Legal Framework for Startups is Sanctioned
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Complementary Law No. 182 was sanctioned on June 01, 2021, with the goal of improving the business environment and increasing the investment in entrepreneurship and innovation through the modernization of rules and enhancement of legal certainty and freedom of contract.
Complementary Law No. 182 was sanctioned on June 01, 2021 and introduced to the Brazilian legislation the Legal Framework for Startups (“Legal Framework for Startups”), with the goal of improving the business environment and increasing the investment in entrepreneurship and innovation through the modernization of rules and enhancement of legal certainty and freedom of contract.
Among the key innovations introduced by the Legal Framework for Startups, changes were introduced to Law No. 6,404/1976 (“Brazilian Corporations Law”) in order to enhance the adoption of the corporate form of corporations (sociedades anônimas) by startups, as well as to the Statute of Micro and Small Businesses (Complementary Law No. 123/2006, hereinafter referred to as “ME/EPP Law”), more importantly with respect to the angel investment agreement. The Legal Framework for Startups also seeks to limit the investors’ exposure for debts and liabilities of the invested startups and further creates a special regime for the contracting of innovative solutions by the Brazilian Government.
The Legal Framework for Startups introduced relevant changes to incentivize innovation and the development of the startup ecosystem in Brazil. However, the statute failed to address problems and gaps that disincentivize the investment in startups and/or that generate legal uncertainty to the ecosystem in general, such as (a) the regulation of stock option plans, which is an important pilar for the retention of talents in startups, but still subject to legal uncertainties from a labor, tax and social security perspectives; and (b) the possibility that corporations (sociedades anônimas) adhere to the “Simples” tax regime in Brazil. Another relevant innovation discussed during the processing of the bill, and that was ultimately vetoed, referred to the possibility of accounting losses incurred in an investment in startups in the tax base related to the investment in other startups for purposes of calculation of tax gains of individuals.
Please find below a summary of the key changes approved by the Legal Framework for Startups, which shall be effective as of August 31, 2021.
1. DEFINITION OF STARTUPS
According to Article 4 of the Legal Framework for Startups, startups are defined as “business or corporate organizations, under formation or with recent operations, whose purpose is characterized by the application of innovation to business models or products or services offered”.
The following corporate forms are eligible to qualify as startups under the Legal Framework for Startups: (i) Individual Entrepreneurs (Empresário Individual); (ii) Individual Limited Liability Companies (Empresa Individual de Responsabilidade Limitada); (iii) Business Entities (Sociedades Empresárias); (iv) Cooperatives (Sociedades Cooperativas); and (v) Simple Entities (Sociedades Simples).
The Legal Framework for Startups also sets forth that the following requirements must be met so that an entity can be qualified as a startup:
(i) A limitation of up to R$16 million in gross revenues in the previous year or, whenever the number of months in operation in the previous year is less than 12 months, a revenue equivalent to R$ 1,333,334.00, multiplied by the number of months in operation in that calendar year;
(ii) A limitation of up to 10 years of registration with the Corporate Taxpayers’ Roll of the Ministry of Economy (CNPJ/ME); and
(iii) A statement in the entity’s incorporation documents or amendments thereto in connection with the use of innovative business models for the generation of products or services or its enrollment with a special regime so-called Inova Simples (art. 65-A of the ME/EPP Law), which refers, in summary, to a regime that establishes a summary proceeding for the setting up and dissolution of entities applicable to Microenterprises (MEs) and Small Businesses (EPPs), which are subject to an annual gross revenue limitation of R$ 360 thousand and R$ 4.8 million, respectively.
2. INSTRUMENTS FOR THE INVESTMENT IN INNOVATION AND LIMITATION OF INVESTOR'S LIABILITY
A relevant change introduced by the Legal Framework for Startups refers to the legislator’s effort to limit the liability for startup investors. The new statute sets forth (in art. 5) that a capital contribution to the startup through the following instruments will not be part of the company’s share capital:
(i) option agreement for the subscription of shares or quotas entered into between an investor and the invested company;
(ii) option agreement for the purchase of shares or quotas entered into between an investor and the shareholders or quotaholders of a company;
(iii) convertible debenture issued by a company pursuant to the provisions of the Brazilian Corporations Law;
(iv) convertible loans entered into between an investor and the invested company;
(v) structuring of a partnership (sociedade em conta de participação) between an investor and the invested company;
(vi) angel investment agreement entered pursuant to the ME/EPP Law, which is an investment instrument that is not widely adopted by the market;
(vii) other capital contribution instruments in which the investor, whether individual or legal entity, does not become a shareholder or quotaholder of the company and/or contribute funds to the share capital of the company.
