The Private Equity and Venture Capital Industry - Second Brazil Census

The Private Equity
and Venture Capital Industry:

Second Brazilian Census
First Edition
Revised March 2012
The Private Equity and Venture Capital Industry - Second Brazilian Census. Based on the original
text of the Research Report - Updated Information for the Second Census of the Brazilian Private Equity and
Venture Capital Industry, Copyright ABDI 2010, prepared by GVcepe of FGV - EAESP - Getulio Vargas
Foundation.
ABDI
Brazilian Agency for Industrial Development
Setor Bancrio Norte
Quadra 1 Bloco B Ed. CNC
70041-902 Braslia DF
Tel.: (61) 3962-8700
www.abdi.com.br
FGV
Getulio Vargas Foundation
Av. 9 de Julho, 2029 - Bela Vista
CEP: 01313-902
Sao Paulo - SP - Brazil
Tel.: (11) 3799-7768
www.fgv.br/cepe
Catalographic Index Record
Brazilian Agency for Industrial Developement.
The Private Equity and Venture Capital Industry Second Brazilian Census. / Brazilian Agency for Industrial Development, Center of
Management and Strategic Studies. / FGV - Getulio Vargas Foundation, GVcepe Braslia: Brazilian Agency for Industrial Development, 2011.
420p.: il.; graf.; tab.
ISBN 978-85-61323-26-4
1-Industry. 2-Industry. 3-. I- Title. II- Center of Management and Strategic Studies. III-Serial.
CDU 338.47674
2011 Brazilian Agency for Industrial Development ABDI
The Private Equity and Venture Capital Industry - Second Brazilian Census
Prepared by GVcepe of FGV-EAESP Fundao Getulio Vargas
Any section of this work can be reproduced, as long it is quoted.
Based in the original text of the Research Report Updated Information of the Second Census of the Brazilian Private Equity and Venture
Capital Industry, Copyright ABDI 2010, revised and expanded in this edition of March, 2012. Works prepared by GVcepe - Getulio Var-
gas Foundation - EAESP.
ABDI Brazilian Agency for Industrial Development
FGV Getulio Vargas Foundation
Supervision
Maria Luisa Campos Machado Leal (ABDI)
ABDI Technical Team
Cssio Marx Rabello da Costa (Project Coordinator)
Joana Wightman (Supervision Communication)
Mario Jorge Sampaio (Project Specialist)
FGV Technical Team
Caio Ramalho (Editor and Author)
Cludio Vilar Furtado (Editor and Author)
Rodrigo Lara (Editor and Author)
Alessandra Brochado (Author)
Alexander Appel (Author)
Carlos Motta (Author/ Tauil & Chequer Advogados)
Diogo Kudo (Author)
Eduardo Paoliello (Author/ Pinheiro Neto Advogados)
Estvo Latini (Author/Fundao Petros)
Fernando Kaufmam (Author)
Gabriel Felisoni (Author)
Gabriella Pegoraro (Author)
Henrique D'Amico (Author)
Henry Sztutman (Author/ Pinheiro Neto Advogados)
Jacques Vaney (Author/Emerge Capital)
Joo Ricardo Ribeiro (Author/ Mattos Filho, Veiga Fillho, Marrey
Jr. e Quiroga Advogados)
Lucas Amorim (Author)
Lucas Martins (Author)
Lucas Cancelier (Author)
Marcelo Coura (Author)
Marcelo Kubli (Author)
Marcelo Person (Author)
Rafael Martins (Author)
Rafael Roldo (Author)
Ricardo Lacaz (Author/ Lacaz Martins, Halembeck, Pereira Neto,
Gurevich & Schoueri Advogados)
Thiago Maia (Author/ Tauil & Chequer Advogados)
William Luk (Author)
Ricardo Silveira (Proofreader)
Federal Republic of Brazil
Dilma Rousseff
President
Ministry of Development, Industry and Foreign Trade (MDIC)
Fernando Pimentel
Minister
Brazilian Agency for Industrial Development (ABDI)
Mauro Borges Lemos
President
Clayton Campanhola
Director
Maria Luisa Campos Machado Leal
Director
Cssio Marx Rabello da Costa
Project Coordinator
Getulio Vargas Foundation (FGV)
Carlos Ivan Simonsen Leal
President
Francisco Oswaldo Neves Dornelles
Marcos Cintra Cavalcanti de Albuquerque
Srgio Franklin Quintella
Vice-Presidents
Getulio Vargas Foundation - Sao Paulo School of Business Administration (FGV-EAESP)
Maria Tereza Leme Fleury
Dean
Maria Jos Tonelli
Deputy Dean
Private Equity and Venture Capital Research Center (GVcepe)
Cludio Vilar Furtado
Center Director
Caio Ramalho
Rodrigo Lara
Project Coordinators
Edgar Alberto Cabral
IT and Database
Coordination
Abdala Razek
Adilon Garcia
Alessandra Brochado
Alexander Appel
Andr Assumpo
Andr Coracini
Ariel Almeida
Breno Lopes
Bruno Villena
Caio Ramalho
Carlos Eduardo Alvares
Diogo Kudo
Eduardo Camargo
Eduardo Silva
Fabio Camillo
Fernando Kaufman
Felipe Mattos
Flavio Fioravanti
Gabriel Felisoni
Gabriella Pegoraro
Henrique D'Amico
Joo Victor de Souza
Lucas Amorim
Lucas Martins
Lucas Cancelier
Lucas Tavolaro
Luiz Tanisho
Marcel Kanopka
Marcelo Coura
Marcelo Kubli
Marcelo Person
Maria Jos Felicio
Marisa Bessa
Maurcio Leusin
Paula Nagle
Pedro Prellwitz
Rafael Auriemo
Rafael Martins
Rafael Roldo
Rachel Pacheco
Renato Chu
Ricardo Silveira
Rodrigo Lara
Thiago Perim
William Luk
Field Research Team
Acknowledgements
11
ACKNOWLEDGEMENTS
This book, The Private Equity and Venture Capital Industry The Second Brazilian Census,
prepared by GVcepe the Private Equity and Venture Capital Research Center of FGV-
EAESP based on the original Research Report Updated Information for the Second Census of the
Brazilian Private Equity and Venture Capital Industry, December 2010, represents the tangible results of
eighteen months of work. The conclusion of this project was only made possible by the support and help of
various organizations as well as the tireless dedication of our research staff, which identied and collected
information from more than 144 private equity and venture capital managers operating in Brazil.
The GVcepe Team, Joo Ricardo Ribeiro (Law Ofce of Mattos, Filho, Veiga Filho, Marrey Jr e Quiroga), Jos
Diniz (Law Ofce of Demarest and Almeida), Ricardo Lacaz (Law Ofce of Lacaz Martins, Halembeck, Pereira
Neto, Gurevich & Schoueri), Henry Sztutman and Eduardo Paoliello (Law Ofce of Pinheiro Neto), Daniel Kalansky
(Law Ofce of Motta and Fernandes Rocha), Carlos Motta and Tiago Maia (Law Ofce of Tauil & Chequer),
Guilherme Forbes (Law Ofce of Souza, Cescon, Barrieu & Flesch) and Estevo Latini (Petros and Latin America
Alternatives) analyzed the most important academic and technical/scientic studies published internationally
and within Brazil, which served as a foundation for the preparation of this book.
We would like to recognize in particular the institutional support and sponsorship provided by ABDI The
Brazilian Industrial Development Agency, our sponsor and partner in this endeavor, and especially its ex-
President Reginaldo Braga Arcuri (President 2007-2010), the Director Maria Luisa Campos Machado Leal, and
the Coordinator of this project at ABDI Cssio Marx Rabello da Costa who were key to its realization. We would
also like to specially thank the current ABDI President Mauro Borges Lemos, for his personal engagement with
and endorsement of this works importance for the Brazilian society.
We wish to thank the founding members of GVcepe: Advent International, Intel Capital, JP Morgan
Partners, Ptria Investimentos, Sebrae-SP, TMG Capital, Votorantim Novos Negcios and Professor
Emeritus Wladimir A. Puggina for their strategic vision and the interest and the condence that they
have placed in our writers and researchers since GVcepe was founded in 2003. Thanks to VISA for its
institutional sponsorship of GVcepe. Thanks to the leadership of FGV the Getulio Vargas Foundation,
FGV/EAESP the So Paulo School of Business Administration, in particular Dr. Maria Tereza Leme Fleury,
Dean of the So Paulo School of Business Adminstration, and GVpesquisa for their support ever since this
projects inception.
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We also wish to thank the committee members selected by ABDI to follow the progress of the original
project for having accepted to participate in a challenge this great: Guilherme Ary Plonski, Jos Aranha
and Antnio Botelho (ANPROTEC), Sidney Chameh e Robert Binder (ABVCAP), Maria Luisa Cravo (APEX),
Leandro Vieira (BANCO DO BRASIL), Eduardo Rath Fingerl and Eduardo S (BNDES), Eduardo Costa,
Patrcia Freitas, Andr Calazans, Rochester Costa and Rafael Silva (FINEP), and Amrico Cicarelli (SEBRAE).
We also wish to thank all the fund management rms in this study that dedicated their time and employees
to participating in this work, giving it an unprecedented breadth and depth. Without you this project would
not be possible!
We would also like to give our very special thanks to Dr. Patricia Dineen (Siguler Guff & Company), Dr.
Roger Leeds (Johns Hopkins University and EMPEA) and Mrs. Hayde Celaya (IFC World Bank) for their
inspiration and encouragement which engaged us and helped us complete our challenging and difcult
mission.
To everyone, our heartfelt thanks.
The authors and the GVcepe Team members,
Prof. Cludio Vilar Furtado
Center Director
Sao Paulo, March 2011
cvf@cvf.com.br
The Private Equity and Venture Capital Industry - Second Brazilian Census. Based on the original
text of the Research Report - Updated Information for the Second Census of the Brazilian Private Equity and
Venture Capital Industry, Copyright ABDI 2010, prepared by GVcepe - FGV - Getulio Vargas Foundation.
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Table of Contents
Introduction: The Second Census of the Private Equity and Venture Capital Industry:
From Innovative Ventures to Corporate Revolution ............................................................ 25
Chapter 1. A History of the Private Equity and Venture Capital Industry ................................................. 35
Chapter 2. The PE/VC Industry Ecosystem in Brazil ................................................................................. 61
Chapter 3. The Private Equity and Venture Capital Cycle, Fundraising, Committed Capital
and the Origin of Fund Managers ...................................................................................... 113
Chapter 4. The Private Equity and Venture Capital Cycle - Investing .................................................... 151
Chapter 5. The Private Equity and Venture Capital Cycle - Exiting ....................................................... 193
Chapter 6. Corporate Governance and Contracts (Monitoring) ........................................................... 215
Chapter 7. Private Equity and Venture Capital in the Context of Sources of Long Term
Financing in Brazil ............................................................................................................. 299
Chapter 8. The Economic Impact of the PE/VC Industry ...................................................................... 323
Chapter 9. Future Prospects: Challenges and Opportunities ................................................................ 371
Bibliographic References ...................................................................................................................... 391
13
The Private Equity and Venture Capital Industry The Second Brazilian Census
14
Tables
Table 1.1 Legislative Impact on PE/VC Investments in the United States ....................................................................................... 41
Table 1.2 Number of VC Fund Managers (US and Europe) ........................................................................................................ 48
Table 1.3 IFC Investments in VC Focused Fund Managers .......................................................................................................... 51
Table 2.1 Structure of Equity Participation Funds vs. Holding Companies (2010) .......................................................................... 70
Table 2.2 PE/VC Ecosystem Actors ........................................................................................................................................... 72
Table 2.3 Investor Categories (2010) ....................................................................................................................................... 86
Table 2.4 Investment Type and Assumed Risk ......................................................................................................................... 102
Table 2.5 Sales of Goods vs. Services ................................................................................................................................... 107
Table 2.6 Operational Details .............................................................................................................................................. 110
Table 3.1 Principal Factors for Success in PE/VC Activities ........................................................................................................ 116
Table 3.2 Macroeconomic Factors as Obstacles to Success ...................................................................................................... 117
Table 3.3 Obstacles Due to Social Factors .............................................................................................................................. 118
Table 3.4 Obstacles Due to Political Factors ........................................................................................................................... 118
Table 3.5.1 Obstacles Due to the Legal-Institutional Framework (PE-Private Equity Organizations) ............................................... 119
Table 3.5.2 Obstacles Due to the Legal-Institutional Framework (VC-Venture Capital Organizations) ........................................... 120
Table 3.6 Obstacles Due to the Structure of the PE/VC Industry .............................................................................................. 122
Table 3.7 Penalty for Failing to Honor Capital Commitments .................................................................................................. 124
Table 3.8 Committed Capital in the PE/VC Industry Allocated to Brazil ...................................................................................... 125
Table 3.9.1 Legal Structure of Investment Vehicles ................................................................................................................... 126
Table 3.9.2 Fundraising in 2009 by Legal Structure ................................................................................................................. 127
Table 3.10 Fund Manager Affiliations ........................................................................................................................ 128
Table 3.11 Capital Expected to be Raised for Final Closing by Fund Manager (PE) .................................................................... 130
Table 3.12 Capital Expected to be Raised for Final Closing by Fund Manager (VC) .................................................................... 131
Table 3.13 Concentration of Committed Capital Allocated to Brazil ....................................................................................... 143
Table 3.14 Origins of Fund Managers .................................................................................................................................... 144
Table 4.1 Sources of In-House Prospecting ............................................................................................................................. 154
Table 4.2 Sources of Third Party Leads .................................................................................................................................... 154
Table 4.3 Received Proposals by Economic Sector ................................................................................................................ 155
Table 4.4 Received Proposals by Investment Stage ........................................................................................................... 156
Table 4.5 Target Company Requisites Which Make an Investment Viable ................................................................................ 157
15
Tables
Table 4.6 Factors Which Preclude Investment in a Target Company ........................................................................................ 158
Table 4.7 Number of Proposals Contained in Deal Flow According to the Sourcing Methods ...................................................... 160
Table 4.8 Principal Reasons Why Proposed Investments that Reach Due Diligence Are Not Viable ............................................... 161
Table 4.9 Minimum and Maximum Expected Returns by Stage ................................................................................................. 165
Table 4.10 Characteristics of Investment Committee Deliberations in the Selection Phase ........................................................... 167
Table 4.11 Valuation Methods ............................................................................................................................................... 169
Table 4.12 Time Taken to Close New Deals ............................................................................................................................ 171
Table 4.13 Increases in Risk Premiums by Country/Region ........................................................................................................ 172
Table 4.14 Investment Vehicles (Funds) and their Lifes .............................................................................................................. 173
Table 4.15 Public Sector Investor Participation in Portfolio Companies (June 2008) .................................................................... 174
Table 4.16 Average Ticket by Stage of Investment.................................................................................................................... 180
Table 4.17 Geographic Distribution of Portfolio Companies (December 2009) ......................................................................... 189
Table 4.18 Economic Sectors of Portfolio Companies in 2009 ................................................................................................ 191
Table 5.1 Investment Exits by Stage in US$ Millions ................................................................................................................. 196
Table 5.2 Investment Exits by Stage ........................................................................................................................................ 197
Table 5.3 Values of Investment Exits by Type ........................................................................................................................... 199
Table 5.4 Net Returns for Investors (Cambridge Associates) ...................................................................................................... 206
Table 5.5 Post-IPO Excess Returns in Brazil .............................................................................................................................. 207
Table 5.6 Median Multiples of Investment ............................................................................................................................... 209
Table 5.7 Median Values for Internal Rates of Return ............................................................................................................... 210
Table 5.8 Median Returns Exceeding CDI ............................................................................................................................... 211
Table 6.1 Participants in the PE/VC Cycle ............................................................................................................................... 219
Table 6.2 Preferred Structures Worldwide .............................................................................................................................. 222
Table 6.3 Percentage of Capital Commitment to be Made Available After The Signing of the Investment Agreement ..................... 224
Table 6.4 Paid Capital Commitments .................................................................................................................................... 224
Table 6.5 Penalties When Capital Commitments Are Not Paid ................................................................................................ 225
Table 6.6 Possibility of Beginning Fundraising for a New Vehicle before the Current One Closes ................................................. 225
Table 6.7 Percentage of Committed Capital Necessary Before Fundraising for a New Vehicle Can Begin .................................... 226
Table 6.8 Life of Investment Vehicles ...................................................................................................................................... 226
Table 6.9 Length of Investment Vehicle Life Extensions ............................................................................................................. 227
Table 6.10 Restrictions Defined in Investment Agreements ....................................................................................................... 228
Table 6.11 Investment Approval Models ................................................................................................................................ 230
16
Table 6.12 Right of One or More Investors (LPs) to Call an Extraordinary Assembly ................................................................... 230
Table 6.13 Percentage of Capital Paid that is Necessary for One or More Investors (LPs) to Call an Extraordinary Assembly .......... 231
Table 6.14 Right of the Investor to Co-Invest Directly in Portfolio Companies ............................................................................ 232
Table 6.15 Length of Investment Period .................................................................................................................................. 233
Table 6.16 Length of Investment Period and Possible Extensions ............................................................................................... 234
Table 6.17 Duration of Exit Period ......................................................................................................................................... 235
Table 6.18 Divestiture Period and Possible Extensions ............................................................................................................. 236
Table 6.19 Costs and Expenses Paid by Management Fees ...................................................................................................... 238
Table 6.20 Actors Receiving Remuneration from Management Fees ......................................................................................... 239
Table 6.21 Management Fees ............................................................................................................................................... 240
Table 6.22 Base for the Calculation of Management Fees during Investment and Exit Periods...................................................... 242
Table 6.23 Timing of Carried Interest Payment ....................................................................................................................... 243
Table 6.24 Hurdle Rate ........................................................................................................................................................ 244
Table 6.25 Catch-Up ........................................................................................................................................................... 245
Table 6.26 Clawback ........................................................................................................................................................... 246
Table 6.27 Carried Interest .................................................................................................................................................... 246
Table 6.28 Management Fees vs. Carried Interest (Received by Administrator) .......................................................................... 247
Table 6.29 Management Fees vs. Carried Interest (Received by Manager) ................................................................................ 248
Table 6.30 Subtracting the Management Fee from the Carried Interest ...................................................................................... 248
Table 6.31 Timing of Carried Interest Calculation ................................................................................................................... 249
Table 6.32 Investor Right to Fire the Manager or Members of the Vehicle Management Team .................................................... 250
Table 6.33 Use of Binding Arbitration to Resolve Conflicts between PE/VC Fund Managers and Investors .................................... 251
Table 6.34 Evolution of Number of Companies in Compliance with Levels of the BM&F Bovespas Corporate Governance Classification .....253
Table 6.35 Willingness to Pay More for Good Corporate Governance ...................................................................................... 255
Table 6.36 Good Corporate Governance Paid in Fact ............................................................................................................. 256
Table 6.37 Level of Corporate Governance during the Investment Selection Process ................................................................... 257
Table 6.38 Categories of Company Structure .......................................................................................................................... 258
Table 6.39 Entrepreneur and CEO Share Participation ............................................................................................................. 261
Table 6.40 Formal Meetings of the Board of Directors and Informal Discussions ........................................................................ 264
Table 6.41 Characteristics of Board Members ......................................................................................................................... 266
17
Tables
Table 6.42 Background of External and Independent Members of the Board of Directors ............................................................ 267
Table 6.43 Characteristics of Key Personnel ........................................................................................................................... 269
Table 6.44 Key Personnel Most Present in Committees and Subcommittees ................................................................................ 270
Table 6.45 Percentage of Auditors That Report to Key Personnel ............................................................................................... 272
Table 6.46 Remuneration of Members of the Board of Directors ............................................................................................... 272
Table 6.47 Performance Evaluations of Key Personnel .............................................................................................................. 274
Table 6.48 Distribution of Executive Compensation for Companies that held IPOs on the BM&F Bovespa after 2004 ................... 279
Table 6.49 Anti-Dilution Protection Clauses and Stock Transfer Rights and Restrictions ................................................................ 279
Table 6.50 Average Time Spent Monthly in Different Types of Contact with Portfolio Companies .................................................. 289
Table 7.1 Portfolio Companies (June 2008) ............................................................................................................................ 307
Table 7.2 Composition of BNDESPar Portfolio ........................................................................................................................ 310
Table 7.3 Sectoral Breakdown by Percentage of Stock, Debentures and Funds for BNDESPar from 2007 to 2009 ......................... 311
Table 7.4 Sectoral Breakdown of the Market Value of Stocks, Debt. and Funds for BNDESPar from 2007 to 2009 ........................ 311
Table 7.5 Investments by Entrepreneurial Capital Area and Capital Markets Area of BNDESPar ................................................... 312
Table 7.6 Issuing of Debentures for Publicly Traded and Private Companies by BNDESPar ........................................................... 313
Table 7.7 Number of Projects and Values of FINEP Programs ................................................................................................... 315
Table 7.8 Investment Funds Supported by FINEP...................................................................................................................... 316
Table 8.1Value Added by Authorial Rights Industries in Mercosul in 1998 .................................................................................. 330
Table 8.2 Obstacles to Fundraising and Investment in Brazil The Protection of Intellectual Property Rights .................................. 333
Table 8.3 Global Ranking in Technological Innovation 2009 2010 ........................................................................................ 335
Table 8.4 Number of People Employed per Year as Reported by Fund Managers ........................................................................ 344
Table 8.5 Comparison of the Increase in Employment and Sales in Companies that Did and Did Not Receive Venture Capital Investment ............... 345
Table 8.6 Obstacles to Fundraising and Investment in Brazil Fund Managers Difficulty in Recruiting Professionals ..................... 346
Table 8.7 Obstacles to Fundraising and Investment in Brazil Investee Companys Difficulty in Recruiting Professionals ................ 346
Table 8.8 PE/VC Investee Companies as of December 31, 2009: Number of Employees Reported by Fund Managers per Sector .. 347
Table 8.9 PE/VC Investee Companies as of December 31, 2009: Number of Employees Reported by Fund Managers per Stage ... 348
Table 8.10 Obstacles to Fundraising and Investment in Brazil Bureaucracy ............................................................................. 349
Table 8.11 Obstacles to Fundraising and Investment in Brazil High Taxation Rates ................................................................... 349
Table 8.12 Obstacles to Fundraising and Investment in Brazil Informal Employment ................................................................ 350
Table 8.13 Annual Venture Capital Investments in Cleantech in North America, Europe, Israel, China and India .......................... 366
18 18
Table 8.14 Largest Sectors in Cleantech Venture Capital in 2009 ............................................................................................. 366
Table 9.1 Long Term Fundamentals "Reasons why Carlyle invests in Brazil" .............................................................................. 376
19
Graphs
19
Graphs
Graph 1.1 The Largest European Markets (1992 to 1999) ......................................................................................................... 48
Graph 3.1 Committed Capital by Legal Structure .................................................................................................................... 127
Graph 3.2 Fund Manager Affiliations (2009) .......................................................................................................................... 129
Graph 3.3 Fund Managers Intentions as to Whether They Will Raise a New Investment Fund in Brazil in the 3 Years Following 2009 ........... 130
Graph 3.4 Supply and Demand of Funds for PE/VC Investments .............................................................................................. 133
Graph 3.5 The Five Countries with the Greatest Expectations of Economic Gains (American Investors) ........................................ 135
Graph 3.6 The Five Countries with the Greatest Expectations of Economic Losses (American Investors) ........................................ 136
Graph 3.7 The Best Markets in Terms of PE/VC Opportunities ............................................................................................. 136
Graph 3.8 Evolution of Committed Capital Allocated to Brazil ................................................................................................ 137
Graph 3.9 Committed Capital as a Percentage of GDP (August 2008) ..................................................................................... 138
Graph 3.10 Comparison of the Fundraising Process ............................................................................................................... 138
Graph 3.11 Evolution of Capital Committed Allocated to Brazil as a Percentage of GDP ........................................................... 139
Graph 3.12 Fundraising for Brazil .......................................................................................................................................... 139
Graph 3.13 Fundraising for Emerging Markets ..................................................................................................................... 140
Graph 3.14 Beginning of Fund Manager Operations ............................................................................................................. 140
Graph 3.15 Vehicle Fundraising by Vintage Year ..................................................................................................................... 141
Graph 3.16 Composition of Investors in PE/VC Funds (2009) .................................................................................................. 141
Graph 3.17 Breakdown of Local Investors (2009) ................................................................................................................... 142
Graph 3.18 Concentration of Committed Capital (Average Capital in Relation to Total Capital) ............................................... 143
Graph 3.19 Origin of Commited Capital available to Fund Managers...................................................................................... 145
Graph 3.20 Duration of Fundraising Period ............................................................................................................................ 145
Graph 3.21 Fundraising as a Proportion of GDP (2005-2009) ............................................................................................... 146
Graph 3.22 Sectoral Focus of Fundraising Vehicles (2009) ...................................................................................................... 147
Graph 3.23 Sectoral Focus of Vehicles in Fundraising Process (2009) ....................................................................................... 147
Graph 3.24 Fundraising by Stage in 2009 ............................................................................................................................. 148
Graph 3.25 Capital Committed by Angel Investor Associations ................................................................................................ 149
Graph 4.1 Number of Investments Made by Private Equity Fund Managers by Stage of Investment ............................................. 177
Graph 4.2 Number of New Investments Made by Private Equity Fund Managers by Stage ........................................................... 178
Graph 4.3 Number of Follow-On Investments Made by Private Equity Fund Managers by Stage .................................................. 179
Graph 4.4 Value of Total Investments Made by Private Equity Fund Managers by Stage .............................................................. 180
20
Graph 4.5 Value of New Investments Made by Private Equity Fund Managers by Stage ............................................................... 181
Graph 4.6 Value of Follow-On Investments Made by Private Equity Fund Managers by Stage...................................................... 181
Graph 4.7 Number of Investments Made by Private Equity Fund Managers by Sector (2009) ...................................................... 182
Graph 4.8 Total Number of Investments Made by Private Equity Fund Managers by Sector (2005 - 2008) .................................. 183
Graph 4.9 Number of New Investments Made by Private Equity Fund Managers by Sector (2009) ............................................... 183
Graph 4.10 Number of New Investments Made by Private Equity Fund Managers (2005 - 2008) ................................................ 184
Graph 4.11 Number of Follow-On Investments Made by Private Equity Fund Managers by Sector (2009) .................................... 184
Graph 4.12 Number of Follow-Ons Made by Private Equity Fund Managers by Sector (2005 - 2008) ......................................... 185
Graph 4.13 Value of All Investments Made by Private Equity Fund Managers by Sector (2009) .................................................... 185
Graph 4.14 Value of All Investments Made by Private Equity Fund Managers by Sector (2005 - 2008) ........................................ 186
Graph 4.15 Value of New Investments Made by Private Equity Fund Managers by Sector (2009) ................................................. 186
Graph 4.16 Value of New Investments Made by Private Equity Fund Managers by Sector (2005 - 2008) ...................................... 187
Graph 4.17 Value of Follow-On Investments Made by Private Equity Fund Managers by Sector (2009) ........................................ 187
Graph 4.18 Value of Follow-On Investments Made by Private Equity Fund Managers by Sector (2005 - 2008) ............................. 188
Graph 4.19 Distribution of Investee Companies by Stage (2009) ............................................................................................. 188
Graph 5.1 Investment Exit Types ............................................................................................................................................ 198
Graph 5.2 Total Number of Exits per Sector (2005 2008 vs. 2009) ....................................................................................... 200
Graph 5.3 Total Value of Exits per Sector (2005 2008 vs. 2009) ........................................................................................... 201
Graph 5.4 A J-Curve ............................................................................................................................................................ 202
Graph 5.5 Review of the Literature General Conclusions....................................................................................................... 203
Graph 5.6 Dow Jones Venture Capital Index .......................................................................................................................... 204
Graph 5.7 Individual Investment Multiples between 2004 and 2009 ........................................................................................ 209
Graph 5.8 Internal Rate of Return for Individual Investments (2004 2009) .............................................................................. 210
Graph 5.9 Relative Frequency of Annual Returns in Excess of CDI for individual investments from 2004 to 2009) ......................... 211
Graph 5.10 Expected Nominal Annual Rate of Return for Individual Investments by Investment Stage .......................................... 212
Graph 6.1 Structure of PE/VC Vehicles ................................................................................................................................... 220
Graph 6.2 Meetings between Investors and Portfolio Companies ............................................................................................. 232
Graph 6.3 Importance by Fund Managers to "Best Practices in Corporate Governance" at Different Stages of Investment .............. 254
Graph 6.4 Fund Managers that payed for Governance ........................................................................................................... 256
Graph 6.5 Distribution of Financial Instruments Used by Investee Companies ............................................................................ 259
Graph 6.6 Characteristics of Investments Financed by Preferred Stocks ..................................................................................... 259
21
Graphs
Graph 6.7 Characteristics of Investments Financed by Debt Instruments .................................................................................... 260
Graph 6.8 Characteristics Related to the CEO of the Investee Company .................................................................................. 261
Graph 6.9 Presence of Relatives of Entrepreneur in Different Positions in Investee Companies .................................................... 262
Graph 6.10 Existence of Succession/Replacement Plans for CEOs and Executive Officers .......................................................... 262
Graph 6.11 Investee Companies that have Directors and Officers Liability Insurance and the Positions Insured............................. 263
Graph 6.12 Formal Boards of Directors and Boards of Directors that also meet informally ......................................................... 264
Graph 6.13 Actions which need Approval from the Board of Directors to be implemented ......................................................... 268
Graph 6.14 Proportion of External Auditors Reporting to the Board of Directors ........................................................................ 271
Graph 6.15 Proportion of Internal Auditors Reporting to the Board of Directors ......................................................................... 271
Graph 6.16 Frequency of Use of Extra-Judicial Mechanisms for Resolving Company Conflicts ................................................... 273
Graph 6.17 Absolute Frequency with which Indicators are used to Evaluate the Performance of Key Personnel ............................. 274
Graph 6.18 Percentage of Fund Managers with Rights of Preference and the Most Common of these Rights ............................... 275
Graph 6.19 Veto Power and Circumstances in which it can be used by the Fund Manager when it is a Minority Shareholder ........ 276
Graph 6.20 Performance Based Incentives and/or Penalties for Entrepreneurs .......................................................................... 277
Graph 6.21 Protection Clauses in the Shareholder Agreement ................................................................................................. 280
Graph 6.22 Those Responsible for 100 Day Plan analysis in various areas of the Investee Company ........................................... 282
Graph 6.23 Characteristics of Target Revisions Made During the 100 Day Plan ......................................................................... 283
Graph 6.24 Characteristics of Management Discontinuities during the First 100 Days ................................................................ 284
Graph 6.25 Changing of Key Personnel during the 100 Day Plan ............................................................................................ 285
Graph 6.26 Contacts Furnished by Fund Manager to Investee Company during the 100 Day Plan .............................................. 286
Graph 6.27 Monitoring of Changes Implemented During the 100 Day Plan .............................................................................. 287
Graph 6.28 Average Time That Fund Managers Spend Monthly (in hours) Monitoring Each Portfolio Company ............................ 288
Graph 6.29 Frequency of Direct Contact between Fund Managers and Executive Officers for Monitoring Purposes ....................... 290
Graph 6.30 Functions Most Affected by Direct Fund Manager Involvement................................................................................ 291
Graph 6.31 Involvement of Fund Managers Stakeholders of the Investee Companies Regarding Operational Activities ................. 292
Graph 6.32 Rounds of Financing in Investee Companies ......................................................................................................... 293
Graph 6.33 Proportion of Investments which Involve Co-Investments ........................................................................................ 294
Graph 6.34 Restructuring of Investee Companies and Areas Restructured ................................................................................. 295
Graph 6.35 Frequency of Investee Company Joint Ventures and Reasons for Them .................................................................... 295
Graph 6.36 Conflicts between Fund Managers and Investee Companies .................................................................................. 296
Graph 6.37 Profitability of Investments after Conflicts with Investee Companies ......................................................................... 297
22
Graph 7.1 Monetary Value of Debentures Issued .................................................................................................................... 302
Graph 7.2 Monetary Value of Primary and Secondary Stock Issued .......................................................................................... 303
Graph 7.3 BM&F Bovespa Index from 2005 to 2009) ............................................................................................................. 303
Graph 7.4 Long Term Interest Rates Charged by BNDES (Annual %) ......................................................................................... 309
Graph 7.5 Average length of Credit Operations in Brazil ......................................................................................................... 318
Graph 7.6 Composition of Terms for Corporate Credit ............................................................................................................ 319
Graph 7.7 BNDES Credit Operations .................................................................................................................................... 319
Graph 7.8 Net Fundraising and Net Fund Assets in the Domestic Markets ................................................................................. 320
Graph 8.1 Importance of Innovative Activities in Brazil (1998-2000 and 2001-2003) ............................................................... 329
Graph 8.2 Quantity of Patent Processes Initiated Around the World (Countries which Adhere to the Patent Cooperation Treaty) ..... 331
Graph 8.3 Variation in GDP between 2008 and 2011 ........................................................................................................... 332
Graph 8.4 Stages of Portfolio Companies ............................................................................................................................. 334
Graph 8.5 Allocation of Financial Resources Invested in Indian Companies ............................................................................... 337
Graph 8.6 Comparison of Revenue Growth between Companies Receiving Venture Capital Investment and the Overall Company Average .....337
Graph 8.7 Percentage of Net Sales Revenues Allocated to Innovative Activities in Brazil (2000 and 2003) .................................. 338
Graph 8.8 Effects of Innovation on Brazilian Companies 1998-2000 and 2001-2003 ........................................................... 339
Graph 8.9 Formal and Informal Employment in Brazil March 2002 to June 2010 ................................................................... 350
Graph 8.10 Companies in Expansion Phase during the Post-Investment Period Changes in Compensation ................................ 351
Graph 8.11 Companies in Seed/Startup Phase during the Post-Investment Period Changes in Compensation ............................ 352
Graph 8.12 Evolution of the Number of PRI Signatories and Assets under Management July 2009 to July 2010 ....................... 357
Graph 8.13 Private Equity Fund Manager Signatories of the PRI .............................................................................................. 358
Graph 8.14 Number of PE/VC Vehicles in Forestry .................................................................................................................. 364
Graph 8.15 Number of Cleantech Vehicles per Vintage Year ................................................................................................... 365
23
Figures
Figures
Figure 2.1The Company Life Cycle .......................................................................................................................................... 64
Figure 2.2 The Origins and Applications of Private Equity and Venture Capital Resources ............................................................ 67
Figure 2.3 PE/VC Ecosystem .................................................................................................................................................... 71
Figure 3.1 Dynamics of the PE/VC Activity .............................................................................................................................. 115
Figure 4.1 Conversion of Business Opportunities into Investments ............................................................................................. 159
Figure 6.1 Structure of PE/VC Vehicles .................................................................................................................................. 221
Figure 8.1 The J-Curve and the Need for Financial Resources .................................................................................................. 341
Figure 8.2 Evolution of the Release of Sustainability Reports .................................................................................................... 360
Figure 9.1 SWOT Analysis of the PE/VC Industry in Brazil ......................................................................................................... 377
Introduction
The Second Census of the Private Equity and
Venture Capital Industry: From Innovative
Ventures to Corporate Revolution
27
Introduction
27
The Second Census of the Private Equity and Venture Capital
Industry: From Innovative Ventures to Corporate Revolution
1
In the second decade of the 21st Century, Brazil contemplates a landscape full of opportunities and
challenges unlike anything that it has seen over the last 50 years.
While the G7 countries are still slowly recuperating from the 2008 crisis, Brazil has been growing
at more than 5% annually. It has become a showcase for business opportunities, a paradigm of
macroeconomic management, institutional development and a consolidation of democracy.
In the business world, Brazil has become the country whose future has arrived. Certain stigmas
still remain in terms of political, social and economic institutions, but an organized society has shown
itself to be capable of isolating them for corrective treatment over the coming years.
No more than a dozen years ago, a generation of Private Equity and Venture Capital (PE/VC)
investment managers emerged in this country in a movement which, though timid during its rst ve
years, grew stronger in the second half of the decade weathering the 2008 nancial crisis without any
great difculties.
Our private equity and venture capital industry completed its rst cycle in 2005: and some of its
managers graduated with honors! What seemed a remote possibility ve or six years before, the exit
of portfolio companies through IPOs, had already become a reality by the end of 2004.Several PE-
backed IPOs offered assets that piqued the interest of the international investors which were then
swarming into the Brazilian capital markets. At each public offering of investee companies made by
PE/VC managers, around two thirds of the shares would be sold to international investors
IPOs, which were already offering favorable returns for PE/VC fund investors, levered fundraising
by the industry as new capital available to fund managers. The newly listed companies, with solid
corporate governance and business models revised by PE/VC managers, offered investors nancial
1 Original text by Claudio V. Furtado for the book Financial Institutions in Brazil Positioning for a New
Scenario, So Paulo, 2010. Copyright Deloitte and Claudio V. Furtado, adapted for this Second Census
of the PE/VC Industry.
28
assets from sectors that had never been seen before in the capital markets: car rentals, railway
logistics, medical diagnostics, dental assistance and electronic commerce among others. These new
entrants diversied the investment opportunities on offer.
The statistics which reected the consolidation of this segment, characterized by nancial
intermediation by rms specialized in managing and creating value for these ventures, began to
appear on the radar of international investors interested in dynamic emerging economies.
At the beginning of 2005, there were 71 fund managers with no more than US$ 6 billion committed
to PE/VC investment vehicles, the equivalent of 0.7% of GDP. By the end of 2009, 144 managers
administered committed capital of US$ 36.1 billion, representing 2.3% of GDP. These fund managers
employed an estimated1,593 professionals of which roughly two thirds had at least college degrees.
These fund managers had share participation and active management participation in 502 companies,
most of them private and a few taken public by these PE/VC fund managers.
The basic functions of PE/VC investments are the creation of businesses and entrepreneurial teams
to administer them strategically, the monitoring of value-added processes and the guaranteeing
of successive rounds of nancing. PE/VC investments generally become liquid after 3 to 5 years
of diligent work focused on long term returns. The following chapters document the extent of this
industrys work in Brazil.
Retirement and pension funds, individual asset managers and family ofces, as well as some
nancial institution assets are typical PE/VC investors. The Chapter The Private Equity and Venture
Capital Cycle Fundraising, Committed Capital and the Origin of Fund Managers documents this
process.
Fund managers need to maintain complex incentive relationships, and establish investment ideas
and decision making rules with their investors. They also need to 1) maintain a track record of
success to raise funds for more investment vehicles to consolidate themselves in the business; 2)
create methods for keeping themselves up-to-date in their prospecting, acquisition, and monitoring
and in the strategic management of the businesses they invest in; 3) be competent in choosing the
form and moment in which to sell their investments; and 4) make prots for their investors. These are
the great strategic challenges for PE/VC fund managers.
29
Introduction
Its very difcult for a fund manager to reach the top quartiles of performance, but when they
do and manage to transfer their leadership talents to the entire PE/VC organization,success tends
to continue. This is the most impressive empirical evidence in regard to this industry in contrast to
what can be seen in mutual fund management: it is estimated that from 1980 to 1995 in the US, the
difference between a great PE/VC manager and a bad PE/VC manager was as much as 13% a year.
The difference was just 2.2% annually between good and bad managers of mutual funds of traded
stocks. (Broedel and Furtado, 2006).
The relationships between PE/VC investors and managers are established contractually, subject
in Brazil to general requirements of public interest and innovative methods of conict resolution as
dened by the Brazilian Securities Commission (CVM) in Instructions 209 and 391. The information
required by the Brazilian Securities Commission (CVM) is much more extensive than that required of
limited partnerships in the United States, as will be discussed in the chapter dedicated to the PE/VC
Industry Ecosystem in Brazil.
The variety of competences required by fund managers in prospecting opportunities, structuring,
monitoring and exiting investments, as well as the level of competition for investors assets, drives the
specialization of PE/VC managers. They nance high risk ventures with expectations of high levels of
return. The decision making process for these investments requires careful due diligence, and after
investing, managers protect the value of their investments by becoming involved themselves in the
management of these ventures, using best practices in governance, and retaining great powers of
supervision and strategic management even if they do not possess the majority of voting shares. The
chapter The Private Equity and Venture Capital Cycle Investing will cover the empirical reality of
these activities in Brazil.
Ventures in the rst phase of their existence, usually based on great innovations and advanced
technology, with high potential growth business models that require great adjustments and feature
entrepreneurial teams that are learning on the job, are the universe of seed, early stage, and later
stage venture capital investments, and, in Brazil, these are now beginning to take on local colors.
In the following stage of maturity, stable ventures can be found that require a supply of capital
to sustain rapid growth. Strategic repositioning, a revision or rethinking of the business model, and
obtaining economies of scale or productivity which translate into better results per capital invested,
characterize the investment opportunities of the build and hold type. This is the universe of private
30
equity investments dedicated to expansion and consolidation. When control of equity is acquired it is
termed a buyout; when acquisitions are nanced by large quantities of senior and subordinated debt,
it is termed a leveraged buyout.
Another form of private equity is a mezzanine vehicle, in which hybrid instruments are used for
nancing. PIPES (Public Investment in Private Equity) are vehicles invested in public companies with
low liquidity and they add value by implementing best practices in governance and better investor
relations.
All these types of vehicles are found in the Brazilian universe of private equity and venture capital,
with leveraged buyouts being a rarity as we will see in the chapter concerning investments.
There are fund managers which are dedicated to particular sectors which require great expertise to
manage their investments such as real estate, energy, infrastructure and forestry. Funds of funds invest
in other PE/VC funds, permitting ample diversication and comparable returns for less risk. Secondary
funds buy lots of PE/VC funds, increasing the liquidity available to investors before the main PE/VC
vehicle expires. In this Second Census, we have made a disaggregated analysis of committed capital
and the ux of nancial resources for these specialized funds and traditional PE/VC funds.
The venture capital fund manager model is derived from the need to nance businesses with great
growth potential in an environment where there is an enormous asymmetry of information between
the manager and the entrepreneurial team, and where there is great uncertainty regarding future
results. These business investments come from proprietary knowledge, from disruptive technologies
or ventures that require changes in business models and expansion by acquisition.
