Apresentação Brian Hutchings no CASE2014

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