The Legal Framework for Startups sets forth that investors that fund startups based on the instruments listed in the paragraph above (a) shall not be considered a quotaholder or shareholder or will be entitled to management or voting rights in the invested company; and (b) will not be held liable for any debt or contingency of the invested company (including in case of a judicial reorganization of the invested company), except in case of fraud, willful misconduct or simulation involving the investor. Therefore, the statute sets forth that the investor will not be subject to the rules relating that set forth the piercing of the corporate veil in the current Brazilian legal framework (such as the rules provided for in Law No. 10,406/2002 (the “Brazilian Civil Code”) or in the Brazilian Labor Code - CLT) or in the Brazilian statutes that provide for joint and several liability in tax matters.
3. INCENTIVE TO RESEARCH, DEVELOPMENT AND INNOVATION
The Legal Framework for Startups also authorizes companies legally obliged to invest in research, development and innovation -- as a result of grants or of delegations of powers from Brazilian regulatory agencies -- to fulfill such obligation through the investment in startups. Such investment must be made through:
(i) Investment Funds destined to innovation;
(ii) Private Equity Funds (so-called FIPs) formed in the following categories: (a) seed capital; (b) emerging companies; and (c) companies with research, development and innovation-intensive economic production;
(iii) Investments in programs, competitive bids or tenders destined to the financing, acceleration and scalability of startups managed by public bodies.
However, the above authorization does not suffice or replace the minimum legal or contractual percentages that must be compulsorily invested in public funds.
The legal representative of the FIP, the investment fund or the public organization that receives funds from such entities will be required to issue a certificate so that the investor may be released from the legal or contractual obligations in connection with the investment in research, development and innovation. In case of investment in an investment fund or FIP, the release with respect to the obligation of investing in research, development or innovation will be subject to compliance with the guidelines for the allocation of funds issued by the supervising entity responsible for attesting compliance with such obligations.
4. EXPERIMENTAL REGULATORY ENVIRONMENT (REGULATORY SANDBOX)
The Legal Framework for Startups also paves the way for the public administration and entities that have specific regulatory jurisdiction to waive the applicability of rules within their regulatory competency with the goal of incentivizing innovation through a “regulatory sandbox”.
Pursuant to item II of Article 2 of the Legal Framework for Startups, “regulatory sandbox” is understood as a set of specific simplified conditions so that participants may receive a temporary authorization from agencies or entities with specific regulatory jurisdiction to develop innovative business models and test experimental techniques and technologies.
Entities of the public administration will have the ability to establish:
(i) The criteria for selection or qualification of the participants;
(ii) The duration and scope of the suspension of the application of the rules; and
(iii) The rules that will be subject to the framework.
5. CONTRACTING OF INNOVATIVE SOLUTIONS BY THE GOVERNMENT
In order to incentivize innovation using the State’s purchasing power, the Legal Framework for Startups establishes a special legal regime for bidding and contracting of innovative solutions by the public administration. Although these articles have been introduced to the legislation through the Legal Framework for Startups, they will not only benefit startups that meet the requirements set out in the statute: “any individuals or legal entities, alone or through a consortium”, will be able to participate in these new bids - and take advantage of the contractual arrangements associated with them.
The new regulatory framework for bidding and contracting generally applies to bodies of the public administration, agencies and foundations, and in the Federal, State and local levels. Public companies and semi-public companies (sociedades de economia mista) may adapt their respective bidding and contracting policies to the Legal Framework for Startups in order to take advantage of the new regulatory framework.
5.1. Special bidding regime
Considering that the exercise of the State’s purchasing power may be directed to the development of innovative solutions, the scope of a bid may now be limited to a mere identification of an issue that requires a solution and the consequent outcomes expected by the public administration, including the technological challenges that should be overcome — without the need of describing a technical solution previously identified and its technical specifications. Contracts with a similar scope have already been authorized under art. 20 of Federal Law No. 10,973/2004 (the “Innovation Law”) and in art. 13 of Federal Decree No. 9,245/2017 (which created the “National Policy for Technological Innovation in Health”).
The proposals will be analyzed and judged by a special committee composed of at least three individuals “of distinguished knowledge on the subject”. One of the members of the commission must be a public servant of the public body that will contract the services; another, a professor at a higher education public institution who lectures in the subject area of the project. The criteria to analyze the proposal, in addition to others that may be defined in the bidding notice, must consider:
(i) The solution’s potential to solve the identified problem and the likely financial savings that the solution may bring to the public administration;
(ii) The degree of development of the proposed solution;
(iii) The feasibility and maturity of the solution's business model;
(iv) The economic feasibility of the proposal, considering the funds available to enter into contracts; and
(v) A comparative study of costs and benefits of the proposal in relation to other options that are functionally equivalent.
