The evolution of funding structures in Brazil: Crowdfunding, Convertible Loan Agreements and Convertible Debentures

In light of evolution of business relations and the “importation” of the American convertible note as a funding mechanism, mainly by early stage tech-companies (statups), new legal structures arose in Brazil and other types of unpopular structures started being used more often, such as the Convertible Loan Agreements and Convertible Debentures. We also noted the popularization of the so-called Equity Crowdfunding by way of a funding platform, which has been structured by the aforementioned legal alternatives.

However, due to the particularities of the Brazilian legal system, it is worth clarifying a few aspects of the Equity Crowdfunding platform, the Convertible Loans and the Convertible Debentures.

Crowdfunding platforms are independent tools used by startups to raise capital with scalability. The Brazilian platforms Kria (former Broota) and EuSócio, the Australian ASSOB (Australian Small WScale Offering Board) and the American Kickstarter are examples of pioneer platforms in its respective markets.

Although practical and somewhat effective, equity Crowdfunding Platforms were just regulated in Brazil with proclamation of Rule # 588 of July 13, 2017, by the Brazilian Securities Exchange Commission (“CVM Rule # 588”), creating (i) an exception to the registration duty of public offerings demanded by Rule CVM # 400, (ii) the need of registering the platform and (iii) few rules and restrictions. The fact that Debentures and group investment agreements are considered securities by law (Section 2 of Law 6,385/76 of December 7, 1976) and the demand for a less bureaucratic market created the need of regulating an exception for the public offering registration rule.

Therefore, in order to quality for an offering registration release, the transaction must meet the following criteria:

• The startup must be considered a small business association, with gross revenue up to R$ 10,000,000.00 (dez milhões de reais);
• The maximum funding amount cannot surpass R$ 5,000,000.00 (five million reais), and the funding period cannot surpass 180 (one hundred and eighty) days;
• The platform must be registered before CVM and comply with the rules set forth on Section 5 of Rule CVM # 588;
• A withdrawal period of at least 7 days must be granted to the investor without any penalty;
• The funding must not be used for a) merger, acquisition or incorporation; b) acquisition of bonds, convertibles or not, and securities issued by other companies; or c) granting credit to other companies;
• The investment per individual must be limited to R$ 10,000.00 (ten thousand reais) except if the investor is considered a leader or qualified investor.

It is import to note that the platform must also comply with the restrictions imposed by CVM, specially on Section 28 of Rule CVM # 588 which forbids the platform to: conduct investors’ solicitation, promise predetermine earnings or make investments recommendation.

As for the Convertible Loan Agreements (used in case of a target incorporated as a sociedade limitada) and Convertible Debentures (used in case of a target incorporated as a sociedade anônima), used to structure the crowdfunding or direct funding investment transactions, a few important legal aspects must be brought to discussion.

The Loan Agreement is a contract established by law, specifically on Section 586 of the Brazilian Civil Code, defined as lending of fungible goods, in other words the debtor is obliged to refund the creditor with a good of the same kind or nature.

On the other hand, the Convertible Loan Agreement establishes a restitution in the form of equity, that is, a different kind of good from what initially was lent. Although some experts defend the possibility of dispute as for the legality of its form, it is our understanding that in this matter the principle of private autonomy prevails. In accordance with such principle, the parties are free to regulate their own agreements within the limits of the law, being also allowed to agree that the creditor is paid in securities instead of capital.

Similar situations have shown to be effective and enforceable such as the so called Advance for Future Capital Increase (AFAC) and renegotiations between creditors and debtors where the effective payment is made by the debtor’s own securities instead of capital. These precedents strengthen even more the thesis that the credit arising from a Convertible Loan Agreement and the obligation to deliver the securities are unquestionable.

With respect to the Convertible Debentures, there is no further debate here, since such structure is consolidated on Section 52 of Law 6,404 of December 15, 1976 (Brazilian Corporation Law), granting its holders the unequivocal right of credit against the company, convertible in equity,  according to the rules set forth on the Debentures Deed.

Thus, it has become very clear that as a consequence of the market evolution and the unquestionable existing demand for flexibility and agility, the importation of foreign legal structures are influencing the adaptation of old structures creating new possible alternatives, which are shown to be effective and legal, as long as developed under the limits of the law.

Gustavo de Lima Palhares – Furriela Advogados