As intermediaries in this process of long term nancial investment, VC fund managers resolve
or minimize some core issues for these ventures which are characterized by a great asymmetry of
information and agency issues.
PE/VC fund managers, as specialized intermediaries resolve or mitigate these problems. They
diligently involve themselves in a thorough understanding of the business model and its future potential
and make a contingency analysis before making an investment. With active governance, they monitor
the business and create value for many years before they sell their share in the investment. This is why
they receive remuneration and incentives strongly tied to adding value to the investment. From the
31
Introduction
point of view of the economy, they reduce asymmetry of information and also eliminate the restrictions
on capital ow in the savings-investment process. This is the economic role of private equity and
venture capital activity (Lerner, 2005).
These functions cannot be conducted by regulated intermediaries such as commercial and investment
banks. Their nature makes the PE/VC model an interesting tool of public policy to capitalize high
risk technology startups and even existing companies that need restructuring and new governance
practices. The Brazilian government has adopted this model for its public policy as we will discuss in
Chapter 7 Private Equity in the Context of Sources of Long Term Financing.
The PE/VC industry is expanding rapidly around the world. In countries where the economy is of
sufcient size, with GDP in excess of US$ 500 billion, where there are institutions that guarantee the
fulllment of contracts, where there is a stock market which facilitates companies being taken public,
where there is institutional and macroeconomic stability, and where the government has a positive
attitude and policies towards the creation of new companies and the transformation of existing
companies, the PE/VC model has taken hold and become established. Today it is present in over 90
countries around the world.
It is estimated (Preqin, 2010) that assets controlled by the PE/VC industry worldwide reached US$
2.4 trillion in 2008, a great leap from a total of US$ 960 billion in 2003. Buyout private equity fund
managers at the end of 2008 had US$ 1 trillion under management; venture capital fund managers
had 15% of industry assets with US$ 380 billion under their control; PE/VC real estate vehicles were
valued at US$ 500 billion and all the rest (restructuring, infrastructure, mezzanine, balanced, natural
resources, etc.) represented US$ 510 billion. In total, it is estimated that the PE/VC industry employs
65,000 people distributed in the following countries in descending order: 37,500 in the United States,
7,500 in the United Kingdom, 2,200 in France, 1,500 in Germany, 1,400 in Australia, 1,200 in
Canada, and 1,100 in Japan. Its surprising to note that in this census prepared by FGVs GVcepe
there were an estimated 1,593 Brazilian professionals in the PE/VC industry in 2008.
The 2008 crisis and the 2009 recession revealed surprising facts: the so-called emerging economies,
and above all China, India and Brazil had a much greater capacity for recovery than the G-7
economies. By 2014 the GDP of the emerging countries is expected to reach half of World GDP and
current growth trends lead researchers at the University of Chicago to project that by 2040 China will
have 40% of the world economy, India will have 12% and Brazil will be among the other countries
32
which will add up to 15%, while the United States will have 14%, the European Union 5%, and Japan
2%! (Fogel, 2010 in Foreign Policy)
This universe of opportunities has galvanized the interest of PE/VC fund managers that operate on
a global scale, a growing number of local managers and investors, Brazilian pension funds whose
participation has risen to 22% of committed capital in Brazil, family ofces (9%); investment funds
(6%), banks (4%), and mother funds (18%), among others. This also indicates the important diversity
of PE/VC investors in Brazil, comparable to that of developed economies.
In 2009, domestic investors held the majority of committed capital in PE/VC investment vehicles
(62%). Even though this is increasing in volume, the relative participation of foreign investors in
fundraising from 2006 to 2009 declined to less than 50% of the total, declining from a peak of 65%
in 2006.
The presence of fund managers from the United States (25) and Europe (8) is also extremely
important as part of the global presence in the country, whether they are in global vehicles or vehicles
exclusively dedicated to investments in Brazil (see Graph 3.17).
Graph 3 - Origin of Fund Managers that invest
in Brazil using global, regional and/or emerging
market investment vehicles.
AAI Global
Advent
Darby
General Atlantic
Merril Lynch
One Equity Partners
Paul Capital
The Carlyle Group
DLJ
US$0,2 bi
Mifactory
Actis
Autonomy
US$0,2 bi
GP Investments
US$ 2,9 bi
Equity Internat.
US$ 1,1 bi
BDF
Alothon (EUA)
ABN AMRO Real (ESP)
Banif (POR)
ES Capital (POR)
DEG-KFW Banking (GER)
Franklin Templeton (EUA)
Inter Capital (EUA)
Itacar (llh VIR)
Marathon (EUA)
Monashees (EUA)
Santander (ESP)
Spinnaker (EUA)
Standard Bank (SAF)
Tarpon (BER)
Timber Capital (BER)
Vita Bioenergia (SUI)
US$0,3 bi
US$38,8 bi
US$0,01 bi
Source: Ramalho and Furtado (2008)1
33
Introduction
This is a reection of the global tendency that can be observed in PE/VC industries in developed
economies: the establishment of investment vehicles through afliations and strategic alliances in countries
and regions which have the conditions for sustained growth, an adequate business environment, and local
managers capable of carrying out the complete PE/VC cycle (Lerner, 2005).
American and European fund managers operate in a very competitive environment which has caused
them to offer a greater variety of vehicles including mezzanines, real estate funds and restructuring funds
(in addition to the usual buyouts and traditional VC) and has also led them to seek strategic partnerships
with local managers, to participate in fundraising and to offer distinctive services (Lerner 2008). More and
more, the Brazilian PE/VC industry is absorbing these global tendencies.
Besides the opportunities to restructure private companies in traditional and high growth sectors, the
degree of dynamism and innovation, and the quantity of highly qualied technical professionals and
administrators who wish to become entrepreneurs, it is the opportunities in infrastructure, education and
energy that create conditions that drive demand for PE/VC investments in Brazil.
Over the last ve years, greater education, more specialized professional management practices provided by
management consulting rms, better accounting and investment management services, and more executives with
knowledge of the PE/VC model, have made it easier to accomplish PE/VC investments in Brazil as documented
by the capital that has owed into the industry. Thus at this time, the ground in Brazil is fertile to reap the benets
of the corporate revolution that has been sown by the private equity and venture capital industry.
This Second Census is the concrete result of more than eighteen months of work and effort by various people,
supporters of this project in the PE/VC industry, and a dedicated research team led by Prof. Cludio Vilar Furtado,
founder and Executive Director of GVcepe. The executive coordination of the research for and the publication of this
Second Census counted on the contributions of Rodrigo Lara and Caio Ramalho, researchers and project managers.
We are convinced that high quality information is an essential requirement in the promotion of this type
of investment in Brazil. This has led FGV to take on the daunting challenge of greatly increasing the detail
of this census compared to the rst one done in 2005 by including all the information that the First Census
contained fund manager structure, investors, the nature of investment vehicles, investee companies and
governance practices and adding much greater depth in the area of governance, presenting a detailed map
of each activity, the time and resources invested in them, and the importance of each step in the PE/VC Cycle:
Fundraising, Screening, Investing, Monitoring, Exits, and an unprecedented albeit tentative study of Returns.
Chapter 1
A History of the Private Equity and Venture Capital Industry
Chapter 1
37
A History of the Private Equity and Venture
Capital Industry
1,2
1.1. What is Private Equity?
Private Equity (PE) by denition refers to investments in the stock (equity investments) of companies
which are not listed on stock exchanges, independent of the companys business structure. Due to their
nature, characterized by low liquidity, long term returns, and an asymmetry of information, private equity
businesses offer higher risks and higher returns than traditional investments which thus classies them as
alternative assets. This high risk high return prole inhibited this type of investment by institutional investors
until the 1970s in the United States. (Gill, 1981; Gompers, 1994; Gompers and Lerner, 2002; Anson,
2006; Metrick, 2007; EVCA, 2007; Mathonet and Meyer, 2008).
But how can we assess risk? The more investors have information about private companies, the lower
the total perceived risk. And when this information is held by private equity fund managers who have this
information because of previous investments or have broad experience in the target sector, the greater
the opportunity these managers have to identify assets which still arent appreciated by the market, which
can be acquired for competitive prices, and which present a clear road to increasing value, permitting the
manager to make above average market gains. This is if the investor selects a manager with the appropriate
fundraising, resources and business portfolio, which can offset bad returns on some investments with good
returns off others and thus offer an average return above the appropriate comparative benchmark.
According to Harper (2010), the term venture originated around 1400, to denote risking the loss
(of something), a more abbreviated version of aventure or adventure in English, meaning opportunity,
fortune, or luck at the beginning of the 13th century. The original meaning of adventure was to arrive
in Latin, but came to mean risk/danger (an attempt to prot from opportunities), and dangerous
undertaking (beginning of the 14th century). Later it came to mean emotional incident (1560). The word
venture, with the general meaning to dare, to presume originated in the middle of the 16th century. As
a noun for running risks, it was rst used around 1560, and as a business undertaking around 1580.
1Authors: Caio Ramalho and Rodrigo Lara.
2 Orignal text by Caio Ramalho in his Masters Thesis Essays on Private Equity in Business Finance and
Economics at EPGE the Graduate School of Economics of the Getulio Vargas Foundation, translated and
adapted for this Second Census of the PE/VC Industry.
38
Its difcult to identify precisely when innovative PE investments began to be termed Venture Capital
(VC). Ellis and Vertin (2001) attribute this term to Benno C. Schmidt (a partner at J.H. Whitney & Co and
later President of Yale University) in the 1960s. At the same time, Bolton and Thompson (2000) cite Arthur
Rock as the creator of the term Venture Capital, also in the 1960s. In contrast to these opinions are Harper
(2010), who points to a rst usage in 1943, and Reiner (1991), who attributes this rst usage to Jean
Witter, partner at Dean Witter & Co, during his speech at the 1939 Convention of the Investment Bankers
Association of America. Avnimelech, Kenney and Teubal (2004) attributed its rst use to Lammot du Pont,
President of Du Pont, in 1938. Even so, they assert that academics in Boston could have used the term
earlier. The rst usage of the term found by Ramalho (2010) occurred in 1925, in a subcommittee formed
by academics and other members of the New England Society as mentioned by Ante (2008).
Even though its clear that VC is a type of PE investment, the terms began to be used to mean different things
as the years passed. PE investments have traditionally been divided into VC and Buyouts, the former referring to a
small stock participation in a startup company which became known worldwide through a number of companies
which began in garages in one of the most famous clusters of innovation in the world, Silicon Valley.
Nevertheless, this doesnt imply that a venture capital rm cant buy a signicant portion of a startup
company, or in the same manner a signicant portion of a large, established company. Its just that these
occurrences were rare during the creation and development of the PE industry in the United States. As a
result, the term VC was established as a brand name to denote investments in startup companies, and
in the same way, PE referred to investments in more established companies as if they were two distinct
activities. Here we refer to the Private Equity/Venture Capital (PE/VC) industry to characterize the entire
industry, VC for the initial stages, and PE for the later stages.
1.2. Historical Origins
Queen Isabella of Castile made a PE/VC investment in Christopher Columbuss innovative project in
1492, one year after King John II of Portugal had refused to participate. Just like current PE/VC investments,
the Catholic rulers of Spain didnt just supply capital for the voyage; they also assisted with management,
the selection of the crew, and the determination of how much of the proceeds each member of the
expedition would receive, crucial PE activities (Pavani, 2003; Mathonet and Meyer, 2008). Even though
Anson (2006) recognizes Columbuss journey as a contribution to the history of PE/VC, he suggests that
the structure and basis for modern PE/VC investment began in the United Kingdom in the 1800s with the
coming of the Industrial Revolution.
Chapter 1
39
1.2.1. The United States and the Rise of the PE/VC Industry
The rst seeds of the PE industry were planted in the United States at the end of the 19th century when the
country began to function as an integrated nation and economy. The ofces that administered the fortunes
of wealthy families (the equivalents of modern family ofces) bought stock in new companies. These
families included the Rockefellers, Vanderbilts, Phippses, Whitneys, and Bessemers, among others who
built their fortunes in the petroleum, merchant marine, railway and other sectors (Bygrave and Timmons,
1992; Gompers and Lerner, 2001a).
The beginning of the 1930s brought the Great Depression and FDRs New Deal. Many of the high
taxes and new fees imposed by the New Deal from 1933 to 1939 were suffocating small companies and
startups. High capital gains taxes inhibited the reinvestment of proceeds as well as investments in new
companies in general by powerful individuals and families (Ante, 2008).
In 1934, Karl Compton, the President of MIT proposed a program called put science to work, which
advocated that science should create new businesses. In 1939, the New England Council, a group of
entrepreneurs, politicians and academics from New England which was founded in 1929, formed the
New Products Committee to examine how new technologies could reverse the decline of the textile industry
in the region. This committee included Karl Compton and brought eight people together to study the
problem. One of them was Georges F. Doriot, Professor at Harvard Business School (HBS) who was
assigned to development and the venture capital subcommittee. The committee concluded there was
capital available for new ventures, but that there were gaps in organization and adequate techniques to
evaluate new businesses. As a result the New England Industrial Research Foundation was created with the
goal of analyzing opportunities and promoting deal ow for any investor in New England (Ante, 2008).
Around the same time, Enterprises Associates, another elite group in New England, was working on
a solution to the same problem. The group was run by William Coolidge, an investor in modern X-ray
technology since 1916. Enterprises Associates raised US$ 300,000 from 20 investors to provide the seed
capital to nance the nal stages of selected projects, and Doriot joined the companys Board of Directors.
From 1938 to 1940, the ofce and stockholders of Enterprises Associates evaluated various ideas and
nally on May 7, 1940 supported a new company called National Research. Even though everything not
related to the Second World War was put aside once the war began, the experiences of the New Products
Committee and Enterprises Associates were extremely useful (Ante, 2008).
40
After the Second World War, Karl Compton decided to create a new way of nancing new technology
startups. He joined together with Ralph Flanders (President of the Federal Reserve Bank of Boston), Merrill
Griswold (Member of the SEC), and Donald David (Dean of Harvard Business School), ex-members of the
New Products Committee to create a venture capital rm. On June 6, 1946 the American Research and
Development Corporation (ARD) was formed and structured as an open end fund traded on the stock
exchange. Georges F. Doriot, at this time a general in the United States Armed Forces and a professor at
Harvard Business School (HBS), became president of the company. ARD was able to get an exemption from
the SEC for the sale of its stock. Thus, in December 1946 it raised US$ 3.5 million out of an initial target
of US$ 5 million. In March 1961, ARD was the rst VC company authorized to sell its shares on the New
York Stock Exchange. ARD was sold to Textron in 1972 as a way to comply with SEC regulations as well as
resolve internal organizational problems (Bygrave and Timmons, 1992; Gompers, P. and Lerner, J., 2001a;
Metrick, 2007; Ante, 2008). In 1946, other PE/VC companies were created by wealthy families: J.H Whitney
& Company and Rockefeller Brothers Company (Ante, 2008). Nevertheless Ante classies ARD as the rst
PE/VC company to acquire capital from non-family sources, principally from institutional investors.
John Hay Jock Whitney had been investing his familys money since 1930 when he decided to found J.H.
Whitney & Company in 1946. The company began with its own funding of US$ 5 million to fund startups,
and small and medium enterprises (SMEs). Benno Schmidt, who is credited with coining the expression
Venture Capital, joined the companys fundraising team. It was only in 1990 that T.H. Whitney and Co.
decided to add non-family capital such as funds from foundations, universities, and pension funds, etc. It
is the oldest company operating in the U.S. market.
In 1946, Laurance S. Rockefeller, the fourth of John D. Rockefeller Jr.s six children, founded the Rockefeller
Brothers Company, one of the rst post-war venture capital fund managers which made an ample variety
of investments in industrial sectors such as aviation, data processing, electronics, optics and lasers. In 1969,
Venrock was created, a company made up of the other ve Rockefeller siblings based in Palo Alto, California
focusing on VC investments to better structure Rockefeller family investments. Its rst investment was in Intel
Semiconductors, followed by various successful investments in Apple, Mosaic (Netscape) and more recent ones
in nanotechnology, biotechnology and the health sector. PE investments by the Rockefeller Brothers Company
and Venrock have totalled more than US$ 25 billion in 44 companies over the years (Venrock, 2010).
The United States government saw the potential in developing small companies in 1953 when it passed
the Small Business Act, which created the Small Business Administration (SBA), and established a program
for small business investment companies or SBICs. The SBIC program offered four dollars of nance for
Chapter 1
41
every one dollar invested by the entrepreneur at low interest rates, and as a consequence, this inexpensive
government money attracted various new participants to the PE/VC industry. In 1962, a total of 585 SBICs
were authorized to operate in the United States (Bygrave and Timmons, 1992).
Even though the SBIC program made it possible to train a large quantity of new fund managers,
there were various problems. Clearly the effort and the monitoring demanded by PE/VC investors were
underestimated. The SBICs also structured their ventures using a large quantity of debt instead of exclusively
utilizing business participation (Bygrave and Timmons, 1992; Metrick, 2007). When the stock market fell
drastically in 1962 after a high technology IPO bubble that developed from 1955 to 1962, the SBICs
were profoundly affected (Ante, 2008). As a consequence, from 1966 to 1967 a total of 232 SBICs
were classied as disasters, with accusations of incompetence and fraud. With this, new regulation was
imposed on the SBICs to reduce their total number to 250. (Bygrave and Timmons, 1992).
Table 1.1.below shows some of the innovations and regulations which were implemented in the context
of the beginning of and subsequent development of SBICs in the United States.
Table 1.1. Legislative Impact on PE/VC Investments in the United States
Small Business Act (1958) Increased the availability of PE/VC nancing for small businesses.
Employee Retirement Income
Security Act ERISA (1974)
Plan to reduce the quantity of high risk investments. As a result, pension funds avoid-
ed PE/VC investments.
Revenue Act (1978)
Reduced capital gains taxes from 49.5% to 28%, thus creating the greatest tax incentive for
long term investment in stocks since the 1960s.
Prudent Man Rule ERISA
(1979)
Directives for pension funds were revised and claried. The principal directive was
that diversifying a portfolio was considered prudent.
Small Business Investment Incen-
tive Act (1980)
Redened VC companies as business development companies, removing the requirement
that they be registered as investment advisors with the SEC.
Safe Harbor Rule ERISA (1980)
Stated clearly that PE/VC fund managers would not be considered duciaries for
stocks invested in by limited partnerships in the funds they administer.
Taxation Act For Economic Recov-
ery (1981)
Diminished the individual capital gains tax even further from 28% to 20%.
Tax Reform Act (1986) Reduced incentives for long term capital gains.
Source: Bygrave and Timmons (1992); Gompers, P. and Lerner, J. (2001a)
42
In 1965, William Elfers left ARD to form Greylock Capital, a limited partnership which was one of the rst
fund managers to raise funds from various important families such as the Watsons (IBM), Warren Corning
(Corning Glass, and later ber optics) and Sherman Fairchild (Fairchild Semiconductors) other than family
ofces (Ante, 2008). Greylock Capital brought another important innovation to the PE/VC industry in 1972,
when it decided to create a new type of investment vehicle, a limited partnership, instead of fundraising for
already existing vehicles (Ante, 2008). This was the beginning of the work intensive fundraising process that so
many fund managers go through today.
In 1966, ARD did an IPO for Digital Equipment Corporation (DEC) which was considered the rst home
run in the PE/VC industry; ARD invested US$ 70,000 for 77% of the common stock of DEC in 1957 and in
1971, its participation was valued at US$ 355 million. This represents half of the impressive annual rate of
return of 15.8% that ARD recorded in its 26 years of operation (Bygrave and Timmons, 1992; Fenn, Liang and
Prowse, 1998; Ante, 2008).
Between 1968 and 1969, one thousand IPOs were carried out totaling US$1.4 billion. A nancial crisis
again at the end of 1969 and a sizeable tax hike to nance the Vietnam War threatened the economic viability
of startups and SMEs just as had occurred in the 1930s. The oil crisis of 1973 -1974 was the last straw for
many companies nanced by SBICs which werent able to survive given their capital structure which was heavily
reliant on debt and a signicant decline in sales. (Bygrave and Timmons, 1992)
The period from 1970 to 1977 was very difcult for the American PE/VC industry. Nevertheless, this was just
when the West Coast bloomed. During the beginning of the 1960s, the West Coast began offering incentives
to the high tech industry based on higher education and an appropriate environment for new ventures which
attracted the rst PE/VC fund managers to the region. It was the beginning of Silicon Valley. (Bygrave and
Timmons, 1992)
In 1957, an important event had marked the evolution of this industry and underlined the importance of
forming clusters of people and assets in an area which became one of the most important clusters in the
world. At the time, eight scientists left the Shockley Laboratory and met with Sherman Fairchild, a big investor
and the largest shareholder of IBM. Besides being rich, Fairchild invented the aerial camera and had to create
a plane to carry the camera. In this way, Fairchild Camera & Instrument and Fairchild Aviation became two
distinct companies.
Chapter 1
43
Fairchild Camera & Instrument loaned US$1.5 million to eight scientists to form a company and received in return
the option to buy the company back for US$ 3 million. Thus Fairchild Semiconductor was born. In two years, Fairchild
bought the company back for US$ 3 million. When the eight scientists left Fairchild Semiconductor it was already
generating greater prots than Fairchild Camera.
Among these eight scientists who left Fairchild were Robert Noyce and Gordon Moore, who left a company
that manufactured transistors to create a new company dedicated to the development and manufacture
of semiconductor memory chips. This new company was named Intel. And this was how the industry was
born! Its very possible that Silicon Valley wouldnt have existed if it hadnt been for the formation of Fairchild
Semiconductor. These eight brilliant minds would have gone their separate ways instead of joining again to
form Intel.
Between the end of the 1950s and the beginning of the 1970s various fund managers began to organize
themselves as such, establishing the fundamental building blocks for some of the most important PE/VC
fund managers in the world. In 1958, General William H. Draper Jr., Rowan Gaither (founder of the RAND
Corporation) and General Frederick L. Anderson (US Air Force) formed Draper, Gaither & Anderson (DGA),
which is considered the rst West Coast PE/VC fund manager and the rst to use the Limited Partnership legal
structure. In 1959, William H. Draper III, son of General Draper and ex-student of Doriot, left DGA to found
Draper & Johnson with his friend Pitch Johnson. In 1965, he decided to leave the company to form Sutter Hill
Ventures (SHV). His son Timothy C. Draper would be the founder of Draper Fisher Jurvetson (DFJ) exactly 30
years after his grandfather entered the PE/VC industry (Ante, 2008; SHV, 2010; DFJ, 2010).
In 1961 Arthur Rock, another ex-student of Doriot, and Thomas J. Davis founded Davis & Rock, using the
limited partnership legal structure. Arthur Rock, who played a fundamental role in the creation of Fairchild
Semiconductor before founding Davis & Rock, decided to start his own venture capital company focused in
private equity in 1968 and nanced, among others, the founding of Intel Capital. Besides this, Thomas J.
Davis founded the fund manager Mayeld in 1969 (Metrick, 2007; Ante, 2008). In 1968, Peter A. Brooke,
ex-executive of the Bessemer Trust, founded T.A. Associates (TAA), a PE/VC fund manager that later in 1984
formed Advent International. In 1981 TAA held US$150 million and 80 companies in its management portfolio
(Brooke, 1981).
In the 1970s the West Coast also witnessed the ascension of other very successful PE fund managers such as
Kleiner Perkins Caueld & Byers (KPCB) in 1972, Institutional Venture Partners (IVP) in 1974, and Sequoia Capital
in 1975, among others. Eugene Kleiner left Fairchild Semiconductor and Tom Perkins left Hewlett-Packard to
44
found Kleiner Perkins Caueld & Byers. This was the largest PE/VC fund at the time with US$ 8 million, focused
on startups and SMEs. Since its creation, KPCB has nanced more than 300 high tech companies, many
of them very successful such as Amazon, America Online, Compaq, Electronic Arts, Flextronics, Genentech,
Google, Netscape and Sun Microsystems among others.
In 1972, Donald Valentine, who had worked at Fairchild Semiconductor, was hired by the Capital Group, a
company specialized in asset management, to work in its special situation division (another term used by the
market to classify PE/VC investments). They raised US$ 5 million from institutional investors to invest in startups
and small private companies and organized the funds Sequoia I and Sequoia II. In 1975 Valentine left the
Capital Group and started his own independent PE/VC fund manager focused on startups and SMEs called
Sequoia Capital. It made many successful companies possible such as Atari, Apple Computer and Genentech,
which in 1980 was the rst biotech company to offer an IPO in a public stock exchange`s history (Bygrave and
Timmons, 1992; Ante, 2008; KPCB, 2010).
Up until this time, the private equity industry in the United States was mainly venture capital. Nonetheless,
during the 1980s the industry changed drastically and began to focus on leveraged buyouts (LBOs) of great size
such as when RJR Nabisco was bought by the private equity rm Kohlberg Kravis Roberts & Co (KKR), a US$25
billion deal, which is still the largest deal realized in the history of private equity
3
. It was probably during this
time that private equity began to be used as a synonym for buyout (acquisition of a majority of voting shares)
through mergers and acquisitions (M&A) and huge LBOs (buyouts nanced by leveraged debt).
Even though capital owed into buyouts during the 1980s, venture capital activities also grew. Investments in
startups and SMEs jumped from US$ 600 million in 1980 to US$ 3.0-3.5 billion from 1983 to 1989. Again,
driven by an overheated stock market, the American PE/VC reached a peak in 1987; there were more than
700 private equity fund managers with US$ 3.9 billion of investments and more than 1,700 companies under
portfolio. Even the SBICs had recovered and represented 450 companies at the time. This phenomenon in
the PE/VC industry has already been thoroughly studied including the classic study of the growth and decline
cycle Boom and Bust by HBS professors Paul Gompers and Josh Lerner (2001), which studies the temporal
disequilibrium between the supply and demand of venture capital and its impact on the industry. We will say
more about this theme in the chapter dedicated to fundraising.
3 In absolute numbers, the acquisition of RJR Nabisco by KKR was surpassed by the acquisition of the Hospital Corporation of
America (HCA) by KKR, Bain Capital and Merrill Lynch in 2006, and aIterward in 2007 by the acquisition oI the Equity OIfce
Properties Trust by the Blackstone Group. Nevertheless, the RJR Nabisco deal is not only an important mark in history, but also,
when the numbers are adjusted Ior infation, it remains the largest transaction in history (Fortune, 2007).
Chapter 1
45
The 1980s were thus a period of great change in the PE/VC industry. The American market began to
specialize in relation to focus, investment stage and strategy (i.e. mezzanines, LBOs, etc). Investment banks and
their structured nance areas boomed enabling the industry to use various forms of complex nancing involving
convertible stock, contingent guarantees, bridge loans, and principal amortization formulas customized for the
needs of specic transactions. In addition, limited partnerships established themselves as the market standard
and greatly increased the availability of these kinds of equity participation to institutional investors (Bygrave and
Timmons, 1992).
The beginning of the 1990s was again challenging for the PE/VC industry. After the stock market crash
of October 1987, the US economy entered into recession in 1990. The increase in oil prices due to the Gulf
War didnt help, and by the middle of the decade a third of the SBICs had failed (Bygrave and Timmons,
1992). After falling in 1990 (US$2.8 billion) and 1991 (US$2.3 billion), VC activity in the United States began
to recover rapidly due to the accelerated growth of the internet and other high tech companies. The market
reached US$4.1 billion in 1994 and US$7.6 billion in 1995. The period of 1995 to 2000 is widely considered
a boom period for VC growth with investments in the United States reaching US$105.9 billion (Bygrave and
Timmons, 1992; Metrick, 2007). The story of Netscape clearly illustrates this scenario.
In the second half of the 1990s, Silicon Valley was the center of the universe as Wall Street had been in the
1980s. The internet was the great Trojan horse by which technogeeks and engineers were able to enter markets
that had previously been inaccessible to this type of professional. The story of Netscape is a classic example of
this phenomenon and revolves around two charismatic entrepreneurial gures, Jim Clark and Mark Andreesen.
Jim Clark was the creator of three billion dollar companies in less than two decades. In 1979 at Xerox
Parc, he was the main inventor of a three-dimensional graphics chip called the geometry engine, and later
he was the founder of Silicon Graphics, his rst billion dollar company.
Silicon Graphics is best known by the computer graphics lms that it helped create, giving life to the
dinosaurs in Steven Spielbergs Jurassic Park and the tornadoes in the lm Twister. Its technology helped in the
design of cars and airplanes as well as virtual reality toys and games. Clark was a visionary in the right place
at the right time. In 1991, after a serious motorcycle accident, he wrote an academic article while still in the
hospital called A telecomputer, in which he prophetically announced the fusion of personal computers with
personal communication. At the time this idea seemed a little absurd, but Clark believed that people would use
their computers to communicate with each other and that it would be more than a work tool. It was with this
scenario in mind that Clark met Marc Andreessen.
46
To create applications for his telecomputer, Clark brought a 22 year old recent graduate from the
University of Illinois, who had written a piece of software called Mosaic which permitted the user to navigate the
internet. On April 4, 1994 Mosaic Communications was formed with US$ 3 million from Clark himself; at that
time the company had seven recent graduates from the University of Illinois and was valued at US$ 18 million.
A little while later, Clark negotiated the injection of capital from PE/VC fund manager Kleiner, Perkins
Caueld & Byers based on an estimate of the companys value of US$54 million, or in other words, a price
three times greater than that he had paid as an angel investor and co-founder. The fund manager bought 5%
of the company while Clark retained 25% of it. Later the company was renamed Netscape Communications
which became famous for its internet product Netscape Navigator.
Eighteen months later, and long before the company had made a cent of prot, he made the most
successful and possibly the most famous IPO in the history of the American stock market
4
. On the rst day
the stocks price rose from US$12 to US$48 and in three months it had already reached US$140, and Marc
Andreessen at 24 already had a personal fortune of US$ 80 million, kicking off the era of the Golden
Geeks as it was called on a famous Time Magazine cover, thus affecting the hearts and minds of every
young entrepreneur in the world and also their dreams of becoming instant millionaires. The company broke
great paradigms of the American PE/VC industry, namely taking a company public only after four consecutive
quarters of prot, which was later called irrational exuberance by Alan Greenspan, the President of the Federal
Reserve, in 1996.
Greenspan used this expression irrational exuberance during a speech he gave at the American Enterprise
Institute during the height of the internet or dot com bubble. Greenspan said on December 5, 1996 that clearly,
sustained low ination implies less uncertainty about the future, and lower risk premiums imply higher prices of
stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios
and the rate of ination in the past. But how can we know when irrational exuberance has unduly escalated
asset values which then become subject to unexpected and prolonged contractions as they have in Japan over
the past decade? [...]
During the 1990s, various PE/VC fund managers became interested in emerging markets and expanded
their activities to Europe and Asia in search of higher returns (Lerner, 2001). Its appropriate here to go over
the history of the interest of these global fund managers in emerging markets. A decade before this interest in
4 Thomas Friedman cites the Netscape IPO as one oI the ten Iorces that made the world fat in his book The World is Flat: A BrieI
History of the 21st Century (Friedman, 2005)
Chapter 1
47
emerging markets appeared the emerging markets were not an attractive area for PE/VC. In fact, in 1981 when
the Dutch nancier Antoine van Agtmael who was working for the International Finance Corporation (IFC), the
investment branch of the World Bank, coined this expression, the emerging markets faced serious difculties.
In that year, many countries, including Brazil, were ready to declare a moratorium on their external debt. The
expression Brazil is the country of the future, and always will be was painful for Brazilians who being proud
of our country could not accept the idea that our country would never reach its full potential. The emerging
markets were known as underdeveloped or Third World. Agtmael suggested that these pejorative terms
be substituted for emerging markets. He believed that it already was possible to capture the latent energy in
Asia, Latin America, the Middle East and even Africa. Agtmael persisted in his cause, and in 1987 created the
fund manager Emerging Markets Management which has US$ 17 billion and whose funds have earned more
than 25% a year. The whole world followed his lead and today there are many different funds and departments
dedicated to emerging markets among which Brazil is one of those receiving the most interest today.
1.2.1. Private Equity in Europe
At the end of the 1970s, PE/VC activity was practically inexistent in Europe, and by the end of the 1980s
only the United Kingdom was relevant. For good or for bad, Europe had always been more conservative and
this tendency was no different in the PE/VC market. In 1980 the European Commission made an analysis of
barriers to industrial innovation in Europe which revealed that the greatest problem was that technology based
companies companies in every member country had a lack of access to adequate nance.
To help overcome this and encourage cross-border operations, the Commission Directory instituted a pilot
regime to support collaboration between risk capital rms that needed to operate on a larger scale than their
domestic economies could provide. The scheme was limited to one risk capital rm per member state and
began in October 1980 with four fund managers: Sonnova from France, TDC from the United Kingdom,
Prominvest from Belgium, and Eurabelge (IMI Group) from Italy.
This investment committee met every two months and in the beginning the participants presented few investee
companies, perhaps because they were reluctant to reveal details of their portfolios to other rms. But, as the
benets became obvious, this hesitation was overcome, the deal ow increased and the meetings became more
frequent. By the end of 1981, three other companies were added to the regime: WFG from West Germany, Parnib
from the Netherlands, and DCC from Ireland. In parallel to this initiative, the Commission organized conferences
in Luxembourg at the end of each year which were focused on different aspects of nancing innovation, and in
48
which program participants spoke about their experiences. This committee formed the European Venture Capital
Association (EVCA) in 1983.
During the 1990s, the PE/VC industry expanded rapidly in Europe, even though its growth was not homogeneous
among different countries. (Bygrave and Timmons, 1992; Martin, Sunley and Turner, 2002).
Graph 1.1 - The Largest European Markets (1992-1999)
The ve largest venture capital markets in Europe, in thousands of European Currency Units, the precursor to the Euro in international nancial
transactions.
0
2,000,000
4,000,000
6,000,000
8,000,000
10,000,000
12,000,000
1 9 9 2 1 9 9 3 1 9 9 4 1 9 9 5 1 9 9 6 1 9 9 7 1 9 9 8 1 9 9 9
Italy
Netherlands
France
Germany
Sweden
The United
Kingdom
The
Source: Martin, Sunley and Turner (2002)
Table 1.2. Number of VC Fund Managers (United States and Europe)
Members of the European Venture Capital Association (EVCA) and the National Venture Capital Association (NVCA)
USA EU UK France Sweden Italy Belgium Spain Other
1991 389 163 42 30 1 10 12 5 21
1992 397 161 38 29 2 12 11 6 20
1993 401 159 40 29 3 11 12 7 19
1994 400 162 42 27 5 11 14 8 17
1995 425 169 40 32 5 11 13 8 16
1996 460 176 42 31 4 13 13 8 18
1997 507 184 52 32 5 12 16 8 19
1998 547 210 61 33 7 12 17 10 25
1999 620 331 79 48 11 16 23 14 32
2000 693 424 90 59 22 19 30 17 33
Source: Bottazzi and Da Rin (2002)
Chapter 1
49
1.2.1.1. United Kingdom
After the Second World War, the British government decided once again to address the problems
of a chronic lack of long term nancing for SMEs which had already been identied in the MacMillan
Committee Report of 1931. In 1945, the government supported the creation of the Finance Corporation
for Industry (FCI), and its subsidiary, the Industrial and Commercial Finance Corporation (ICFC), by
the Bank of England (15%) together with other banks in the UK (85%).
During the 1970s, the FCI and the ICFC merged to create Finance for Industry (FFI), which during
the 1980s became Investors in Industry (3i). 3i, as it ofcially became known in the 1990s, was one
of the rst PE/VC fund managers in the world to be publicly listed on the stock market (IFC, 1981; 3i,
2010).
In 1948, the National Research and Development Corporation (NRDC) was the rst public company
to make PE/VC investments in the United Kingdom. As part of the national R&D support program
for startups and SMEs, the British government created the National Enterprise Board (NEB) in 1975.
The NEB acted as the private equity arm of the government, and by 1980 it had already invested
in various industries. In 1981, the NRDC and the NEB were merged to form the British Technology
Group (BTG). In 1991, BTG had 430 companies from many diverse sectors in its investment portfolio,
totalling more than US$ 430 million in investments (Souza Neto and Stal, 1991).
1.2.1.2. France
The Societs de Developpement Regional (SDRs) were created in 1955 to furnish equity and debt to
startups in France. Later in 1968, the French government formed the Agence Nationale de Valorisation
de la Recherche (ANVAR), which turned into the most important source of PE/VC investment for innovative
startups and SMEs (IFC, 1981).
At the end of 1963, the European Enterprise Development Company (EED) was created in France with the
support of ARD and the personal efforts of George Doriot (Ante, 2008). This appears to have been the rst
private PE company in France, a title normally attributed to the Societ pour le Financement de IInnovation
(Sonnova), which was formed in 1972 by the largest banks in the country. Peter Brook was one of the Members
of the Board of Administrators of Sonnova which invested in more than 460 companies from its creation till
the present day (IFC, 1981; Brooke, 1981; Sonnova, 2010).
50
Sonnova was one of the Societs Financiere dInnovation (SFIs) created in France in the 1970s under
government regulation designed to stimulate stock investments in innovative and high potential growth
startups and SMEs. The SFIs resemble the American SBICs because of their public nancing and the ability
to invest through loans instead of stock. In 1981, the SFIs operating in France were Sonnova, its subsidiary
Batinnova, and Soginnove, a joint venture between Sonnova and Socit Gnrale (IFC, 1981).
1.2.1.3. Other European Markets
In the 1980s, the rest of Europe felt a lack of an active or minimally structured PE/VC market. For example, even
though the rst PE/VC fund manager in West Germany had been formed in the 1960s as a the PE/VC arm of a
commercial bank, the PE/VC industry was very small until the middle of the 1980s (Von Drathen, 2007).
At the beginning of the 1980s there were just two PE/VC fund managers in Spain: the Sociedad Espanola de
Financiacion de la Innovacion (Sennova), founded in 1978 by Banco de Bilbao and other local investors with
the support of the IFC and the Spanish government; and the Fomento de Inversiones Industriales, the PE/VC
arm of the Banco Espaol de Credito, the largest bank in the country at the time (IFC, 1981).
1.2.2. Emerging Markets
The Commonwealth Development Corporation (CDC) was created in 1948 by the British government in order
to develop its current colonies and ex-colonies. It began by offering loans and equity to private companies. PE/
VC investments represented around 10 to 20% of its assets under management. In 1972, the CDC expanded
its coverage to developing countries outside of the Commonwealth. In 2004, CDC spun off ACTIS as an
independent PE/VC company focused on emerging markets (Fox, 1996; Actis, 2010; CDC, 2010).
Bygrave and Timmons (1992) recognize the efforts made by various institutions, especially the World
Bank and the International Finance Corporation (IFC) to spread PE/VC activity to emerging markets during
the 1980s. They also point out the difculties and challenges that existed as a result of a lack of a proper
environment for this activity.
In 1988, emerging markets (at that time called developing countries) represented US$350 million in capital
commitments according to Bygrave and Timmons (1992). According to Gill (1981), the IFC invested in a diverse
group of PE fund managers around the world such as the Sociedad Espanola de Financiacion de la Innovacion
(SEFINNOVA), Ventures in Industry and Business (VIBES) and Brasilpar (in Brazil).
Chapter 1
51
Table 1.3. IFC Investments in VC Focused Fund Managers
Data Country Name
Jan 1978 Spain SEFINNOVA I
Sep 1979 Philippines VIBES
Nov 1980 Brazil BrasilPar
Jun 1982 Kenya (1) IPS (Kenya)
May 1983 South Korea KDIC
Nov 1983 Malaysia Malaysia Ventures
Nov 1983 Asian Region SEAVIC
Oct 1984 Argentina SADICAR
Jun 1987 China JF China
Nov 1987 Ivory Coast (1) IPS (Cte D'Ivor)
May 1988 Portugal Inter-Risco
Jul 1989 Hungary First Hungary Fund
Dec 1989 Madagascar AEF-FIARO
Apr 1990 ndia TDICI-VECAUS II
Dec 1990 Thailand SEAVI Thailand
Dec 1990 Indonesia SEAVI Indonesia
May 1991 Zimbabwe VC of Zimbabwe
Dec 1992 Eastern Europe Advent PEF: Europe
Dec 1993 Russia Framlington Russian Investment Fund
Dec 1993 Ukraine Ukraine VC Fund
May 1994 Bulgaria Balkan Fund
Jun 1994 Mauritius Mauritius VC Fund
(1) Holding Company
Source: Carter (1996)
1.2.3. Evolution of the Brazilian Industry
We can trace the origins of the Brazilian PE/VC industry to the expedition of Pedro lvares Cabral (the
discoverer of Brazil) and Portuguese investment in this venture. In the same way as in the US, the concept
of PE/VC began to develop during the countrys industrialization, which in Brazil occurred in the beginning
of the 20th century, when wealthy families began to invest in companies directly.
In the 1950s and 60s, Brazilian businessmen were investing in traditional businesses such as textiles, furniture,
food, clothing and civil construction when multinationals began to enter the country to produce consumer
goods. Brazil was growing rapidly. At this time the country began to diversify which would prove to be very
important in the future for the structuring and consolidation of the PE/VC industry.
Due to an import substitution program, government owned companies began to support the development
of their product and service suppliers. As a consequence, many SMEs ourished in Brazil which offered
fertile ground for PE/VC investments (Souza Neto and Stal, 1991). The beginning of the modern PE/VC
52
industry in Brazil is widely viewed in the literature as having begun between the middle of the 1970s and
the beginning of the 1980s (Romani, 1997; Checa, Leme and Schreier, 2001; Freitas and Passoni, 2006;
Sousa, 2008). Nevertheless, it is necessary to correct this historic imprecision based on new evidence
which is presented here for the rst time.
a) 1960 1970: the Missing Link
According to Ramalho (2010), the rst initiative to found the Brazilian PE/VC industry began on September
24, 1964 with the creation of the Adela Investment Company S.A., one year after the Atlantic Community
Development Group for Latin America (ADELA) had been formed, based on a model created by a NATO
task force lead by US Senator Jacob K. Javits. The task forces objective was to propose policies that would
support Latin American economic development.