Similarly to the framework that was established in the new Bidding Law (Federal Law No. 14,133/2021), the analysis of the qualification requirements will only occur after the review of the proposals. Even in this case, the public administration may, provided that it does so by express justification, waive the presentation of legal qualification requirements, technical qualification, economic and financial qualification and proof of tax and labor good standing - with the exception of the proof of regularity before social security authorities. Also, upon justification, the public administration is allowed to waive the presentation of a collateral for the contract.
The novelty presented in the above paragraph may be one of the most sensitive issues in the application of the new bidding model. Even though the waiver of such requirements can be important to allow a greater participation of the private sector — and especially by startups — the public administration must take into account a minimum degree of protection in order to employ public funds in such contracts. The Legal Framework for Startups should not be read, however, as a blank check so that guarantee and qualification conditions are entirely waived by the public administration to the benefit of an alleged “greater competitiveness” of the bidding process.
At the end of the bidding process, the public administration may select one or more proposals for the execution of the so-called “Public Contract for Innovative Solution” (CPSI), provided that the bidding notice may, however, limit in advance the number of winning proposals. Following the judgment of the proposals, public authorities may negotiate with those who submitted the best proposals “more advantageous economic conditions in favor of the public administration and the form of compensation criteria to be adopted”. We also understand that this novelty must be weighed with caution: a space for negotiation cannot lead to the grant of unequal treatment— nor offer advantages that have not been offered to other parties who have submitted proposals during the bidding process (but that have not been selected by the public administration).
5.2. New Contract Framework
Contracts entered with the public administration based on the Legal Framework for Startups may have as scope “the testing of innovative solutions developed or to be developed [by the contractors], with or without technological risk factors”. After the homologation of the results of the bid, the public administration will enter into a Public Contract for Innovative Solution (CPSI) with the selected bidders, with a validity term limited to 12 (twelve) months renewable for an additional period of up to 12 (twelve) months. The CPSI must necessarily provide for:
(i) Goals to be achieved in order to establish the success of the innovative solution;
(ii) Form and frequency of delivery of reports on the progress of the performance under the contracts;
(iii) Matrix of risks between the parties;
(iv) Definition of the ownership of intellectual property rights of the creations resulting from the CPSI; and
(v) Participation in the results arising from the use of the solution, ensuring to the parties the rights to commercial exploration, licensing and transfer of technology to which they are entitled.
The maximum amount to be paid by the public administration for each CPSI entered cannot exceed R$ 1,6 million. The contractor's compensation must be made through one of the following alternatives: (i) fixed price; (ii) fixed price plus variable incentive compensation; (iii) reimbursement of costs without additional compensation; (iv) reimbursement of costs plus variable incentive compensation; and (v) reimbursement of costs plus fixed incentive compensation. For cases involving a technological risk, payments must be made in proportion to the work performed - in accordance with the approved physical-financial timeline.
As a rule, payments will be made following the completion of the works. However, the public administration must — if necessary, and with due justification — provide for the advance payment of a portion of the price in order to secure funding for the implementation of the initial stage of the project. The statute did not set forth parameters or limits for such anticipation of payments. At the same time, the statute establishes that if there is an “unjustified non-performance”, the public administration must demand the refund of the anticipated payment or offset it with subsequent payments due.
Once the CPSI is successfully executed, the public administration may enter with the same contractor, with no need for a new bidding process, a supply agreement for products, process or solutions resulting from the CPSI or, if applicable, for the integration of the solution into the technological infrastructure or to the work process of the public administration. In this case, the supply contract must be valid for up to 24 months, renewable for a further period of up to 24 months, provided that its value shall be limited to five times the maximum amount of R$1,6 million established for each CPSI.
6. CHANGES TO THE BRAZILIAN CORPORATIONS LAW (LAW No. 6,404/76)
The Legal Framework for Startups also introduced changes to the Brazilian Corporations Law that apply to any companies, even if they are not categorized as startups under the new statute. Among the key innovations, we highlight the following:
6.1. Changes to the Executive Board of Corporations
Article 143 of the Brazilian Corporations Law was amended to the effect that the executive board of corporations (sociedades anônimas) may now be composed of only one member, elected and dismissed by the board of directors or by shareholders in general meetings. The previous rule provided for the need of at least two officers.
