving to be a particularly good alternative.
civil and administrative responsibility.
Nevertheless, transactions where both seller and buyer are
Instrução 391 does not regulate whether quota-holders with
PE funds may trigger a question of great relevance to the PE
a conflict of interest (and committee members appointed
industry: how to deal with potential conflict of interests?
by them) are allowed to cast votes at meetings called to decide on investment strategy. There is no body of case law
Large PE management firms often manage different funds
addressing the issue. Even if the rules on conflict of interest
with diverse investment policies. There is a possibility that,
set forth in the Brazilian Corporations Act are applied by
for example, one such firm runs simultaneously a venture
analogy to FIPs – which is questionable –, doubts are not
capital fund interested in selling and an industry-consolidation
cleared, since the CVM case law on the interpretation of such
fund interested in buying the very same company. In such
rules has swung between absolute prohibition from voting and
situations, the risk of conflict of interest exists at least in
partial permission with subsequent scrutiny of the fairness of
theory, even though management firms usually appoint
transactions challenged by minority shareholders.
different individuals to lead each of their funds and the compensation scheme of these individuals encourages them
In this context, investment managers and investors should
to seek the highest possible yields for the funds they head.
consider the risk of potential conflicts in drafting/negotiating organizational documents of FIPs and in deciding whether to
Likewise, a growing number of PE funds in Brazil, especially
set up investment committees. If a concrete conflict of interest
those in which Brazilian pension funds hold equity interests
arises, immediate disclosure must follow and a quota-holders
(quotas), have set up investment committees. Such committees,
meeting held to authorize the transaction. The risk of casting
whose members are appointed by quota-holders, are generally
votes in conflict of interest situations should also be carefully
tasked with discussing and approving the manager’s investment
weighed in view of the CVM case law at the moment. And it
strategy. Therefore, secondary buyouts involving two PE funds
may also be prudent to set up a “chinese wall” and secure
in which the same individual holds investment committee seats
an independent third-party assessment of the fairness of
poses a theoretical risk of conflict of interest (that being one of
transactions carried out in situations of conflict of interest.
the numerous reasons why investment committees are not wellregarded by the international PE community). In view of the foregoing, article 36 of CVM’s Instrução 391, which
Please see Issue No 3 of our newsletter for the differences between the roles of investment and administrative managers. Available at www.loboeibeas.com.br/publicacoes/informativos.
regulates Fundos de Investimento em Participações (FIPs), the
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ISSUE No 5 MARCH 2015
of its net worth in mid-market companies 2, (ii) imposes a
Brazilian FIA-MAs: a New Option for Investments in Mid-Market Companies and Private Equity
minimum period of 180 days for the redemption of quotas; and (iii) has at least 10 investors. Additionally, each investor (or group of related investors) must own no more than 10% of the fund’s quotas.
The CVM (the Brazilian SEC) regulated last year a new type
Despite the risk involved in the liquidity of mid-market
of investment fund: the Fundo de Ações – Mercado de
companies’ securities, the FIA-MAs may be organized
Acesso or simply FIA-MA. The declared purpose of the FIA-
either as closed-ended or open-ended funds. Instrução 549
MA is to encourage investments in mid-market companies
authorizes the FIA-MA’s administrative manager to retain the
and foster new IPOs.
services of a market maker. The market maker will buy and sell the fund’s quotas on a regular and continued basis, ensuring
According to CVM’s new Instrução 549, a FIA-MA must invest
liquidity and establishing some control over the average price
at least 2/3 of its net worth in shares issued by companies
of the fund’s quotas.
listed in stock exchange or over-the-counter market segments focused on mid-market companies and that impose additional
In FIA-MAs organized as closed-ended funds, the new
corporate governance practices in comparison to those set
regulation allows the repurchase of quotas by the fund when
forth in law. It is tailored to benefit the Bovespa Mais 1, a
they are negotiated for a price lower than their net worth value.