Originally a private-public partnership, it turned into an exclusively private initiative supported by Senators
Javits and Hubert Humphrey. The Adela Investment Company (AIC) would acquire minority participations in
startups and SMEs, sell its participations once its investments matured, and then reinvest the prots in new
ventures. It would apply market principles in the search for protable projects that would be of great impact
to the local economy, without any political or philanthropic aims. (U.N, 1965; Fox, 1996; Rivera, 2007;
Boyle and Ross, 2009).
AIC raised US$16 million from 50 investors in 12 countries, including Canada, various European countries
and Japan. Each investor could contribute from US$ 100 thousand to US$ 500 thousand. AIC managed to
attract 240 investments from 23 countries including Brazil
5
. A holding company was created with US$100
million of authorized capital and a duration of 30 years (Boyle and Ross, 2009).
AIC made its rst investment in Brazil in 1965, and made a total of 22 investments (totalling US$23
million) over 15 years. After investing a total of US$122 million in 141 businesses in Latin America, the Adela
Investment Company closed its operations in 1980 due to nancial difculties.
Another pioneering initiative was made by the IFC, an arm of the World Bank, created in 1956 to support
international development. Around 1966 and1967, the IFC began to make direct equity investments in
5 Banco de Investimentos Residencia, Banco Itau de Investimentos, Banco Real de Investimentos, Banco Safra de Investimentos,
Companhia Antarctica Paulista, Companhia Brasileira de Participaes Cobrapar S.A, Companhia Nacional de Tecidos, Kablin
Irmos & Cia, Monteiro, Aranha Engenharia, Comrcio and Indstria S.A. (Boyle and Ross, 2009)
Chapter 1
53
companies in Latin America including Brazil with the goal of promoting local economies and developing
stock markets (U.N, 1965).
b) 1970 1990
In 1974 BNDES (Brazilian National Bank of Development) created three subsidiaries to provide capital
for SMEs and especially support industrial development policy in Brazil: Insumos Bsicos S.A., Investimentos
Brasileiros S.A. and Mecnica Brasileira S.A. In 1982, these companies merged to form a new company
named BNDESPar (Gorgulho, 1996; Pavani, 2003) which would become very important for the PE/VC
industry in the following decades.
In 1976, the Financer of Studies and Projects (FINEP), created the Support Program for the Technological
Development of Brazilian Companies (ADTEN) with the aim of promoting technological innovation in
SMEs through PE/VC investments. However, ADTEN just used subsidized loans instead of stock in its
roughly 60 investments. Because of its weak results, FINEP discontinued the program in 1991 and decided
to restructure its monitoring and control methodology (Souza Neto and Stal, 1991; Gorgulho, 1996).
Brasilpar was also created in 1976 as a result of a partnership between Unibanco and Banco Paribas,
with the aim of making PE/VC investments in Brazil. This initiative was supported by Roberto Teixeira da
Costa, the rst president of the Securities Commission (CVM) and was structured as a holding company.
Brasilpar invested US$4 million up until 1980 when it was restructured to admit new partners and increased
its capital to US$10 million
6
(Gorgulho, 1996).
The 1980s and the beginning of the 90s were marked by hyperination and economic recession which
inhibited long term investments, especially private ones. It was practically impossible to imagine the PE/
VC industry ourishing in such difcult times.
According to the IFC (1981), there were 6 private and 3 public fund managers operating in Brazil in 1981:
6 Roberto Teixeira da Costa, IFC, Villares Group, Po de Acar, Brasmotor, and Joo Fortes Engenharia (Gorgulho, 1996).
54
Founded Control Observations
ADELA Empreendimentos e
Consultoria
1967 Private Began investing in Brazil in 1965. Local operation opened in
1967.
COBESA Cia. Brasileira de
Empreendimentos
1973 Private
IBRASA, FIBASE and EMBRA-
MEC
1974 Public Reorganized as BNDESPar in 1982
Brasilpar Comrcio e Par-
ticipaes
1975 Private
Brazilinvest S.A. Investimen-
tos, Participaes e Negcios
1976 Private 33.33% private groups, 33.33% Brazilian government and
33.33% international rms
Minas Gerais Participaes
(MGI)
1976 Public
Multipar Empreendimentos
e Participaes Ltda
1977 Private
Promoes e Participaes da
Bahia (PROPAR)
1977 Public Used preferential shares and made minority investments
Brasilinterpart Intermediaes
e Participaes S.A
1979 Private Brazilian government, Brazilinvest, ADELA and various other lo-
cal and international shareholders
Source: IFC (1981)
Besides these PE/VC fund managers highlighted by the IFC (1981), Montezano (1983) identies Monteiro
Aranha S.A. and PHIDIAS Administrao e Participaes S.A. as operating in Brazil since 1982, while
Leonardo (1985) also mentions the operations of Riopart and da Property beginning in 1983.
However, the Brazilian PE/VC industry did not have access to scal stimuli or a proper legal framework
as the industry had in the United States. It was only in 1986 that PE/VC activity benetted from Legal Decree
2287, regulated by Laws 1184/86 and 1346/87. The new regulation recognized risk capital companies
(SCRs), VC fund managers focused exclusively on minority participations in SMEs. SCRs benetted from
scal exemptions and incentives (Gorgulho, 1996; Pavani, 2003; Sousa, 2008).
Even though this regulation was a good idea for stimulating the PE/VC industry in Brazil, it wasnt sustainable
because a) it excluded medium and large companies; b) it didnt permit the use of debt instruments; c) the BACEN
Chapter 1
55
regulation of capital was incompatible with SCRs; d) Law 7714/88 canceled its scal benets. As a consequence,
few initiatives were realized under the regulation of Legal Decree 2287/86 and they didnt prosper long (Costa
and Lees, 1989; Gorgulho, 1996; Pavani, 2003). Examples of SCRs formed were the ACEL Sociedade de Capital
de Risco of Rio de Janeiro which was focused on technology companies, and PAD Investimentos of So Paulo,
which was focused on differentiated products and services. They made less than 10 investments in total and
closed their operations in the beginning of the 1990s (Gorgulho, 1996).
According to Costa and Lees (1989), in July 1988 there were 15 fund managers with committed capital
totaling US$ 150 million
7
.
In 1981, Mr. Ary Burger, ex-President of the Regional Development Bank of the Extreme South (BRDE)
and ex-Director of BACEN, the Central Bank of Brazil, created the Rio Grande Participation Company
(CRP). This was a holding company for investments called PARGS, and it raised capital from local private
investors, the BRDE, a regional development bank, and the Development Bank of Rio Grande do Sul
(BADESUL). This last investor was later acquired by the Bank of the State of Rio Grande do Sul (BANRISUL).
From 1981 to 1990, CRP invested US$ 5.2 million (US$ 2.5 million from shareholders and US$ 2.7
million from capital gains) in 40 businesses (Gorgulho, 1996). In 1990, CRP created a new holding
company called CADERI to accommodate the Inter-American Investment Corporation (IIC), a subsidiary
of the Inter-American Development Bank (IBD) and brought in ve new private investors (Docas, Petropar,
Siderrgica Riograndense, Olvebra and DG Participaes). This investment holding company possessed
US$ 6.5 million in capital and a term of 14 years (Gorgulho, 1996).
During the 1980s, Jorge Paulo Lemann, Carlos Alberto Sicupira and Marcel Hermann Telles, partners at
Banco Garantia, bought Lojas Americanas (1982) and Cervejaria Brahma (1989) with their own capital.
This was the rst step of what turned into GP Investimentos in 1993.
c) 1991 1995
At the beginning of the 1990s, the Brazilian government began a series of structural reforms in the country,
such as reducing trade barriers, deregulating various sectors and privatizing public companies.
7 It included Acel Investimentos, Arbi Participaes, Brasilpar, Brazilian Venture Capital (BVC), Citicorp Venture Capital (CVC),
Companhia Riograndense de Partipaes (CRP), Credibanco Participaes and Partbank. It excluded BNDESPar (Costa and Lees,
1989).
56
In July 1991, BNDESPar created a vehicle specically to support tech-based SMEs through minority
participations (including convertible debentures) called the Capitalization Condominium for Technologically
Based Companies (CONTEC), which incorporated four companies that had received investment directly
from the bank from 1988 to 1990. CONTEC was later restructured and renamed the Capitalization
Program for Technologically Based Companies. Between 1991 and 1995, BNDESPar, through CONTEC,
analyzed around 300 business opportunities and invested in 24 of them, two of them being PE/VC fund
managers: CRP and Pernambuco Participaes S.A. (Souza Neto and Stal, 1991; Gorgulho, 1996).
CADERI, the holding company of CRP, received extra capital in 1993 to accommodate the entrance
of BNDESPar and again in 1995 for the entrance of the IFC. In 1995, CADERI had a total of US$
10.5 million in capital to invest in PE/VC (Gorgulho, 1996). Pernambuco Participaes S.A was
structured as a holding company to make PE/VC investments in Pernambuco, Alagoas, Paraba
and Rio Grande do Norte. It raised US$ 8 million from 81 investors in the Northeast along with
BNDESPar (Gorgulho, 1996; Pavani, 2003).
In 1994, GP Investimentos was the first PE/VC fund manager to create a large investment vehicle
dedicated to Brazil, the GPCP I fund with US$ 500 million of committed capital. In 1994, the
Securities Commission (CVM) launched Instruction 209 which regulated SME investments with the
creation of Emerging Company Mutual Funds (FMIEEs). That year the Brazilian government finally
managed to control inflation due to the Real Plan. Nevertheless, interest rates remained high,
making private credit difficult and limiting sustained economic growth.
According to Carvalho, Ribeiro and Furtado (2006), committed capital in the PE/VC industry
totaled US$ 732 million in 1993. However, already by 1994, financial resources on the order of
US$ 578 million were raised as committed capital to funds of the infant PE/VC industry.
d) 1995 - 1998
From 1995 to 1998, Brazils PE/VC industry developed in function of the economys newfound stability
as well as new business opportunities brought about by privatizations.
International fund managers, such as Advent International, AIG Capital, Darby International and
WestSphere, began to raise money for investment vehicles dedicated to Latin America and Brazil. During
Chapter 1
57
this period, they saw the region as a buy option, where they could allocate a small percentage of their
global or regional funds to test the dynamics of the local market.
In 1994, GP Investimentos created its second fund GPCP II with US$ 800 million. Banco Bozano Simonsen,
a partner with Advent International, created the Bozano Simonsen-Advent Fund in 1995, which Romani
(1997) deemed to have been the rst Emerging Company Mutual Fund (FMIEE) created in the country. In
1994, Patrimnio Private Equity was created as the PE/VC arm of Patrimnio. It initially had been a mergers
and acquisitions nancial consulting rm when it was created in 1988, and was later transformed into an
investment bank in partnership with Salomon Brothers. In 1997, the Patrimnio Brazil Private Equity Fund
I was created with US$ 235 million in partnership with the American bank Oppenheimer (later acquired
by the Canadian Imperial Bank of Commerce).
In 1996, Brasilpar sold its PE/VC operation called BPE to WestSphere, which raised US$ 220 million with its
South America Private Equity Fund that year (Pavani, 2003). Already in 1997, Brazil witnessed the creation of
its rst billion dollar PE/VC fund CVC/Opportunity, which was a partnership between Citibank Venture Capital
(CVC) and Opportunity, a local capital management rm. This fund was mainly focused on privatizations.
The wave of nancial crises around the world in 1997 and 1998 brought turbulence to the Brazilian market
which culminated in the oating of the real at the beginning of 1999. The increase in volatility caused a
signicant reduction in PE/VC commitments in the country during 1998 and the beginning of 1999, especially
by international investors.
e) 1999 - 2000
During the 1990s, PE/VC investments in startups and SMEs were very small, despite Securities
Commission`s (CVM) Instruction 209. However, this regulation was important during the period from
1999 to 2001 which was characterized by the accelerating growth of internet businesses and electronic
commerce which reignited PE/VC fundraising for these businesses.
During this period, PE/VC investments jumped from US$ 200 million in 1997 to US$ 1.1 billion in 2000, with 78 of
118 these businesses in 2000 being related to the internet (Stein, Trigueiro and Herndl Filho, 2001).
As a result of the accelerated growth of the PE/VC industry, the Brazilian Association of Risk Capital (ABCR)
was formed in 2000, and was renamed the Brazilian Association of Venture Capital and Private Equity (ABVCAP)
58
in 2005. Even so, the Brazilian industry suffered another reversal of fortune with the bursting of the internet
bubble in March 2000.
f) 2001 - 2003
GVcepe - The Private Equity Studies Center of Getulio Vargas Foundation - EAESP was created in
April 2003 responding to the demand of the investment community, multilateral agencies, branches
of the government, and capital markets institutions for reliable information reported independently
with rigorous statistics related to the nature, structure and investments of fund managers based in
Brazil (Carvalho, Ribeiro and Furtado, 2006). Beginning in the second half of 1999, the Getulio
Vargas Foundations Sao Paulo School of Business Administration (EAESP-FGV), was the first to offer
a course in PE/VC called Entrepreneurial Finance and Private Equity. It was a pioneering initiative in
the country, led by Professor Cludio V. Furtado and sponsored by some fund managers
8

The period from 2001 to 2003 was once again a difficult one for the industry. After the decline
of internet business strategies, the world faced the terrorist attacks of September 11, 2001. Besides
this, Brazil passed through an energy crisis in 2001 and the presidential elections of 2002 brought
high volatility back to the markets with a large devaluation of the real and a large increase in
interest rates. The macroeconomic stability and growth of the country appeared to be compromised.
As a consequence the infant Brazilian PE/VC industry restructured as part of its natural evolution. With
problematic companies in their portfolios, some local fund managers, mainly international ones, closed
their Brazilian operations during this period or liquidated part of their portfolios. According to Carvalho,
Ribeiro and Furtado (2006), 35 investments were liquidated and 10 others were sold back to the founders.
In 2003, the Securities Commission (CVM) published Instruction 391, which regulated PE/VC investment
vehicles established in Brazil, making way for a larger participation by pension funds, and in particular local
pension funds, as investors in new vehicles increasing their PE/VC allocations in the country.
8 Founders of GVcepe Advent International, Intel Capital, Ptria Banco de Negcios (Ptria Investimentos), Sebrae-SP, TMG
Capital Partners, Votorantim Novos Negcios, and J.P. Morgan Partners.
Chapter 1
59
g) 2004 - 2008
In 2005, after the rst phase of reorganization, the Brazilian PE/VC industry began its second cycle.
The rst exits by portfolio companies through IPOs occurred at the end of 2004.
At the end of 2005, GVcepe, in a pioneering effort in emerging markets, published in Brazil and
abroad The Private Equity and Venture Capital Industry The First Brazilian Census, co-authored by
A.G. Carvalho and Leonardo Ribeiro. It gathered crucial information, statistics and systematized
knowledge about the Brazilian Private Equity and Venture Capital Industry.
h) 2009 - 2011
After passing safely through the nancial crisis of 2008, Brazil emerged as one of the great powers of the future,
uniting macro- and micro-economic fundamentals that today put it in the spotlight, competing for international
investment with China. Just as in the other BRICs, the fundamentals that make Brazil an attractive country are
centered on the size of its population and this populations potential for economic growth, some of the most
competitive basic industries in the world, its great agricultural potential and its chances to become a great producer
of food and petroleum, among other things. Its this scenario that helped it amass the impressive quantity of
US$ 36.1 billion in committed capital in 2009, the base year of this census, and it is from this context that we will
analyze everything that affects the participants of this industry at every step of the PE/VC cycle.
The rst step in understanding the PE/VC cycle is the mapping and detailing of its Ecosystem in Brazil
which well cover in the next chapter.
Chapter 2
The PE/VC Industry Ecosystem in Brazil
63
Chapter 2
The PE/VC Industry Ecosystem in Brazil
1
2.1. Introduction
Although its clear that VC is a type of PE investment, the terms have come to be used to indicate different
segments over the years. As seen in Chapter I, PE investments traditionally have been divided between
VC and buyouts, the former referring to shareholder participation in innovative companies in an early
stage of development and with high growth potential. This doesnt signify that PE/VC fund managers cant
acquire majority participation in a company in an early stage of development or a minority participation in
a large established company. The effect has been, however, that VC has become established as a brand
for investments in companies in their initial stages and PE for investments in more mature companies to
differentiate the management of each situation and undoubtedly the tools used as well.
Around the world the classication of PE/VC investment stages is far from unanimous, but they are
based on the classications used in the American market.
In Brazil, De Carvalho, Ribeiro and Furtado (2005) classied investment stages together with share
structure, while Ramalho and Furtado (2008) separated these characteristics, but still maintained the
international pattern of buyouts together with the company life cycle: the seed, startup, early stage, and
later stage phases as part of Venture Capital and the PE-expansion, PElater stage, and PE-buyout phases
together with Mezzanines and PIPEs as part of Private Equity.
The present study reexamines the denitions that permeate this question and introduces a new
classication for stages and types, which observes domestic and international denitions, and redenes
the stages based on the company lifecycle.
1 Authors: Joo Ricardo Ribeiro, Ricardo Lacaz, Gabriella Pegoraro, Caio Ramalho, Rodrigo Lara,
Marcelo Coura, Henry Sztutman, Eduardo Paoliello and Jacques Vaney.
64
Figure 2.1. The Company Life Cycle
Start Development Expansion Maturity Decline
Time in Companys Life
Initiavive
Vision
Perseverance
Mobilization
Vision
Strategy
Organization
Leadership
Strategy
Leadership
Organization
Focus
Management
Control
Rigor
Organization
Management
Control
Leadership
Focus
Source: GBB (2010)
In this way, we maintained the separation between Venture Capital and Private Equity, because it is
easily recognized by all participants in the industry, whether they be fund managers, public policy agents,
or local or international entrepreneurs. However, we excluded the term buyout from our classication
because it refers to the way in which shareholder participation in a company is acquired. Instead we use
Private Equity - Growth and Private Equity - Later Stage. Even though it is normally associated with
Private Equity in the United States, the term buyout can also be associated with Venture Capital in cases
in which majority participation is acquired in companies in their initial stages. This is uncommon in the
United States but occurs frequently in Brazil in certain investment agreements characterized by high risk
and the need for alignment of business incentives.
First Stage:
Seed: Seed capital. Small initial investment made during the pre-operational phase of the development
of an idea, a project or for initial market tests or tests for the registration of patents; (Pre-incubation phase,
which can include the seed nancing).
Startup: Capital investment for companies that are being constructed, in general during the rst or
second year of operations, when it still is not selling its services commercially. In this phase the company
has already begun hiring professionals and has already made the necessary studies to put its business
plan into action, to make beta tests, and tests of concept. During this stage, investment is usually used for
product development and initial marketing (First round nancing - series A).
65
Chapter 2
Development:
U Venture Capital Early Stage: First stage of nancing for companies which have products or services
that have already been tested commercially, which usually have been in operation for up to four
years and whose revenues do not exceed R$8 million. (Usually, second round of nancing).
U Venture Capital Later Stage: The company has already reached the full commercialization phase
of the product and its rapid expansion requires more nancial resources than those that can be
generated by internal investment vehicles to broaden commercialization, increase productive
capacity, distribution, etc. The company may or may not have reached its break-even point. The
third and fourth rounds of nancing occur during this phase.
Expansion:
U Private Equity Growth: Expansion or growth. Capital investment for the expansion of an established
company with consolidated product lines and brand name. The investment is to expand the company
physically or expand its distribution network, cashow, or may still be used to create the brand
name. Sales growth is usually above 25% during this stage.
Maturity:
U Private Equity Later Stage: During this stage the company has already achieved a high and stable
rate of growth, solid cashow, a consolidated brand name, and can be characterized as a platform
for growth or acquisition by other companies in the same sector.
U Distressed: Investments destined for the restructuring of companies who are heading towards or are
already suffering nancial difculties, receivership, etc.
Besides traditional PE/VC investments, this work sees private PE investment divided into the following
categories:
U Greeneld: Investment in large physical initial facilities or expansion where few or no pre-existing
installations are present. Normally related to investments in real estate, forestry, energy or
infrastructure.
U Read Estate: This type includes shopping centers, residential lots, and commercial and industrial real
estate. These projects do not possess a single focus, but they are all related to developing the real estate
market in a determined commercial area or industrial district.
U Forestry: Investments for the sustainable use of forests, changing landholding patterns, as well as
the development, management and expansion of the size of forests for industrial and commercial
use. In the United States, conservation efforts can generate Biodiversity Conservation Certicates
which, when sold, guarantee nancial returns for investors.
66
U Infrastructure: Represents investments in a great variety of ventures related to the production
or sale of energy, including extraction, manufacturing, rening, distribution and transmission.
It also includes investments in public activities such as the construction of bridges, tunnels,
highways, airports, sanitation, water distribution and public transport.
There are also other methods of aiding companies, beyond traditional shareholder investments, which
can present different structures.
U Mezzanine: Investments in infrastructure companies or ventures with high potential stable cashow
through investments based on subordinated debt or hybrid instruments including debentures that can
be converted into shares or other subscription rights.
U PIPE Private Investment in Public Equity: The acquisition of shareholder participation related to a publicly
traded company that normally possesses low liquidity. With this type of investment the fund manager
is involved in improving governance, strategic management and shareholder and investor relations
through the Board of Directors.
In traditional Private Equity and Venture Capital investments, investors commit themselves to
investing capital in vehicles which are administered by fund managers. Fund managers for their part
make investment decisions and buy shares of companies that after 3 to 5 years are sold generating a
return on capital for the investors (shareholders) and partially for the managers.
In this context, the PE/VC industry is composed of four participants: fund managers, investment
vehicles, investors and investee companies. Fund managers administer investment vehicles. Investors
(the source of capital committed to investment vehicles) invest their capital in investment vehicles to
the extent that they are asked to do so by fund managers. The nancial resources of these vehicles in
turn are applied to investee companies (or portfolio companies).
Other nancial instruments such as debt that can be converted into shares, buy options and
subscription bonuses are also used. PE/VC investments are temporary and long term. These PE/VC
vehicles normally have limited duration. At the end of the time frame, the managers must liquidate
all investments and return any remuneration to investors, following rules governing the regulation of
these vehicles, equity participation funds and investment vehicles.
67
Chapter 2
Figure 2.2 The Origins and Applications of Private Equity and Venture Capital Resources
Fund Managers
Investors
Investment
Vehicles
Companies
Capital:
Commitment and
Investments
Capital:
Knowledge and
Management
Financial
Returns
Shareholding
Participation or
Debt Instruments
Source: GVcepe Database Getulio Vargas Foundation
Variations of traditional PE/VC structures exist. In a few cases, investment vehicles do not possess dened
capital commitments. In others, the investors themselves act as fund managers and administer their own
nancial resources by direct investments or through holding companies. In this study, the following types
of PE/VC investments were considered:
U Limited Partnership: A fund manager which assumes the role of partner-administrator is termed
general partner (GP), and the other investors in the investment vehicles are termed limited partners
(LP). The investors are removed from the management of the investment vehicle and do not assume
any nancial responsibility for liabilities that exceed the value of the capital invested. This is the
prevalent type in the United States and is still very important in Brazil.
U CVM Equity Participation Funds CVM Instructions were created to compensate for the absence
of Limited Partnerships in Brazilian legislation. The most important of these were CVM 209 which
instituted Emerging Market Mutual Funds in 1994 and CVM 391 which created Equity Participation
Funds (FIPs) in 2003.
U Direct Investment: There doesnt exist the classic separation between fund investor and fund
manager. The investment manager acts with the same tools of a PE/VC manager, but it does not
administer funds provided by third parties in the companies within its portfolio.
68
U Holding Companies: In the majority of cases this is very similar to a direct investment, with the
difference being that the investment manager makes its investments through a holding company
that can have various distinct investors in its shareholding structure.
U Corporate Ventures: Subsidiary of a company or economic group responsible for PE/VC investments
in businesses which are usually not part of the companys or groups focus sector.
U Others: Other structures which do not t the above denitions including club deals or hybrid
structures, which make PE investments but do not administer third party nancial resources.
PE/VC fund managers raise funds from investors, which commit these nancial resources to investment
vehicles which are overseen by fund managers. The capital in these vehicles is used to invest in investee
companies, using the following instruments:
U Share Participation: This is the most common PE/VC investment realized in Brazil, and it can consist
of common shares or preferred and subscription bonuses.
U Debt: The capital received by the company becomes long term debt, with the nancer being the
vehicle which made the investment.
U Convertible Debt: The acquisition of debentures or bonds with an option to convert them into
shares issued by an investee company. Also designated as Mezzanine Financing, it usually carries
with it a clause about the subordination to senior and generally senior in relation to shareholder
rights.
After making its decision to invest, the central point that characterizes PE/VC fund managers is their
effective participation in the decision making process, and the strategy formulation and management
in companies and ventures that they invest in under CVM Instruction 391. As weve seen, having or not
having a specic fund to manage, is not a major prerequisite for a fund manager to be recognized as
part of the PE/VC industry in this study, if it fullls the prerequisite of fully participating in the management
decision making process as dened above.
In Brazil, the structuring of an investment vehicle, its legal home and its regulation are inuenced by one
or more of the following conditions:
U Taxes: Taxes in Brazil accounted for roughly 33.58% of GDP in 2009 (The Economist, 2009). In
Brazil these include taxes that affect the nancial markets, and more specically the PE/VC industry,
such as the Tax on Financial Operations (IOF) and the capital gains tax on prots of non-residents.
69
Chapter 2
U Corporate Governance: The governing body through which fund managers normally exercise
control is the Board of Directors, but they have other mechanisms available as well. These include
management committees, scal boards, etc. as well as contractual norms that can be utilized such
as catch-up and clawback clauses, which have the goal of minimizing possible conicts that arise
from the asymmetry of interests between managers and other shareholders in investee companies.
U Liquidity: In an economy with a high liquidity of investments (such as an active IPO market), investors
are more likely to make investments which, as a consequence, create favorable conditions for the
PE/VC industry.
U Investors Appetite for Risk: Risk and return go together. Investors require a higher rate of return to
compensate for greater risk involved in a given investment. A classic concept in the asset management
industry which reects the investors expectations is the risk-adjusted return, or in other words, an
investors expected return adjusted for risk. The structure of investments and consequently the way
in which the PE/VC industry develops is inuenced by the investors appetite for risk.
The tax rate, particularly for foreign investors, can affect the form an investment vehicle takes
for a certain business. The preferential treatment received by vehicles registered with the Securities
Commission (CVM) has consequently resulted in a growth of this type of PE/VC investment. This
tendency has also been influenced by the search for additional liquidity in negotiable instruments.
The decision to make an investment using equity or debt can be influenced by the investors
appetite for risk. For example, some more conservative investors may opt for a debt investment
to avoid exposing the investment to the companys total risk. In other cases, an equity investment
may be more attractive because it offers a more advantageous position which increases the
investors participation in the governance of the investee company.
Equity Participation Funds (FIPs - CVM Instruction 391/03) have been used increasingly by the
industry because they have a lower tax impact on international investors when compared to a
traditional holding structure, basically because of the advantageous treatment given to expected
capital gains when the exit occurs.
70
Table 2.1 Structure of Equity Participation Funds vs. Holding Companies (2010)
EQUITY PARTICIPATION FUND (FIP) HOLDING COMPANY
Regulation CVM Law 6404
Registration CMN Resolution 2689/00,
Sec. Exchange Comm. (CVM) - Instruction 391/03
Law N
4131
Tax on Financial Opera-
tions (IOF)
2% of inows; 0% on dividends or partial or total
redemptions (outows)
3x 0.38% on direct foreign investments,
dividends or repatriated capital
Tax on Capital Gains
(for Investment Vehicles)
0% on capital gains from the sale of stock in port-
folio companies in Equity Participation Fund invest-
ments
34% on capital gains from the sale of
shares in companies held by the holding
co.
(for Brazilian Investors)
15% due just when Equity Participation Fund shares
are redeemed
20% due on capital gains
(for International Inves-
tors)
0% for International Investors who have less than
40% of the shares of the Equity Participation Fund;
15% for International Investors who have more
than 40% of the shares of the Equity Participation
Fund
15% due on capital gains
Dividends Exempt Exempt
Source: the Authors
Traditionally in Brazil, investors have had a tendency to keep their investments in xed income because
of high interest rates that give them relatively high returns compared to the United States and Europe where
real interest rates are close to zero. Thus, we see a diverse prole of Brazilian investors in comparison
to American and European investors: these latter two groups tend to seek alternative investments which
deliver higher returns within their countries.
Another important factor is that more developed countries tend to have a stronger entrepreneurial
culture. This is why investors there tend to be more aggressive.
In this manner, an investors appetite for risk has an important inuence on the formation of the PE/VC
industry which can differ signicantly based on the economic and historical characteristics of each nation.
The PE/VC ecosystem consists of a combination of much more complex agents formed by interdependent
actors. Besides fund managers, investors and investee companies, the principal actors in this environment
are angel investors, service providers (lawyers, consultants, auditors, etc.), incentive and support entities,
71
Chapter 2
governmental institutions, universities, incubators and associations. Within this ecosystem, these actors work
in a cooperative manner with the aim of promoting the evolution of these companies during their whole
development cycle.
Figure 2.3 PE/VC ECOSYSTEM
Service Providers
LegaI Advisors
AudiIors
MahagemehI
lhvesImehI
8ahks / M1As
Commercial
AccouhIihg
PromoIion and 5upporI
GovernmenIaI
A8Dl
8NDES
FlNEP
Gvcepe - FGV
Research Labs
ahd 1echhological
A8VCAP
LAVCA
Academic
AssociaIions
PF/VC ParIicipanIs
InvesIors (LPs)
AngeI InvesIors
CorporaIe VehIures
High lmpacI
Compahies
Mahagihg Orgs. (GPs)
"Search Funds"
Entities
Parks
UhiversiIies ahd
lhcubaIors
EMPEA
CohsulIahIs
8ahks
Firms
Source: Adapted by the authors from Ferrary and Granovetter (2009)
2.2. PE/VC Ecosystem Actors in Brazil
We can classify the agents of this ecosystem into three large groups:
Service Providers Includes lawyers, auditors, consultants, investment banks, mergers & acquisitions and
nancial consulting boutiques, technology providers, etc. Among other functions, these service providers
bring business proposals to fund managers, help structure businesses, help negotiate between fund
managers and entrepreneurs, execute and assist due diligence, and collaborate in the implementation of
operational improvements in investee companies.
Non-Governmental Representation, Promotion and Support Entities Aim to develop the Brazilian PE/
BC industry through institutional action, research and publications, the creation of industry databases, the
mobilization of fund managers, the development of qualied professionals and related activities. In this
group, the Brazilian Private Equity and Venture Capital Association (ABVCAP) and GVcepe The PE/VC
Studies Center of FGV-EAESP stand out.
72
Governmental Promotion and Support Institutions Develop PE/VC entrepreneurship, PE/VC
investment, and participants in vehicle creation as PE/VC managers. In this group, the Brazilian Industrial
Development Agency (ABDI), the Financer of Studies and Projects (FINEP), the National Economic and
Social Development Bank (BNDES), the Brazilian Micro and Small Business Support Service (SEBRAE).
All of the actors of this ecosystem have well dened formal and informal functions in their social and business
relations with the industry, as shown in Table 2.2
Table 2.2 PE/VC ECOSYSTEM ACTORS
Actors Formal Functions Informal Functions
ABDI
Promotes and executes Industrial Development Policy in accor-
dance with Foreign Trade and Science and Technology Policy.
Promotes Entrepreneurship, In-
novation and PE/VC
ABVCAP
Represents the interests of fund managers of entrepreneurial
capital in Brazil. Revolves around the stimulus, development and
propagation of long term investments in the supply side of the
Brazilian economy.

APEX
Promotes Brazilian exports and attract foreign investment in
Brazil.
Works with ABVCAP to attract
foreign capital to the PE/VC
industry.
Commercial Banks Permit nancial transactions.
Investment Banks
Organize IPOs, M&A transactions,facilitate capital investment
and organize the acquisition of high impact companies
Generate deal ow
BNDES / BNDESPAR
Provide long term nancing for the realization of investments in
all sectors of the economy. Invests directly in companies and into
PE/VC funds.
Offers nancial resources for
investments in Brazil. Also offers
cashow nancing program.
Lawyers
Gather legal knowledge; Work with legal, business and intellec-
tual property issues.
Provide specialized legal con-
sulting.
Government Research Foun-
dations (e.x FAPESP, FAPERJ,
FAPEMIG, etc)
Encourage Scientic and Technological Research.
Integrate high impact compa-
nies into the network.
FINEP
Promotes public policies in the PE/VC sector. Encourages Sci-
ence, Technology and Innovation in companies, universities,
technological institutes and other public and private institutions.
Supports Research.
Incubators Incubate and accelerate businesses and ventures in the rst stage of life.
Public encouragement of Sci-
ence, Technology and Innova-
tion in institutions.
GVCEPE
Provides analysis, produces knowledge, professional training,
and the formulation of proposals for the institutional evolution of
the PE/VC industry.
Studies the PE/VC Industry.
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Chapter 2
Actors Formal Functions Informal Functions
Research Labs and Techno-
logical Parks
Encourage innovation; Accumulate knowledge.
Encourage interaction, princi-
pally between fund managers
and companies seeking invest-
ment.
Media Circulate information. Accumulate knowledge.
Incubate startups; Encourage
interaction between actors.
PE/VC Fund Managers Finance high impact companies.
Sustain entrepreneurial culture;
Promote high impact compa-
nies.
SEBRAE
Supports the creation and development of micro and small
Brazilian businesses in the most diverse sectors through entrepre-
neurship.
Creates jobs and earnings
through the stimulus of entre-
preneurial activity.
Universities
Promote innovation through basic and applied research; Accu-
mulate and disseminate knowledge.
Select companies; Accumulate
entrepreneurial knowledge; In-
tegrate high impact companies
into the network. Create interac-
tion between actors.
National Board of Scientic
and Technological Develop-
ment (CNPq)
Agency of the Ministry of Science and Technology devoted to
nancing scientic and technological research and the develop-
ment of human resources for research in the country. Accumulate
and disseminate knowledge.
Promotes scientic and techno-
logical development in Brazil.
Source: Adapted by the authors from Ferrary and Granovetter (2009)
a) ABDI
The Brazilian Industrial Development Agency (ABDI), associated with the Ministry of Development,
Industry and External Commerce (MDIC) promotes the Productive Development Policy (PDP). After the
consolidation of economic stability in the country, the MDIC created the PDP which has four primary goals:
increase xed investment, increase Brazilian exports, elevate private spending on R&D and increasing its
dynamism with a focus on micro-and small sized exporting companies.
ABDIs role in promoting the PDP and an innovative environment seeks to increase Brazilian industrys
access to the instruments of development and innovation which involves the promotion of entrepreneurship,
innovation and venture capital. The strategic areas which ABDI considers fundamental for the future of
industrial development and with horizontal applications for the national production chain are: biotechnology,
the semiconductor industry, bioethanol, nanotechnology, and information and communications technology.
These areas are the focus of innumerable PE/VC fund manager investment vehicles and the PE/VC industry
provides horizontal elements in the agencys strategic design.
Table 2.2 PE/VC ECOSYSTEM ACTORS
74
b) ABVCAP
The Brazilian Private Equity and Venture Capital Association seeks to promote the Brazilian PE/
VC industry by following seven basic objectives: 1) To represent and defend the interests of the
community that makes long term investments in Brazil; 2) To develop the long term investment
industry in Brazil; 3) To promote the entrepreneurial capital industry (venture capital and private
equity) in Brazil and abroad; 4) To act as a facilitator in the relationship between members of
the long term investment industry in Brazil and abroad; 5) To collect, process and disseminate
knowledge about and data related to the long term investment industry in Brazil; 6) To defend
ethics and best practices zealously in the realization of long term investments in Brazil; and 7)
To cooperate with related national and international institutions.
The Brazilian Private Equity and Venture Capital Association (ABVCAP) seeks to achieve its
objectives through cooperation with the members of related public and private institutions,
through the creation of committees and centers devoted to PE/VC in Brazil, through the holding
of national and international conferences, as well as the sponsoring of training and studies
about the Brazilian PE/VC industry (ABVCAP, 2010).
c) ANPROTEC
The National Association of Innovative Venture Promotion (ANPROTEC) represents the interests of incubators,
technological parks and innovative ventures in Brazil. It promotes training, the articulation of public policy, and
the generation and dissemination of knowledge.
Incubators and technological parks are very important to the PE/VC ecosystem, encouraging and giving
great support to startups. The focus of incubators are researchers or people with a focus on technology who
possess an innovative product or service but dont have management experience and want to better structure
their business model. Today there are around 420 incubators and technological parks in Brazil.
d) APEX-BRASIL
A The Brazilian Association of Export and Investment Promotion (Apex-Brasil) attends the needs of Brazilian
companies focused on the external market and foreign entrepreneurs who wish to invest in Brazil. To do this,
75
Chapter 2
it has service communities and business centers spread throughout the world which function as platforms to
further the internationalization process of Brazilian companies and increase the countrys participation in large
markets such as Asia and North America.
Seeking to attract international investment, Apex-Brasil and the Brazilian Private Equity and Venture Capital
Association (ABVCAP) hold the ABVCAP/Apex-Brasil Convention which unites investors, mutual funds and
Brazilian companies active in the PE/VC sector, creating a platform which facilitates connections between these
groups and offers information about the sector and its trajectory.
Apex-Brasil offers solutions in terms of information, qualication for exports, commercial promotion,
positioning and image, as well as internationalization support.
e) BNDES
The National Bank for Economic and Social Development is a federal state owned company which
seeks to nance long term investment in the most diverse sectors of the countrys economy considering
social, regional and environmental factors.
f) FINEP
The Financer of Studies and Projects (FINEP) is a Brazilian company that stimulates innovation, promotes
economic and social development in the country, and lends assistance to the public support offered to
science, technology and innovation in companies, universities, technological institutes and other public
and private institutions. It promotes innovation through strategic actions designed to be well structured
and have an impact on the countrys sustainable development.
g) GVcepe
The Private Equity and Venture Capital Study Center of FGV-EAESP is committed to providing analysis,
producing knowledge, and formulating proposals for the institutional evolution of the PE/VC industry. Through
its programs it promotes education for the industry, innovation, competitiveness, and the creation and
modernization of practices and ventures, thus affecting the socioeconomic development of the country as a
whole.
76
h) SEBRAE
The Brazilian Micro and Small Business Support Service helps micro and small business entrepreneurs,
promotes competitiveness and sustainable development, encourages the formalization of companies of
this size, and also plays an important role in the Brazilian PE/VC industry.
This institution was one of the rst to invest in PE/VC fund managers, given that from 1999 to 2004 it
contributed capital to eight investment vehicles. Besides this, it helped create the Brazilian Private Equity
and Venture Capital Association (ABVCAP) and conferences about the area, and was the rst to raise the
subject of worker issues in investee companies.
SEBRAE also was an important actor in the creation of the INOVAR (Innovation) program, which involved
fund manager participation in the selection process and due diligence.
The Brazilian government promotes incentives such as increasing investor safety through reforming
shareholder legislation and acting as a shock absorber in periods of low fundraising and investment. In
this way, it stands out as an important catalyst for the development of this industry in Brazil.
2.2.1. Actors in PE/VC Investment in the Brazilian Economy
The actors involved in PE/VC investment in the Brazilian economy have diverse origins and structures
and may be based in Brazil or abroad. The categories are:
Independent Fund Managers They dont belong to any nancial institution or entrepreneurial
group and have a completely independent management team (so-called PE/VC
managers). These fund managers have private capital or in some cases they are
publicly traded. An independent structure based on private capital is the most
common type of PE/VC fund manager in the world and is characterized by their
fundraising and managing of the nancial resources of third parties. Others
are managers of investments in nancial stocks (excluding hedge funds) which
have a specic allocation in their portfolio and professional teams assigned to
exclusively manage private equity investments
Corporate Ventures These are corporate or business group structures which allocate the resources
of a determined department or division to PE/VC investments, normally in startup
companies or high impact innovative small companies. Note that the allocation of
77
Chapter 2
nancial resources from corporations or conglomerates in PE/VC vehicles managed
by third parties is not counted in this category. Intel Capital, Google Ventures,
Siemens Venture Capital, Dow Venture Capital and Votorantim Novos Negcios
are examples of corporate ventures.
PE/VC Subsidiaries Associated with a Financial Institution Some banks and nancial institutions
operate in the PE/VC industry directly or through a particular dedicated structure
such as a department, division, subsidiary or through their asset management
structure.
PE/VC Managers In the Public Sector Even though the public sector acts primarily as an investor,
having others manage their nancial resources in PE/VC, some public institutions
make these investments directly. In Brazil, BNDES is an example of a public sector
manager.
In Brazil, an entrepreneurial model characterizes the industry giving a concentration of 73% of fund
managers in the independent category according to the classication above.
2.2.2. Investors
Given their characteristics of low liquidity, high risk and high expected rates of return, PE/VC vehicles
are especially attractive to wealthy investors with a long investment horizon wealthy individual investors,
institutional investors (insurance companies and pension funds), trusts and endowments, companies, bank
holding companies, and multilateral institutions, etc. Given the importance of PE/VC to the creation of
companies, the creation of jobs and investments in technology and innovation, various countries have
promoted PE/VC as a mechanism to achieve economic growth, greater innovation and competitiveness. For
this reason, it is also common to nd among PE/VC investors supporting agencies, multilateral institutions,
and public banks, etc.
Besides traditional PE/VC investments, it is also important that entrepreneurs know two important ways
to nance new business, startups, and entrepreneurial projects: (i) gain access to high net worth individuals
who possess experience and the entrepreneurial spirit and who are disposed to support the project; or (ii)
to be nanced by a group of individuals looking to identify and acquire a business in a sector where they
have substantial knowledge or a company which they know has management problems that can be xed.
These are respectively angel investors and search funds.
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2.3. Institutional Framework
The structuring of investment operations have, as a general rule, two main points of departure: to know (i)
what is the best structure to safeguard the business in legal terms; and (ii) what is the most efcient structure
from the point of view of nance and taxes.