6.2. Simplified requirements for privately held corporations with an annual revenue of up to R$ 78 million (Article 294 of the Brazilian Corporations Law)
The new language of art. 294 of the Brazilian Corporations Law sets forth that privately held corporations that register an annual gross revenue of up to R$ 78 million shall, in summary, have the following differentiated treatment:
(i) Exemption from the obligation to publish certain documents required under the Brazilian Corporations Law in the official gazette and in a mass-circulation newspaper, as long as such publications are made electronically;
(ii) Replacement of corporate books by mechanized or electronic records; and
(iii) In case the bylaws is silent with respect to dividends, they may be freely distributed as approved in a general shareholders’ meeting, without the application of the rule of mandatory distribution of 50% of the adjusted net income and other rules set forth in article 202 of the Brazilian Corporations Law.
We note that the previous exception set out in art. 294 of the Brazilian Corporations Law only provided for simplified rules for the call of meetings and waiver of publication obligations and only applied to privately held companies with less than 20 shareholders and a net equity of up to R$10 million. The statute delegated powers to the Ministry of Economy to issue additional regulations on the provisions of art. 294 of Brazilian Corporations Law.
6.3. Small Size Companies (new Article 294-A of the Brazilian Corporations Law)
The Legal Framework for Startups also creates the concept of “small size companies” (companhia de menor porte), which are defined as those that register an annual gross revenue of less than R$ 500 million.
Article 294-A of the Brazilian Corporations Law delegated to the CVM powers to issue rules providing facilitated conditions so that “small size companies” may access the capital markets. In this sense, CVM may waive or issue rules relating to:
(i) Mandatory installation of the fiscal council (article 161 of the Brazilian Corporations Law);
(ii) The obligation to involve financial institutions as intermediaries in public distributions of securities (§5 of article 170 of the Brazilian Corporations Law);
(iii) Distribution of mandatory dividends (art. 202 of the Brazilian Corporations Law), including with respect to the rules on shareholders’ participation in profits (art. 109, I, of the Brazilian Corporations Law) and voting rights of preferred shares (art. 111, §§1 and 2 of the Brazilian Corporations Law); and
(iv) Publications in the official gazette and in mass-circulation newspapers (art. 289 of the Brazilian Corporations Law).
7. ANGEL INVESTOR AND RULES IN CONNECTION WITH THE ANGEL INVESTOR AGREEMENT PROVIDED FOR IN THE ME/EPP LAW
The Legal Framework for Startups sets forth that an angel investor shall be defined based on the following criteria:
(i) The angel investor shall not be considered a shareholder or quotaholder of the invested company;
(ii) The angel investor shall have no management or voting rights in the invested company;
(iii) The angel investor shall not be held liable for any obligations of the company; and the rules setting forth the pierce of corporate veil provided for in art. 50 of the Brazilian Civil Code, for example, shall not apply; and
(iv) The angel investor’s contributions shall be subject to earnings.
Pursuant to the above criteria, the Legal Framework for Startups establishes the following changes to the ME/EPP Law in connection with the angel investment contract applicable to Microenterprises (Microempresas - ME) and Small Businesses (Empresas de Pequeno Porte - EPP) subject to the simplified taxation regime (regime simples de tributação):
(i) Angel investors may now participate in resolutions of the invested company on a consultative basis;
(ii) The maximum period that the angel investor may receive earnings over the investment was increased from 5 years to 7 years;
(iii) The angel investor is now entitled to demand management accounts from management and, annually, also the balance sheet and financial statements;
(iv) The angel investor may now inspect, at any time, the books, documents and cash position and portfolio of the company, unless a different periodicity was agreed contractually; and
(v) The earnings over the investment are no longer subject to a limitation of 50% (fifty percent) of the profits of the microenterprise or small business for purposes of the ME/EPP Law.
The limitation on the earnings over the angel investment was subject to criticism in the previous version of the ME/EPP Law. The Legal Framework for Startups innovated by removing this limitation and establishing that the earnings over the investment will be agreed upon among the parties in the investment agreement. However, the Legal Framework for Startups maintained the provision that the angel investor may only exercise a redemption right after at least two years counted as from the investment, and that the proceeds will be repaid based on the net worth of the company (unless otherwise agreed) pursuant to art. 1,031 of the Brazilian Civil Code, and that such repayment cannot exceed the amount invested in addition to an agreed indexation.
The flexibilization of the previously existing rules demonstrates the legislator’s intention to align the rules on angel investment with market practices. However, the Legal Framework for Startups has not solved the problem of excess of legislator’s intervention in the conditions negotiated among the parties in an angel investment agreement, which may result that the instrument continues to be narrowly adopted by the market as a mean to formalize investments in startups.
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