special over-the-counter market managed by BM&FBovespa,
The new regulation has also brought about some other
the main Brazilian exchange, currently the only listing segment
interesting rules. For instance, FIA-MA’s investment managers
in Brazil that targets mid-market companies.
are allowed to charge performance fees based on the fund’s
Where organized as closed-end funds, FIA-MAs may invest
performance in comparison to inflation or interest rate
up to 1/3 of their net worth in shares and other securities of
indices 3. The reasoning behind this rule is that stock market
unlisted companies. Prior to Instrução 549, the Fundo de
indices normally used as a gauge for performance fees do not
Investimento em Participções – FIP (also known as Brazilian
properly capture the development of mid-market companies, in
private equity fund) was the only type of fund allowed to
particular unlisted ones.
invest in unlisted companies. Similarly to a FIP, a FIA-MA must
Another important rule applies to FIA-MAs offered exclusively
have decision-making powers with respect to the unlisted
to accredited investors. In this case, the FIA-MA’s investors
companies in which it invests and such companies must
may execute partnership agreements committing to provide
follow higher corporate governance practices. The unlisted
money to the fund in the future, upon capital calls made
companies must also undergo an appraisal every year to
by the fund’s manager. The investor does not have to put
determine their fair value.
money upfront but undertakes to make the investment when
While a FIP may invest all of its net worth in unlisted
and if the fund’s investment manager finds good and viable
companies, it is only available to accredited investors
investment alternatives. This enables the FIA-MIA to operate
(financial institutions, insurance companies, investors with
similarly to a FIP and thus be used as an alternative vehicle for
large portfolios and other sophisticated investors). The
private equity investments in Brazil.
FIA-MA, on the other hand, may be offered to all kinds of investors, including non-accredited investors. It is the first Brazilian fund that allows less sophisticated investors to invest at least partially in assets negotiated in the private equity sector, opening up new investment alternatives. To make the FIA-MA more appealing, the Brazilian government
In Issue No 1 of our M&A/Private Equity Newsletter we take a look at the Bovespa Mais. A copy of Issue No 1 can be found at www.loboeibeas.com.br/publicacoes/informativos.
enacted Law 13,043/14, establishing that if certain conditions
Law 13,043/14 sets forth which companies will be considered mid-market companies. Basically, they have to have a market value under BRL 700 million and annual gross revenues under BRL 500 million.
are met, gains obtained by individuals from the redemption of quotas of a FIA-MA are exempt from income tax. This
As a general rule, the benchmark used to calculate the performance fee in funds available to non-accredited investors has to be directly linked to the type of assets held in the fund’s portfolio.
exemption only applies if the FIA-MA (i) invests at least 67%
M&A / Private Equity
ISSUE No 5 MARCH 2015
extraordinary occasions, insurance companies may also
R&W Insurance: a Useful Tool for Private Equity & Venture Capital Transactions
get briefly involved in the actual due diligence process). An underwriting fee is charged to cover related expenses. From the purchaser’s standpoint, R&W insurance offers the following advantages: (1) reduction of frictions along the
A major challenge in M&A deals is to negotiate collection devices
negotiation process (which is desirable, for instance, where
and guarantees, such as escrow accounts and security interests.
the seller will continue to do business with the purchaser);
There is a natural tension between the purchaser’s desire to obtain
(2) assurance that losses related to misrepresentations
maximum protection, and the seller’s aspiration to receive the
will be indemnified (within coverage limits), regardless of
price and cease to have responsibility for liabilities involving the
the seller’s financial condition; (3) agility in the collection
company that is being sold. Such tension is exacerbated when the
of indemnification, without the need to await the end of
seller is a private equity or venture capital (PEVC) fund, given the
strenuous litigation with the seller (and/or other guarantors);
frequent need to wind up the fund within a tight timeframe.