To the extent that large PE/VC investors are based abroad, the structure used by managers of PE/VC vehicles
for fundraising seeks to create an environment that will be favorable to such investors.
To facilitate the process of educating these kinds of investors about operations in Brazil, the Brazilian PE/VC
industry has long used traditional structures that have already been utilized in other countries to make it easier
to attract nancial resources. These structures guarantee investors that, whether the investment is successful or
not, the investor will have invested in a vehicle which is (i) already familiar in terms of nancial and tax structure;
and (ii) gives him the desired legal security in terms of his or her relations with other investors and, principally,
with the vehicle manager.
2.3.1. Investment Structures
We can divide the structures of PE/VC investment vehicles in Brazil into two cycles. The rst was the period
before the creation of a regulatory environment with an exclusive focus on PE/VC investors.
The second period began after the creation of this referred-to regulatory environment: the passage of
Securities Exchange (CVM) Instruction 209/94, which regulates Emerging Company Mutual Funds (FMIEEs),
CVM Instruction 391/2003, which regulates Equity Participation Funds (FIPs), CVM Instruction 462, and most
of all Law 11312/2006 which reduced capital gains taxes for investors in Emerging Company Mutual Funds
(FMIEEs) and Equity Participation Funds (FIPs) to zero.
2.3.1.1. First Cycle
Structures during the rst cycle consisted of PE/VC investment vehicles located under foreign jurisdiction.
The rights and duties of investors are normally described in a document called the partnership agreement,
also governed by foreign law.
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Chapter 2
The partnership agreement denes a general partner as the vehicle manager, who has duciary obligations
to the vehicle and the investor. Investors are termed limited partners who have an obligation to invest in
the vehicle that conforms to their subscription commitment, but do not have obligations in terms of the
management of the nancial resources. The structure is set up so that the limited partners can invest and
recover their investment in the most efcient form nancially as well as in terms of taxation.
When the investment occurs, the vehicle located abroad makes an investment in a Brazilian company,
whether it be an investee company or a holding company (i.e. vehicles that invest in companies that are
the focus of this business). In terms of the attractiveness of this investment, general partners structure
their business model so that when investment exits occur, capital gains of 15 to 25% will have to be paid,
depending on the jurisdiction where the investment takes place (EMPEA and Coller Capital, 2010).
2.3.1.2. Second Cycle
The growing demand for capital from Brazilian companies together with the attractiveness of investments
in Brazil has lead to the rapid growth of the PE/VC industry. This wave has become stronger with the
growth of capital markets in Brazil, which has given fund managers new investment exits through the
public offerings of investee companies.
Foreseeing the necessity for a regulatory framework to meet market demand, the Securities Commission
(CVM) worked on the creation of institutions to regulate Emerging Company Mutual Funds (FMIEEs) and
Equity Participation Funds (FIPs). For sure, there was a great desire in Brazil to implement a structure similar
to that which already existed outside the country. What gave this creation by the Securities Commission
(CVM) a boost were the scal benets brought by Law 11312/2006. Only after the law was passed did
local structures begin to be used on a large scale. Another important motivation was to align CVM vehicles
with the needs and requirements of pension funds. Local investors began to make their investments in
Equity Participation Funds (FIPs) from this point on.
The continued utilization of Equity Participation Funds (FIPs) as investment vehicles did not represent a
complete abandonment of the previous model. Many fund managers still use the rst cycle model with a
structured based abroad and with capital commitments and the relationship between general and limited
partners regulated by a partnership agreement.
80
This model is chiey used to accommodate foreign investors who still prefer the security and tax model
of limited partnerships that they are used to, with Equity Participation Funds (FIPs) being used in these cases
for local investment.
It can already been seen this year that the Equity Participation Fund model is becoming predominant in
PE/VC investments in Brazil and the growing number of fund managers, especially local ones, conrms
this.
2.3.2 Institutional Framework for PE/VC Vehicles and their Investments in Investee
Companies
Despite the growing role of PE/VC vehicles in Brazil, whether through foreign direct investment or the
constitution of local investment vehicles, it is important to note that there is no difference whatsoever in Brazilian
legislation between the rights and prerogatives of PE/VC vehicles and those of other shareholders and or
minority shareholders in Brazilian companies. This being so, minority investments on the behalf of PE/VC
vehicles in their investee companies have, in principle, only the rights attributed in Brazilian legislation to
minority shareholders. Besides this, the acquisition of shares in publicly traded companies in Brazil, does not
guarantee PE/VC vehicles any additional privileges beyond those established under Law 6404/76, reformed
by Law 9457/97, under Law 10303/01, under Law 11638/07 and Law 11941/09 and Security Commission
(CVM) regulations, which are always based on the percentage of capital shares held in a company, and have
no relationship to what type of shareholder the minority holder is.
That being so, the most common method adopted by PE/VC fund managers to obtain differentiated rights in
investee companies such as the right to inuence management, to veto certain deliberations, tag along, drag
along, etc. is through shareholder agreements with the controlling shareholders of these companies.
Due to the uncertainty that existed in the 1990s as to the enforceability of shareholder agreements in Brazil,
which will be further detailed later on, practical experience has shown that many PE/VC investments in Brazil
resulted in the acquisition of control of investee companies.
Given the relative judicial insecurity of minority shareholdings, whether they be PE/VC vehicles or not, and the
consequences of underdevelopment of various important sectors of the countrys economy such as the capital
markets and the PE/VC industry, for example, there has been a legislative and institutional effort to strengthen
the capital markets in Brazil to give greater protection to minority shareholders, to adopt standards of corporate
81
Chapter 2
governance (segments of shares negotiation in the stock market based on issuing companies gorvernance
and reporting standards), and to increase transparency, accountability, and the professionalization of publicly
traded companies, etc. All of these factors have made it a more secure environment for minority shareholders,
compared to that which existed for PE/VC vehicles in Brazil in the beginning of the 1990s.
Next we will analyze the rights that PE/VC fund managers have as minority shareholders, taking into account
the alterations that have taken place in Brazilian business legislation, and the executability of shareholder
agreements in the legal system as well as in binding arbitration procedures which are another form that has
been adopted by PE/VC fund managers to secure differentiated rights in their investments. We will also cover,
in a summary manner, bankruptcy law in Brazil. It is not an objective of this study to analyze the tax questions
that inuence PE/VC investments.
2.3.2.1 Private Equity and Venture Capital Investment Vehicles
Before we get into an analysis of minority shareholder rights with the aim of concluding as to up to what
point the protection offered by these rights answers the concerns of PE/VC fund managers in making a
given investment, we should make a brief analysis of what has been done to develop the PE/VC industry
in Brazil through the development of investment vehicles.
From a legal point of view, besides the judicial concerns mentioned above, the lack of PE/VC investments
by institutional investors can be attributed to the lack of adequate specic regulation that existed up until
2003. In 2003, however, the Securities Commission (CVM) issued Instruction 391 which sought to meet
the concerns about adequate regulation for this industry.
The Securities Commission (CVM) had already tried to regulate the PE/VC industry in Brazil adequately
in previous opportunities in 1994 and 1999 through Instructions 209/94 and 302/99. Instruction 209
regulated the creation, functioning and management of Emerging Company Mutual Funds (FMIEEs),
but its application was limited to companies with net revenues below R$ 100 million, the value used to
dene an emerging company according to Instructions 225/94, 236/95, 246/96, 253/96, 363/02 and
368/02. Instruction 302 governed funds investing in publicly traded companies, and thus did not cover
funds investing in private companies.
Instruction CVM 391 created the Equity Participation Funds (FIPs) and sought to address complaints
about the lack of regulation of PE/VC investments by means of local vehicles. This preoccupation can be
82
seen not just by the fact that these investment vehicles can invest in publicly traded or private companies,
but also by the various PE/VC investor concerns that were expressly addressed in the legislation.
Thus, Instruction 391 determined that an Equity Participation Fund (FIP) must participate in the investee
companys decision making process and to have effective inuence in dening its strategic policy and
management, notably through having representation on the Board of Directors. It also provides that
this participation in the management of the company can be achieved through a controlling block of
shares or through shareholder agreements. For private companies that receive investments from Equity
Participation Funds (FIPs), Instruction 391 determines that certain standards of corporate governance need
to be adopted, facilitating the compliance with the same laws that apply to publicly traded companies
foreseeing the moment when such companies go public, which is traditionally when PE/VC fund managers
choose to exit these investments.
Equity Participation Funds (FIPs) are so appropriate for PE/VC investments that the records of the Securities
Commission (CVM) indicate that there are 275 such funds as opposed to 29 Emerging Company Mutual
Funds (FMIEEs) despite the fact that the legislation regarding this latter category has existed for a longer
period of time. Note that not all Equity Participation Funds (FIPs) registered with the Securities Commission
(CVM) are considered PE/VC investment vehicles, because these may simply be formed to structure a
business just from a tax point of view (ex. acquisitions, business reorganizations, sales of shares, IPOs,
etc.). Thus we frequently nd only one investor in this structure which has invested all of its capital in an
investee company.
2.3.2.2 The Rights of Minority Shareholders
As mentioned above, in recent years there has been a growing preoccupation with reinforcing the rights
of minority shareholders.
2.3.2.3 Reforming the Law of Publicly Traded Companies
In 2001, a reform of the Law of Publicly Traded Companies was effected through the passage of Law
10303/01, which sought to protect minority shareholder rights through important innovations, some of
which are referred to below. It is important to emphasize that in many cases these rights are only applicable
to publicly traded companies.
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Chapter 2
2.3.2.4 The Rights of Minority Shareholders in Publicly Traded Companies
a) Delisting: minority shareholders are granted protection under the hypothesis of delisting conditioned
on the realization of a public offering of the shares in circulation for a just price, or at least equal
to the valuation of the publicly traded company. The valuation of the company should be made
based on the following criteria taken together or separately: net assets valued at market prices,
discounted cashow, a comparison by multiples, stock price or other criteria accepted by the
Securities Commission (CVM). In addition, holders of at least 10% of the shares in circulation can
require a review of the pricing of the public offering.
b) Representation on the Board of Directors: it is the right of minority shareholders (holders of at least
15% of voting capital) and preferred shareholders (holders of at least 10% of capital) of the publicly
traded company to elect members to the Board of Directors in a separate election, while it should
be emphasized that the Securities Commissions (CVMs) current policy has reduced the percentage
of voting capital required to 10%.
c) Tag Along Rights: this was granted to holders of common shares who, in cases where the majority
shareholders have sold their shares, have the right to receive 80% of the value received for these
majority shares, and this same right may be extended to holders of preferred shares.
2.3.2.5 Rights Applicable to Minority Shareholders in Publicly Traded and Private Companies
a) Limits for the issuing of preferred shares: a reduction of the maximum limit required for the issuing
of preferred shares without voting rights, which went from 2/3 to 50% of the companys capital.
b) Cashing in Shares: the cashing in of a determined class of shares will only be allowed if it is
approved by more than half of the shareholders of the class affected in a Special Assembly, unless
otherwise stated in the companys shareholder bylaws.
c) Representation on the Finance Board: the members of the Finance Board received greater individual
prerogatives in terms of investigation and surveillance in their representing of the interests of minority
shareholders (holders of at least 10% of voting capital and owners of preferred shares can elect
members to the Finance Board through a separate election).
Besides the rights mentioned above, important alterations were introduced in relation to Shareholder
Agreements and the introduction of binding arbitration in conict solutions, seeking to make it easier for
minority shareholders to assert their rights. We will cover these topics in greater detail when we cover the
enforceability of Shareholder Agreements.
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Another way in which this concern for the development of the capital markets in Brazil was addressed by
the Brazilian Stock Exchanges (BM&F Bovespas) creation of different trading segments or listing of stocks
based on the different levels of corporate governance practiced by listed companies.
2.3.2.6 The Brazilian Stock Exchanges Levels of Corporate Governance
In December 2000, the Brazilian Stock Exchange (BM&F Bovespa) categorized its stocks based on different
Levels of Corporate Governance Level 1, Level 2 and New Market which correspond to graduated rules
for the adoption of best practices in corporate governance which publicly traded companies may comply with.
This is optional, but once a company chooses to comply with these best practices they must be adopted and
a company may leave its contractual level (or trading segment) only if it follows the procedures laid out in the
respective legislation.
Besides this, the Brazilian Financial and Capital Markets Association (ANBIMA) and the National Association
of Investment Banks (ANBID), in their bylaws regarding public offerings and the acquisition of shares, which
should be observed by investment banks associated with ANBIMA, determine that their members only should
participate in public offering in which the company has complied with or committed to complying with within
the next 6 months at least Level 1 of Corporate Governance. As a consequence, all of the recent IPOs realized
in Brazil have been done with the company complying with one of the differentiated Levels of Corporate
Governance (notably the New Market).
The New Market contained in 2011,131 listed companies, 97 of which were admited in the new market
from the period of 2004 to 2011.
The principal characteristics of each of the Levels of Corporate Governance are presented below
a) Level 1:
U Greater transparency and presentation of additional information in its Annual and Quarterly
Financial Reports;
U holds Annual Meetings open to the public to present the companys economic-nancial situation,
projects and perspectives;
U releases the companys calendar of corporate events;
U its administrators shall report share transactions on a monthly basis;
U releases the terms of contracts signed between the company and related parties;
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Chapter 2
U maintains a minimum of 25% of its stock in circulation, to improve liquidity and the decentralization
of share ownership;
U adopts special procedures for public distributions;
U prohibits the issuance of equity participation certicates; and
U provides for the leaving of Level 1 only through the approval of the General Assembly
and with 30 days advance notice given to the Brazilian Stock Exchange (BM&F BOVESPA).

b) Level 2:
U adopts all the rules applicable to Level 1(presented above);
U releases financial information in accordance with international standards, observing US GAAP
and IAS, and translated into English;
U has a Board of Directors composed of at least 5 (five) members, to increase the chances of
members being elected by minority shareholders, in cases where the election is held with a
multiple voting system;
U requires a unified mandate of at least 2 years for Board of Directors members, and further
requires that at least 20% of the members are independent (with no ties to controlling
shareholders);
U offers the right to vote by non-voting preferred shares in determined cases, such as
incorporation, merger, division, asset valuations, approval of contracts between companies
and other companies of the same group, among other rights;
U offers tag along rights for minority shareholders (common and preferred) in case a majority
of shares are sold, with 100% of the value that the shares were sold for going to shares held
by common shareholders, and 80% of the value that the shares were sold for going to shares
held by preferred shareholders;
U offers binding arbitration in the Arbitration Hall of the Brazilian Stock Exchange (BM&F
BOVESPA) to solve conflicts between shareholders and the company; and
U provides that in the event of leaving Level 2 or the closing of capital, the controlling shareholder
must make a public offering for the acquisition of minority shares for a price determined by
a report prepared by a company that is a specialist in this area.
c) New Market:
U adopts all the rules applicable to Levels 1 and 2 (presented above);
U issues exclusively common shares; and
86
U offers tag along rights to all other shareholders at 100% of the sales price of the controlling block
of shares.
The increasing compliance of companies with these differentiated levels of corporate governance,
motivated by the economic gains they have realized through higher valuations of their shares,
demonstrates the success of this Brazilian Stock Exchange (BM&F Bovespa) initiative. It can be said
that the Brazilian capital markets have become stronger since 2001, with a growing participation
of foreign shareholders that in November 2010 represented 16.37% of purchases and 15.89% of
sales on the Brazilian Stock Exchange (BM&F Bovespa), as can be seen in the table below:
Table 2.3 Investor categories (2011)
Types of Investors
Purchases Sales
R$ Thousands Participation (%) R$ Thousands
Participation
(%)
Individuals 23,468,352 12.1 24,097,207 12.4
- Individual Investors 22,246,564 11.5 22,821,912 11.8
- Investment Clubs 1,221,789 0.6 1,275,294 0.7
Institutional 32,020,264 16.5 32,575,578 16.8
Foreign Investors 31,711,430 16.4 30,784,069 15.9
Priv./Publ. Companies 1,730,267 0.9 1,922,567 1.0
Financial Institutions 7,833,606 4.0 7,389,772 3.8
Others 72,949 0.1 67,676 0.1
Total in R$ Thousands (Purchases and Sales): 193,673,738
Source: BM&F Bovespa (Period: 02/01/2011 to 02/16/2011)
Despite all the advances presented above, it is important to note that the Brazilian capital markets
are still in the development stage. Many publicly traded companies are run by family groups which
hold an absolute majority of voting shares for any type of decision, leaving little space for minority
shareholders to be involved in administration, given that a majority of the members of Boards of
Directors represent the controlling shareholder, or especially in family companies, are members of the
controlling family. With this, minority shareholders have few chances to inuence the management of
companies, and often are limited to being represented in Assemblies (General Shareholders Meetings).
But the scenario is changing and the Brazilian capital markets are expanding rapidly. In August
2010 there were 464 companies listed on the Brazilian Stock Exchange (BM&F Bovespa). According
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Chapter 2
to a study made by Amcham-Brasil between August and October 2010, 49% of the companies
interviewed were considering going public. Currently, at least 8 publicly traded Brazilian companies
(including Natura, Embraer, Lojas Renner, and PDG Realty) are characterized by their decentralization
of share ownership.
Besides this, at the beginning of the year the Securities Commission (CVM) released two new
normative Instructions (480/08 and 481/09) with the aim of increasing the transparency of companies
listed in the Brazilian capital markets.
The Brazilian Stock Exchange (BM&F Bovespa), for its part, held an audience, featuring 159
companies which participate in the levels of corporate governance that it administers, which resulted
in various changes to the Regulations, strengthening even further the Brazilian markets commitment
to following the best practices in corporate governance.
2.3.2.7 Right of Divestiture
Minority shareholders are guaranteed the right of divestiture and the receipt of the value of their
shares (book value or economic value, if covered in the company bylaws), if they are dissidents in the
deliberations concerning certain matters. Under the terms of Law 6404/76, this right is dened as a
right of divestiture. The circumstances in which the right of divestiture may be used under the terms
of Law 6404/76 are:
a) The creation of preferred shares or the increase in the number of preferred shares in existence,
without maintaining the same proportions in relation to other preferred shares, except as previously
authorized by the company bylaws;
b) Alterations in preferred, advantages and conditions of divestiture or amortization of one or more
classes of preferential shares, or the creation of a new more favored class;
c) Reduction of a mandatory dividend;
d) Merger of the company, or its incorporation into another;
e) Participation in a group of businesses;
f) Change in the company objective;
g) Splitting up of the company which implies (a) a change in the company objective; (b) a reduction of
a mandatory dividend; or (c) the participation in a group of businesses.
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2.3.2.8 Other Minority Shareholder Rights
Besides the rights mentioned above, Brazilian legislation confers other rights to minority shareholders,
which, however, confer a very poor level of protection, as we will soon see:
(i) any shareholder has the right to:
a) call a General Assembly (General Shareholders Meeting), whenever the management delays calling
it for more than sixty days when it is scheduled to be called by law or by the company bylaws;
b) call a General Assembly when all the senior management posts are vacant and when the company
does not possess a Board of Directors;
c) present in a General Assembly opposition to a deliberation about distributing a dividend inferior to
the minimum required or the retaining of all net prots;
d) require constant certicates of consent for the company books;
e) participate in company prots;
f) participate in the division of company assets in case of liquidation;
g) investigate the management of company business;
h) call for civil action against a manager for the damages caused to the company, if the action has not
taken place 3 (three) months after a company General Assembly has been held to consider such
action;
i) preference in the subscription of shares, participation certicates that may be converted into shares,
debentures that can be converted into shares or subscription bonuses;
j) call for civil action against the controlling company for damage to the companys assets; and
k) call for the liquidation of the company if its administrators or a majority of its shareholders fail to
or refuse to do so.
(ii) any shareholder or group of shareholders with holdings of at least 5% of the companys capital has
the right to:
a) legally require a presentation of the companys books;
b) initiate legal action against members of the administrative team who have caused damage to the
company, if this has not been proposed in the companys General Assembly;
c) obtain information from the Surveillance Board;
d) initiate legal action to dissolve the company when its objectives cant be reached;
e) in publicly traded companies, require information from members of the administrative team
about the ownership and negotiation of shares and subscription rights issued by the company and
information relative to the compensation and benets of the related members; and
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f) call a General Assembly of the shareholders whenever the company has not called one for 8 (eight)
days after this request has been made by these shareholders.
(iii) of the voting capital, has the right to:
g) call a General Assembly of the shareholders when the companys administrative team does not call
one for 8 (eight) days after a request for one has been made to install a Finance Board (art. 123,
item d).
(iv) of the non-voting or restricted voting shares, has the right to:
a) call a General Assembly of the shareholders when the companys administrative team does not call
one for 8 (eight) days after a request for one has been made to install a Surveillance Board (art.
123, item d) and
b) request a General Assembly and the installation of a Surveillance Board.
(v) any shareholder or group of shareholders with at least 10% of the companys voting capital has the
right to:
(a) request that the General Assembly install a Surveillance Board;
(b) elect, in a separate vote, one of the members of the Surveillance Board; and
(c) request the adoption of a multiple voting system in the election of members of the Board of Directors.
(vi) of the non-voting or restricted voting shares, has the right to:
a) in the publicly traded companies traded companies, elect and dismiss a member and his or her
substitute on the Board of Directors in a separate vote in the General Assembly.
2.3.2.9 Limited Companies
Even though the great majority of effort expended on the development of the Brazilian capital
markets and improved protection of minority shareholder rights considers investments made by publicly
traded companies, most businesses in Brazil adopt the form of a limited company.
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In this way, one can sense a certain lack of judicial instruments to protect minority shareholders in
limited companies (except the obligation of large scale limited companies to maintain their corporate
accounts in accordance with the terms required by Law 6404/76). On the other hand, almost all of the
relevant aspects of a company are covered in the companys articles of incorporation, which can only be
altered by shareholders representing at least 75% of the company shares, giving indirectly protection to
the minority shareholder which has at least 25% of the companys shares.
In addition, shareholders in the limited company can sign a Shareholder Agreement, to codify their
rights in the company, such as tag along, drag along, preference, minimum price, and administrative
rights as well as the right to resolve conicts by binding arbitration, among others. The lack of a legal
ruling in relation to Shareholder Agreements, however, raised questions about the enforceability of such
agreements, a topic which we will now address.
2.3.3 Enforceability of Minority Shareholder Rights
From the perspective of a PE/VC investor, a problem no less serious than the lack of minority shareholder
protection is their lack of force.
2.3.3.1 Shareholder Agreements
As mentioned above, keeping in mind the incipient protection offered by Brazilian legislation
to minority shareholders, even though it offers improvement with the reform of Law 6404/76, PE/
VC investors normally look to safeguard their rights to participation in the management of the
investee company and regulate the procedures for the sale of their shares (given that there is PE/
VC investment) through the signing of a Shareholder Agreement.
Even before the reform of Law 6404/76, it was clearly envisaged that Shareholder Agreements
stored at the companys headquarters should be respected by companies and that the onus of the
obligations stipulated in the Shareholder Agreement would be enforceable against third parties if
noted in the registry books and stock certificates, if issued. However, there were always discussions
about the possibility and the effects of the specific execution of Shareholder Agreements, notably in
the case of agreements about voting.
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Moreover, other discussions also existed in the sense that it only could be executed if a shareholder
who has signed a Shareholder Agreement appears at a General Assembly and votes against the provisions
in the Agreement or leaves it blank. If the shareholder simply didnt appear at the Assembly, there was
no way to ask for it to be enforced if the sentence didnt have the effect of bringing the shareholder to
the General Assembly.
With the aim of ending the above mentioned discussions and to give greater certainty that the rights
spelled out in Shareholder Agreements are enforceable and executable, if necessary, the reform
of Law 6404/76 introduced important alterations to the legal dispositions that cover Shareholder
Agreements.
In fact, with the new items 8 and 9 of Article 118 of the same law, it was determined that the
president of the General Assembly or the governing deliberating body of the company (notably
the Board of Directors) would not count a vote which was not in keeping with the Shareholder
Agreement stored in the company headquarters, and the non-appearance of a shareholder or
member of the Board of Directors at the General Assembly or administrative company meetings as
well as the abstention of said shareholder or board member, would give the injured shareholder the
right to vote with the shares of the abstaining or absent shareholder or board member.
Discussions persist, however, about the full validity of some common dispositions in Shareholder
Agreements, such as voting in blocks defined by previous shareholder meetings and the obligations
of company administrators to Shareholder Agreements.
2.3.3.2 Binding Arbitration
Finally, we should mention another attempt to confer greater enforceability to minority shareholder
rights through the efforts to include binding arbitration as a solution for shareholder conicts.
Law 9307/96 permits the development of binding arbitration in Brazil, guaranteeing the effectiveness
of binding clauses inserted in contracts in general, including Shareholder Agreements, and giving binding
arbitration rulings the same weight as judicial rulings. Besides this, Brazil is now part of the 1958 New
York Convention, which makes possible a ratication of foreign sentences in keeping with international
standards.
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Strengthening the legislative policy regarding binding arbitration, Item 3 of Article 109 of Law 6404/76
(extended by Law 10303/2001) states expressly that a companys bylaws can establish that disagreements
between shareholders and the company and between majority and minority shareholders can be settled
through binding arbitration, under the terms specied by the bylaws.
In the same sense, the Brazilian Stock Exchanges (BM&F Bovespas) New Market Regulation stimulates
listed companies to adopt binding arbitration as a way to diminish conicts between the company and its
shareholders or governing bodies by requiring that as one of the mandatory practices for a company to be
admitted to the Level 2 and New Market standards of corporate governance, said company must include
a binding clause in its bylaws
2.3.3.3 Bankruptcy Law
It should also be mentioned that Law 11101/05 has as one of its objectives the development of
entrepreneurial activity in Brazil, especially to substitute the old procedure of receivership with recovery,
looking to create a real and viable alternative for the resurrection of companies in a state of pre-insolvency.
This proposal itself has already improved the security of PE/VC investors, and has also created an opportunity
for new investment which could be attractive to PE/VC fund managers.
In fact, Law 11101/05 determines that one who acquires shares of a company that is in recovery
including afliates and operational units, among others, which can be segregated in a subsidiary of the
company in recovery, will not assume these goods with onus, given that Article 141 states that the assumer
will not inherit the obligations of the debtor, including tax, worker and workplace accident obligations.
2.3.3.4 Possibility of Judicial Developments in the Future
Based on concrete examples from the discussion of the exercising of minority shareholder rights in
Brazilian companies, we have identied a few ideas for alternative legislation that could be important in
strengthening the set of rights of minority shareholders:
(i) Admission of common shares of different classes in publicly traded companies. This mechanism
would let PE/VC vehicles subscribe to common shares of a special class in publicly traded companies
with special rights, even without this class having a majority of votes in the company;
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(ii) Admission of voting by plurality. With this type of voting it would be possible to create business structures
in which a shareholder could have greater voting rights than others independent of the quantity of
shares held.
(iii) Increasing the powers of the Securities Commission (CVM) in a way that it can intervene and prevent any
company actions that are prejudicial to minority shareholders or violate Shareholder Agreements or legal
dispositions. Currently the powers of the Securities Commission (CVM) are limited in terms of interfering in
shareholder matters; and
(iv) Explicit recognition in the Brazilian Civil Code of rights typically negotiated in PE/VC investments such as:
tag along and drag along rights, registration rights and forced sale/liquidation rights.
2.3.4 Self-Regulation and Best Practices in Equity Participation Funds (FIPs) and Emerging
Company Mutual Funds (FMIEEs) in Brazil
In December 2010, the Brazilian Private Equity and Venture Capital Association (ABVCAP) and the Brazilian
Financial and Capital Markets Association (ANBIMA) instituted the ABVCAP/ANBIMA Code Regulating Best
Practices in the Equity Participation Fund (FIP) and Emerging Company Mutual Fund (FMIEE) Market. This code
went into effect in March 2011 with the goal of developing and improving best practices in management and
the handling of information and is supervised by a Regulation Board, made up of members from ABVCAP
and ANBIMA.
The objective of the Regulation Board is to establish parameters which should orient the activities of PE/
VC fund managers related to the construction and functioning of Equity Participation Funds (FIPs), Emerging
Company Mutual Funds (FMIEEs), as well as Investment Funds with Shares of FIPs or FMIEEs, seeking
to: make the performance of their activities transparent, permit better measurement and analysis of the
development of the sector; promote standardization of practices and processes; promote its credibility and
proper functioning; maintain the highest standards of ethics and honor fair practices; elevate duciary
standards and promote market best practices; and make viable where appropriate, the Brazilian FIP/FMIEE
markets increased compatibility with and gradual integration into the international PE/VC market.
Besides this, the Board undertakes to: (i) acquaint itself and analyze reports sent by the Analysis Commission;
(ii) initiate, always with reason, investigations of any breaking of the rules that govern Equity Participation
Funds (FIPs) and Emerging Company Mutual Funds (FMIEEs); (iii) acquaint itself and judge, in a single
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instance, these investigations imposing appropriate penalties; (iv) publish deliberations; (v) emit opinions,
including in respect to the frequency and criteria of evaluations of FIP/FMIEE shares; (vi) edit summaries; (vii)
make decisions regarding the waiving of any procedure and/or demand listed in the related regulations; (viii)
request explanatory information and additional clarications in regard to pre-determined rules and principles
from Participating Institutions; (ix) institute supervisory mechanisms to be performed by the Supervision Area;
and (x) establish the value and form of nes for infringements of the regulations.
Adherence to these rules is mandatory for all Participating Institutions (active members of the Brazilian
Private Equity and Venture Capital Association ABVCAP and institutions afliated with the Brazilian Financial
and Capital Markets Association ANBIMA). Portfolio management and the distribution of shares of Equity
Participation Funds (FIPs) and Emerging Company Mutual Funds (FMIEEs) are subject to the regulation
imposed by the Board of Regulation.
In order for this regulation to occur in an effective fashion, the Information Area was developed, made
up of employees of the Brazilian Private Equity and Venture Capital Association (ABVCAP), with the objective
of maintaining a fund participant database. In addition, this area veries the integrity of the information
sent by Participating Institutions and informs the Supervisory Area whenever there are any indications of
infringements of the regulations.
The code also establishes a distinct classication of funds: Type 1 FIP/FMIEE funds foresee the installation
and functioning of an Investment Committee, with representatives nominated by fund shareholders; Type 2
FIP/FMIEE funds foresee in their regulations: (i) the installation and functioning of an Investment Committee,
composed only of members of the administration of the fund, if it is managed in an independent manner; and
(ii) the functioning of a Board of Supervision. Finally, Type 3 FIP/FMIEE funds do not foresee the installation
and functioning of an Investment Committee.
This is how this innovative proposal for self-regulation of Private Equity Funds (FIPs) and Emerging Company
Mutual Funds (FMIEEs) is structured, with the objective of improving and encouraging the best practices of
fund managers in this promising PE/VC market in Brazil.
2.3.5 Investment Vehicles
The activity of PE/VC fund managers consists of the management of one or more investment vehicles.
These vehicles are structured in various forms. As we have seen, the most common are limited partnerships,
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holding companies, funds governed by Security Commission (CVM) instructions, or divisions of non-nancial
companies.
Instituted in the United States by the Uniform Limited Partnership Act (ULPA) of 1916, a Limited Partnership
is one of the most common PE/VC vehicles in the United States. Other countries such as Canada and Chile
and some scal paradises such as the Cayman Islands, Panama and Bermuda also have legal provisions
for this type of structure. However, Brazil does not have legal provisions for this type of structure. One of the
principal advantages of limited partnerships is their exibility in terms of taxation. Capital gains are taxed
only when money is withdrawn, with each investor paying his or her share. In an LP, the manager is termed
the general partner and the investors are limited partners. In exchange for their distancing from the day to
day management of the vehicle and thus control over PE/VC activity, limited partners do not assume any
legal responsibility except for the money that they have invested. However, this does not prohibit one from
being a member of the advisory board of an LP. The general partner, on the other hand, assumes all the legal
responsibilities deriving from the management of the investment vehicle (limited partnership).
In a limited partnership, general partners in general cannot be dismissed because it would be a violation
of the terms of the companys formation. This aspect is fundamental to PE/VC considering the risk inherent
in PE/VC investments and the importance of managing it, the remuneration of managers necessarily will
be variable and will be tied to the performance of the investments (termed performance fee). The xed
component of this remuneration (termed the management fee) is smaller than the variable and normally
covers administrative costs. Since the nancial gains of this investment are realized only at the end of the
vehicles existence, the possibility of being relieved of its position puts the fund manager under unacceptable
risk (to work several years receiving very low remuneration only to be replaced before receiving its share of
the capital gains).
Up until 1994 in Brazil, holding companies were the most appropriate vehicles for PE/VC investments.
Under Brazilian legislation, holding companies can wield management powers, whether they be in the
selection of administrators or participation in the governance bodies (the board of directors, the nance board,
etc.) of controlled companies. Nevertheless, when they invest through a holding company, PE/VC investors
become shareholders and thus are subject to the laws and regulations that govern corporations. Thus, there
is no classic separation between the investor and the manager with a clearly duciary role. In terms of PE/VC
vehicles, holding companies present some deciencies that do not exist in limited partnerships, such as: 1)
taxes on realized capital gains are withheld by the holding company itself, signifying that every investor pays
the same rate as the company; 2) they do not have a limited duration; 3) they have difculty in getting tax
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credits; and 4) they can only receive investments from qualied foreign investors if they are publicly traded
companies, making them liable to all the maintenance costs of a publicly traded company.
2.3.6. FI-FGTS
The Investment fund of the Empoyee Severance Fund (FI-FGTS) is a collection of financial
resources constituted as an open-end fund, destined for infrastructure investments in th sectors of
construction, repairs, the extension and implementation of infrastructure projects in the highway,
port, waterway, railway, energy and sanitation sectors. It is managed by the Caixa Econmica
Federal, a government owned financial institution, under the Vice President of Third Party Resources.
The funds shareholders are the Employee Severance Fund (FGTS) and, when authorized by the
FGTS Board of Trustees, the Stock Investment Fund of the FI-FGTS.
The basic functioning of the fund is regulated by Securities Commission (CVM) Instruction 462.
This regulation is in its essence, distinct from Instruction 391. Both differ in the administration
and management of the fund, which in the case of Instruction 391 is undertaken by a legal entity
authorized by the Securities Commission (CVM). FI - FGTS investments are managed by a committee
composed of twelve members, six representing the company with consent of the companys Board
of Trustees and six representing bodies of the federal government.
The central distinguishing characteristic of the management of FI-FGTS investments (in shares,
debentures, subscription bonuses or investment amounts that can be converted into shares) is that
neither Securities Commission (CVM) Instruction 462 nor FI-FGTSs regulations require that the
manager of this fund (CEF) have participation in the decision making process in the companies or
undertakings in which it invests. The requirement of influencing the management and strategy of
portfolio investee companies is central to PE/VC vehicles constituted under Securities Commission
(CVM) Instruction 391. Because of this distinction, the FI-FGTS was not included in the Brazilian PE/
VC industry in this Census.
The initial capital of the fund totals R$ 5 billion. After this initial capital is applied, the Caixa
Econmica Federal can propose, to the Operating Agent of FGTS, additions of R$ 5 billion apiece,
until a limit of R$ 24.3 billion has been reached, equivalent to 80% of the net assets of FGTS. The
facts described above imply an important conclusion: FI-FGTS presents a very significant portion
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of investment generated by the government sector in Brazilian infrastructure, providing important
opportunities for co-investment with PE/VC vehicles generated by the private sector.
2.3.7. A Comparison of Brazil, the United States and Europe
Up until 2000, the United States had a higher prole than Europe in terms of the number of businesses,
money invested, fund managers, and returns on investment. Historically, the United States has had a very
innovative market and a large unied economy which has consistently favored high prole innovative
ventures. Other factors that favored the great evolution of the sector were: the liquidity and development
of the countrys capital markets which made possible important alternatives to PE/VC exits.
Since the end of the 1990s, Europe has begun to adopt a culture more conducive to the PE/VC industry.
Currently, when referring to the number of fund managers, the size of returns and the total volume of
business, Europe and the United States are quite close. The European regions ample growth has been
based on two main factors: greater acceptance and usage of the PE/VC model, with various fund
managers beginning operations in Continental Europe, and substantial debt nancing for megadeals.
One has to remember that investments vary considerably in the European region, with the United
Kingdom having a disproportionately large number of fund managers and deals completed.
Nevertheless, some interesting differences remain. Even though currently Europe makes a large number
of VC investments, there are signicantly more early stage investments in the United States. Besides this,
the United States has a larger and more active base of angel investors. European investments in VC tend
to be made by smaller companies and in the initial stages of production and development. As a result
of this consistent base of angel investors and portfolios with more focused initial investments, American
activities in VC investment continue to be signicantly more robust than in Europe. Also, the appetite for
and the acceptance of risk in initial investments on the part of pension funds and institutional investors is
signicantly greater in the United States. For PE investments, the largest and most traditional transactions
over the past ve years, the availability of debt nancing will have a great impact on business in both
regions.
Brazils active market, by comparison, is much more recent and has some characteristics in common
with the United States, some in common with Europe, as well as characteristics all its own. The country
has a strong entrepreneurial culture and, like Europe, an ample quantity of government funding and
programs. The almost complete lack of long term debt nancing provided by the banking sector, the
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presence of more rigid labor legislation, and a more gloomy legal climate in the scal, retirement and
labor areas makes business more challenging.
In any event, given the strong performance and growth of the Brazilian economy, it is quite probable
that the PE/VC industry will continue to show growth above the world average in the coming years. High
levels of liquidity in pension funds, the obtaining of an investment grade rating, and well regulated
capital markets combine to create a scenario in which the industrys growth will certainly be based on
stable co-existence between national and foreign investors and managers.
2.3.7.1. Brazil
In August 2003, the Securities Commission (CVM), given the lack of adequate PE/VC investment
vehicles up until 2003 in Brazil, introduced legislation creating entities which came close to limited
partnerships. Thus Instruction 391 instituted Equity Participation Funds (FIPs) in 2003, following the
institution of Emerging Company Mutual Funds (FMIEEs) created by Instruction 209 in 1994. These
private funds are jointly owned, and are structured expressly for investments in private companies.
Some of the deciencies of holding companies as PE/VC vehicles are not present in Equity Participation
Funds (FIPs) and Emerging Company Mutual Funds (FMIEEs).
For example: 1) they can receive investments from qualied foreign investors which are not public
companies; 2) these funds allow different levels of taxation for their shareholders: all gains from
the funds appear as capital gains and taxes are collected only at the moment that the investment is
exited and taxes are withheld proportionately according to the rates to which they are subject. If there
is reinvestment, taxes are automatically deferred; 3) have a limited duration; 4) are more agile for
receiving tax credits; 5) are easier to use to charge management fees and 6) the liquidation of nancial
investments is simpler. Their principal disadvantage is that they require transparent management
which is frequently undesirable; as in, for example the furnishing of information considered strategic
by the manager.
The management of Emerging Company Mutual Funds (FMIEEs) is performed by a person or
legal entity authorized by the Securities Commission (CVM). The administration and governance
of these funds is carried out according to the funds own rules, approved by a General Assembly
of shareholders where decisions are taken by a majority of votes with one vote granted per share.
The duration of an Emerging Company Mutual Fund (FMIEE) is limited to ten years, which can
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be extended once by ve more years. Unlike limited partnerships in the United States, shares in
Emerging Company Mutual Funds (FMIEEs) can be traded in the stock or over-the-counter markets
with approval from the Securities Commission (CVM). The number of investors is limited to 35. Each
investor should individually subscribe to values no less than R$ 400 thousand. Investment policy for
Emerging Company Mutual Funds (FMIEEs) is formally established by the corresponding regulation
and fullls several minimum requirements established by the Securities Commission (CVM) such as:
1) investments should be made in securities (stocks, debentures, subscription bonuses) issued by a
corporation; 2) investee companies should have annual revenues below R$ 100 million, should not
be part of an economic group with consolidated net assets above R$ 200 million and shouldnt have
partners or managers holding more than 10% of the companys capital.
The introduction of Equity Participation Funds (FIPs) was another important mark in the history of the
PE/VC industry in Brazil. In relation to Emerging Company Mutual Funds (FMIEEs), Equity Participation
Funds (FIPs): 1) remove the size limitation for investee companies (present for Emerging Company Mutual
Funds (FMIEEs), which can be publicly traded or private; 2) regulate the participation of managers/
administrators in the decision making process in investee companies; 3) adopt a fund governance
model composed of investment, technical and advisory committees; 4) regulate the decision making
processes of investments and divestitures; 5) require transparency of information for shareholders;
and 6) require that the accounting rules for the evaluation of investments and shares be established
in the regulations of the fund. The contractual freedom that exists between the parties (managers/
administrators and shareholders) and the automatic registration of Equity Participation Funds (FIPs)
with the Securities Commission (CVM) give unequaled exibility to PE/VC investment instruments
in Brazil. PE/VC fund managers can also institute investment vehicles under Securities Commission
(CVM) Instruction 409 from 2004. Among the different types of funds with standard designations in
Instruction 409 are stock funds and their use as PE/VC vehicles. These funds should maintain 67%
of their portfolio in traded securities in the stock or over-the-counter markets (especially appropriate
for PIPE and Mezzanine investments). Investment decisions follow policy directives emanating from
a General Assembly of shareholders, giving the manager the right to make security decisions in the
funds name. According to Instruction 409, these funds can be structured as public or private funds,
in the latter case it must be directed only by qualied investors with the additional requirement that
their shares be registered with the Securities Commission (CVM) before the distribution.
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2.3.7.2. United States
The American nancial market is based on common law and federal and local courts have ample
credibility. Federal laws create a general framework for relevant nancial activity in the nancial markets.
The pillars are: regulations for trading stocks, corporate governance, insurance, pension funds and general
regulations for banks.
It is impossible to nd a single form of capital investment. Investors in this industry can be: venture
capital funds, SBICs, corporate ventures, buyout funds, banks, or angel investors. Currently venture capital
funds make up 60% of the American PE market, and all the others total 40%.
In the United States, Limited Partnerships have a xed cycle of investment activity, with 10 years being
the most common, mainly because American regulations offer scal exemptions to companies that t this
prole. The Limited Partnership structure has two different levels of partners: General Partners and Limited
Partners. In a Limited Partnership, the manager is the GP, while the suppliers of capital are the LPs. The LPs
are fund investors that do not manage the company and their responsibility extends only to their investment.
In any event, the participation of LPs in the capitalization of the fund is usually around 99% of the total.
GPs as managers are completely responsible for the companys debts. Their investments correspond to
approximately 1% of capital committed to PE/VC funds. The great success of Limited Partnerships is based
on two factors: its simplicity and the fact that it is characterized by a very transparent system of taxation.
2.3.7.3. United Kingdom
The nancial market of the United Kingdom, like that of America, is ruled by common law and its federal
and local laws have great credibility. There are a large variety of legal regulations for capital investments and
there is no one single form of equity investment. Capital investors in the United Kingdom use the following
vehicles: venture capital funds, VCTs, commercial banks, angel investors, and targeted public institutions. VCTs,
or Venture Capital Trusts, are groups of investors who invest their own nancial resources. In the PE/VC market
in the United Kingdom, venture capital funds and VCTs constitute 50% of the total and all others represent the
remaining 50%.
2.4. The Taxation of Investors in Private Equity and Venture Capital Investments in
Investee Companies in Brazil
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2.4.1. Brazil
In a competitive international investment environment, it is obvious that structural aspects such as
economic stability and the availability of basic services (ex. electricity, logistics, transport), among
many others, are fundamental to an investors choice. There is no doubt, however, that favorable and
clear rules are also crucial in this choice. Thus, the modernization of legislation is indispensable for a
country like Brazil to stimulate investment.
In this sense, we cite the most recent revisions of the Law of Publicly Traded Companies such as Law
11638 in 2007 and Law 11941 in 2009, which require Brazilian accounting legislation to converge
with International Financial Reporting Standards (IFRS).
Our scope, however, concerns taxation legislation. In this eld, we can cite the recent Law 12249
of 2010, which brought the rules of thin capitalization to Brazil, which look to avoid excessive levels
of debt in associated companies.
In terms of PE/VC capital investments, specic investment vehicles, such as Equity Participation
Funds (FIPs), are already regulated by the Securities Commission (CVM) and Brazilian tax legislation.
The specic taxation of non-residents in nancial investments (especially stock market operations)
should also be noted, but in general PE/VC investment is subject to the general tax rules that apply to
individuals and legal entities.
Next we will analyze three distinct moments in the investment process: (i) capitalization and the
resulting taxation, (ii) the maturation and taxation of an investee company during this period, and (iii)
the exit and taxation of capital gains for residents and non-residents
2.4.1.1. Capitalization
The current topic covers two forms of business capitalization, i.e. debt investment or thin capitalization,
and share investment or gross capitalization.
The choice between these two forms of investment will be made based on, among other factors,
the relationship between the return sought and the risk to be undertaken. Thus the table below
summarizes the options in terms of risk.
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Table 2.4 Investment Type and Assumed Risk
Investment Type Assumed Risk
Debt: debentures, loans with options to buy shares. Low Level
Equity: preferential stock, without participation in the direct management of the
company
Medium Level
Equity: investment in common shares with participation in the management of the
company.
High Level
Source: The authors
We refer to this aspect of investment, even before treating scal issues, because it seems fundamental
to us to analyze a problem which has aficted PE/VC investors in Brazil, in other words the responsibility
of administrators and partners for unfullled investee company obligations.
This theme, which is so vast and important, deserves careful study itself. Thus, we do not intend to make
an exhaustive analysis of this subject here. We are broaching this subject just to alert the reader that this
is a vital issue.
a) The Responsibility of Partners
The possibility of holding administrators and partners responsible for unfullled company obligations
was limited until the 1990s. Today, however, there are a growing number of legal actions in which any
individual with decision making power is considered jointly responsible for damage caused to the company.
Furthermore, there are more and more areas entering into this consideration such as taxation, labor
legislation, consumption, and the environment, etc.
It is true that for a long time the National Taxation Code and labor legislation have allowed such a
holding of personal responsibility of partners, the so-called ignoring of legal entities, in certain situations.
In any event, since the passage of the new Civil Code in 2003, as well as the Consumer Code and
environmental legislation, the number of such actions, as well as imprecise and rushed decisions, has
grown at a dizzying rate.
In any case, the legal rationale in these situations is to hold a partner responsible who acts intentionally
in an improper manner, and not simply arbitrarily attribute to him or her a company debt. Happily, even
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though the lower courts commit abuses in the application of the law, the Supreme Court (ERESP 260107 /
RS ) in judging the question of a companys tax debts, decided that Simple default is not a legal infraction.
Without proof that the partner has exceeded his or her powers, or has committed an infraction against the
companys rules of incorporation or bylaws, one cannot speak of responsibility for taxation.
With the decision of the Supreme Court, the conclusion is inevitable that a partner must commit an
infraction for he or she to be held responsible for a company nancial default. In any event, the reader
should be aware that this law has been applied in many cases thoughtlessly, which, without a doubt,
inhibits investors.
b) Taxing of Remuneration from Debt and Equity Investments
It is evident that remuneration resulting from the above cited forms of investment only occurs when the
investment matures, which will be covered in the next topic. However, we think it more instructive to discuss
the differences in taxation now in comparing thin and gross capitalization.
The remuneration of debt instruments, or in other words, interest, has an advantage in that it can be
deducted from a companys tax bill. When the payment is made, 15% income tax should be withheld,
whether the beneciary is a Brazilian resident or not.
In the case of payment of interest to a non-resident, however, there is a limit to the deduction equivalent
to the LIBOR rate plus an annual rate of 3% (proportionate to the time frame that the interest covers). In
this situation, the law itself establishes a market rate, and the rules of transfer prices do not apply.
In terms of an equity investment, we will consider rst a typically Brazilian creation: interest earned
on equity capital (JCP). A byproduct of the alternative form of remuneration for partners through capital
participation as created by Law 9249/95, JCP is calculated based on the application of the Long Term
Interest Rate (TJLP), pre-xed by the government (currently 6% annually) on the net assets of the paying
company.
For purposes of taxation, JCP is the same as interest, and for this reason is deductible for those who pay
it, as well as being subject to 15% withholding. This represents a considerable advantage compared to
dividends, which even though they are not subject to withholding, are not deductable from a companys
tax bill.
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As we will see later, corporate taxation is made up of the Corporate Income Tax - IRPJ (15%), with an
additional 10% for the portion of the prot that exceeds R$ 240,000 per year, as well as the Business
Contribution on Net Income CSLL (9%). With the JCP deduction, this money no longer pertains to the
companys income, taxable at 34%, and is withheld instead at a 15% rate, or in other words, roughly 19%
less tax than in the case of dividends.
However, here lies the problem with the JCP; the values paid are subject to Contributions to the Financing
of Social Security (COFINS) and the Program of Social Integration (PIS). Contributions need to be made
to both, in principal, by legal entities subject to the cumulative system by the older Law 9718/1998 and
to those subject to the non-cumulative system under Laws 10637/2002 and 10833/2003, even though in
both cases the tax is paid based on the total revenues of the company.
It is worth remembering that in respect to the latter case, two subsequent decrees after Laws 10637 and
10833 reduced the rate of COFINS and PIS to 0% on nancial transactions in general but with the express
exception of the JCP. In relation to the former case, it is important to mention that the Supreme Court has
judged unconstitutional the increase of the base for the calculation of contributions stipulated by Law 9718
and later in Law 11941 this increase was revoked. Thus, a company subject to the old cumulative regime
can treat COFINS and PIS in their original format, or in other words, as applying to revenues but excluding
nancial revenues and among them the JCP.
In this way, companies subject to the old regime (for example those opting for the at tax on sales) should
not, in principal, have to pay COFINS and PIS taxes. In the case of the current regime, the non-cumulative
one, 9.65% is the percentage to be taken into account in choosing the best form of remunerating partners.
Obviously, this preoccupation does not apply to non-residents.
In regard to COFINS and PIS, the Brazilian legislature deserves praise; if well utilized it can be an
extremely efcient tax planning instrument for residents and especially non-residents. No less praiseworthy
is the taxing regime for dividends in Brazil. In accordance with the Brazilian system, the company and
partners are considered in an integrated fashion, so that the revenues are considered one, and thus
should be taxed only once.
Thus, the investment income of a company is taxed once in the ways cited above, at 34%, and is not
withheld or counted as part of the base of calculation for individual or company taxes. Dividends also are
not subject to COFINS and PIS.
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Chapter 2
c) Limits to Thin Capitalization
Law 12249/2010 established rules which limit the deductibility of interest paid to non-residents (i) in
terms of individual investors under Brazilian price transfer legislation (Article 24), or (ii) when the payment
or credit is realized with the recipient residing in a country or dependency which is deemed to be a scal
paradise or a privileged scal regime (Article 25).
The limit of Article 24 of Law 12249/2010 refers to two types of relationships. For associated individuals
or legal entities with capital participation, the debt to each creditor cannot exceed more than twice the
participation of this creditor in the companys net assets (individual limit). Besides this, the sum of debts to
creditors, with or without participation, cannot exceed twice the sum of their participation in the net assets
of the debtor (global limit).
For associated individuals or legal entities without capital participation, the debt to each creditor cannot
exceed more than twice the value of the net assets of the debtor (individual limit). If all the debt has been
contracted with this type of creditor, the sum of all the debt with this type of creditor cannot exceed more
than twice the value of the net assets of the debtor (global limit).
In relation to the limit of Article 25 of Law 12249/2010, it only applies to people who are residents of
scal paradises or privileged scal regimes. According to this rule, the sum of all debts to these types
of investor cannot be more than 30% of the net assets of the debtor residing in Brazil.
In both cases (Articles 24 and 25 of Law 12249/2010), the interest paid which exceeds the above
mentioned limits will be considered non-deductible expenses, whether or not the contracts of these loans
are registered with the Brazilian Central Bank. This treatment also applies whether the associated foreign
company is acting as a bondsman, a guarantor, a procurator or an intervenor.
2.4.1.2 Maturation of the Investment
Before beginning, we will repeat that corporate taxation in Brazil is composed of the Corporate Income
Tax - IRPJ (15%), with an additional 10% for the portion that exceeds R$ 240,000 per year, as well as the
Business Contribution on Net Income CSLL (9%). In practice, we can assume a total tax rate of 34%.
106
This rate is applicable independent of which calculation method is used, which in Brazil can be: net
income tax, assumed income, or an arbitrated tax. Below we will cover the rst two regimes leaving the
last one out of our scope because it is a rare occurrence.
a) Net Income Tax
The Net Income Tax is the traditional regime of measuring income for tax purposes, and looks at the
effective income of a business. In accordance with this regime, a company should calculate its taxes
based on net income, adjusted for additions and deductions permitted by tax legislation, respecting the
normal rules of accounting. The same norms apply to the application of the CSLL with specic exceptions
permitted by law.
To determine the tax due, a few norms should be highlighted: (i) the examination of revenues and
expenses should follow the appropriate regime; (ii) only usual and necessary expenses can be deducted;
and (iii) it is mandatory to register the revenues of controlled companies or afliates in accordance with
the equivalent asset method.
It should be emphasized that Law 11638/2007, when introduced, sought to bring Brazil closer into line
with international standards, oriented by the predominance of essence over form. This new orientation
diverges from traditional Brazilian accounting which interprets the assets of a company as a group of goods
and rights rather than a group of economic relations. Annual reports also were constantly inuenced by
the tax norms which determined directly what form of accounting was used to treat a determined element
of interest.
Given that the Brazilian model of taxation derives its measurement of taxable income from annual
reports listing net income, it was known that any alteration of the accounting laws that altered the overall
paradigm used would affect taxation, an end which was not intended by the law makers.
Seeking to resolve this issue, originally Law 11638/2007 included Item 7 of Article 177 of the Law of
Corporations, which ruled generically that accounting entries made to harmonize the old accounting norms
with the current ones would not be used for taxation. This item was later revoked by Law 11941/2009,
which introduced the Transition Tax Regime (RTT) in Articles 15 to 24.
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Chapter 2
The Transition Tax Regime (RTT) is nothing more than a tax regime in which accounting presented
in the new form reverts to the old form (as it existed on December 31, 2007) for purposes of taxation. It
should be emphasized that choosing the RTT signies adopting these accounting patterns whether they
lead to greater or lesser withholding. It is not possible to choose an intermediary position between the old
and the new regime, depending on which is more convenient to the taxpayer
b) Assumed Taxable Income
The Assumed Taxable Income is an alternative form of assessing IRPJ and CSLL which assumes a certain prot
margin, and thus assesses a xed tax rate based on assumed income depending on the type of activity and ignores
real expenses.
For commercial sales a value of 8% is used to arrive at this assumed income for IRPJ and a value of 12% is used
for CSLL. For services in general a value of 32% is used for both types of taxes. Here is an example for a company
with monthly revenues of R$ 1 million:
Table 2.5. Sales of Goods vs. Services
Sales of Goods Services
Revenues R$ 1,000,000.00 R$ 1,000,000.00
Percentage (%) 8.00* (%) 32.00
Assumed Taxable Income R$ 80,000.00 R$ 320,000.00
IRPJ and CSLL (34%) R$ 27,200.00 R$ 108,800.00
Effective Rate as % of Revenues (%) 2.72 (%) 10.88
Source: The authors
Using the Assumed Income Tax option makes sense for a company with sufciently high protability. It
should be emphasized, however, that the company choosing this option is also required to pay an extra
3.65% on revenues for COFINS and PIS, without any possibility of an offsetting credit.
The Assumed Income Tax regime, however, is not available to all companies. Besides limitations in
terms of sectors where it is allowed, there is a limitation in the origin of its revenue which cannot be
from direct investments in non-resident companies, and its annual gross revenues cannot exceed R$ 48
million.
Despite this, once again we can emphasize the effort that legislators have made to augment the
options available to investors. According to the original version of Law 8541 of 1992, there were a
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much larger number of limitations with provisions prohibiting the use of this option by publicly traded
companies, companies with non-resident partners, or afliates, branches, representatives or agencies
of companies with foreign headquarters.
2.4.1.3 Exits
In this nal phase of investment, it is important to know how capital gains are taxed in Brazil. This
taxation can vary depending on three factors, which are: (i) the residence of the investor (whether it is
a resident or non-resident); (ii) the kind of investor (individual, legal entity, or fund); and (iii) where the
investment takes place (within the stock market or outside of it).
a) Taxation of Residents: Legal Entities
Legal entities located in Brazil do not have capital gains withheld when they exit their investments. The
gains will be the difference between the sale price and the cost according to the equivalent asset method
(MEP), and should be part of the base of the calculation of the IRPJ and CSLL due for the corresponding
period, and will be taxed at 34%.
When the exit occurs in the stock market, a legal entity can anticipate part of the tax to be paid (34%),
by having 15% of monthly gains withheld. Eventual losses are compensated for by gains in subsequent
periods. Besides this, there is a retention of 0.005% on the gains in every operation, compensated for in
the tax that is paid at the end of each month.
b) Taxation of Residents: Individuals
Capital gains in the exit of a PE/VC investment for individuals are not part of the base of the calculation
of taxes. They are subject only to 15% withholding for private transactions and the monthly capital gains
are subject to this percentage when a stock market transaction is involved. In this case as above, a further
0.005% of these gains are retained.
c) Taxation of Residents: Equity Participation Funds (FIPs), Investment Funds in Shares of FIPs
(FIC-FIPs) and Emerging Company Mutual Funds (FMIEEs)
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Chapter 2
PE/VC operations through private investment funds such as Equity Participation Funds (FIPs) have the great
advantage of deferring taxation on capital gains. This is because these funds are exempt for gains obtained
from exiting stocks or other securities convertible or permutable into stock.
Thus, taxation is limited to 15% withholding when the exiting takes place. This fact makes it clear that
Equity Participation Funds (FIPs) and Investment Funds with Shares of FIPs (FIC-FIPs) and Emerging Company
Mutual Funds (FMIEEs) are subject to specic taxation treatment, envisioned for private investment funds.
These funds, however, should have portfolios composed of 67% or more of publicly traded stock, and
if this is not the case, there is regressive taxation on shareholder gains on xed income investments (15%
to 22.5% withholding).
d) Taxation of Non-Residents
The type of investor has no bearing on the taxation of non-resident investors. Individuals, legal entities,
collective investment entities, such as investment funds and pension funds (except governmental ones),
foundations and trusts are all treated alike. Differences, however, can exist because of the business
environment (within the stock market or outside of it).
e) Taxation of Non-Residents: Direct Investments (outside the stock market)
Up until 1975 there was no taxation of capital gains for direct investments made by non-residents. From
that year on, however, with the issuing of Decree/Law 1401, these gains began to be taxed at 25%. This
taxation lasted until the issuing of Law 9249/95, when the rate was reduced to 15%.
There is still today a controversy about the extension of the change introduced by Law 9249/95. To
some, this law did not revoke Decree/Law 1401, which treats capital gains in foreign currency, but only
Law 7713/88, which alludes to gains from the selling of goods and rights. To us, however, the revocation
extends to both, making the rate in all cases 15%. For residents of jurisdictions which are considered scal
paradises a 25% rate applies.
f) Taxation of Non-Residents: Market Investments (within the stock market)
There are two distinct taxation regimes that apply to market investments made by non-residents: General
and Special. The General Regime applies to those who are deemed disqualied investors, which includes those
110
residing in scal paradises, and the rules that apply are the same as those for resident individuals. Thus their
gains are subject to 15% withholding.
Qualied investors, as dened by Resolution 2689 of the National Monetary Board (CMN), are treated
under the Special Regime. For these investors, taxes are signicantly lower. See the table below:
Table 2.6. Operational details
Operation/Event Rate
Net gains in stock market operations, the sale of goods, futures and similar items with the exception of
xed income operations. FIP/FIC-FIP/FMIEE and publicly traded securities.
Exempt
Applications in stock funds, swap operations and operations realized in liquidation markets outside the
stock market
10%
Fixed Income and Other Earnings 15%
Source: The authors
It is important to also mention that according to the law, this also covers entities whose rules of
incorporation are analogous to the referred stock markets and also function under the supervision
and surveillance of the Securities Exchange Commission (CVM). In short, the over-the-counter
market.
Thus, it is curious to note that the regime in terms of stockholder remuneration dividends and
interest on capital assets doesnt differ in relation to the stocks negotiated in the stock market,
however, the principal difference is in the taxation of capital gains for non-residents. While in the
case of minority and stock market shares, it is possible to utilize the tax exemption (if the foreigner
is registered as a market investor with the Central Bank and the CVM), in the case of permanent
business shares, there is no exemption for capital gains.
We can thus note a somewhat questionable preference for temporary investments (in many cases
mere speculation) to the detriment of permanent or long term investments such as PE/VC investments.
We imagine that, given the benefits derived from PE/VC (e.g. technological development and job
creation, among many others) in most cases more profound that those of capital market investments,
there is no reason for such discrimination.
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Chapter 2
The creation and development of most country taxation systems occurred when international
commerce was limited and largely controlled and large movements of capital were almost inexistent.
In this scenario, domestic taxation policies could be formulated without significant preoccupation in
relation to the effects of other countries, and the taxation policies of other countries were of minimal
importance to the decisions taken by governments.
The internationalization of the world economy thus has implied an exponential increase in the
benefits that come from the progressive integration of international economies. The growth in the
economic interrelationship of countries complicates the international competition between them,
and all of them in any event seek to attract international investment.
One of the most visible and significant consequences of the opening of domestic economies is
the need for the state to adopt a taxation policy oriented to the internationalization of domestic
companies and the attraction of foreign investment.
This opening, even though it was significantly delayed, began to appear in Brazil in the beginning
of the 1960s, increasing significantly with the resumption of democracy and the ratification of the
Federal Constitution in 1988. However, some factors that still afflict this internationalization such
as political turbulence, the intricate bureaucracy, infrastructure problems, the high cost of credit,
the poor distribution of income and the low level of savings occupy a central role in the regulation
and taxation of Brazilian markets.
As a result, from the need of developing countries for financial resources to make growth possible
comes the demand for domestic financial markets which will diminish capital flight to the exterior
and allow the private sector to reduce its dependence on loans as the principal source of financing.
Hence the need for the constant evolution of tax legislation, and especially that which stimulates
long term PE/VC investment, the object of this study.
Weve seen over this exposition that there is still much to be done to make this an attractive
taxation system. On the other hand, we must recognize that, despite the slow rate of progress
which can to some extent be criticized, effort has been made, showing at least that the Brazilian
government is committed to the goal of reforming legislation and facilitating investment.
112
2.4.2. France
Even though the standard corporate income tax rate is 33%, and an extra 3.3% surcharge is paid by
some companies, SMEs and new companies have some benets. The principles of scal exemptions are
applied to some companies, and in case these dont apply, dividends and capital gains are subject to taxes
and surtaxes. The scal exemption applies to participation of less than 5% of total equity. There are more
consistent scal incentives in the research and development sectors.
2.4.3. Italy
For corporations, standard taxation is 31.4% which represents the sum of the IRES (27.5%) and IRAP
(3.9%). In any event, some local authorities can increase the total value with a spread. In Italy, scal
exemptions are applied to companies, so dividends are 95% exempt, except when the subsidiary distributor
of dividends is directly or indirectly a citizen of a country on the Italian black list (countries with scal
exemptions). There are various incentive programs for companies in Italy, but there are some prerequisites
in reference to size, location and type of business. In Italy, there is no tax on net income but the tax system
is progressive and can reach as high as 47.5%.
2.4.4. Germany
German corporate taxes are based on rates from 30 to 33%, including a surtax of approximately 5.5%.
The system of scal exemptions allows the exclusion of 95% of dividends and capital gains for companies
based in Germany. Many support programs are available for German companies, and in case of losses,
the scal system offers advantages.
Chapter 3
The Private Equity and Venture Capital Cycle
Fundraising, Committed Capital and the Origin of Fund
Managers
115
Chapter 3
The Private Equity and Venture Capital Cycle Fundraising,
Committed Capital and the Origin of Fund Managers
1
3.1. Introduction
Once a fund manager is incorporated, its long PE/VC cycle begins. This cycle is composed of four principal
stages, as illustrated in Figure 3.1: (i) fundraising, (ii) deal ow screening, (iii) investment and (iv) exit from
investments made. The experience of this process creates a fth stage in the cycle which is the formation of a
track record, resulting from the success obtained in each of the previous stages, and which enables the fund
manager to begin again, in the case of success, this whole dynamic cycle (Gompers and Lerner, 2002).
Figure 3.1. Dynamics of the PE/VC Activity
Fundraising
Deal origination
Exiting Investing
Track Record
Source: Adapted by the authors from Gompers and Lerner (2002)
There are various factors that determine the success of a PE/VC industry participant. Among them
investment agreements with investee companies (contractual negotiations) are considered the most relevant
according to the fund managers that responded. The monitoring of companies and the exit model are
considered equally important to success by fund managers. With the recent heating up of the economy,
many companies are avid for fund manager investment, which has naturally led to a greater relative
importance being placed on the structuring of deal ow.
1 Authors: Henrique DAmico, Caio Ramalho and Rodrigo Lara
116
The main issue in contractual negotiations is frequently price, which tends to be high, and frequently the sizeable
difference between the expectations of the buyer and the seller shoots down deals. It can also be control, given that
the fund manager whether it is seeking majority or minority participation seeks very clear rules for its exit which can
be very uncomfortable for the entrepreneur and can in the same manner sabotage deals. In any event these are
just hypotheses that have arisen from our qualitative interviews, because it is impossible to distinguish statistically
between the 5 factors presented in Table 3.1 below.
Table 3.1. Principal Factors for Success in PE/VC Activities
This table describes the principal factors that fund managers consider most relevant to success in the PE/VC cycle. Sample: 87 Fund managers
representing US$21.7 billion of committed capital (60% of total) Note: Contract Negotiations refer to Investment Agreements between Fund Managers
and Investee Companies (Investment Agreements)
Factors Points Attributed Percentage
Investment Strategy 217 16.4%
Deal Flow Structure 240 18.1%
Monitoring 281 21.2%
Exit Strategy 281 21.2%
Contractual Negotiations 307 23.1%
Total 1,326 100%
Table 3.2 and Graph 3.1 below highlight the obstacles to the fundraising process due to macroeconomic
factors. The high level of taxation is considered to be an obstacle to PE/VC activity by 90% of fund managers
in Brazil. In Brazil the average tax rate for a corporation is 34% of their earnings before taxes. The other
obstacles in decreasing order are high interest rates on nancing, restrictions imposed by labor legislation
and the informal market, cited by 85%, 70% and 69% of fund managers respectively. The macroeconomic
environment has ceased to be an obstacle according to 58% of fund managers, but 29% still consider it
to be an obstacle.
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Chapter 3
Table 3.2 Macroeconomic factors as obstacles to success
Degree of relevance, by percentage, of each macroeconomic obstacle for PE/VC fundraising and investment. Responses provided by 84 fund
managers (58% of total) representing US$ 20.6 billion of committed capital (57% of total).
Obstacles Agree Indifferent Disagree Total
Total for Macroeconomic Factors 62% 18% 20% 100%
High Level of Taxation 90% 6% 5%
100%
(*)
High Interest Rates on Financing 85% 9% 6% 100%
Restrictions imposed by worker legis-
lation
70% 20% 10% 100%
Informal Market 69% 15% 15%
100%
(*)
Development of the capital markets
and the viability of exits
58% 18% 24% 100%
Availability of debt for the purchase
of companies (leverage)
58% 21% 20%
100%
(*)
Inadequate Infrastructure 56% 16% 27%
100%
(*)
Unfavorable exchange rates 41% 41% 19%
100%
(*)
Macroeconomic Environment 29% 13% 58% 100%
(*) Difference appear due to rounding
Corruption is a phenomenon which affects political stability and socioeconomic development,
being responsible for an estimated loss of 1.4% to 2.3% of national GDP (FIESP 2009). Sectors such
as infrastructure, education and health could receive this capital, public or private, and thus present
considerable evolution. Over the last few years despite some scandals involving political leaders and
representatives, the Brazilian political environment has been good and has given the economy more
predictability, facilitating the entrance of foreign capital. It should be noted that social factors do not
appear to be important obstacles, even though they are strongly linked to political and macroeconomic
obstacles as we can see from Tables 3.3 and 3.4 below.
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Table 3.3 Obstacles due to social factors
Degree of relevance, by percentage of each social obstacle for PE/VC fundraising and investment. Responses provided by 84 fund managers (58%
of total) representing US$ 20.6 billion of committed capital (57% of total).
Total for Social
Factors
27% 34% 39% 100%
Social Environment 30% 25% 45% 100%
Cime 23% 44% 33% 100%
Table 3.4 Obstacles due to political factors
Degree of relevance, by percentage of each political obstacle for PE/VC fundraising and investment. Responses provided by 84 fund managers (58%
of total) representing US$ 20.6 billion of committed capital (57% of total).
Total for Political Factors 52% 23% 24% 100%(*)
Corruption 66% 19% 15% 100%
Instability of Public Policy 53% 28% 19% 100%
Political Environment 38% 23% 39% 100%
Table 3.5.1 analyzes obstacles due to the countrys legal and institutional framework where barriers
appear in the form of (i) bureaucracy, (ii) the quality of the legal system and (iii) the quality of
corporate governance in investee companies. These were selected as the most relevant of those
factors receiving respectively 76%, 73% and 57% of fund manager votes. It is interesting to note that
in several factors Brazil has done its homework correctly, because the barriers which are relatively
minor in their perception are (i) the cost of registering and maintaining an investment vehicle, (ii) the
quality of local accounting, and (iii) the security of minority shareholders, which are listed below as
the weakest obstacles to the PE/VC industry.
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Chapter 3
Table 3.5.1 Obstacles due to the legal-institutional framework (PE - Private Equity
Organizations)
Degree of relevance, by percentage of obstacles due to the legal-institutional framework for PE/VC fundraising and investment. Responses provided
by 84 fund managers (58% of total) representing US$ 20.6 billion of committed capital (57% of total).
Legal-Institutional Framework 58% 22% 20% 100%
Bureaucracy 76% 17% 7% 100%
Quality of the legal system 73% 18% 10% 100% (*)
Quality of corporate governance in investee companies 57% 24% 19% 100%
Limits on the enforceability of contracts 57% 31% 12% 100%
Perception of business value by the entrepreneur 54% 25% 21% 100%
Bankruptcy and receivership procedures/ Rights of creditors/ Respon-
sibility of managers
52% 30% 18% 100%
Difculties in recruitment of professionals for investee companies 49% 20% 31% 100%
Difculties in recruitment of professionals for fund managers 44% 22% 34% 100%
Quality of industry statistics 43% 33% 24% 100%
Willingness of entrepreneur to take on partners 43% 26% 31% 100%
Quality of potential deals received by fund managers 39% 28% 33% 100%
Cost of registering and maintaining investment vehicles 38% 36% 26% 100%
Quality of entrepreneur 38% 13% 49% 100%
Restrictions on individual investors 37% 34% 29% 100%
Difculties of investors (LPs) in the management and monitoring of this
class of securities
37% 34% 29% 100%
Regulation of the creation and operation of PE/VC vehicles 34% 35% 31% 100%
Quality of local accounting (adjusting to international standards) 34% 36% 30% 100%
Fiscal treatment of PE/VC investment vehicles 33% 34% 33% 100%
Protection of intellectual property rights 30% 44% 26% 100%
Protection of minority shareholder rights 22% 34% 44% 100%
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Table 3.5.2 Obstacles Due to the Legal-Institutional Framework (VC - Venture Capital
Organizations)
Degree of relevance, by percentage of obstacles due to the legal-institutional framework for venture capital fundraising and investment. Responses
provided by 12 fund managers which make investments exclusively in venture capital. Fund managers that make both PE and VC Investments were
not considered.
Legal-Institutional Framework 46% 31% 23% 100%
Difculty in recruiting professionals for investee companies 67% 17% 17% 100%(*)
Quality of corporate governance in investee companies 67% 17% 17% 100%(*)
Limits on the enforceability of contracts 64% 27% 9% 100%
Bureaucracy 58% 42% 0% 100%
Cost of registering and maintaining investment vehicles 58% 33% 8% 100%(*)
Difculty in recruiting professionals for the fund manager 58% 25% 17% 100%
Quality of the entrepreneur 58% 8% 33% 100%(*)
Quality of the legal system 58% 25% 17% 100%
Quality of prospective deals received by Fund Managers 58% 8% 33% 100%(*)
Perception of business value by entrepreneur 50% 17% 33% 100%
Fiscal treatment of PE/VC investment vehicles 50% 33% 17% 100%
Difculties of investors (LPs) in the management and monitoring of
classes of securities
33% 33% 33% 100%(*)
Willingness of the entrepreneur to take on partners 33% 17% 50% 100%
Protection of intellectual property rights 33% 33% 33% 100%(*)
Protection of the rights of minority shareholders 25% 50% 25% 100%
Regulation of the creation and operation of PE/VC vehicles 25% 58% 17% 100%
Restriction on individual investors 25% 50% 25% 100%
Quality of local accounting (adjusting to international standards) 17% 42% 42% 100%(*)
Table 3.5.2 above analyzes obstacles due to the legal-institutional framework for fund managers that
invest exclusively in venture capital. The barriers presented by (i) difculties in recruiting professionals
for investee companies, (ii) the quality of corporate governance in investee companies, and (iii) limits to
the enforceability of contracts were deemed the most relevant receiving 67%, 67% and 64% of the votes
respectively from the fund managers that responded. Intellectual property rights were considered slightly
more important by this group than by the PE fund managers with a value of 33% for VC fund managers
and 30% for PE/VC fund managers. This fact demonstrates that venture capital investors do not have a
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Chapter 3
great deal of preoccupation about this factor suggesting that they maximize their efforts on the constitution
and development of new business.
In sum, analyzing the obstacles to development which have been classied as linked to the structure of
the industry, the ones that stand out are (i) the perception of business value by the entrepreneur; (ii) the
difculty in recruiting professionals for investee companies; (iii) the difculty in recruiting professionals for
fund managers; (iv) the quality of industry statistics and (v) the willingness of the entrepreneur to take on
partners.
Since the private equity cycle is interconnected, the difference in the perception of business value between
a fund manager and an investee company presents a barrier to the closing of a transaction, at least within
the time frame agreed to by investors and fund managers for the creation of, investment in and exit from
the vehicle. And the negotiating talents of the fund manager are not enough. Entrepreneurs who look for
this type of capital for their businesses need to have a certain maturity to understand what each one is
bringing to the table in terms of business value. In the same way, fund managers need to evolve to count
on managers with operational and not just nancial experience, in order to adequately evaluate the merits
and value of each investee company and identify the factors that will leverage business value.
The difculties in terms of recruiting professionals for fund managers and investee companies is a
result of the accelerated economic growth that exists in Brazil today without the presence of a structured
education system strong enough to supply enough professionals to meet demand. This lack of supply is
more acute in more remote and less developed regions of Brazil where the professionals present have
frequently moved there from large economic centers.
It should be emphasized that there is still insufcient quality in terms of industry statistics and that along
with the high valuations attributed by entrepreneurs in regard to their businesses still present obstacles that
need to be overcome. The willingness of entrepreneurs to take on partners is especially relevant to venture
capital investments. In interviews we saw that this lack of willingness was not only in relation to whether or
not to take on a partner, but part of a lack of perspective in all the issues related to the business especially in
terms of what was the scope and the value of each partners activity. This frequently ends up being a subjective
discussion where there is no general agreement on the part of the partners in terms of the value of each one,
what each will bring to the table and what each will get in return. In general the participation of the partners
will necessarily be different and this requires a great degree of maturity on their part to handle this well. In sum,
122
almost 40% of those interviewed listed the qualities of entrepreneurs and the prospective deals offered to fund
managers as relevant obstacles to the development of the industry.
Table 3.6 Obstacles Due to the Structure of the PE/VC Industry
Degree of relevance, by percentage, of each obstacle caused by the structure of the PE/VC industry for PE/VC fundraising and investment. Responses
provided by 84 fund managers (58% of total) representing US$ 20.6 billion of committed capital (57% of total).
Total for Factors Related to the Structure of the PE/VC Industry 43% 25% 32% 100%
Perception of business value on the part of the entrepreneur 54% 25% 21% 100%
Difficulties in recruiting professionals for investee companies 49% 20% 31% 100%
Difficulties in recruiting professionals for fund managers 44% 22% 34% 100%
Willingness of the entrepreneur to take on partners 43% 26% 31% 100%
Quality of potential deals received by fund managers 39% 28% 33% 100%
Quality of the entrepreneur 38% 13% 49% 100%
Difficulties of investors (LPs) in the management and monitoring of
securities
37% 34% 29% 100%
In aggregate terms, microeconomic factors present the greatest barriers for the industry. In fact, now
that Brazil has achieved macroeconomic maturity conrmed by its recent receipt of an investment grade
rating, the great remaining challenges are microeconomic such as removing obstacles to company growth
and educating people capable of lling positions in these companies.
Brazil is following an evolutionary path where creating prosperity shouldnt just depend on the
government for economic development through public policies and incentives, but should become a
collaborative process based on a collaboration by government, companies, and academic and research
institutions. This is the classic process of forming and developing clusters that is carried out specically in the
123
Chapter 3
microeconomic environment (Porter, 1980). Clusters offer a platform which enables industry participants
to remove specic obstacles rather than the generic ones to which all companies are exposed. Through
this microeconomic sector reform companies achieve higher competitiveness.
3.2. Fundraising
In the fundraising stage, fund managers attract potential investors through presentations and visits,
and publications in the industry press. In order to do this, prospectuses are sent out with such basic
information about vehicles such as funds under management, investment strategy, sector focus, the
maturity of portfolio companies as well as other information. From the investor point of view, the
viability of the potential investment is evaluated by looking at the track record of other vehicles
sponsored by this fund manager, the quality of the professional experience of these managers and
the deal pipeline that they present.
Investors commit themselves formally to subscribing to shares in investment vehicles thus providing
capital commitments and are later called upon to make this money available so that the vehicle can
invest in portfolio companies in addition to the investors requirement to pay management fees.
This fullling of capital commitments established between investors and fund managers occurs in
accordance with the vehicles partnership agreement or fund by laws (CVM 391). If these commitments
are not fullled, there are penalties that in most cases consist of diminishing the participation of the
offenders or rarely nes and the distribution of shares to other investors. Table 3.7 shows the options
used in such situations.
In 2004 the majority of vehicles had no penalty whatsoever (59%) and the most common penalty
was discounting or diminishing the investors participation. In 2009 the number of vehicles without
a penalty had decreased to 27.1%, probably because of greater experience in fundraising. The
most common penalty continued to be discounting or diminishing the investors participation with
increasing nes.
124
Table 3.7 Penalty for Failing to Honor Capital Commitments
Different mechanism for penalizing the failure to honor capital commitments established in agreements between managers and investors. Responses
were furnished for 118 investment vehicles (46% of total). Values reported in reais and converted to dollars using the Central Banks average annual
exchange rate.

Penalty for Failing to Honor Capital Commitments
Penalty Instru-
ment
Number of
Vehicles
% Total
Commitments
(Billions US$)
% Total
Number of
Vehicles
% Total
2004 2009
No penalty 57 59 2.83 51 32 27.12
Discouting/
diminishing
participation
18 19 0.82 15 27 22.88
Reduction of
Capital Gains
* * * * 10 8.47
Frequency of
Interested Paid
5 5 1.22 22 7 5.93
Decided in
Assembly
3 3 0.02 0 1 0.85
Fine 3 3 0.02 0 11 9.32
Redistribute
investors shares
to others
1 1 0.03 1 4 3.39
Fine and
redistribute
investors shares
1 1 0.03 1 3 2.54
Others 9 9 0.61 11 23 19.49
Total 97 100 5.58 100 118 100(*)
Source: GVcepe Database Getulio Vargas Foundation and First Brazilian PE/VC Census (2005)
Table 3.8 below lists the types of fund managers within the PE/VC industry in Brazil where most are
traditional organizations which acquire companies with cash ow which are looking for capital to grow
and have opportunities for organic or inorganic growth, and show potential for exits through the capital
markets or strategic sales. We have identied, however, a growth in specialized fund managers frequently
tied to greeneld projects that present high potential for value growth but with high levels of risk and with
returns expected only in the long term in such areas as infrastructure (frequently tied to greeneld projects),
real estate (which can also be a collection of greeneld projects) and forestry
2
.
2 For Iurther inIormation about Iorestry assets see 'Investing in Forestry Assets in Brazil: An Alternative Class oI Assets that can
contribute to the increase of wood sales in the country, Masters Dissertation for the Getlio Vargas Foundations School of Busi-
ness Administration by Iago Whately (Whately, 2007)
125
Chapter 3
Table 3.8 Committed Capital in the PE/VC Industry Allocated to Brazil
Committed Capital allocated to Brazil through Traditional PE/VC, Corporate Ventures, Infrastructure, Real Estate and Forestry Specialists. Responses
furnished by 144 Fund Managers and 252 Investment Vehicles. Values reported in reais and converted to dollars using the Central Banks average
annual exchange rate.
US$ Billions Private Public Sector Total %
2009
Traditional 27.2 0.94 28.10(*) 78
Corporate Venture 0.35 - 0.35 1
Infrastructure 3.96 - 3.96 11
Real Estate 2.73 - 2.73 8
Forestry 0.97 - 0.97 3
Total 35.2 0.94 36.1(*) 100(*)
(*) Difference due to rounding
Investment vehicles are structured so that the interests of entrepreneurs, fund managers and investors are
aligned in a way that is contractually dened between these parties. In the United States, the organizational
structure which provides this for PE/VC investments is the limited partnership. The relationship between investors
(limited partners) and managers (general partners) is based on investment agreements that seek to align their
interests. The model of fund by laws in Brazil is established by Securities Commission (CVM) Instructions 391 and
209 which are eminently contractual in nature and give the parties great freedom and cover the participation
of fund managers in the decision making processes of publicly traded or private investee companies, with
no qualications based on their revenues (CVM 391). They also establish a differentiation between classes of
shares, and cover the functioning of investment committees, technical committees and consulting boards.
PE/VC vehicle regulations, given their totally contractual nature, should also cover questions about conicts
of interest between investors and managers, such as managers nancial incentives, decisions on investments
and exits, investor access to portfolio company information, how to determine share values, how to treat
investments in terms of accounting, as well as how to treat expenses related to the management and operation
of vehicles. Equity Participation Funds (FIPs) and Emerging Company Mutual Funds (FMIEEs) must be registered
automatically with and supervised by the Securities Commission (CVM).
Table 3.9.1 groups vehicles by their legal structure. Note that in 2004, limited partnerships were relatively
lightly represented in the industry with 29 (29.9%) of the 97 vehicles being of this type, representing 61.8%
of committed capital in Brazil. In parallel to this, holding companies were relatively numerous with 20%
of the vehicles which represented less than 10% of committed capital. In 2004, following the regulatory
evolution of the industry, vehicles constituted under the Brazilian Securities Commission (CVM) instructions
126
were the most common type of vehicle with 44 total, which reinforces the fact that the creation of these
instructions was a decisive event in the evolution of the PE/VC industry in Brazil, making it possible for an
increase in funds coming from institutional investors such as pension funds.
By 2008, there were 45 limited partnership vehicles with committed capital of US$ 9.06 billion. However, this
structure didnt represent most of the committed capital in the industry, because the investment vehicles structured
under the Securities Commission (CVM) instructions held US$ 10.39 billion in committed capital. In 2009 there
was a strong growth in the number of limited partnerships which surpassed the Securities Commission (CVM)
structured vehicles in terms of numbers of vehicles and committed capital.
Table 3.9.1 Legal Structure of Investment Vehicles
Distribution of investment vehicles based on legal structure. Values reported in reais were converted into dollars using the Central Banks average
annual exchange rate. In relation to 2009 responses were received for 245 vehicles (97% of total) which possess US$35.1 billion in committed
capital (97% of total).