(4) possibility of making a more attractive buyout offer with the promise to pay the whole price or a large fraction of it upon
Largely used in the American and European markets, an
closing; and (5) better negotiating position to obtain financing
interesting alternative to overcome deadlocks over collection
for the buyout (given a lower risk of large unforeseen losses
devices and guarantees has recently been made available in Brazil
that could negatively impact cash flow).
by insurance companies: the representations and warranties (R&W) insurance. Such insurance covers losses, including litigation
From the point of view of the seller, some of the benefits of
costs, suffered by either the seller or the purchaser as a result of
R&W insurance are: (1) better bargaining position to negotiate
misrepresentations in M&A deals (provided, of course, that the
the payment of the whole price (or a large fraction of it)
insured party was not aware of the misrepresentation at the time of
upfront; and (2) reduced exposure to unforeseen expenses
execution of the relevant agreements or closing).
with the payment of indemnification.
Contingent liabilities known by the parties, even if the likelihood
The main downside of R&W insurance is its cost, which is
of a loss is low, are generally not covered. The insurer may
often higher than the expenses related to the typical collection
impose additional exclusions in view of the particularities of
devices and guarantees. However, such expenses are not the
each case. And there is often great flexibility for the insured
only cost of collection devices and guarantees: sellers generally
party to negotiate other exclusions it might be comfortable with,
accept to reduce the price of the deal where purchasers agree
which usually leads to reductions in the insurance premium (for
neither to deposit part of such price in escrow accounts nor to
example, if the seller does not have many employees and the
request extensive guarantees (which is evidence that sellers
purchaser is confident that all representations made with regard
charge a sort of fee, included in the asking price, to consent to
to compliance with labor laws are true, it may feel no need to
collection devices and guarantees). Furthermore, buyers and
insure against the risk of misrepresentations in this field).
sellers are frequently uncomfortable with insurers’ extensive degree of interference in the conduct of litigation, which limits
Although there is room for negotiation, it is trade usage to have
the insured parties’ ability to settle the dispute or to insist on
an indemnification cap between 10% to 30% of the value of the
appealing without the insurance company’s consent.
deal and to limit the period of coverage to no longer than 3 to 5 years. In most cases the premium for R&W insurance corresponds
R&W insurance works as a substitute or a supplement to
to 3% to 7% of the amount involved in the transaction, though a
collection devices and guarantees. The decision to buy
minimum fee is almost always charged regardless of the size deal,
R&W insurance instead of, or together with, an escrow
which may make it economically unfeasible for smaller cases.
account, security interests or personal guarantees involves
Preliminary quotations can be obtained by furnishing insurance
a cost-benefit analysis, which should take into consideration
companies with drafts of the relevant agreements.
the concrete aspects of each deal. The extensive use of such insurance in transactions carried out in international
To mitigate the risk of fraud and moral hazard, insurance
markets shows it is an important and efficient tool, of which
companies hardly ever provide a firm quotation without
dealmakers, investment bankers and M&A lawyers in Brazil
reviewing the purchaser’s due diligence report (and in
should be well aware.
M&A / Private Equity
ISSUE No 5 MARCH 2015
Brazilian Healthcare Industry Now Open for Foreign Investment
Tax advantages of Brazilian Real Estate Investment Funds
The Brazilian healthcare industry is on the rise. Over the
The FII (Fundo de Investimento Imobiliário) is a vehicle for
past decade, millions of Brazilians have made it to the
investments in the Brazilian real estate industry. A FII may hold
middle class, consolidating Brazil as one of the largest
in its portfolio an extensive variety of assets, including real
consumer markets in the world. The increase in consumers’
property, mortgage and other real estate bonds, real estate
purchasing power, a willingness to pay for better healthcare
companies’ securities, as well as equity in other investment
services and an expanding elderly population, among other
funds. With regard to certain classes of such assets, the
factors, have prompted expectations that the Brazilian
FII, if properly structured, may provide relevant tax benefits,
healthcare industry will continue to experience substantial
especially for investors who are natural persons.