Legal Structure
Number of
Vehicles
Commitments
(US$ billions)
Number of
Vehicles
Commitments (US$
billions)
Number of
Vehicles
Commitments
(US$ billions)
2004 2008 2009
Limited Partnership 29 3.5 45 9.1 61 13.5
FMIEE (CVM 209) 21 0.2 26
10.4
34 0.8
FIP (CVM 391) 11 0.6 37 70 11.8
CVM 302 and 409 12 0.5 9 9 0.5
CVM 398 - - 1 1 0.0
Holding Company 20 0.5 31 0.5 35 1.4
Direct Investment - - 13 4.5 17 5.3
Division of non-
nancial company
2 0.3 4 0.3 3 0.4
Others 2 0.0 15 1.9 15 2.5
Total 97 5.6 181 26.6 (*) 245 36.1(*)
In 2009, the Brazilian PE/VC industry raised US$ 6.1 billion in funds for future investments (equivalent to
0.4% of GDP). Table 3.9.2 below shows fundraising by legal structure, for the fund managers that furnished
this information, totaling US$ 5.5 billion (239 vehicles or 94% of the total), and there is only US$ 631 million
for which we do not have this information. A large part of the money raised (US$1.75 billion or 32% of
the total raised by vehicles in 2009) came from Securities Commission (CVM) structured vehicles. Besides
127
Chapter 3
this, notice the relevance of limited partnerships with US$ 2.6 billion (47% of the total raised) and direct
investment with US$ 475 million (9% of the total raised).
Table 3.9.2 Fundraising in 2009 by Legal Structure
Distribution of fundraising of investment vehicles by legal structure. Some values reported in reais and converted into dollars using the Central Banks
average annual exchange rate. Sample: 239 vehicles (94% of total) which possess US$ 35.1 billion of committed capital (97% of total).
Legal Structure R$ (US$) US$ Total (US$)
CVM Fund 906 - 906
CVM Fund (infrastructure) 764 - 764
CVM Fund (Investing at Cost) 80 - 80
Limited Partnership - 1,317 1,317
Limited Partnership (Investing at Cost) - 736 736
Limited Partnership (Increasing the
Allocation to Brazil)
- 540 540
Other Funds (Infrastructure) 245 - 245
Direct Investment (Increasing the
Allocation to Brazil)
- 200 200
Direct Investment (Investing at Cost) 23 252 275
Holding Company 406 - 406
Total 2,424 3,045 5,469
In 2009, 37% of the committed capital in the Brazilian PE/VC industry was allocated to limited partnerships
according to Graph 3.1 below. Securities Commission (CVM) vehicles represented 36% of this capital and
Equity Participation Funds (FIPs) represented 20% of the capital committed to Brazil.
Graph 3.1. Committed Capital by Legal Structure
Committed Captal by Legal Structure in 2009. In the case of direct investments hedge funds are excluded and the CVM category includes all vehicles
structured according to Instructions 391, 302, 409, 308 and 398. Sample: 252 investment vehicles from 144 fund managers
Limited
Partnership
37%
CVM* 36%
Participation
Companies
4%
Direct
Investment
15%
Corporate
Venture 1%
Others 7%
128
In 2004, in the rst census, the distribution of committed capital was made up of 65 typical PE/VC fund
managers and six fund managers specializing in PIPEs. According to Table 3.10 below the group of fund
managers was made up of: 45 independent fund managers which managed US$ 3.0 billion of committed
capital (53.4%), 20 fund managers afliated with nancial institutions managing US$ 2.1 billion (37.9%),
4 corporate ventures managing US $0.3 billion (6%), and 2 fund managers afliated with the public sector
managing US $0.2 billion (2.7%). This last category included the investment and participation area of the
National Bank of Economic and Social Development (BNDES), BNDESPar. Among PIPE fund managers, there
were 3 independent fund managers and 3 afliated with nancial institutions, with committed capital totaling
US$ 0.5 billion (9%).
As of 2009, the data show that the industry is mainly composed of independent fund managers and fund
managers afliated with nancial institutions. The data also show that the role of the government as a direct
manager of VC is limited in terms of committed capital, because BNDESPar`s directly managed venture capital
area represented less than 3% of the committed capital in the industry in 2009. However, the number of
companies in BNDESPars portfolio was more than 10% of the industry total, reinforcing the fact that in terms
of promoting growth and innovation in small and medium sized companies, BNDESPars role has increased
in relative importance. Also note that the public sector has a relevant role as an investor in various vehicles
managed by independent fund managers.
Table 3.10 Fund Manager Affiliations
Distribution of fund managers with ofces in the country and committed capital as of December 2004, 2008 and 2009. Values reported in reais
were converted into dollars using the Central Bank average annual exchange rate.
Afliation
Number of
Fund Mana-
gers
Commitments
(US$ Billion)
Number of
Fund Managers
Commitments
(US$ Billion)
Number of
Fund Mana-
gers
Commitments
(US$ Billion)
2004 2008 2009
Independent Fund
Managers
45 3.0 107 20.5 116 29.0
Private 45 3.0 100 109 26.0
Public - - 7 7 3.0
Financial Institu-
tions
20 2.1 15 5.3 16 5.8
Corporate
Ventures
4 0.3 3 0.5 2 0.4
Public Sector 2 0.2 2 0.4 2 1.0
Angels - - - - 5 0.0
Total 71 5.6 127 26.7 (*) 144 36.1(*)
129
Chapter 3
According to Graph 3.2, in 2009 private independent fund managers represented 71% of the
committed capital in Brazil. Organizations afliated with nancial institutions represented 16%, publicly
traded independent fund managers represented 9% and corporate ventures represented 1%. The public
sector, with BNDESPar, represented just 3% of committed capital.
Graph 3.2 Fund Manager Affiliations (2009)
Committed Capital by Fund Manager Afliation in 2009. Sample: 252 investment vehicles from 144 fund managers
Publicly Traded
8%
Sector 3%
Public
Affiliated
with Financial
Institutions 16%
Corporate Ventures 1%
Private (Close End) 72%
Nineteen (19) vehicles in Brazil were in the fundraising process as of December 2009, showing that the
nancial crisis that aficted 2008 was still affecting fundraising in emerging markets. The tendency over the next
few years, despite continuing threats of recession in the developed economies, will be for PE/VC investments
to heat up again due to the strong performance of emerging markets in comparison to developed markets.
Another fact to be pointed out is that domestic fundraising is growing due to the continued interest of domestic
institutional investors and the successful experiences of fund managers since 2004.
During 2010 and 2011, not covered by this study, this tendency indeed has been maintained and has even
increased. During the rst half of 2011, when this study is being published, we know of at least three new
investment vehicles with capital in excess of US$ 1 billion ready to be announced in the market.
In September 2009 the National Monetary Board (CMN) altered the regulation of pension funds, the
principal source of committed capital for PE/VC in Brazil, raising the maximum limit for the acquisition of
various investments categories from 2% to 20%. Of the 19 vehicles in the fundraising process, 14 or 74%
are Equity Participation Funds (FIPs).
130
At the end of 2009, responses were obtained from 81 fund managers to the question about whether they planned
to raise a new fund vehicle for the Brazilian market over the following 3 years. Nine (9) of these were exclusively venture
capital rms and 72 were private equity. In tables 3.11 and 3.12 we can see that the amount of capital expected to be
raised for nal closing for venture capital oriented fund managers was US$ 732 million, and for private equity fund
managers a total of US$ 19.37 billion.
Graph 3.3 Fund Managers Intentions as to Whether they Will Raise a New Investment Fund in
Brazil in the 3 Years Following 2009

Sample of 81 (56% of total) fund managers, 9 being oriented towards Venture Capital and 72 being oriented towards Private Equity.
17%
83 %
No
Yes
Table 3.11 Capital Expected to be Raised for Final Closing By Fund Manager (PE)
The 46 PE fund managers out of a sample of 72 that intended to start a new PE vehicle in Brazil over the three years following 2009 and specied
the amount to be raised for nal closing.
Range of Capital in US$ MM Fund Managers %
Up to 50 2 4.35%
From 100 200 21 45.65%
From 201 to 500 15 32.61%
From 501 to 1,000 6 13.04%
Above 1,000 2 4.35%
Total 46 100%
Statistics:
Mode: $283.34
Min: $30.00
Max: $2,500.00
Weighted Average: $421.09
Amount of Capital Expected to be
Raised for Final Closing (US$ MM)
$19,370.00
131
Chapter 3
Table 3.12 Capital Expected to be Raised for Final Closing By Fund Manager (VC)
The 7 VC fund managers out of a sample of 9 that intended to start a new PE vehicle in Brazil over the three years following 2009 and specied the
amount to be raised for nal closing.
Range of Capital in US$ MM Fund Managers %
Up to 50 3 42.86%
From 100 to 200 2 28.57%
Above 200 2 28.57%
Total 7 100%
Statistics:
Mode: $200.00
Min: $12.00
Max: $200.00
Weighted Average: $104.57
Amount of Capital Expected to be Raised
for Final Closing (US$ MM)
$732.00
3.2.1 Supply and Demand for PE/VC Investments and the Fundraising Process: Current
Microeconomic Fundamentals
Diverse factors directly inuence the fundraising process. First, we need to understand how the PE/VC market
and its instruments and mechanisms work. The demand for PE/VC investments is represented by the quantity
of companies looking for PE/VC investments which believe that they are capable of, in a determined amount of
time, being selected and passing through the investment, monitoring and exiting stages of the process in such a
way that they can make large returns. The supply for this market is represented by the willingness of PE/VC fund
managers (investors in this case) to provide nancial resources for these companies (Gompers and Lerner, 2004).
The price, in this market, is established according to the expected rate of return. Thus, great expected returns lead
to a greater desire on the part of investors to furnish the capital for the investment (Clifford Winston, 1998)
The demand curve for this market is affected basically by the oscillation of the price, given that an elevated price
will mean a decrease in the number of companies willing to receive such an investment, due to the smaller number of
projects that meet the lower limit of expected return. The supply curve of capital for PE/VC investments, and especially
VC investments, is almost at and very elastic, given that there are other types of investments that can appear and offer
a better cost benet ratio in return for the risk (Scholes, 1972). However, there are no other investments that perfectly
substitute PE/VC investments, which is why the supply curve is not totally at. In relation to elasticity we can infer that a
small variation in price and expected returns causes a great variation in the quantity of capital offered for the investment.
132
Taxes are another story and are very complex, but since PE/VC returns are taxable as a general rule, their
principal substitute would be non-taxable returns, principally in countries where the corporate tax rate is very high
like Brazil (Porteba, 1989). It is not easy, however, for other classes of securities to offer the same high expected
returns as private equity does. Sometimes these securities offer, however, a competitive risk adjusted return, where
the potential return is less than in PE/VC investments but the risk is also lower, making these alternatives attractive
enough to compete for the same pool of capital.
Capital gains taxes are, unfortunately, responsible for shifting this supply curve; thus a decrease in tax rates
causes an increase in the quantity offered, thus forcing the supply curve lower.
Besides this, a reduction of capital gains taxes (and in Brazil, not just capital gains taxes given the enormous
percentage of indirect taxes) also affects the demand curve, principally for the rst stages of VC, because individuals
will become more motivated to start entrepreneurial ventures and thus better projects will be available in the
market (Gompers and Lerner, 2004). In this way, we can conclude that a fall in capital gains taxes benets the
PE/VC industry in the instances where investors do not have to pay taxes and in the instances where investors
are sensitive to tax rates, because in both cases demand will be greater. Ironically, while this study was being
published, Brazil was implementing some scal alterations with relevance to the PE/VC industry. In order to restrict
the inow of dollars into the country, and to bolster the value of the real, the government raised the tax on nancial
operations (IOF) from 2% to 4% on operations in the nancial and capital markets, and with this, affected PE/VC
investments and the real economy. Rapidly the government identied the problem with this measure, which while
trying to solve a macroeconomic question ended up hurting the PE/VC sector economically, and reconsidered its
earlier decision on taxing variable income investments.
Another institutional factor which also inuences the structure of the PE/VC industry is the percentage allocated
by pension funds for PE/VC investments. In the United States, for example, since 1979 the permissions for pension
funds to diversify their portfolios and make prudent PE/VC investments have been regulated by the resolution of
the US Department of Labor associated with the Employment Retirement Income Security Act (ERISA). Even though
only a small portion of the capital of these funds is destined for this type of investment, this resolution began a
process that facilitated fundraising by increasing the supply of money available for these kinds of investments.
Brazil has been passing through a similar evolutionary process, and today pension funds (domestic and international)
are already responsible for 22% of the capital committed to PE/VC vehicles. After the passage of a resolution by the
National Monetary Board (CMN) in September 2009, the permitted percentage allocated to investments in the alternative
133
Chapter 3
securities class, which includes PE/VC investments, rose from 2 to 20 percent greatly increasing pension funds interest
in this class of securities.
Graph 3.4 below shows the oscillations of the supply and demand curves for the PE/VC market. Q1 represents the
equilibrium point before the changes implemented by ERISA, Q2 represents the equilibrium point after the changes
implemented by ERISA and Q3 is the equilibrium point after a reduction in taxes on capital gains. S1 represents the
supply curve for PE/VC investments before the ERISA changes; A represents the shift in the supply curve due to the
ERISA resolution; S2 the supply curve after the ERISA changes; C the shift due to a reduction in taxes on capital gains
and S3 the supply curve after this reduction. D1 and D2 represent the demand curve for PE/VC investment, with B
being the shift in demand caused by the reduction in taxes on capital gains (Gompers and Lerner, 2004).
Graph 3.4. Supply and Demand of Funds for PE/VC Investments
Price
B
Q1 Q2 Q3 Quantity
S 1
A
D1
S 2
C
S3
D2
Source: Gompers and Lerner (2004)
Finally, we should emphasize the relationship between the performance of investee companies and the
fundraising processes which follow. The capital held by these companies for the previous two years has a strong
positive correlation with the fundraising process which follows. Fund managers show these good results from
past investments at road shows to bargain for more capital and the structuring of a new fund or an increase
in the capital of an established fund. We should also underline the fact that reputation is another factor which
positively inuences fundraising, because it is well known that large and experienced PE/VC fund managers
are much more successful in raising cash for their new vehicles, principally when were talking about the great
134
quantities of capital necessary to cover the costs of a large number of managers and employees (Gompers and
Lerner, 2004).
In this way, regulatory reforms and public policy have a great inuence on fundraising for PE/VC vehicles,
above all in relation to fundraising for venture capital vehicles. It will be increasingly necessary to adopt
regulatory reforms and public policy favorable to the PE/VC industry in order to make conditions more
attractive for the founding of new companies and new business models and the adoption of new technologies.
3.2.2. The American Model and Equity Participation Funds (FIPs)
It should be emphasized that fund managers get capital commitments when they constitute a fund,
and as opportunities for investment arise, they call in these capital commitments to make the investments
effective (Inocima, 2010). In the American model, investors commit capital to a vehicle in which they do
not have the right to sell their positions except when the fund manager authorizes it. In 2008 34% of
capital committed to Brazil is associated with Limited Partnerships. In 2009 this percentage was 37%.
In relation to the Equity Participation Fund (FIP), the PE/VC fund model used widely in Brazil, we can
highlight the increase in importance that these funds have been gaining. In 2004 funds regulated by the
Securities Commission (CVM) represented 23% of capital commitments, whereas in 2008 and 2009 these
gures where 39% and 26% respectively. Just taking into account Equity Participation Funds (FIPs), their
share of capital commitments has risen from 11% in 2008 to 20% to 2010. In contrast, over the same
period limited partnerships which represented 62% of capital commitments in 2004, declined to 34% in
2008 and 37% in 2009. These oscillations can be explained by the fact that pension funds, which already
represent the majority of capital commitments in Brazil, invest through Equity Participation Funds (FIPs) and
this represents a reason why this type of vehicle has obtained greater importance (Inocima, 2010).
3.2.3. The Fundraising Environment
The business environment for PE/VC in Brazil has been consistently evolving over the past few years.
According to LAVCA (2008) which seeks to analyze the PE/VC business environment in the region by
identifying the positive and negative aspects for conducting business in each country (a balanced scorecard),
Brazil has jumped from 59 to 75 points in the ranking out of a total of 100 in just 3 years (2006 to
2008). The criteria used were: the laws for creating a PE/VC vehicle, tax treatment of PE/VC vehicles and
investments, the protection of minority shareholder rights, restrictions on institutional investors making PE/
135
Chapter 3
VC investments, the protection of intellectual property rights, the regulation of the bankruptcy process,
the development of the capital markets and the viability of local exits (i.e. public offerings), registration
requirements for inward investments, the requirements of corporate governance, the strength of the judicial
system, the perception of corruption and the use of accounting norms. More important than the numbers
themselves is the evolution of the development and consolidation of the PE/VC business environment in
Brazil during the period in question. Consider that World GDP was US$54.35 trillion in 2007 and total of
committed capital in the worldwide PE/VC industry was US$ 2 trillion (3.7% of World GDP).
In 2009 we can see that China was the country that American investors believed would have the greatest
economic gains over the following three years (Graph 3.5). It should be emphasized that, besides the
United States, the other countries that complete this list are India, Brazil and Russia. Looking at this data
it is obvious that investors will look to include companies from these countries in their portfolios. Also in
2009, Brazil became the second ranked country in terms of attractiveness for emerging market investments
for the next 12 months according in the opinion of fund managers (EMPEA, 2009).
Graph 3.5 THE FIVE COUNTRIES WITH THE GREATEST EXPECTATIONS OF ECONOMIC GAINS
(AMERICAN INVESTORS)
42%
24%
12%
5%
2%
0 0,05 0,1 0,15 0,2 0,25 0,3 0,35 0,4 0,45
China
USA
India
Brazil
Russia
Source: Deloitte (2009)
Analyzing Graph 3.6, we can see that along with the United States which was confronting an economic
crisis in 2009, China appears to have considerable signicance as the country with the second greatest
expectation of economic losses over the next three years. This duality inherent in the opinion of American
investors probably comes from different weights being given to economic potential, industrial development
136
and social policy in China. Brazil stands out positively because it doesnt appear on this list, a fact that
underlines the countrys good environment for fundraising and investment.
Graph 3.6 The Five Countries With The Greatest Expectations Of Economic Losses (American
Investors)
57%
12%
12%
7%
2%
0% 10% 20% 30% 40% 50% 60%
USA
China
United Kingdom
Russia
India
Source: Deloitte (2009)
Brazils good business environment is further supported by Graph 3.7 which shows its position as rst
among Latin American countries in terms of positive expectations with twice the percentage of Mexico,
which came in second.
Graph 3.7 Best Markets In Terms Of PE/VC Opportunities
Brazil Mexico Colombia Peru Chile Others
Source: LAVCA (2009)
137
Chapter 3
3.2.4. Evolution of Committed Capital
The Brazilian PE/VC industry reached US$ 36.1 billion in committed capital in December 2009, an increase of
29% in relation to 2008. The Brazilian PE/VC industry has 180 fund managers, of which 144 were included in our
survey. In terms of investment vehicles, our research covers 252 investment vehicles managed by an estimated total
of 1,593 professionals and staff. Besides this, the number of new investments from 2005 to 2009 grew to 439 out of
a total of 502 PE/VC portfolio companies. Over the same period, there were 37 IPOs of PE/VC investee companies,
raising around R$ 31.3 billion. During 2009, the PE/VC industry showed exceptional growth, evidenced by the total
committed capital allocated to investments in Brazil.
Between the beginning of 2005 and the end of 2009 almost US$ 28 billion in committed capital was raised for
the country, of which US$ 9 billion (34% of the total) was raised by 52 of the 67 fund managers who began their
activities starting in 2005, and US$ 12 billion by 26 of the 60 fund managers who began their activities in Brazil
between 1981 and 2004. It should be noted that the 7 fund managers which started their activities in the country in
2009 still do not have active investment vehicles and are currently engaged in fundraising.
Graph 3.8 Evolution of Committed Capital Allocated to Brazil In US$ Billions
40
35
30
25
20
15
10
5
0
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
36*
29
27
13
8
6
5 5 5 5
4
Traditional PE/VC Funds: 28.10 (78%)
Infrastructure Funds: 3.96 (11%)
Real Estate Funds: 2.73 (8%)
Forestry Funds: 0.97 (3%)
Corporate Venture: 0.35 (1%)
*Breakdown into investment categories only avaliable for 2009. Source: GVcepe Database Getulio Vargas Foundation and First Brazilian PE/VC Census (2005)
Committed capital in the Brazilian PE/VC industry in 2008 represented 1.8% of GDP, as compared to 1% in 2004; however,
this number is practically half of the world average of 3.7%. In the United States and the United Kingdom, two countries with
decades of tradition in PE/VC, the respective percentages are 3.7% and 4.7% (Graphs 3.9 and 3.10). In 2009 committed capital in
the Brazilian PE/VC industry increased to 2.33% of GDP. Emerging markets in Asia achieved the greatest amount of fundraising
during the period from 2003 to 2008. This fact is amply explained by the amount of money raised in India and China. With
the exception of the European Community and the Commonwealth of Independent States (EC&CIS), all regions raised more
138
money in 2008 as compared to 2007, and we should note the continuing growth in money destined for Latin America. It
should be noted that this research focused primarily on American investors. Its important to compare these characteristics
with the fundraising numbers for Brazil found in this Second Census of the Brazilian PE/VC Industry.
Graph 3.9 Committed Capital as a Percentage of GDP (August 2008)
5,0%
4,0%
3,0%
2,0%
1,0%
0,0%
4,7%
4,2%
3,7%
2,8%
1,9%
1,8%
England Israel USA South Africa Europe Brazil
Source: National Empowerment Fund (2008) and GVcepe Database Getulio Vargas Foundation
Graph 3.10 Comparison of the Fundraising Process (Thousands of US$)
2008
2007
2006
2005
2004
2003
40,00
35,00
30,00
25,00
20,00
15,00
10,00
5,00
0
Emerging Asia EC & CIS Latin America Africa Middle East
Source: EMPEA (2008)
139
Chapter 3
Graph 3.11 Evolution of Committed Capital Allocated to Brazil as a Percentage of GDP
2,50%
2,00%
1,50%
1,00%
0,50%
0,00%
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
0,63%
0,77%
0,91%
0,93%
0,87%
0,97%
0,82%
1,24%
1,66%
1,70%
2,33%
3.2.5. Evolution of Fundraising
The development of the Brazilian industry can also be seen through PE/VC fundraising which reached
US$ 6.1 billion in 2009, 6.4% more than 2008. Around US$10 billion of the total raised up until now
(US$25.5 billion) has been invested since 2005.
Graph 3.12 Fundraising for Brazil
Fundraising for Brazil between the years 2005 and 2009, with a total of US$ 25.5 billion raised during this period. For 2009 the sample was 144
fund managers with 252 investment vehicles.
30
25
20
15
10
5
0
2005 2006 2007 2008 2009 Total
2,3
5,3
7,2
4,6
6,1
25,5
140
Graph 3.13 shows that Brazil has demonstrated an important evolution in fundraising among emerging markets. In 2005
the countrys participation in emerging market fundraising was 8.9% and it reached a peak of 15.9% in 2007.
Graph 3.13 Fundraising for Emerging Markets (US$ Billions)

0 20 40 60 80
2008
2007
2006
2005
2004
Brazil 4.6 (6.9%)
Brazil 7.2 (12.1%)
Brazil 5.3 (15.9%)
Brazil 2.3 (8.9%)
66.5
59.2
33.2
25.8
6.4
Source: EMPEA (2008), GVcepe Database Getulio Vargas Foundation and First Brazilian PE/VC Census (2005)
This study identies 252 investment vehicles in existence and active in the Brazilian PE/VC industry. They are
run by 144 of the 180 fund managers. We have also identied the year they were founded (their vintage). This
permits the making of parallels between the macroeconomic environment of the last few years and the industrys
evolution. In 2009, seven more fund managers began operations in Brazil. We can follow fundraising for new
vehicles beginning with before 1993, when there were just the PE/VC pioneers in the market, and 1997, during
the era of privatizations, between 1999 and 2001 during the internet bubble, and nally between 2005 and
2009, with the spreading of Private Equity Funds (FIPs), the increase in world liquidity, IPOs, macroeconomic
stability, Brazils receiving investment grade status, and the reduction of interest rates.
Graph 3.14 Beginning of Fund Manager Operations
Before 2005
50%
2005
8%
2006
12%
2007
17%
2008
8%
2009
5%
141
Chapter 3
Graph 3.15 Vechicle Fundraising by Vintage Year
50
45
35
30
20
10
0
8,00
7,00
6,00
5,00
3,00
2,00
1,00
95 or
less
1996 1997 1998 1999 2000 2001 2002 2003 2004 2004 2006 2006 2008 2009
Number of Vehicles
Committed Capital
3.2.6. PE/VC Investors
The principal investors in PE/VC vehicles are pension funds, corporate ventures and nancial institutions.
Also note that there are important investors such as family ofces, trusts and endowments, public institutions
and multilaterals. Graph 3.16 shows that pension funds are the source of most committed capital allocated
in Brazil (22%), followed by banks (18%), trusts and endowments (10%) and family ofces (9%).
Graph 3.16. Composition of Investors in PE/VC Funds (2009)
Source of committed capital by investors. Sample of 239 vehicles.
MulLllaLeral lnsLlLuLlons 1
8anks (Cwn orLfollo) 4
CovernmeL and ubllc lnsLlLuLlons 4
rlvaLe Companles 3
CLhers 3
lnvesLmenL lunds 6
lunds of lunds 6
lund Manager arLners 9
lamlly offlce 9
1rusLs and LndownmenLs 11
arenL CrganlzaLlons and CorporaLe venLures 18
enslon lunds 22
22
1 4
4
3
3
6
6
9
9
11
18
142
Analyzing just local investors, we can see that there is a much greater participation of pension funds (38%) and,
principally an increase in the participation of fund manager partners (20%) in capital commitments in Brazil.
Graph 3.17 Breakdown of Local Investors (2009)
Source of committed capital by local investors only. Sample of 239 vehicles.
Pension Funds
Parent Organizations
Fund Manager Partners
Banks (Own Porfolio)
Family offices
Governmental and Public Institutions
Others
Private Companies
Investment Funds
38%
22%
20%
5%
4%
4%
2%
1%
4%
0% 5% 10% 15% 20% 25% 30% 356% 40%
and Corporate Ventures
PE/VC fund managers administer both nancial resources from third parties and nancial resources
from their own partners. Graphs 3.16 and 3.17 show the distribution of the sources of capital commitments
for investment vehicles that they administer.
The rst Census (2005/2006) has shown that in 2004, 30 fund managers (42.3% of the total number
of fund managers) administer third party nancial resources totalling US$ 1.65 billion (29.6% of the
total of committed capital in the industry). Another 13 fund managers (18.3% of the total number of
fund managers) administer their own nancial resources, with this being responsible for 9.3% of all
committed capital. Finally, 28 fund managers administer third party nancial resources and their own
nancial resources, and this represents 39.4% of the total number of fund managers managing US$3.41
billion (61.1% of all committed capital).
In the same way that managers and committed capital are concentrated in a few cities and regions,
a small number of fund managers administer the majority of the capital: Table 3.13 shows that, in
2004, the 15 largest fund managers administered 76.2% of the industrys committed capital. The ve
largest controlled almost half of all committed capital. This is indicative of an infant industry which is still
143
Chapter 3
fragmented, where on average the 15 largest fund managers held US$283 million in committed capital,
while the other 56 averaged US$ 26 million.
In December 2009, the 10 largest fund managers administered 50.1% of committed capital in the
industry, US$13.96 billion. By looking at Table 3.13 and Graph 3.18, we can see that a process of
deconcentration of commited capital has taken place with the 15 largest fund managers then controlling
a lower 63% of all committed capital in Brazil. It is also relevant to note that the 15 largest fund managers
had an average of US$ 1.5 billion, as compared with 0.3 US$ billion in 2004, and the other fund
managers administered on average US$ 106,5 million, against just US$ 26 million in 2004, indicating a
robust growth in the principal fund managers that have continued to operate in the country over the past
ve years and practically a quadrupling of the money administered by other fund managers during the ve
years since the rst Census. Even though the industry is still fragmented, it is very probable that the existing
smaller fund managers are operating on a viable economic scale or are undergoing consolidation.
Table 3.13 Concentration of Committed Capital Allocated to Brazil
Sample: 144 fund managers with committed capital of approximately US$ 36.1 billion in 2009.
Fund Managers by
Size
Commitments (US$
billion)
Average Commitments
(US$ billion)
Commitments (US$
billion)
Average Commitments
(US$ billion)
2004 2009
5 largest 2.56 0.513 11.3 2.265
10 largest 3.61 0.361 18.1 1.811
15 largest 4.25 0.283 22.8 1.520
Others 1.33 0.026 13.3 0.107
All Fund Managers 5.58 0.085 36.1 0.258
Graph 3.18 Concentration of Committed Capital (Average Capital in Relation to Total Capital)
100
90
80
70
60
50
40
30
20
10
0
5 largest 10 largest 15 largest Others All Fund
Managers
92
63
65
50 51
42
5
3
15
7
2004
2009
144
3.2.7. The Origins of Committed Capital and Fund Managers in Brazil
In 2004, the majority of PE/VC fund managers operating in Brazil in terms of quantity and amount of
committed capital (Table 3.14) were from Brazil. The 53 domestic fund managers (74.7% of the total)
managed US$ 3.54 billion (63.4% of the total of committed capital). The second most common country of
origin was the United States with 10 fund managers (14.1% of the total) managing US$ 1.76 billion, 31.6%
of all committed capital. It should be noted that Brazil and the United States together represented 95% of
the committed capital in the countrys PE/VC industry. The presence of European fund managers was 6%.
In 2009, the 102 fund managers from Brazil represented the majority of the industry corresponding to
13% of the total, compared to a total of 53 fund managers in 2004, which represented 75% of the total.
In 2009, fund managers from the United States were the second largest contingent (22), followed by other
parts of the world (7), the Europeans (7), and Latin America (3). It is important to note the substantial
increase in international fund manager operations through global, regional and emerging market funds.
In 2009, Brazilian fund managers held 61% of the total volume of committed capital, American fund
managers held 19%, and European fund managers 9%. In 2009, 62% of this committed capital was
Brazilian in origin, 25% American in origin, 8% European in origin, and 5% originated from other areas,
notably the Middle East and Asia.
Table 3.14 Origins of Fund Managers
Descriptive table listing the origins of fund managers. In 2009, the sample included 140 fund managers
Origin
of Funds
Resources
Number
of Fund
Managers
Percentage
Committed
Capital (US$
billions)
Percentage
Number
of Fund
Managers
Percentage
Committed
Capital (U$
billions)
Percentage
2004 2009
Brazil 53 74.7% 3.54 63.4% 102 73% 21.5 61%
Latin
America
- - - - 3 2% 0.4 1%
United
States
10 14.1% 1.76 31.5% 22 16% 6.6 19%
Europe 4 5.6% 0.19 3.4% 7 5% 3.3 9%
Others 4 5.6% 0.09 1.6% 6 4% 3.3 9%
Total 71 100% 5.58 100% 140 100% 35.1 100%(*)
145
Chapter 3
Graph 3.19 Origin of Committed Capital Avaliable to Fund Managers
Middle East
1%
Asia 1%
Others
3%
Europe
8%
United States
25%
Brazil
62%
3.2.8. Duration of the Fundraising Period
On average it takes 12 months from the launch of a vehicle to the closing of fundraising. Graph 3.20
presents the number of vehicles in function of the duration of their fundraising period. Each point on the
curve indicates the number of vehicles whose fundraising lasted less than or equal to the time that appears
on the horizontal axis. Of the 57 vehicles that could be analyzed up until December 2009, 30 vehicles had
a fundraising period of less than 15 months, while in December 2004, 47 vehicles out of a total of 57 had
this same duration of fundraising (Carvalho, Ribeiro and Furtado, 2004). Just one small group of 4 vehicles
had a fundraising period longer than 48 months.
Graph 3.20 Duration of Fundraising Period
60
55
45
40
35
30
20
15
10
5
0
M
o
n
t
h
s
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 51 53 55 57
Number of vehicles in relation to the duration of the fundraising period. For each point, the vertical axis denotes the number of vehicles that had a
fundraising period less than or equal to the time on the horizontal axis. Includes 57 vehicles which declared the beginning and end of their fundraising
process and which operated using third party nancial resources. Vehicles that were created to assume the portfolio of other vehicles were excluded
(secondary transactions and vehicles formed exclusively for exits), as well as open vehicles that didnt have precise ending dates for fundraising.
146
3.2.10. Fundraising by Sector and Type
Brazils rapid economic recovery from the international crisis of 2008/2009 enabled fund manager
fundraising to reach US$ 6.1 billion in 2009, close to the record level of US$ 7.2 billion, observed in
2007. The Crisis of 2008 led to a reduction of fundraising by 36% in that year as compared to 2007, but
2009 led to a growth of 32.6% over the previous year, just 15% off the all time high of 2007.
The volume of fundraising that appears in Graph 3.21 below represents roughly 0.5% of GDP in the record
years of 2006 and 2007 and closer to 0.3% of GDP in other years, with 2009 representing 0.4% of GDP.
Of the fundraising in 2009, 24% refers to investments, valued at cost, made by fund managers in private equity
investee businesses which didnt utilize typical private equity funds as fundraising vehicles. These cases we conservatively
consider as committed capital the nancial resources effectively invested at cost. Another 12% of the fundraising volume
refers to global, regional and emerging market funds which increased their specic allocations for the Brazilian market.
The ve year period from 2005 to 2009 also saw an expansion in the number of new investment
vehicles (new funds) created which reached a peak of 47 new vehicles in 2008, falling to 19 in 2009: a
vigorous industry expansion during this period.
Of a total of US$ 6.1 billion raised, 66%, or approximately US$ 4.0 billion, was raised for vehicles with a traditional
PE/VC focus (manufacturing industries, commerce, services, agriculture and other traditional business), 24% or US$
1.5 billion in funds with a focus on infrastructure, and 10% or US$ 0.64 billion in funds with a focus on forestry.
Graph 3.21 Fundraising as a Proportion of GDP (2005-2009)
Fundraising in Brazil between 2005 and 2009, with a total of US$ 25.5 billion raised during this period. For the year 2009 the sample was 144
fund managers and 252 vehicles.
8
7
6
5
4
3
2
1
0
2005
2.3
0.3%
2006
5,.3
0.5%
2007
7.2
0.5%
2008
4,.6
0.3%
2009
6,1
0,4%
Fundraising (US$ billion)
GDP in U$ %of
Source: GVcepe Database Getulio Vargas Foundation Sample: 252 Investment Vehicles
147
Chapter 3
Of the vehicles which were in the fundraising process in December 2009, just 9% did not have a sector
focus according to Graph 3.22. Of those that did have sector focuses, Energy and Fuel was the sector with
the greatest portion of capital to be raised. It was followed by the Energy, Oil and Fuel, the Pharmaceutical
and Medical sector, and the Real Estate sector.
Graph 3.22. Sectoral Focus of Vehicles in Fundraising (2009)
Dont have a sectoral focus
Have a sectoral focus 91%
9%
Sample: 57 Investment Vehicles
Graph 3.23 Sectoral Focus of Vehicles in Fundraising Process (2009)
3,2%
3,2%
3,2%
3,2%
3,2%
3,2%
3,2%
6,5%
6,5%
6,5%
6,5%
6,5%
9,7%
9,7%
9,7%
16,1%
0 0,02 0,04 0,06 0,08 0,1 0,12 0,14 0,16 0,18
Communicaons
Civil Construcon
Chemical Industry
Miscellaneous Services
Financial Services
Transport Services and Logiscs
Retail
Biotechnology
Educaon
IT and Electronics
Infrastructure
Others
Agribusiness
Real Estate
Pharmaceucals, Medicine and Beauty
Energy and Oil
Sectoral focus of vehicles fundraising in 2009. Sample: 39 vehicles in the fundraising process during 2009
148
Looking at investments vehicles (funds) that were still raising capital at the end of 2009 by stage we can see
that the most common stages were Private Equity Growth (25.6%) and Startup (10.2%). It should be stressed that
venture capital oriented funds (all stages from seed to later stage V.C.) accounted for 28% of the total (11funds).
Graph 3.24 Fundraising by Stage in 2009
Target stage for future investments in fundraising vehicles in 2009. Sample: 39 vehicles in the fundraising process during 2009.
10 Private equity Growth
Start-Up
Venture capitallater stage
Mezanino
Venture capital EarlyStage
Seed
Greenfield
PIPE
Private equitylater stage
Distressed
2 4 6 8 10 12
4
3
2
2
2
1
1
1

Source: GVcepe Database Getulio Vargas Foundation Sample: 57 Investment Vehicles
3.3. Emerging Clusters of Angel Investors
Even though they are not considered fund managers, Angel Investors are an important component of the value
chain of the PE/VC industry, constituting the initial link between seed and startup companies and VC investments.
These investors are, in general, a group of individuals with broad executive experience who have already passed
through the entire PE/VC vehicle investment and exit process many times. This is why they can be an excellent source
of experience, monitoring and seed capital for projects in their infancy, which are still in an incubation phase of
development where a little capital and business developmnet experience greatly inuence their maturing process.
Through their experience, these professionals utilize their competencies to detect promising businesses in
the market which, with adequate supervision, and frequently a series of rounds of nancing, followed by the
entrance of a PE/VC vehicle, can grow rapidly generating high returns for their investors. These angel investors
contribute capital, knowledge, and above all relationships for the investee company.
The United Kingdom is the most mature country in Europe in terms of angel investors. It has 34 associations
with more than 5,000 investors. According to EBAN European Business Angel Network data, Europe has 297
associations with more than 16,000 angel investors.
149
Chapter 3
Currently there are 4 angel investor associations in Brazil: Bahia Anjos (BA), Floripa Angels (SC), Gvea
Angels (RJ) and the oldest, created in 2002 So Paulo Anjos (SP), totalling 62 associates, 19 support
professionals and capital estimated at US$ 9 million in June 2008. Even though these organizations represent
themselves as such, each of the 62 associates in these organizations decides individually if he or she wishes to
enter a business opportunity or not after initial analyses and presentations made by the group. In this way, in
terms of investment decisions, these individuals participate directly in the capital of investee companies. There
is no investing entity which represents the whole association as there is in the case of PE/VC fund managers.
Some new initiatives are appearing in the country, due to important public policies for the development of
angel investor networks. The Brazilian Innovation Agency (FINEP) has developed and implemented various
forms of support from the federal government to stimulate this industry in Brazil. The typical value of an angel
investor investment in Brazil varies from US$ 50 thousand to US$ 500 thousand per company and can reach
US$ 1 million. In June 2008, just 4 companies were part of Brazilian angel investor association portfolios. By
an angel investor association portfolio we mean the collection of companies which received investments from
angel investor association members during association meetings (Ramalho and Furtado, 2008).
According to Botelho (2005), angel investors can play an important role in transforming the business culture in
Brazil by assuming calculated risks and sharing their experience with entrepreneurs which will mold the development
of entrepreneurs in the 21st century and, more importantly, create value through knowledge. The data listed below
about committed capital in angel investor associations was obtained by estimate, given that there are no formal
capital commitments made by the associates.
Graph 3.25 Capital Committed by Angel Investor Associations (US$ MILLIONS)
Committed Capital in Angel Investor Associations, in 2009. Sample: 4 associations of angel investors and 57 investment vehicles.
10
9
8
7
6
5
4
3
2
1
0
Dec/2008 Mar/2008 Jun/2008 Dec/2009
5.5
7.2
9
9.4
Dec 2008, Mar 2008, Jun 2008, Dec 2009
Chapter 4
The Private Equity and Venture Capital Cycle - Investing
153
Chapter 4
The Private Equity and Venture Capital Cycle - Investing
4.1. Introduction
PE/VC investments are characterized by a low conversion rate of the investee company proposals
analyzed by fund managers. The reasons for this are diverse, as we will analyze later. In this thorough
selection process, after presentations have been made to the manager, the ones that are in line with
the vehicles investment theses are selected, and meetings are held with the entrepreneurs leading
hopefully to the signing of a letter of intent.
4.2. Deal Flow Origination
After fundraising is completed by PE/VC fund managers, the investment screening process begins.
Origination is the fund manager activity in which new investment opportunities are identied. During
this selection stage, the manager evaluates the merits of the business opportunity based on aspects
that vary between PE/VC fund managers. In the next section, we will analyze deal origination and the
deal selection process in Brazil, which in 2009 was quite rigorous and required many resources. Such
opportunities can reach fund managers in various ways.
4.2.1. Obtaining Proposals and Deal Characteristics
Deal proposals that lead to PE/VC investments are classied into three types: In-House Prospecting,
Third Party Leads and Spontaneous Candidates.
When the investment possibilities arise from leads or through the fund manager itself, the manager
has a strong inuence on the deal, whether it is Private Equity or Venture Capital. This data is presented
in Table 4.1 which shows the percentage coming from each source for deals that arrived through In-
house prospecting between 2008 and 2010 by type.
Table 4.1 Sources Of In-House Prospecting
Responses furnished by 88 fund managers (60% of the total).
Source % %
PE VC
Manager/Partner Contacts 38.94 36.92
Incubators/Technological Parks 0 5
154
Startup Competitions/Business Plans (eg: Desao Brasil, Latin Moot Corp, I2P, Prmio
Santander, etc.)
0 6.92
Seed Forum/Venture Forum (FINEP) 0 5.77
Entrepreneurial Institutes (eg: Endeavor) 0.06 2.31
Competitors (Companies from the same sector as portfolio companies) 1.45 2.69
Clienst/Suplliers of Portfolio Companies 5.58 2.69
News in the Media (newspapers, magazines, websites, etc.) 10.97 4.62
Others 43 33.08
Total 100 100
From the data above, we can see that Manager/Partner contacts account for 38.94% of Private
Equity sources and 36.92% of Venture Capital sources. The least representative sources for Private
Equity are Incubators/Technological Parks, Seed Forums/Venture Forums, and Startup Competitions/
Business Plans, all with 0% utilization. In terms of Venture Capital sources of opportunities, we
observe the opposite: these sources represent 26.4% of the total.
When alternative investments reach fund managers through third party leads, we also observe a
large variety of sources as shown in Table 4.2, which shows the percentage of each source between
2008 and 2010 by type.

Table 4.2 Sources of Third Party Leads
Responses furnished by 88 fund managers (60% of total).
Source
%
PE VC
Incubators/Technological Parks 0.3 13.1
Vehicle Investors 1.9 10.0
Other PE/VC Fund Managers 5.1 3.8
Consultants/Auditors /Advisors/Brokers 30.8 5.4
Law Offices 4.7 5.8
Banks 8.4 0.0
Entrepreneurs/Portfolio Companies 7.2 15.8
Others 41.6 46.1
Total 100 100
Table 4.1 Sources Of In-House Prospecting
Responses furnished by 88 fund managers (60% of the total).
155
Chapter 4
Banks represent 8.4% and are the second most common source for Private Equity. However, they
represent 0% for Venture Capital, being the least common source. For Private Equity Consultants/
Auditors/Advisors/Brokers were the most common source with 30.8%. Incubators/Technological
Parks were the least common source, representing just 0.3%. For Venture Capital Entrepreneurs/
Portfolio Companies were the most common source with 15.8%. Other sources for third party leads
represented respectively 41.59% and 46.15% for Private Equity and Venture Capital.
In general, the Venture Capital market has more intermediation than the Private Equity market
(Berger and Udell, 1998). Or in other words, more investments come from third party leads than from
other sources. Deal proposals which reach PE/VC fund managers, whether they be from In-House
Prospecting, Third Party Leads, or Spontaneous Candidates, reect a wide range of economic sectors.
The distribution of these sectors between 2008 and 2010 is shown in Table 4.3.
Table 4.3 Received Proposals by Economic Sector
Sector %
Entertainment/ Tourism 0.7
Raw Materials 0.8
Chemical Industry 1.1
Transport Services and Logistics 1.5
Communications 1.6
Financial Services 2.6
Metallurgical, Mechanical and Electrical Supply Industries 2.8
Biotechnology 3.2
Education 3.3
Miscellaneous Services 3.5
Civil Construction 3.8
Energy and Fuel 6.8
Pharmaceuticals, Medicine, and Beauty 6.8
Retail 6.8
Food and Beverage 7.1
Infrastructure 8.0
156
Real Estate 8.7
Agribusiness 10.8
IT and Electronics 19.9
Total 100 (*)
Source: GVcepe Database Getulio Vargas Foundation (*) Difference appear due to rounding
In this way, we can see that most of the deal proposals come from the IT and Electronics sector,
followed by Agribusiness and Real Estate. These sectors represented, respectively 19.9%, 10.8% and
8.7% of all proposals received. On the other hand, the least represented sectors were Entertainment/
Tourism, Mining and Forestry and the Chemical Industry representing respectively 0.6%, 0.7% and
0.9% of all business opportunities.
In addition to this, the proposals which reach fund managers are quite distinct in terms of the stage
of investment sought as can be seen in Table 4.4.
Table 4.4 Received Proposals by Investment Stage
Sector %
Distressed 2.9
PIPE 3.5
Mezanine 6.5
Private Equity Later Stage 6.6
Venture Capital Early Stage 6.7
Greeneld 8.8
Venture Capital - Later Stage 10.4
Startup 11.2
Seed 11.6
Private Equity Growth 31.5
Total 100(*)
Source: GVcepe Database Getulio Vargas Foundation (*) Difference appear due to rounding
Table 4.3 Received Proposals by Economic Sector
157
Chapter 4
The data obtained shows that the most proposals received were for the Private Equity Growth
stage, representing 31.5% of the total. The next in order was the Seed stage with 11.6% followed
by the Startup stage with 11.2%. Thus, as with the First Census, 40% of the proposals are typical of
Venture Capital stages, almost 1/3 from Private Equity Growth and relatively few, around 7% from
Private Equity Later Stage. Greeneld proposals have begun to take off with approximately 9%.
4.2.2. Analysis of Investments and Deal Flow
After receiving investment proposals, the fund manager judges investee companies in accordance
with how well they t into the investment strategy of the vehicles that it administers. The preliminary
negotiation thus occurs in accordance with the investment strategy of the manager. Tables 4.5 and
4.6 show the principal aspects which attract and discourage this rst investment by a fund manager.
Table 4.5 Target Company Requisites Which Make an Investment Viable
Responses furnished by 61 fund managers (40% of total) in 2009.
Characteristics
Disagree % Neutral % Agree %
Total Partial Total Partial
The fund manager has the right to veto key target
company decisions
3.3 0.0 3.3 18.3 75.0
The fund manager has seat on or can nominate members
to the board of directors
1.6 1.6 3.3 18.0 75.4
The fund manager can acquire control
45.9 14.8 18.0 14.8 6.6
The target company has received angel investor capital
61.7 11.7 26.7 0.0 0.0
Essential requisites which make a deal viable are the fund managers right to veto key target
company decisions and to have a seat on the board of directors, while acquiring control of the
company is not viewed as necessary.
158
Table 4.6 Factors Which Preclude Investment in a Target Company
Responses furnished by 59 fund managers (40% of the total) in 2009.
Factor
Disagree % Neutral % Agree %
Total Partial Partial Total
A large part of the target companys business is in the
informal market and it isnt worth legalizing it
1.7 3.4 1.7 8.5 84.7
There is no agreement on the basic terms of the
Shareholder Agreement
3.4 3.4 5.2 37.9 50
The target company is family run 61 23.7 13.6 0.0 1.7
The target company is more than 100km away 67.8 11.9 6.8 11.9 1.7
One factor that is constantly analyzed is the distance from the fund manager. It is common for Venture
Capital managers to ask if a potential investment is located close enough to be monitored (LAI, 2006),
because the performance of investee companies can vary according to the physical presence of members
of the fund manager. However, this commitment can be signicantly reduced when a venture capital fund
manager has more than one investment in a relatively distant region, reducing the marginal costs of
monitoring (Chen, Gompers, Kovner & Lerner, 2009). In the case of angel investors, this proximity is even
more important if the market in this type of investment is local (Berger and Udell, 1998).
On the other hand, our research reveals that, in Brazil, only 13.6% of our respondents agree (totally
or partially) that the fact that a proposed investment is located more than 100km away constitutes an
impediment to an investment.
4.2.3. Deal Flow
Deal flow is the flux of investment proposals received by a fund manager during its screening
period. This flux can occur in two distinct forms: proprietary deal flow and competitive deal flow.
Proprietary deal flow is the process of presenting investment proposals in which there is exclusivity
between the target company and the fund manager during the negotiation process and the analysis
of the investment opportunity. In this case, the target company negotiates with just one fund manager
(Metrick, 2006).
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Chapter 4
In competitive deal flow there is no exclusivity between the proposer and the fund manager. The
entrepreneur can present his proposal to various fund managers directly or through intermediaries
(law offices, accountants, investment banks, among others). These intermediaries are interested in
offering their services to these target companies and want them to be their clients after they receive
capital from PE/VC fund managers.
Fund managers prefer proprietary deal flow as compared to competitive deal flow. If a target
company negotiates with just one fund manager, there isnt competition with other fund managers
for this investment and there will not be a price auction to buy participation in the target company.
We expect competitive deal flows to be dominant in the next few years as Latin America becomes
attractive to foreign General Partners. This perception became evident during the second half of
2009 when global appetite for Brazilian investments increased and the local PE/VC industry showed
rapid signs of recovery (Deloitte, 2010).
In proprietary deal flow as in competitive deal flow, there is a rigorous investment selection
process undertaken by fund managers. It is estimated that of every hundred proposals presented to
fund managers, just one actually receives investment (NVCA, 2007). This process can be compared
to filtering through a funnel, as shown in Figure 4.1, which illustrates the quantity of business
opportunities that passed through each step of the fund manager selection process in 2009.
Figure 4.1 Conversion of Business Opportunities Into Investments
3931 Proposals received (100%)
1681 Proposal Analyzed (43%)
92 Submited to Due
Diligene (2%)
50 Investments
Made (1%)
160
As can be seen in Figure 4.1, most of the proposals are eliminated at the start. Thus, 1681 (43% of
the total received) proposals were analyzed more carefully, some of which made it to the due diligence
process and 50 received investments, or roughly 1% of the total, conrming the hypothesis that one
proposal in a hundred is funded. In this phase, companies are generally chosen that t in the vehicles
investment strategy, which is one reason why various opportunities are discarded (GVcepe, 2010).
The funneling process for these proposals varies with the source of presentation as we can see in Table
4.7, but in the end the number of investments for each type of presentation was similar to the others.
Table 4.7. Number of Proposals Contained in Deal Flow According to the Sourcing Methods
Note: Number of proposals (ex., business plans) received by managers according to the method used, number of proposals which were completely analyzed, number of proposals
that went through due diligence and number of investments made in 2009 for which there is information about their origination. This does not include PIPE transactions nor fund
managers that were not looking for investments (inactive). Transactions that involved an operation in which investments were transferred from one fund manager to another with
the second including the investee companies in its portfolio were not considered. Cases in which fund managers did analyses for other fund managers to make investments were
also not included to avoid double counting. The percentages refer to the previous phase. Responses were furnished by 88 fund managers (60% of total).
Origination Phase
Proposal
Received
Proposals
Analyzed
Due
Diligence
Investments
Made
Spontaneus
Candidates
1,399
804
(57.5%)
23 (2.9%) 17 (73.9%)
Third Party
Leads
1,410
386
(27.4%)
24 (6.2%) 14 (58.5%)
In-House
Propecting
1,122
491
(43.8%)
45 (9.2%) 19 (42.2%)
Total 3,931
1,681
(42.8%)
92 (5.5%) 50 (54.3%)
Of all proposals received, 36% originated from Spontaneous Candidates, 36% from Third Party
Leads, and 29% from In-House Prospecting. In terms of all investments made, 38% originated through
In-House Prospecting, 34% through Spontaneous Candidates and 28% through Third Party Leads. In
terms of the conversion rates of business opportunities to investments, we see that 1.7% of the proposals
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Chapter 4
presented through In-House Prospecting received investment, with the respective percentages being
1.2% for Spontaneous Candidates and 1% for Third Party Leads.
In India, proposals presented through Third Party Leads (ex. investment banks) represent 51% of the
investments made, while In-House Prospecting and Spontaneous Candidates represent respectively 25%
and 24% of this total (KPMG, 2008). In Brazil as shown in the table above, these respective percentages
are 28% for Third Party Leads, 38% for In-House Prospecting, and 34% for Spontaneous Candidates
In the past, proprietary deal ow was predominant in Latin America, given the regional culture which
values relationships. However, as the PE/VC industry matures, different sources of business opportunities
become necessary. In this way, we believe that Third Party Leads will increase as the industry develops
(Deloitte, 2010). In fact, this hypothesis seems conrmed by the proportions of proposals received.
4.2.4. Preliminary Due Diligence Process
Preliminary due diligence begins with the first contact with target companies and then fund
managers explore the assumptions which would lead to the realization of this business (GVcepe,
2010). In general, these assumptions involve conditions outside the company such as consumer
demand, competitors, products and technology, and legal issues, among others.
When the scenario presented by the target company does not correlate with the initial expectations
of the fund manager, the investment is then not considered viable for diverse reasons as shown
in Table 4.8.
Table 4.8 Principal reasons why proposed investments that reach due diligence are not viable
Reason %
Company Bankruptcy 0.5
Regulatory/Competition Factors (ex. CADE - Antitrust Board) 1.1
Seller desists for no apparent of transaction 3.2
Difculty in legal structuring of transaction 3.2
162
Change in the macroeconomic environment 6.8
Conclusion of investment with other potential buyer 8.3
Change in value parameters due to accounting adjustments 9.9
The use of veto power by one or more members of the Investment Committee 11.3
Change in value parameters due to permanet market changes (ex. price, cost of relevant items, competition,
etc.)
16.2
Manager does not register the reasons 18.1
Contingencies/liabilities that appear during due diligence that were not revealed by the entrepreneur 21.4
Total 100
The principal reasons given by managers were Contingencies/liabilities that appear during the diligence
that were not revealed by the entrepreneur with 21.4% of the responses. This was followed by Manager
does not register the reasons and Changes in value parameters due to permanent market changes (eg.
price, cost of relevant items, competition, etc.), with, respectively 18.1% and 16.2% of all obtained responses.
The least relevant factors were Regulatory/Competition Factors (ex. CADE Antitrust Board) and Difculty
in legal structuring of transaction with respectively 1.1% and 3.2% of the responses. Thus questions of a
legal or contractual nature are not the principal impediments to making these capital investments.
4.2.5. The Analysis of Business Opportunities and a Demonstration of Interest
After preliminary due diligence, managers already know which companies merit deeper analysis. In this
phase, managers show their interest by initiating negotiations with the entrepreneurial team to make an
investment (GVcepe, 2010).
At this point, we begin the second phase of the due diligence process, something more complex developed
through the use of a term sheet. Its used to study the more internal aspects of the target company, taking
into account risk factors such as:
Table 4.8 Principal reasons why proposed investments that reach due diligence are not viable
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Chapter 4
1. Business model and market size: the manager of the investment vehicle needs to know whether
the business model is the most appropriate one and also has to verify the estimated demand
of the potential market.
2. Consumer demand: diverse questions are related to this aspect, such as how demand will
evolve over the years, the characteristics of the target consumer and how he or she will respond
to factors such as competing products.
3. Competitive advantage: what is the competitive advantage of this new business and is it
sustainable in the long term.
4. Distribution model: evaluate how the product or service will arrive to the consumer, particularly
taking into account operational and nancial factors.
5. Product and technological development: verify that the product can be made, that the technology
to be used really exists and that it is possible to do this within the investment parameters. Verify
what nancial resources are necessary to take the product from development to production,
among other things.
6. Management of operations and human resources: evaluate if the entrepreneurial team and
the company executives are capable of administrating the business and attracting talent to the
company.
7. Financial factors: evaluate nancial factors related to the new business, what are the direct
and indirect costs, what are the prospects for the future, etc. Analyze nancial liabilities due to
worker, scal and environmental regulations, etc.
8. Legal aspects: all regulatory issues should be investigated, including those having to do with the
production of goods, intellectual property, labor, nances, and the environment, etc.
9. Risks: the manager needs to verify the known risks, as well as investigate the existence of
other unknown risk factors such as scal, labor, and environmental contingencies, and identify
strategies to mitigate these risks.
10. Dependency on suppliers and access to alternative suppliers, scarcity of raw materials that can
limit the growth of the company, etc.
11. Conditions of use for industrial equipment and installations, installed capacity, and the necessity
of investment for expansion and reinvestment for maintenance, as well as other aspects related
to production and the xed assets of the company.
In relation to this last aspect, problems can be found that were omitted or unknown and these can
end negotiations, and thus are termed deal breakers. The sooner these are discovered, the fewer
will be the risks and expenses related to poorly allocated nancial resources. Nevertheless, its worth
164
reecting that its not always possible to avoid these problems, and people have differing opinions
about them. Or in other words, what could be considered a deal breaker by one potential investor
will not be considered one by another. In general, deal breakers arise from three main factors:
a) The Business commercial or accounting irregularities, labor, environmental, or tax issues,
nancial or scal debts, transactions with allied parties, discrepancies in declared prots,
number of shares and the time to convert them, among others;
b) Administrative Culture cultural differences in terms of corporate governance, the release of
and quality of information, shareholder disagreements, etc;
c) The Market changes in market prospects (macroeconomic tendencies, new technologies, etc.)
changes in the nancial markets (which can complicate or impede access to nancial instruments
or reduce potential fundraising for the buyers), regulatory aspects, competitive positioning, local
and international competitiveness, and general attractiveness of the investment, among others.
Terminating the due diligence process, the interested parties generally return to the negotiating
table to align the terms and conditions between the parties related to labor, scal and environmental
contingencies.
4.2.6. Risk Analysis for PE/VC Fund Investments
PE/VC fund managers nance high risk innovative businesses that also have high potential returns.
Typically, investments are made in companies with great potential growth that need capital to develop
new technologies, research and development investments, expansion, consolidation and the acquisition
of new businesses. These companies normally have the characteristics of high risk investments, which
are typical of Venture Capital investments: a low quantity of tangible assets, the prospect of various
years of negative cashow and uncertainty about the ability to obtain bank loans and other types of
nancing.
Expected high returns and growth are necessary to justify the high costs involved in the structuring,
negotiating and monitoring of the investment, just as low liquidity and risk are associated with
investments in private companies or undercapitalized publicly traded companies. The main business
risk factors are those related to: development, manufacturing, marketing, nancial management and
growth (GVcepe, 2010).
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Chapter 4
With the goal of managing this investment risk in the most efcient manner possible and to protect
the value of their capital participation in investee companies, PE/VC fund managers perform careful
due diligence before making investments, which can be carried out in phases (rounds of nancing)
and continue to monitor investee companies carefully after they have made their investment.
As a way to reduce the risks of the endeavor and agency costs, PE/VC investments are often
made in phases based on whether goals have been met. For fund managers this dividing up of
the investment is an excellent option for maintaining control, because the companys prospects are
reevaluated periodically taking into account the panorama that surrounds it. With this diagnosis, the
fund manager can decide what will be the investment guidelines and take decisions on additional
investments, the structuring of the investment, the amount to be invested and whether to abandon
the project. Besides this, dividing the investment into stages reduces potential losses, because at each
stage the fund manager will reevaluate if and how much it wants to continue to invest in the business
based on past performance and future expectations (GVcepe, 2010).
By assuming these risks, fund managers have some criteria for selecting their investments. Table
4.9 shows minimum, median and maximum returns demanded by or expected by fund managers,
listed by development stage.
Table 4.9 Minimum and Maximum Expected Returns by Stage
In the responses per stage, a fund manager can respond for more than one stage. Responses furnished for 71 fund managers (50% of total).
Development Stage
Expected Return (%)
Responses per
Stage
Std. Dev.
Avg. of Mini-
mum
Avg. of Maxi-
mum
Median
Seed 45.92 114.47 na 26 15.00
Start-up 41.52 79.74 42.5 25 15.00
Venture Capital
Early Stage
32.78 110.00 35 27 28.36
Venture Capital
Later Stage
27.94 57.50 30 31 21.07
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Private Equity
Growth
22.51 40.93 25 54 13.97
Private Equity
Later Stage
20.00 28.50 22.5 31 12.99
Mezanine 15.62 24.33 19.5 21 9.80
PIPE 18.29 40.00 22.5 17 18.86
Greeneld 16.89 23.19 19.75 18 15.00
Distressed 23.00 32.50 26.25 16 14.70
Based on Table 4.9 we can see a positive relation between stage risk and return in PE/VC
investments. We know that for a given investment risk the investor should receive a premium. In this
sense, we observe that the riskiest stages, such as Seed and Startup, need to offer greater returns
to be attractive to managers, and in general less capital is necessary in these less mature stages.
We can also see that the median returns are very close to the minimum returns, suggesting a very
asymmetric distribution to the right.
In relation to the data obtained, we can see that the highest returns required were for the Seed
stage, with minimum and maximum expected returns of 45.9% and 114.5%. Following this, the
highest demanded returns were for the Venture Capital/Early Stage, with minimums and maximums
of 32.8% and 110.0% respectively and the Startup stage, with minimums and maximums of 41.5%
and 79.7% respectively. On the other side, we can see that the lowest required returns were for
Mezzanine (15.6%), PIPE (18.3%) and Greenfield (16.9%) investments. In regard to this last type, we
should remember that these are normally investments in the real estate, forestry and infrastructure
sectors with new development in areas with little or no preexisting structures and installations.
It is interesting to note that the Private Equity Growth stage had the largest number of responses
with 54, which shows the importance of this stage. Distressed had the fewest number of responses
Table 4.9 Minimum and Maximum Expected Returns by Stage
In the responses per stage, a fund manager can respond for more than one stage. Responses furnished for 71 fund managers (50% of total).
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Chapter 4
with just 16.
4.2.7. Role of the Investment Committee in the Selection Phase
When the negotiations have been nalized, the PE/VC fund managers submit the terms and conditions
of the investment agreement to the vehicles investment committee. This is the body responsible for the nal
approval of investments and usually exists just in large fund managers (Metrick, 2006). It acts during the
nal phase of the selection process when proposals have already been analyzed by managers. Despite the
long process leading up to this step, entrepreneurs should be aware that the investment committee has nal
say and can decide to decline an investment opportunity. Table 4.10 shows details in relation to the role of
Investment Committees in Brazil.
Of the 41 fund managers that responded, in 70% of them the committee analyzed each proposal on
average just once. Of this group, committees never analyzed the same proposal more than three times. In
this same table only 5% of fund managers analyzed the same proposal twice on average. The percentages
for analyzing an average of three, four, or ve or more times were 17.5%, 2.5% and 5% respectively. At
a maximum, 33.3% of proposals were analyzed ve or more times. Just 11.1% had a maximum of one
analysis made by the Investment Committee per proposal.
Finally, fund managers responded as to what was the most common number of times a proposal was
analyzed. 43.9% the proposals were analyzed once, 17.1% twice, 22% three times, 2.4% four times, and
14.6% of fund managers responded that they were analyzed ve or more times.
Table 4.10 Characteristics of Investment Committee Deliberations in the Selection Phase
Distribution of the number of times the investment committee analyzed business opportunities that received investments. Considers just fund
managers that reported average values. Does not include PIPEs. In total, 43 fund managers (30%) responded but not all of them responded to all
of the items.
Number of Analyses Number of Fund Managers
Average Absolute Number Percentage
1 28 70.0
2 2 5.0
3 7 17.5
4 1 2.5
5 or more 2 5.0
168
No information 1 -
Total 41 100.0
Maximum
1 4 11.1
2 8 22.2
3 10 27.8
4 2 5.6
5 or more 12 33.3
No information 5 -
Total 41 100.0
Most frequent
1 18 43.9
2 7 17.1
3 9 22.0
4 1 2.4
5 or more 6 14.6
No information - -
Total 41 1
4.2.8. Company Valuation Methods
Valuation methods are heavily used by fund managers during two points in the process: rst, when
evaluating the value of the participation that they tend to acquire in an investee company (investment) and
second, when calculating at which price the fund manager should sell its participation in its investment
(exit). Note that this process repeats every time a reinvestment takes place.
There are various methods that can be used to value a company and its very important to be aware
that, whatever the method, there will be differences in the perception of value on the part of the buyer
Table 4.10 Characteristics of Investment Committee Deliberations in the Selection Phase
Distribution of the number of times the investment committee analyzed business opportunities that received investments. Considers just fund
managers that reported average values. Does not include PIPEs. In total, 43 fund managers (30%) responded but not all of them responded to all
of the items.
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Chapter 4
and of the seller. This occurs because the assumptions that the buyer uses are not the same as those that
the seller deems appropriate. This fact doesnt invalidate the valuation methods used by either side, but it
underlines the need to keep in mind the assumptions used to reach these valuations. Doing it in this way,
its possible to understand the logic of the valuation and reach a consensus on the group of assumptions
made and the most appropriate valuation method for the situation.
It is important to differentiate between the valuations made when the investment is made and when the
investment is exited depending on the stage or type of business opportunity. When the fund manager is
looking at a Venture Capital investment opportunity, the valuation method used is more focused on less
quantitative methods. This happens because these companies are in the initial phase of their life cycle and
it is difcult to estimate free cashow to calculate the companys value. As a consequence, the Relative
Valuation Method is most used.
The principal methods considered in this work are: Relative Valuation, Internal Rate of Return, Replacement
Value, Discounted Cash Flow, Adjusted Present Value, and Market Value for publicly traded companies.
In Table 4.11 we have the principal valuation methods used by fund managers to quantify potential
investments. The Discounted Cash Flow Method was predominant with 52.1% of all valuations. This is a
relatively simple quantitative method. The next most common methods were the Market Value Method for
publicly traded companies and Others with 15.6% and 13.5% respectively. The least used methods were
the Replacement Value and Equity Method methods with 5.2% and 1.0% respectively.
Table 4.11 Valuation Methods
The table shows the number of valuations done before the business receives investments. The same business may have been evaluated more than
once. Responses furnished by 67 fund managers (47% of total) in 2009.
Valuation Method
Number of
Valuations
Total%
Discounted Cash Flow 50 52.1
Multiples 6 6.3
Adjusted Present Value 6 6.3
Replacement Value 5 5.2
Market Value 15 15.6
Equity Method 1 1
Other 13 13.5
Total 96 100
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4.2.9. Principal Problems Detected by Fund Managers during the Selection and Acceptance
of Proposals
As seen in Table 4.7, on average, around 1% of the proposals received by fund managers (through
In-House Prospecting, Third Party Leads and Spontaneous Candidates) manage to pass through all the
steps of the selection process and receive PE/VC investment. Next we will discuss some of the criteria which
affect the chances of a proposal being accepted.
Fund managers use diverse criteria to select investee companies. The principal obstacles to this process
are the difculty of obtaining information about a business, the value proposition and the characteristics
of the entrepreneur and his or her management team. Given the private nature of the business that they
conduct, fund managers are reluctant to provide information about portfolio companies. Thus, to make
a study of this aspect of the PE/VC process viable, assertive questions were used. In other words, fund
managers received a list of assertions and expressed the extent to which they agree or disagree with them.
The results of this analysis are presented in Tables 4.5 and 4.6 located under Section 4.2.2 (Analysis of
Investments and Deal Flow).
Initially, the demand for a signed condentiality agreement so that the project details do not become
exposed is an impediment for just 30% of fund managers (the assertion is we do not invest when the
entrepreneur demands that we sign a condentiality agreement before revealing details of the project). The
most important characteristics in evaluating the merits of a project are: 1) the absence of irregularities
in the business (the assertion is Fund managers do not invest when there are irregularities in part of or all
of the business) with 93% agreement; 2) veto power (the assertion is Fund managers invest when they
have veto power over key investee company decisions), with 93% agreement; 3) a seat on the board
of directors (the assertion is Fund managers invest when they have a seat or can nominate members for
a seat on the board of directors), with 93% agreement (These last two show the importance of having
participation in the companys decision making); and nally 4) reaching an initial accord on basic
terms of a shareholder agreement (the assertion is Fund managers do not invest when they have not
previously reached an accord on the basic terms of the shareholder agreement), with 87% agreement.
The least important characteristics are: 1) having received seed capital from angel investors ( the
assertion is Fund managers do not invest when the company has already received capital from angel
investors) with 0% agreement; 2) being a family run company (the assertion is Fund managers do not
invest in family companies), with just 1.7% agreement; 3) the company is far from the fund manager
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Chapter 4
location (the assertion is Fund managers do not invest when the investee company is more than 100km
from the fund manager), with just 13% agreement; and 4) control can be acquired (the assertion is
Fund managers invest when they can acquire control) with just 21% agreement. This shows that fund
managers do not insist on having control of the investee company, but do insist on inuencing and
wielding veto power in its important decisions.
4.2.10. Time Taken to Close New Deals
Table 4.12 shows the time taken to conclude the selection process and make the initial investment. The responses
were divided into four groups (quartiles) according to the average time to complete the process. The rst quartile
contains the fund managers that were fastest in terms of closing new deals. In this quartile, the fastest fund
manager conducted the selection process and closed the new deal in just one month. The slowest fund manager
in this group took an average of four months to complete this process. In this quartile, the fastest process took one
month, while the slowest took eight months. In the slowest group (fourth quartile) the process takes between ten
and twelve months. In this group, the fastest process took four months while the slowest took thirty-six months. It is
good to note that the time taken during this analysis does not necessarily reect on the capacity of the managers
to evaluate projects. Other factors, such as the investment focus (stage, region, sector, etc.) and negotiations over
acquiring control, veto power and the investment value also inuence the duration of this process.
Table 4.12 Time Taken to Close New Deals
Minimum, average, and maximum time, in months, taken for a project to pass through the selection process and receive its rst capital investment.
To classify quartiles, the fund managers were placed in order of average time. For each quartile, the minimum and maximum times per project are
indicated. The sample represents 88 fund managers (60% of total).
Time Taken in Each Quartile (months)
Quartile (ordered by average time) Minimum Average Maximum
1 (more agile) 1 1 to 4 8
2 2 4 to 7 10
3 3 7 to 10 12
4 (least agile) 4 10 to 12 36
4.3. Investment Activity and Structuring
The PE/VC industry concentrates its investments in companies with high potential returns, but with
greater risk and lower liquidity, thus being classied as alternative asset industry. This type of investment
172
normally has a low correlation with other securities (such as stocks and real estate securities, among
others), and the lower this correlation is, the greater is the probability that the total risk of a diversied
portfolio which contains them will diminish. In this way, the investor can nd a greater equilibrium between
risk and return by adding participation in a PE/VC fund to his or her portfolio. The result will be better
overall management of the investors portfolio so that it can reach maximum efciency.
Emerging markets are attracting the attention of PE/VC investors. A study done by EMPEA (2009) showed
that of 156 PE/VC investors around the world, 78% have already begun investing in emerging markets or have
plans to invest by 2013. Macroeconomic stability, the opening of the economy, and constitutional reform were
determining factors for investors choosing Brazil as one of the principal targets of this investment.
Brazil has an advantage in the eyes of investors in terms of its risk premium. According to the same
study by EMPEA (2009), Brazil was the only country in the region with a lower risk premium in 2009 as
compared to 2008 as can be seen in Table 4.13. Brazil appears as the most attractive market for those
investing in Brazil for the rst time.
Table 4.13 Increases in Risk Premiums by Country/Region
Country/Region 2009 2008 Increase in Risk Premium
Brazil 6.4% 6.9% -0.5%
China 6.4% 6.3% 0.1%
India 6.4% 6.1% 0.3%
South Africa 7.0% 6.4% 0.6%
Latin America (excluded Brazil) 7.0% 6.7% 0.3%
Middle East 7.3% 6.5% 0.8%
North Africa 8.0% 6.7% 1.3%
Central and Eastern Europe (incl. Turkey) 6.4% 5.0% 1.4%
Russia 8.4% 6.9% 1.5%
Sub-Saharan Africa (excl. South Africa) 8.4% 6.7% 1.7%
Other Asian Emerging Markets 6.7% N/A N/A
Source: EMPEA, 2009
As one can see, fund managers can be found in environments which currently are both very attractive and
present great difculties. To navigate through this environment successfully, a solid investment structure is
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Chapter 4
fundamental to reducing risk and maximizing return. In striving for this, some practices appear consistently:
1) a shareholder agreement to align their interests with those of the entrepreneur; 2) the right to choose
auditors as a way to guarantee the reliability of accounting data; 3) the naming of key executives such
as the nancial director or CEO; 4) the adoption of nancial instruments which permit the acquisition of
control or force the liquidation of the business if the investee company performance deteriorates or is well
below projections; 5) making investments gradually based on the companys meeting of pre-established
performance targets, giving the fund manager the option to desist if the company performance deviates
greatly from expectations, among other actions which seek to provide the greatest safety for the investment.
Next, we make a structural analysis of investments made, in order to understand their peculiarities and
essential characteristics.
4.4. Life of Investment Vehicles
The uncertainty associated with investments in general is directly related to the willingness of the
shareholder to contribute his or her capital, with the option of increasing the time its invested, and
the decisions of the managers. This is a characteristic that also contributes to the duration of these
investments. Investors need to know how information related to company activities can affect issues such
as the amount of capital to be invested over the duration of the investment, and when these decisions
should be taken (Lerner & Gompers, 2004).
The investment period is a great factor which differentiates PE/VC investments from traditional
investment funds (Bushrod, 2004). In PE/VC investments, the decisions made during the investment
process are strongly interrelated. The nature and the circumstances of the business and the company
that works in it, for example, tend to interfere with the rate of return and thus the investment duration.
Being a distinct type of security, its return curve is different from those of other types of securities. The
duration depends on the type of investment made as can be seen in Table 4.14.
Table 4.14 Investment Vehicles (Funds) and their Lifes
Life
2005 2009
Vehicles % Vehicles %
<5 0 0.0 8 4.40
5 and 6 9 9.28 18 9.89
174
7 and 8 24 24.74 49 26.92
9 and 10 33 34.02 58 31.87
12 and 20 7 7.22 8 4.40
>20 0 0.0 1 0.55
Not dened 24 24.74 40 21.98
Total 97 100.00 182 100.00(*)
The rst PE/VC industry census identied a majority of investment vehicles with durations from seven
to ten years. Looking at the evolution of these numbers in 2009, we can see this same concentration of
durations of seven to ten years, but with a greater number of vehicles with durations of seven or eight years.
Some vehicles have a longer life, like those dealing with infrastructure or public concessions, with time
frames of 12 to 20 years, and proportionately they diminished in frequency. However, quantitatively the
numbers remained practically the same. Another important aspect that we can see here is the number of
vehicles that do not have a dened time to maturity; these vehicles represented a smaller proportion of all
vehicles in 2009 as compared to 2005, showing a certain tendency to guarantee the vehicles liquidation.
4.4.1 Participation of Public Sector Investors
The Brazilian government has had a fundamental role in promoting the development PE/VC industry through
several of its vehicles and public policy instruments. In this area, we can highlight the large volume of nancial
resources allocated over the last few years by BNDES through BNDESPar, the seed capital support program Criatec,
the Financer of Studies and Projects (FINEP - The Brazilian Innovation Agency) through its Programa Inovar/Inovar
Semente, together with FINEP Forums, and the Brazilian Support Service for Micro and Small Companies (SEBRAE).
Table 4.15 Public Sector Investor Participation in Portfolio Companies (June 2008)
Sector
BNDESPar as manager BNDESPar as investor FINEP as investor
Total of ventures per
sector
Units % Units % Units % Units %
IT and Electronics 13 33 21 33 13 42 109 23
Metallurgical,
Mechanical, and
Electrical Supply
Industries
9 23 6 9 5 16 61 13
Real Estate - - 1 2 - - 60 12
Table 4.14 Investment Vehicles (Funds) and their Lifes
175
Chapter 4
Communications - - 2 3 1 3 32 7
Energy and Fuel - - 10 16 - - 29 6
Agribusiness 1 3 4 6 1 3 21 4
Financial
Services
- - - - - - 20 4
Biotechnology 6 15 4 6 - 13 20 4
Retail - 1 2 4 - 19 4
Food and
Beverages
5 13 1 2 - - 17 4
Pharmaceuticals,
Medicine and
Beauty
2 5 3 5 3 10 15 3
Telecom 4 10 2 3 3 10 13 3
Transport
Services
- - 5 8 - - 13 3
Logistics 1 2 - - 12 2
Education - - - - - - 9 2
Others - - 3 5 1 3 31 6
Total 40 100(*) 64 100(*) 31 100 481 100
Source: Ramalho, 2010
In Table 4.15 one can see that BNDESPar and FINEP invest directly or indirectly in 26% of the PE/VC industrys
total portfolio. In this way, considering that in Brazil those LPs as well as pension funds have active participation
on investment committees, government investment in the PE/VC industry is in fact an instrument in the promotion
of public policy. Thus, the presence of public agents in highly innovative sectors such as IT and Electronics,
Biotechnology, Pharmaceuticals, Medicine and Health Care besides strategic sectors or those with an infrastructure
focus like Energy and Oil, and Transport Services shows government promotion of high potential growth areas
of the Brazilian economy, especially areas associated with innovation and high impact entrepreneurship.
In the same way, its interesting to know that BNDESPar as a manager of PE/VC vehicles invested
in more than 8% of the industrys portfolio companies. Thus we can understand the PE/VC financing
of private companies as an important instrument used by the federal government to encourage the
capitalization of companies, to the extent that it not only invests in them but also manages vehicles
itself (The Entrepreneurial Capital Area of BNDESPar).
Table 4.15 Public Sector Investor Participation in Portfolio Companies (June 2008)
176
In total, the Brazilian government invested in more than 40 vehicles managed by 28 fund
managers, which corresponded to 20% of all industry vehicles in June 2008 (Ramalho, 2010).
According to Ramalho (2010), Brazilian government investment in PE/VC is part of a national effort
that has accelerated in the years since 2000, leveraged by economic stability and growth.
Next, we analyze the history of the main government PE/VC investment vehicles and instruments.
4.4.2.BNDES The National Bank of Social and Economic Development
BNDESs PE/VC investments have increased since the 1980s as part of a public policy to strengthen
Brazilian companies. The merger of FIBASE, IBRASA and EMBRAMEC (subsidiaries of BNDES) led to
the origin of BNDESPar, which was instituted to capitalize private companies in accordance with the
plans and policies of BNDES: to support companies noted for economic, technological and managerial
efciency, seeking returns compatible with the risks of the investments; to develop innovative technological
ventures; to stimulate the capital markets through the wider availability of securities to democratize
shareholder ownership, as well as administer its own portfolio companies and those of third parties.
In 2008, BNDES created the Fund Program to make investments worth R$ 1.5 billion in eight Equity
Participation Funds (FIPs) and two Emerging Company Mutual Funds (FMIEEs). Up until now, ve fund
management companies have been selected to manage BNDES sponsored funds in the agribusiness,
bioenergy, petroleum and gas, biotechnology, nanotechnology, and logistics infrastructure sectors. In this
way, this public company seeks to disseminate best practices in corporate governance and entrepreneurial
capital culture.
4.5. Distribution of Investments
In 2009, a sample of 95 PE/VC investee companies was obtained comprehending new investments (71)
and follow-ons (24). Total PE/VC investment in Brazil totaled US$ 3.1 billion in 2009 which represented
0.17% of GDP. This total covers various types of PE/VC investments made by fund managers (traditional
PE/VC, corporate ventures, infrastructure funds, real estate funds and forestry-timber funds), not including
governmental investments (BNDESPar). Thus in all graphs and tables of Section 4.5 all gures refer to non-
govermnental, private sector fund management investing activity.
177
Chapter 4
4.5.1. Distribution by Stage
Fund manager portfolios, as indicated in Graph 4.1, are no longer made up of just more mature
companies. According to Graph 4.1 even though Private Equity investments still represent the largest
part of investments with 41%, the Venture Capital stages (Early Stage and Later Stage) represent a
substantial 31% of all deals made. This denotes an important concentration during the initial and
intermediate stages of entrepreneurial development guaranteeing the consolidation of the links that
permit the sustained growth of the industry over the long term. The stages Startup and Seed together
represent 15%, the Greeneld stage represents 5%, and Mezzanine represents 4%. Last were the PIPE
and Distressed investments representing respectively 3% and 1% of all investments made during the year
in question. Its interesting to note the similarity in the gures for investments in emerging companies
classied as VC or Seed Startup (46%) and those in more mature companies in the PE stage (41%).
Graph 4.1 Number of Investments Made by Private Equity Fund Managers by Stage of
Investment
Considers all new investments (71) and follow-ons (24) during these period, out of a sample of 95 investee companies (100%) and 45 fund managers (30%).
1% 3%
4%
5%
15%
31%
41%
PE (Growth and Later Stage)
VC (Early and Later Stage)
Seed/Start-up
Greenfield
Mezanine
PIPE
Distressed
However, when we separate new investments from follow-ons, the scenario becomes a bit different. Even
though they continue to exhibit the same order in terms of size (Private Equity is the stage with the largest
number of investments and Distressed the smallest), the relative quantities for each one are slightly different.
As we can see in Graph 4.2, 39% of new investments are in the Private Equity stage and 32% in Venture
Capital stages. Together they represent two thirds of observed investments. Next come the Startup and Seed
stages which were 1percent higher with a total of 14%. The Greeneld stage was 6% and the least frequent
were PIPE, Mezzanine and Distressed with 4%, 3% and 1% respectively.
178
Graph 4.2 Number of New Investments Made by Private Equity Fund Managers by Stage
Considers all new investments made during the period, with a sample of 71 investee companies (75%) from 33 respondents (23%). Difference
appear due to rounding.
1% 3%
4%
6%
14%
32%
39%
Seed/Start-up
Greenfield
Mezanine
PIPE
Distressed
Now considering follow-on investments the scenario is different than the other two analyzed above.
Graph 4.3 below shows an increase in the Private Equity stage as compared to the results for new
investments (39%). Using this same basis for comparison, the percentage of follow-on investments in the
Venture Capital phases was smaller (25%) when compared to the results for new investments.
This is due to the fact that many companies which found themselves in the initial stage of development
(Venture Capital) when they received their rst allocation of capital (new investments) can be in a more
advanced phase when they receive more investment (follow-ons). In this way, it would be expected that
there would be an increase in the Private Equity phase and a decrease in the Venture Capital phase in this
follow-on group.
The other stages showed few alterations in their relative quantities. The Startup and Seed stages
represented 17% of the total. The Greeneld, Mezzanine and PIPE stages each represented 4%. There
were no investments in Distressed companies in this sample. In total 24 follow-on investments were
analyzed for the year 2009.
179
Chapter 4
Graph 4.3 The Number of Follow-On Investments Made by Private Equity Fund Managers by Stage
Considers all follow-on investments during this period, with a sample of 24 business (25%) from 12 respondents (8%).
4%
17%
25%
46%
Seed/Start-up
Greenfield
Mezanine
PIPE
Distressed
4%
4%
However, this scenario changes drastically when investment stages are analyzed in relation to the
amount of capital invested. The Private Equity group represented more than two thirds of all capital
invested in this sample. According to Graph 4.4, this stage represents 72% of the total invested in
these 95 investments in 2009.
This result was to be expected, because as we can see from Table 4.17, the average ticket of Private
Equity investment was the second largest in absolute value (US$ 73.4 million). Besides this, this stage
represents the largest number of investments in the industry. This is the reason it represents such a
large portion of the investments made in terms of total capital invested.
The Seed and Startup stages follow in second place in terms of amount invested. These stages totalled
7% of all capital invested. This result follows the same logic as the explanation for the Private Equity
stage. Even though the average ticket for Seed and Startup investments was not very large, the number
of investments was (15%). In this way the product of multiplying the number of these investments by their
average ticket value gave the second largest total in terms of overall capital. The Mezzanine stage also
represented 7% of the total capital invested in 2009. PIPE investments followed with 6%, followed by
Greeneld and Venture Capital with 3% apiece and nally Distressed with 2% of all capital invested.
180
Graph 4.4 Value of Total Investments Made by Private Equity Fund Managers by Stage
Considers all new follow-on investments during this period with a sample of 78 investments (82%).