growth within the next few years, notwithstanding the slow
The FII is a flow-through entity not subject to the usual income
pace of the overall economy.
and revenue taxes applicable to Brazilian companies. At the
Until now, the healthcare industry was one of the few
investor’s level the gains obtained with the investment in a
sectors of the Brazilian economy that was not open to
FII may be subject to income tax in Brazil 1, which (as well
foreign investments. In an effort to bring more foreign
as the applicable rate) will depend on (i) how the gains were
investments to Brazil, the Brazilian government has lifted
obtained, (ii) whether the investor is a natural or legal entity,
this longstanding ban.
and (iii) where the investor is resident, domiciled or set up.
On January 19, 2015 Federal Law 13,097 was enacted
Gains arising from distribution of proceeds, as well as
to expressly authorize foreigners to acquire, directly or
amortization or redemption 2 of quotas will be taxed as follows:
indirectly, equity interests, including controlling ones, in
(1) natural persons, whether resident or domiciled in Brazil or
legal entities carrying out the following activities in Brazil:
abroad: are exempted from income tax, provided that (a) the
(1) running hospitals, clinics and laboratories; (2) production
FII quotas are traded exclusively in exchanges, (b) such quotas
and distribution of medicines and other health products; (3)
are held at least by 50 different investors, and (c) the investor
research and services related to human genetics; (4) clinical
that intends to benefit from the exemption neither holds more
analysis, diagnostic imaging and analysis of anatomical
than 10% of the FII quotas nor is entitled to more than 10% of
pathology; and (5) family planning.
the FII’s proceeds; and (2) legal entities and natural persons not exempted: are subject to income tax at a fixed rate of 20%, if
This is good news for the international private equity & venture
the investor is resident, domiciled or set up in Brazil, and 15%,
capital community, which now has a new open field for
if the investor is resident, domiciled or set up abroad, of the
investments in Brazil, with encouraging prospects of returns.
proceeds distributed (in case of amortization or redemption, though, only the investor’s net gain is taxed). Such tax, where applicable, will be levied at the moment the FII transfers profits to investors. The FII’s administrative manager must withhold and pay on investors’ behalf the amount due. It is noteworthy that FIIs must transfer to investors at least 95% of their profits recognized in each semester on a cash-basis accounting system (in accordance with financial statements dated as of June 30 and December 31). Such a rule is targeted at avoiding that profits remain untaxed indefinitely. Direct distribution of dividends by invested companies to the FIII’s investors is exempted from income tax. On the other hand, direct payment of interests on net equity (juros sobre o
M&A / Private Equity
ISSUE No 5 MARCH 2015
capital próprio) by invested companies to the FII’s investors is
in distribution of proceeds, as well as redemption, amortization
subject to withholding income tax at a fixed rate of 15%. Such
and sale of quotas. Dividends paid to tax-haven domiciled and
rules apply to all investors, whether natural persons or legal
“privileged tax regime” foreign investors are – as usual – exempt
entities, or resident, domiciled or set up in Brazil or abroad.
from income tax. Interests paid on net equity for those investors,
Additionally, PIS and COFINS will be levied on direct payment
on the other hand, are subject to a 25% (rather than the normal
of interest on net equity made to legal entities set up in Brazil.
15%) withholding income tax.
FIIs’ income and investors’ gains arising from distribution of
Notwithstanding its flow-through entity status, gains obtained
proceeds, as well as amortization or redemption of quotas
by the FII with investments in financial instruments other
are not subject to PIS and COFINS, which are generally levied
than mortgage and real estate bonds are subject to the
on the income of real estate companies set up in Brazil (as a
same income tax regime generally applicable to financial
rule, natural persons and legal entities set up abroad are not
investments in Brazil 5. However, such tax may be offset
subject to PIS and COFINS).
against the income tax due at the moment the FII transfer such gains to investors. Gains arising from investments in
As to sales of quotas to third parties, gains will be taxed as
mortgage and real estate bonds are exempt from income tax.
follows: (1) if the investor is resident, domiciled or set up in Brazil, at a fixed rate of 20% of the investors’ total net gain within the
The FII will lose its flow-through entity status if it invests
respective month of all transactions involving quotas of FIIs
in ventures where the developer, the constructor or other
(however, if the investor is a natural person and the transaction
investor is also an investor of the FII who holds, either severely
does not occur in an exchange, the 20% rate will be calculated
or jointly with related persons 6, more than 25% of the FII
on the capital gain of each separate transaction); and (2) if the
quotas. In such case, the FII will be subject to the same tax
investor is resident, domiciled or set up abroad, whether a natural
regime applicable to Brazilian companies. The goal of such
person or legal entity, transactions (a) executed in exchanges will
a rule is to discourage real estate companies from benefiting
be tax free, and (b) transactions carried out outside exchanges
from tax advantages granted to FIIs in ventures where there is
will be taxed at a fixed rate of 15% of the investors’ total net gain
no or small investments from third parties.
with all transactions involving quotas of FIIs within the respective
Given all its peculiarities, the FII is not always the most suitable
month. The income tax due in quota sales, where applicable,
vehicle for private equity investments in the Brazilian real estate
must be paid directly by the selling investor.
industry, although under certain circumstances it may offer
In any scenario, if the investor is resident or domiciled in Brazil
material tax advantages if properly structured. Hence, before
and a natural person, the income tax withheld or paid is final
resorting to the FII it is important to carefully consider whether
and no additional amount is due to the Brazilian IRS. If the
other investment vehicles would not be more tax-efficient.
investor is a legal entity set up in Brazil, the realized gains, as well as the corresponding tax withheld and paid, will be taken This article deals only with taxation in Brazil. It does not address the foreign taxation of gains obtained by investors with their investments in a FII.
into account for the calculation of the investor’s total taxable profit, and additional payment of income tax may be necessary,
along with social contribution on net profits, PIS and COFINS 3.
Which may only occur when the term of the fund expires or upon dissolution of the FII.
additional tax due, if any, will depend on the tax regime adopted by the investor in Brazil.
Additionally, FIIs’ investors may also be subject to a financial
Instrução 1,037/2010 of the Brazilian IRS lists the jurisdictions considered to be tax havens and the business entity types that are considered to have a privileged tax regime (for example, the Uruguaian Sociedades Anónimas Financieras de Inversión).
transaction tax (IOF) under the categories “Securities” and “Money Exchange”. However, the current rates applicable to transactions related to FIIs are zero.
Unless such financial instruments are subject to a special tax regime, the applicable income tax will vary according to the time period elapsed between the investment date and the date of recognition of gains, as follows: (i) up to 180 days: 22.5%; (ii) from 181 up to 360 days: 20%; (iii) from 361 up to 720 days: 17.5%; and (iv) for more than 720 days: 15%.
Specific rules apply to investors domiciled outside Brazil in jurisdictions that do not impose any income tax or charge income tax at a rate lower than 20% (frequently referred to as tax havens)
For this purpose, a related investor means (i) with regard to a natural person, her/his close relatives (parents, children, grandparents, grandchildren and siblings), legal entities controlled by such investor or by any of his/her close relatives, and partners, directors or officers of a legal entity under the control of such investor or his/her close relatives; (ii) with regard to a legal entitiy, its controlling shareholder, controlled companies and affiliates.
or that are organized under a business entity type considered to have a privileged tax regime 4. Such investors are subject to the same tax treatment applicable to individuals resident in Brazil
Editorial Team C.A. da Silveira Lobo Manoel Vargas Franco Netto Joaquim Simões Barbosa Pedro Paulo Salles Cristofaro Renata Novotny Natalie Sequerra Paulo Eduardo Penna Guilherme Leporace Juliana Zielinsky Yonenaga Bruno Haack Vilar Ana Carolina Pimentel Juliana Carvalho de Azevedo
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