2%
7%
72%
Seed/Start-up
Greenfield
Mezanine
PIPE
Distressed
6%
3%
3%
7%
Table 4.16 Average Ticket by Stage of Investment
Considers 77 investments with declared value and stage (81%)
Stage
Average Ticket
(US$ Millions)
Number of
Investments
Seed/Startup 0.4 12
Venture Capital 4.4 22
Greeneld 46.6 6
Mezanine 50.2 4
Distressed 64.4 1
Private Equity 73.4 30
PIPE 91.8 2
Total 39.4 77
Also observe (Table 4.17) that PIPE investments are easily the largest in terms of average ticket
value (US$ 91.8 million). As mentioned above, Private Equity comes in second with an average of
US$ 73.4 million. The stages Distressed, Mezzanine, Greeneld, Venture Capital (Early Stage and
Later Stage) and lastly Seed/Startup follow. This analysis is based on looking at stages in relation to
all investments made in 2009. When we analyze new invesments and follow-ons separately we get
different results.
181
Chapter 4
As Graph 4.5 shows, Private Equity continues to represent the largest proportion of newly invested
capital with 67%, followed by Seed/Startup with 9%, Mezzanine with 8%, PIPE with 6% and Greeneld
with 4%. Finally, the Venture Capital and Distressed stages each represented 3%.
Graph 4.5 Value of New Investments Made by Private Equity Fund Managers by Stage
Sample of 56 new companies invested in 2009 (79% of total).
3%
8%
67%
VC (Early and LaterStage)
Mezanine
PIPE
Greenfield
Seed/Star-up
Distressed
6%
4%
3%
9%
Considering follow-on investments, the Private Equity stage represents 88% of all capital invested
in 2009. Following this are the PIPE phase with 6%, Venture Capital with 4% and Mezzanine with 1%.
The Startup/Seed and Greeneld phases represented percentages too small to be shown in the graph.
In Graph 4.6 we can see the differences when we analyze follow-on investments separately.
Graph 4.6 Value of Follow-On Investments Made by Private Equity Fund Managers by Stage
Considers all follow-ons during the period, with 22 investments (92%). Difference appear due to rounding.
4%
88%
Mezanine
1%
6%
182
4.5.2. Sectoral Distribution
The IT and Electronics sector was rst with 15% of the number of investments made during this period,
followed by the Energy and Oil sector with 15% as well, Pharmaceuticals/Medicine/Beauty (11%) and
Agribusiness (8%). The representation of the IT and Electronics sector rose marginally from 14% in the
period from 2005 to 2008 to the 15% registered in 2009.
The Communications sector, which during the years from 2005 to 2008 represented 9% of all
investments, fell to 1% in 2009. In the same way, the Civil Construction/Real Estate sector diminished its
participation in the number of investments from 18% in the years from 2005 to 2008 to 4% in 2009 as
can be seen in Graph 4.7.
The Energy and Oil sector, which during the years from 2005 to 2008 represented 11% of all
investments, rose to 15% in 2009.
Graph 4.7 Number of Investments Made by Private Equity Fund Managers by Sector (2009)
Considers all new investments (71) and follow-on investments (24) during this period, with a sample of 95 investments (100%) from 45
responding fund managers (30%). The Miscellaneous Industries sector includes the following types of industry: Chemical, Mechanical,
Electric, Metallurgical, Packaging, and Textile. Difference appear due to rounding.
IT and Eletronics
Energy and Oil
Pharmaceuticals/Medicine/Beauty
Agribusiness
Miscellaneous Industries
Transport Services and Logistics
Biotechnology
Retail
Financial Services
Entertainment/Tourism
Civil Construction/Real State
Education
Raw Materials
Extractive Industry
Infrastructure
Communications
15%
15%
11%
8%
7%
6%
6%
5%
4%
4%
4%
4%
3%
2%
2%
1%
1%
0% 23% 4% 6% 8% 10% 12% 14% 16%
Food and Beverage
183
Chapter 4
Graph 4.8 Total Number of Investments Made by Private Equity Fund Managers by Sector (2005 - 2008)
Considers all new investments and follow-on investments during the period, based on a sample of 394 investments (100%). Difference appear due
to rounding.
18%
14%
11%
9%
8%
5%
3%
2%
1%
1%
0% 4% 6% 8% 10% 12% 14% 16% 18%
IT and Eletronics
Energy and Oil
Communications
Agribusiness
Retail
Food and Beverage
Financial Services
Education
Infrastructure
Biotechnology
Raw Materials, Paper and Celulose
1%
1%
3%
3%
3%
3%
15%
2% 20%
When we consider new investments made, we can see that IT and Electronics represented the largest
portion with 14% of the total, followed by Energy and Oil and Pharmaceuticals/Medicine/Beauty with 13%
and 11% respectively. At the other extreme is the Infrastructure sector which represented just 1% of the total
as indicated in Graph 4.9.
Graph 4.9 Number of New Investments Made by Private Equity Fund Managers by Sector
(2009)
Considers all new investments during the period, using a sample of 71 investments (75%) by 33 fund managers (23%). The Miscellaneous Industries sector includes
the following types of industry: Chemical, Mechanical, Electric, Metallurgical, Packaging, and Textile. There were no new investments in the Communications and Raw
Materials sectors in 2009.
14%
13%
11%
10%
7%
6%
4%
4%
4%
3%
1%
0% 4% 6% 8% 10% 12% 14% 16%
7%
7%
6%
3%
1%
IT and Eletronics
Energy and Oil
Miscellaneous industries
Miscellaneuous Services
Transports Services and logistics
Agribusiness
Retail
Financial Services
Education
Biotechnology
Food and Beverage
Infrastructure
184
In relation to the entire Census period from 2005 to 2008, the representation of IT and Electronics rose
from 13.4% to 14% as a proportion of total new investments. Energy and Oil rose from 9.6% to 13%.
Miscellaneous Services went from no representation from 2005 to 2008 to 7% of new investments in 2009.
Graph 4.10 Number of New Investments Made by Private Equity Fund Managers by Sector (2005 - 2008)
Considers all new investments during the period, with a sample of 343 investments (87%).
13,4%
9,6%
9,0%
7,0%
5,2%
2,9%
2,3%
0% 6% 8% 10% 12% 14% 16%
3,5%
3,2%
2,6%
1,5%
1,5%
1,2%
0,6%
0,3%
17,5%
18,7%
2% 4% 18% 20%
IT and Eletronics
Energy and Oil
Communications
Agribusiness
Retail
Food and Beverage
Financial Services
Education
Infrastructure
Biotechnology
Raw Materials, Paper and Celulose
As can be seen in Graph 4.11, in relation to follow-on investments made in 2009, the Energy and Oil sector
stood out with 21% of all investments. The IT and Electronics sector and the Agribusiness sector represented
17% and 13% respectively of all of these investments in 2009. The other extreme is represented by the
Communications sector which dropped to 4% after representing 6.7% for the period from 2005 to 2008.
Graph 4.11. Number of Follow-On Investments Made by Private Equity Fund Managers by Sector (2009)
Consider all follow-on investments during this period, using a sample of 24 business (25%) from 12 respondents (8%). There were no new investments on
sectors of Food and Beverage, Education, Miscellaneous Industries, Infrastructure, Financial Services and Retail in 2009. Difference appears due to rounding.
Energy and Oil
IT and Electronics
Agribusiness
Raw Materials
Biotechnology
Communications
21%
17%
13%
8%
8%
8%
8%
4%
4%
4%
4%
0% 5% 10% 15% 20% 25%
185
Chapter 4
Graph 4.12 Number of Follow-On Investments Made by Private Equity Fund Managers by
Sector (2005 2008)
Considers all follow-on investments during this period, using a sample of 45 investments (15%).
0% 5% 10% 15% 20% 25%
IT and Electronics
Retail
Energy and Oil
Agribusiness
Civil Construction/Real Estate
Communications
Education
Infrastructure
Biotechnology
Food and Beverage
6,7%
8,9%
17,8%
20%
22,2%
4,4%
2,2%
2,2%
2,2%
2,2%
2,2%
2,2%
6,7%
Even though it represented just 1% of all capital invested in 2009, the IT and Electronics sector represented
15% of all investments made. This was because most of these investments were in the Venture Capital
segment which had a relatively low average investment ticket (US$ 4.41 million).
Graph 4.13 Value of all Invesments Made by Private Equity Fund Managers by Sector (2009)
Considers all follow-on investments during this period, using a sample of 78 investments (82%) made by 37 fund managers (26% of total).

1%
1%
1%
1%
1%
1%
1%
1%
3%
5%
5%
6%
9%
10%
54%
0 10% 20% 30% 40% 50% 60%
Civil Construcon/Real State
IT and Electronics
Other Industries
Retail
Food and Beverages
Pharmaceucal/Medical/Aesthecs
Other Services
Infrastructure
Agribusiness
Educaon
Transportaon and Logiscs Services
Extracve Industries
Financial Services
Energy and Oil
186
The Civil Construction/Real Estate sector, which represented 15% of the capital invested from 2005 to
2008, fell to 1% in 2009. In the same way, the IT and Electronics sector, which represented 5% of all capital
invested from 2005 to 2008, fell to 1% in 2009.
Graph 4.14 Value of all Investments Made by Private Equity Fund Managers by Sector (2005 - 2008)
24%
15%
14%
11%
11%
5%
5%
3%
3%
3%
2%
2%
1%
0% 5% 10% 15% 20% 25% 30%
Food and Beverages
Unidentified
Financial Services
Retail
Energy and Oil
IT and Electronics
Education
Agribusiness
Pharmaceutical/Medicine/Beauty
Communications
Infrastructure
Biotechnology
Communications
Analyzing new investments, the most noticeable difference between the two periods is in the Energy and Oil
sector which went from 5% to 54% of the value of all new investments in 2009. The Retail sector fell from 12%
to 1% of all new investments in terms of amount invested.
Graph 4.15 Value of New Investments Made by Private Equity Fund Managers by Sector (2009)
Considers all new investments during the period, using a sample of 56 investments (79%) made by 33 fund managers (23% of total).
1%
1%
1%
1%
1%
1%
2%
3%
6%
6%
10%
13%
54%
0 10% 20% 30% 40% 50% 60%
Biotechnology
IT and Electronics
Retail
Food and Beverage
Infrastructure
Agribusiness
Education
Transportation and Logistics Services
Entertainment/ Tourism
Financial Services
Energy and Oil
187
Chapter 4
Graph 4.16 Value of New Investments Made by Private Equity Fund Managers by Sector (2005
- 2008)
0% 5% 10% 15% 20% 25% 30%
24%
15%
15%
12%
12%
5%
3%
3%
3%
3%
2%
2%
1%
Food and Beverages
Unidentified
Financial Services
Retail
Energy and Oil
Education
Pharmaceutical/Medicine/Beauty
IT and Electronics
Agribusiness
Communications
Infrastructure
In relation to follow-on investments, the Energy and Oil sector had a negligible participation from
2005 to 2008. Suddenly in 2009 its participation soared to 55% in terms of value invested. Agribusiness
meanwhile fell from 9% to 2% of capital invested in follow-on investments.
Graph 4.17 Value of Follow-On Investments Made by Private Equity Fund Managers by Sector (2009)
Considers all follow-on investments during this period, using a sample of 22 investments (92%) made by 10 fund managers (7% of total).
Energy and Oil
Raw Materials
Enterteinment/Tourism
Pharmaceutical/Beauty
Agribusiness
0% 10% 20% 30% 40% 50% 60%
55%
28%
5%
4%
3%
2%
2%
1%
188
Graph 4.18 Value of Follow-On Investments Made by Private Equity Fund Managers by Sector (2005 - 2008)
Raw Materials, Paper and Cellulose
Communications
Retail
Food and Beverages
Agribusiness
Education
5% 10% 15% 25% 30%
24%
22%
21%
18%
9%
6%
20%
4.6 Characteristics of Portfolio Companies
4.6.1. Distribution by Stage
Graph 4.19 shows stages of the portfolio companies for the vehicles reported in our research as of December
2009. It can be seen that the most common stage was Private Equity Growth with 36.5% representation,
followed by Venture Capital Early Stage at 20.9%. The number of portfolio companies in the Seed stage
diminished when compared with the data from December 2004, declining from 11.8% to 7.6%. The number
of companies in the PIPE stage also declined from 14.2% to 6.2% of the total. Its important to note that 46.6%
of investee companies are in the VC (Early and Later Stage) and Startup/Seed stages.
Graph 4.19 Distribution of Investee Companies by Stage (2009)
Distribution by stage of the 436 portfolio companies in this research. A total of 502 companies were reported, but only 436 specied the investment
stage. Difference appear due to rounding.
PE - Growth
VC - Early
Start-up
Seed
PE - Later Stage
PIPE
VC-Later stage
Mezanine
Greenfield
Distressed
36,5%
20,9%
13,1%
7,6%
6.2%
5.0%
2,1%
1,6%
0,2%
6,2
10% 20% 30% 40% 0%
189
Chapter 4
4.6.2. Geographic Distribution
Table 4.17 shows the geographic distribution by state of portfolio companies in 2009. As expected,
the Southeastern region holds 80% of portfolio companies, representing a 200% increase in the
number of investments in this region relative to the rst census (Dec. 2004). The State of So Paulo
stands out because it contains more than half of the portfolio companies. This is one reason why the
Southeastern region continues to be the region with the most PE/VC investments.
The Southern region declined in terms of the number of portfolio companies in the region as compared
to the census in 2004. In 2009 it had 11.2% of portfolio companies as compared to 27.3% during the rst
census. A fall in investments in Rio Grande do Sul and Santa Catarina was the principal reason for this
result, because the State of Paran increased its number of investments. The Central-Western region also
suffered a reduction in the number of companies in its territory, but not one as extreme as the Southern
region. The Northeastern and Northern regions increased the number of investments in their territories,
especially in the States of Penambuco, Cear, Rondnia and Amazonas.
Table 4.17 Geographic Distribution of Portfolio Companies (December 2009)
Geographic distribution for 484 portfolio companies that participated in the study. Note that of 502 total portfolio companies, only 484 specied an
investment stage. There were 2 companies that did not specify a stage in 2004 and 18 in 2009.
State
2004 2004
Number of Compa-
nies (2009)
Percent Valid (2009)
Number of Compa-
nies
Percent Valid
Southeast
SP
127 41.8 274 56.6
RJ
39 12.8 75 15.5
MG
28 9.2 34 7.0
ES
1 0.3 4 0.8
Sub Total
195 64.1 387 80.0
South
PR
15 4.9 24 5.0
RS
38 12.5 18 3.7
SC
30 9.9 12 2.5
Sub Total
83 27.3 54 11.2
Northeast
190
PE
5 1.6 9 1.9
CE
3 1.0 8 1.7
BA
5 1.6 5 1.0
MA
- - 3 0.6
PI
- - 2 0.4
RN
2 0.7 2 0.4
PB
1 0.3 1 0.2
Central West
GO
3 1.0 3 0.6
MS
1 0.3 2 0.4
DF
4 1.3 1 0.2
Sub Total
16 5.3 30 6.2
4.6.3. Sectoral Distribution
The 502 portfolio companies were spread throughout 17 sectors as described in the following table.
Similar to what happens in other countries, Table 4.18 shows that the IT and Electronics sector represents
the largest number of portfolio companies (20.5%). Even though the number of portfolio companies in
this sector rose from 92 to 103 (an increase of approximately 12%), its relative proportion decreased
due to an increase in investment in other sectors, principally civil construction. The Energy sector also
increased its participation reaching 11.2%, increasing more than 100% in relation to 2005. This occurred
principally because of the demand for energy that has been growing in this country.
Another important discovery is that the Civil Construction/Real Estate sector has increased its
participation. Fed by a reduction in interest rates and the increase in real estate nancing offered by the
government and private sector, it rose to represent 13.7% of all portfolio companies in 2009. Over the last
ve years this sector has been in the top ve sectors in terms of portfolio company representation. All
of this can be observed in the table below along with the data for other sectors that represented PE/VC
portfolio companies in 2009.
Table 4.17 Geographic Distribution of Portfolio Companies (December 2009)
Geographic distribution for 484 portfolio companies that participated in the study. Note that of 502 total portfolio companies, only 484 specied an
investment stage. There were 2 companies that did not specify a state in 2004 and 18 in 2009.
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Chapter 4
Table 4.18 Economic Sectors of Portfolio Companies in 2009
Distribution of portfolio company sectors as of December 2009. In total there were 502 investee companies. Miscellaneous Industries sector includes
the following types of industry: Chemical, Mechanical, Electric, Metallurgical, Packaging and Textile. Miscellaneous Services sector includes the
following types of services: Call Center, Consulting and Others.
Macrosector Number of Companies in
Portfolio
Percent Valid
IT and Electronics 103 20.5
Civil Construction/Real State 69 13.7
Energy and Fuel 56 11.2
Miscellaneous Industries 55 11.0
Communications 33 6.6
Retail 26 5.2
Agribusiness 25 5.0
Transport Services and Logistics 20 4.0
Food and Beverages 19 3.8
Infrastructure 19 3.8
Financial Services 16 3.2
Pharmaceuticals/Medicine/Beauty 15 3.0
Biotechnology 14 2.8
Miscellaneous Services 10 2.0
Education 8 1.6
Entertainment/Tourism 7 1.4
Raw Materials Industries 7 1.4
Total 502 100.0%
Chapter 5
The Private Equity and Venture Capital Cycle - Exiting
195
Chapter 5
5.1. PE/VC Exits in Brazil
Successful exits from investments are critical to ensuring attractive returns for investors, to constructing a
track record and raising funds for new vehicles by fund managers. Even though the exit is the last phase
of the cycle, it is extremely important to ensure the health of the other phases of the PE/VC cycle, which as
weve just seen through this census, is an interactive process.
A great example of this process is what occurred in Europe between the end of the 1980s and the beginning
of the 1990s. The development of the secondary market in various European nations made exits and the
subsequent fundraising for new investment vehicles viable during this period (Gompers and Lerner, 2004).
To a certain extent and given its proportions, the Brazilian market passed through a similar situation
between the rst census in 2004 and the sub-prime nancial crisis of 2008, during which a strong
acceleration of the Brazilian capital markets made IPO exits viable replacing the predominance of strategic
sales and stimulating PE/VC fundraising as we saw in Chapter 3.
5.1.1. Stages
Table 5.2 shows a retrospective of the investment exits made in the industry classied by the stages of
the exiting companies. Its important to distinguish between the number of investments and the number of
investee companies because one company can receive investment from two PE/VC fund managers (which
can act as co-investors in the same company) and this is counted by the Census as two investments. For
the period from 2005 to 2008 we obtained a sample of 180 Exits or Divestitures (113 total and 67 partial)
in which 34% were in the Venture Capital stage and 42% in the Private Equity stage.
In 2009 we obtained a sample of 41 divestitures (31 total and 10 partial) reported by 22 fund managers.
Over half of these exits were during the Private Equity stage and 34% during the Venture Capital stage.
In addition, Table 5.1 identies 180 divestitures (total and partial) between 2005 and 2008 and
the values were given for 175 of them totalling US$2.3 billion. Of the 41 divestitures (total and
partial) in 2009, values were obtained for 32 of them totalling US$ 2.96 billion. Companies in the
Venture Capital stage represented 12% of the value of these exits, Private Equity represented 85% and
The Private Equity and Venture Capital Cycle - Exiting
196
Mezzanine represented 1%. Even though there are a large quantity of Venture Capital exits, their total
monetary value is lower because their average tickets are lower than Private Equity exits. In 2009 the
average ticket of VC stage exits was US$1.4 million, compared to US$130 million for Private Equity.
It should be noted that, compared to previous years, there were large PE exits in 2009 of companies
such as Brasil Telecom, BR Malls, DASA, Hypermarcas, Tivit and Zamprogna Comrcio e Indstria.
Table 5.1 Investment Exits by Stage In US$ Millions
Value of exits (total and partial) made according to phase of exited company. The sample includes 180 divestitures (113 total and 67 partial from
2005 to 2008 and 41 divestitures (31 total and 10 partial) in 2009 where there was information about the type of exit.
Stage 2005 2006 2007 2008 2009
Seed 0 1 0 1 0
Start-up 0 0 0 4 0
VC - Early Stage 1 1 9 14 5
VC - Later Stage 0 0 0 0 14
PE Growth 1 120 207 143 861
PE - Later Stage 23 416 263 463 2,004
Mezzanine 0 0 1 1 18
PIPE 169 346 97 38 0
Greeneld 0 0 0 0 0
Distressed 0 0 0 0 59
Total 194 884 577 664 2,961
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Chapter 5
Table 5.2 Investment Exits by Stage
Number of exits ordered by the investee company stage. Total exit signies the sale of all of fund managers participation in the company and all of owned assets of
this company. In case this has occurred through several partial exits, the last transaction was considered the total exit and the others partial ones. Values in parentheses
represent percentage of total. Sample includes 180 divestitures (113 total and 67 partial) from 2005 to 2008 and 41 divestitures (31 total and 10 partial) in 2009 with
information about the stages of companies exited.
Stage
Year
2005 2006 2007 2008 2009
Total Investment Exits
# % # % # % # % # %
Seed 0 0 2 8.0 0 0 2 4.3 0 0
Start-up 0 0 1 4.0 0 0 4 8.7 1 3.23
VC - Early Stage 3 27.3 2 8.0 11 35.5 13 28.3 10 32.26
VC - Later Stage 0 0 0 0 0 0 0 0 2 6.45
PE Growth 3 27.3 5 20.0 4 12.9 6 13.0 5 16.13
PE - Later Stage 2 18.2 8 32.0 11 35.5 11 23.9 11 35.48
Mezzanine 0 0 0 0 0 0 0 1 3.23
PIPE 3 27.3 7 28 5 16.1 10 21.7 0 0
Greeneld 0 0 0 0 0 0 0 0 0 0
Distressed 0 0 0 0 0 0 0 0 1 3.23
Subtotal (total exits) 11 25 31 46 31 100
Partial Investment Exits
# % # % # % # % # %
Seed 0 0 0 0 0 0 1 3.2 0 0
Start-up 0 0 0 0 0 0 3 9.7 0 0
VC - Early Stage 3 37.5 1 9.1 3 17.6 13 41.9 1 10
VC - Later Stage 0 0 0 0 0 0 0 0 0 0
PE Growth 3 37.5 4 36.4 4 23.5 4 12.9 2 20
PE - Later Stage 1 12.5 2 18.2 3 17.6 4 12.9 4 40
Mezzanine 0 0 2 18.2 2 11.8 2 6.5 1 10
PIPE 1 12.5 2 18.2 3 17.6 3 9.7 1 10
Greeneld 0 0 0 0 2 11.8 1 3.2 0 0
Distressed 0 0 0 0 0 0 0 0 1 10
Subtotal (partial exits) 8 11 17 31 10 100
Overall Total (partial+total) 19 36 48 77 41 -
198
5.1.2. Types of Exits
Table 5.3 shows a retrospective of investment exits made in the PE/VC industry. Note again that the
number of investments exited is not the same as the number of companies exited as was explained
before. During the period from 2005 to 2009 the most common types of exits were: Buybacks, followed
by Secondary Public Sales, Trade-Sales and IPOs. This industry conguration also reects the period
of the nancial crisis, when IPOs were not protable. This explains why there were more Buybacks
and Trade-Sales and fewer IPOs. Also note that write-offs represented just 10% of all exits. Buybacks
quintupled in 2008. The most important conclusion is that in 2007 Trade Sales surpassed Secondary
Sales. This number is very important, because it indicates an increase in strategic buyers, a maturation
of the Brazilian industry and greater earning potential for PE/VC fund managers. The year 2007
marked the peak of exits through IPOs (19), showed the maturity of the Brazilian PE/VC industry and
also showed that fund managers were capable of completing the full investment cycle. Table 5.3 shows
that 2009 was the year with the largest reported monetary value for the industry. This greatest value was
for Trade Sales, or in other words a sale to a strategic buyer.
Graph 5.1 Investment Exit Types
Note: Sample included 151 divestitures (107 total and 44 partial) for the period from 2005 to 2008 and 37 divestitures (30 total and 7 partial) in
2009 with information about the exit type. The number of exits listed by stage of exited company. Total exit signies the sale of all of fund managers
participation in this company and all assets of this company. In case this has occurred through several partial exits, the last transaction was considered
the total exit and the others partial ones.
70
60
50
40
30
20
10
0
2005 2006 2007 2008 2009
IPO Secondary Trade Buyback Write-off
24
1
4
6
8
42
3
4
6
12
17
48
4
3
12
10
19
61
2
15
27
16
1
37
4
8
11
10
4
5

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Chapter 5
Table 5.3 Values of Investment Exits by Type in US$ Millions
Values of exits by exit type. Sample includes 151 divestitures (107 total and 44 partial) from 2005 - 2008 and 37 divestitures (30 total
and 7 partial) in 2009 with information about exit type.
Exit Type 2005 2006 2007 2008 2009
IPO 0 380 130 0 273
Secondary Public Sale 180 484 336 228 772
Trade Sale 2 9 104 338 1,825
Secondary Private Sale 0 0 4 3 13
Buyback/Amortization 13 14 2 97 20
Write-off 0 1 0 0 59
TOTAL 195 888 576 666 2,962
5.1.3. Sectors
In the period from 2005 to 2008 there were 181 reported divestitures with sector information, and
22 fund managers reported 40 divestitures in 2009.
The largest number of divestitures was registered in the IT and Electronics sector with 52 divestitures, representing
29% of the total, a sector that, with the coming of the Internet and more recently social networks and companies
like Facebook, has attracted a lot of attention and nancial resources. The sector includes software, hardware,
the Internet and other technologically based mini-sectors. In second place, with 34 divestitures representing 19%
of the total was the Miscellaneous Industries sector. This sector represents the traditional areas of the Brazilian
industrial base such as the Metallurgy, Automobiles, the Chemical Industry, Textiles, etc. The Communications
sector was the third sector in terms of divestitures with 9% of the PE/VC industry total.
200
Graph 5.2 Total Number of Exits by Sector (2005 2008 Vs. 2009)
Total number of divestitures per sector between 2005 and 2008 and in 2009. In 2009, the sample consisted of 40 divestitures made by 20 fund
managers.
4%
1%
1%
4%
4%
3%
3%
1%
9%
3%
2%
2%
22%
5%
4%
6%
27%
0%
0%
0%
3%
3%
3%
3%
3%
5%
5%
5%
5%
8%
8%
8%
10%
35%
0 0,05 0,1 0,15 0,2 0,25 0,3 0,35 0,4
Agribusiness
Entertainment / Tourism
Infrastructure
Biotechnology
Retail
Pharmaceucals/Medicine/Beauty
Transport Services and Logiscs
Raw Material, Paper and Celulose
Communicaons
Foods and Beverages
Educaon
Energy and Oil
Financial Services
Civil Construcon / Real Estate
IT and Eletronics
2009 2005 to 2008
In monetary terms, the IT and Electronics sector falls to 3rd position in 2009 and 5th position for the
years 2005 to 2008, since these companies are not very capital intensive and thus the monetary values
are lower and most of the time they are in the Venture Capital stage. Nonetheless, it was the sector with
the most divestitures in both periods and was followed by the Miscellaneous Industries sector during the
period from 2005 to 2008. This intensity of business in the Miscellaneous Industries sector indicates that
PE/VC culture is becoming present in the most traditional of Brazilian economic sectors.
201
Chapter 5
Graph 5.3 Total Value of Exits per Sector (2005 2008 vs. 2009)
Note: This sample for 2005-2008 includes 180 divestitures (113 total and 67 partial) of which 41 divestitures (31 total and 10 partial) had
sector information reported. Miscellaneous Industries included divestitures in the Chemical, Metallurgy, Electrical, Packaging and Textile industries.
1%
0%
2%
6%
12%
3%
50%
13%
0%
1%
2%
5%
9%
15%
33%
35%
0 0,1 0,2 0,3 0,4 0,5 0,6
Biotechnology
Financial Services
Foods and Beverages
Civil Construcon/Real Estate
Pharmaceucal/Medicine/Beauty
IT and Eletronics
2009 2005 a 2008
Communicaons
5.2. Returns
In this section we will cover the general characteristics of PE/VC returns. How are these returns measured?
How do returns behave in different situations? How can we compare PE/VC returns with those of other
classes of assets? What are the benchmarks used by the PE/VC industry and in what way may they be used?
5.2.1. Understanding the J-Curve and Compound Returns
PE/VC is a very distinct class of assets compared to all others. The most explicit difference is that annual
returns cannot be used as a guide to calculate PE/VC performance, when annual returns are generally the
most signicant guide for evaluating other classes of assets. The reason why annual returns are not a good
tool to measure PE/VC returns is one more indication that it is very different from other classes of assets.
A PE/VC investment represents a series of cash ows. This could be buying a class of debentures, however
there is an enormous difference between the two. While a debenture only has one negative cash ow on the
day when the purchase is made, and then has a series of positive cash ows (or periodic coupons and then
nally its face value), a PE/VC investment will have a series of negative cash ows as investments are made by
the fund manager and the timing and values of these investments is unknown. In the same way there will be
a series of positive cash ows as the fund manager distributes the gains realized on the investment which also
will be unknown before they occur. The return made by the fund manager can only be calculated after the fact.
202
This should make clear why annual returns do not make sense for PE/VC investments, because this
depends on the positive cash ow of the fund manager which will vary from year to year and is impossible
to predict. This is why a calculation using compound returns over time, the Internal Rate of Return (IRR), is
used to analyze PE/VC fund performance. But do we try to use this at the initial stage of the investment?
To answer this we need to use the J-curve concept.
The J-curve, or hockey stick, is designed to look at an investment vehicles accumulated returns
year after year. Every PE/VC investment vehicle has negative returns in the beginning of its cycle as
investments are made and management fees need to be paid. To the extent that distributions are
returned to the investor, the curve begins to climb until it reaches the break-even point where the value
of negative cash ow is equaled by positive cash ow. After this point the J-curve crosses the abscissa
and the IRR becomes positive.
Graph 5.4 A J-CURVE
1 2 3 4 5 6 7 8 9 10
Year
Smoothed returns
Actual returns
R
e
t
u
r
n
s

(
%
)
Source: The Epicurean Dealmaker, 2007.
In summary, PE/VC returns are not calculated using annual returns in a specic year, they are calculated
using accumulated returns beginning with the creation of the vehicle until a specied date. When comparing
returns between different investment vehicles, they should be grouped according to their creation date and
these together show the vintage year return.
5.2.2 World Returns: A Brief Review of the Literature
The academic discussion of PE/VC industry returns and how to adjust for risk remains contradictory and
the results undened. Academic publications which examine returns are contradictory, with some nding
203
Chapter 5
that PE/VC investments outperform other classes of investments, while others nd that they underperform
other investments. Preqin (2010) published that PE/VC presented above average returns of 10.3% per
year after the fth year of an investment in a portfolio company. Moskowitz and Vissing-Jorgensen (2000)
found evidence that PE/VC returns are in line with market returns. A more negative scenario is painted by
Phalippou and Gottschalg (2008) who afrm that PE/VC investments perform 6% below the stock market
when adjusted for risk. Graph 5.5 below summarizes the divergent results found by academics in relation
to risk adjusted returns since 1980.
PE/VC returns can be expressed as gross returns (before management and performance fees) for investee
companies or as net returns (after reductions for management and performance fees) for the investment
vehicle. Returns can be analyzed during the investment cycle or after the PE/VC fund manager exits. First
we will analyze the returns during the cycle and afterward the returns after the exit.
Graph 5.5 Review of the Literature General Conclusions
Note: General conclusions regarding a review of the literature. This sample includes 14 academic articles published about returns
9
8
7
6
5
4
33
2
1
0
N
u
m
b
e
r
8
3 3
Outperformance Equal Underformance
5.2.2.1 Returns During the PE/VC Cycle
5.2.2.1.1 Gross Returns
Gompers and Lerner calculated risk adjusted returns of one PE/VC fund manager, using the market
value of portfolio companies, thus eliminating the problem of stale pricing. They concluded that using
market values had a signicant impact on allocating risk to the investment and found evidence of
returns that exceed the stock market by 7% or 8% per year.
204
Moskowitz and Vissing-Jorgensen (2000) calculated the average return and the standard deviation of all
private investments, including private companies and deals, using a sample from the Survey of Consumer
Finances. They were surprised that the returns were so low and similar to returns for the stock market.
Peng (2001) analyzed a sample of 5,643 rounds of nancing from 1987 to 1999 furnished by
VentureOne. He constructed a Venture Capital index analyzing individual investment returns and
compared them to returns from the NASDAQ. For this index, Peng found a geometric annual average
of 55% and a beta value of 2.4 concluding that PE/VC investments are highly volatile.
Susan Woodward (2010) of Sand Hill Econometrics also constructed a Venture Capital index, shown
in Graph 5.6, which calculates gross returns for investee companies since 1987. The sample includes
twenty thousand (20,000) investee companies and 65,000 valuation events.SHE calculates cumulative
returns for each company month by month and uses these to compute cumulative return indices, thus
constructing a value-weighted index. This index represents an estimated average value, measures
its variation over time, and its covariance with returns from other investments. The index presented
an annualized return of 16.9% during the period from 1988 to the end of 2004. More recently the
computed return for the period from 2005 to 2009 represents an annualized return of 8%.
Graph 5.6 Dow Jones Venture Capital Index
Source: Sand Hill Econometrics,2010.
Ljungqvist and Richardson (2003) were the rst to look at PE/VC returns based on cash ow, using a database
made up of the largest institutional investors in the United States from 1981 to 1993. They analyzed performance
205
Chapter 5
using the IRR of invested capital, nding evidence that PE presents annual returns 5% to 8% greater than the
S&P 500, with an average IRR of 19.81%, greater than the 14.1% IRR of the S&P 500 during the same period.
In conclusion, Ljungqvist and Richardson afrm that these above market returns are obtained just after the end
of the investment vehicle life cycle.
Caselli (2009) analyzed 804 investments made by 87 investment vehicles of 58 PE/VC fund managers in
Italy during the period from 1999 to 2005 and not exited before 2007. The investee companies in 70% of
these cases were not leveraged and had median revenues of US$ 126 million and a median EBITDA of US$ 16
million. The stages of the portfolio companies were 52% Private Equity Growth, 26% Buyouts, 16% Early Stage
and 6% Turnarounds. Summarizing, Casellis database is very similar to GVcepes database. Caselli indicates
an average IRR of 33.17% in his work and states that the greatest returns are obtained in the Buyout stage.
PE/VC investments outperform the stock market (17.95%) in the sample period, double the weak stock market
performance of the time and four times larger than 2 year government bonds. Caselli concludes that IRR is
driven by sales, return on assets (ROA), and return on equity (ROE). Besides this, it is inuenced by put options
and tag along rights as well as contractual agreements (exit ratchets and lockups). In sum, Caselli argues that
investments that are maintained for longer periods generate higher returns (IRRs) for their investors.
5.2.2.1.2 Net Returns
Kaplan and Schoar (2005) calculate returns using a database offered by Thomson Venture Economics,
a sample which includes 746 quarterly reported returns for investment vehicles from 1980 to 2001. The
authors measured the IRR, the total value to paid-in capital (TVPI), and the distributed value to paid-in capital
(DPI). They assume a beta value of 1 and use public market equivalents (PMEs) to compare PE/VC returns to
the S&P 500. Finding PME = 1, Kaplan and Schoar concluded that PE/VC investments offer the same returns
as the American stock market and thus do not offer returns superior to other classes of investments.
Cambridge Associates is an investment advisor for foundations and endowments and serves as a
gatekeeper for PE/VC investors. Cambridge Associates constructed an index of net returns for Venture
Capital, the Cambridge Associates US Venture Capital Index, and for Private Equity, the Cambridge
Associates Private Equity Index. Here we will describe the VC index. This sample provides data for
investment vehicle returns for 1,279 American venture capital vehicles since 1981, representing 75% of
US fundraising during this period. The data obtained was from PE/VC fund manager quarterly reports to
their investors. As can be seen in Table 5.4 below, the ve year returns for Latin America and the Caribbean
were 19% per year, more than any other area shown.
206
Table 5.4 Net Returns for Investors (Cambridge Associates)
Region 5 years 10 years Absolute Return % Return
PE Latin America and the
Caribbean
19.06% 1.71% 17.35 1015%
PE/VC Emerging Markets 12.83% 6.63% 6.2 94%
Buyout - USA 10.44% 7.68% 2.76 36%
VC Western Europe -2.01% -4.13% 2.12 51%
Source: Cambridge Associates, 2010.
According to IESE and BCG (2010) emerging market returns increased greatly during the rst decade of
the 21st century. In a sample of 176 PE/VC fund managers analyzed since the 1980s, average emerging
market returns increased from 4.4% in the 1980s to 5.3% in the 1990s. In the period from 2000 to 2006,
emerging market returns increased substantially rising 12 percentage points from 5.3% to 17.3%.
Preqin (2010) examines PE returns using its own database of 860 pension funds, which represents US$
437 billion invested in PE/VC fund managers. The returns are calculated using exits and cash ows of
investors over one, three and ve year periods up until June 2009 and compares them to the stock market,
hedge funds and real estate funds. They nd evidence that PE investments present returns of -22.2% during
their rst year, below those of other assets, but yield positive returns for the three and ve year periods with
returns of 2.3% and 10.3% respectively, or in other words PE investments perform above all other classes
in their third year (with the exception of bonds) and perform above all other types of investments in their
fth year, when real estate funds had 5.5% returns and bonds 4.9% returns.
5.2.2.2 Post-Exit Performance
According to Neus and Walz (2005), the PE/VC fund managers with the best track record are capable of
exiting through IPOs more quickly and for a more just value than other fund managers. In addition, Krishnan
et al (2009) report that newer and less experienced PE/VC fund managers have incentives to make IPOs for
their portfolio companies too soon.
Brav and Gompers (1997) demonstrate that excess returns of post-IPO PE/VC investee companies were
signicantly better than those that did not receive PE/VC investment. This is especially true for small companies,
showing the importance of PE/VC investments.
207
Chapter 5
Van Frederikslust and R. Van der Geest (2004) found the same evidence in the Amsterdam stock market,
while Neus and Walz (2003) veried the same effect in Germany, and Vu, Worthington and Laird (2008) did
the same for Australia.
On the other hand, Rindermann (2003) concluded that post-IPO investee companies do not always perform
better than those that do not receive PE/VC investment. Their analysis of the French, German and UK markets
demonstrates that performance depends on some key variables such as the nature of the fund manager.
For Brazil, an initial study done by Furtado and Ramalho (2010) indicates that excess returns for IPOs in
Brazil from 2004 to 2009 were greater for companies that received PE/VC investment than for those that did
not as shown in Table 5.5. This result for Brazil was also found by Tavares and Minardi (2009) and Ferrari and
Minardi (2010).
Table 5.5 Post-IPO Excess Returns in Brazil
* Returns up to 02/12/2010
IPO Date With PE/VC Without PE/VC
2004 -3.2% -6.5%
2005 5.9% -6.2%
First Half 2006 -1.3% -13.9%
Second Half 2006 -11.2% -15.7%
First Half 2007 -11.4% -19.0%
Second Half 2007 -28.0% -14.5%
2008 19.9% 11.1%
2009 36.5% -12.8%
Total -5.1% -14.4%
Source: Furtado and Ramalho (2010)
208
The negative post-IPO excess returns found for Brazil by Furtado and Ramalho (2010) and Ferrari and
Minardi (2010) are compatible with international ndings from Ritter (1991) and Loughran and Ritter
(1995), for IPOs in general, and Brav and Gompers (1997) in their comparison of the excess returns for
companies with and without PE/VC investment.
5.2.2.3 Returns in Brazil from 2004 to 2009
As explained above, the calculation of returns continues to be a sensitive topic where there is some controversy
as to how to estimate returns properly. In Brazil this challenge is even greater. Fewer than 50 PE/VC fund managers
have more than 10 years of investment history in the country, of which around 40% have completed the investment
cycle until the exit phase. This fact makes it very difcult to obtain data on returns in Brazil. Net return data for
investment vehicles (funds) still isnt available in Brazil except for private placement memoranda and internal
management reports to which we didnt have access. We hope that with the recent advent (2010) of Security
Commission (CVM) regulation of performance information, and by working with pension funds, managers and
the Brazilian Private Equity and Venture Capital Association (ABVCAP), that we can present data on net returns in
the near future. While waiting for this, we will present the following data for gross returns (individual investments).
Based on a non-random sample of 25 individual investments (10 trade sales and 15 IPOs) reported
by 13 fund managers from 2004 to 2009, we calculated the median multiple of investment, the median
internal rate of return (IRR) and the median return in excess of Certicates of Deposit, dividing them into
quartiles. The average holding period in our sample was 4.2 years and the average exit value was US$
86.8 million. We should emphasize that this sample is extremely limited in its size and coverage.
Much more work will be necessary to obtain truly representative information for the industry.
That said, we analyzed the multiples of investment exits from 2004 to 2009. We found a median
multiple ve times the initial investment in the company. As shown in Graph 5.7 and Table 5.6, the top
quartile presented a median exit multiple of 13.42 while the median multiple of the lowest quartile was
much smaller, less than twice the initial investment.
209
Chapter 5
Graph 5.7 Individual Investment Multiples Between 2004 and 2009
Note: This sample includes 25 investment exits (15 IPOs and 10 Trade Sales) during the period from 2004 to 2009.
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
0%
5%
10%
15%
20%
25%
30%
MOI / COC
8elauve lrequency
Cumulauve lrequency
Mu|np|e of Investments
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 Above
Table 5.6 Median Multiples of Investment
Note: The sample includes 25 investments (15 IPOs and 10 Trade Sales) during the period from 2004 to 2009.
Quartile Interval Median
Highest 10 > 13.42
2nd 5 9.9 6.6
3rd 2 4.9 3.45
Lowest
1 2.9 2
When looked at from another perspective, the median IRR was 57% and the average IRR was 85%. As
we can see in Graph 5.8 and Table 5.7 below, the highest quartile presented a median IRR of 162% and
the median IRR of the lowest quartile was 18%.
210
Graph 5.8 Internal Rate of Return For Individual Investments Between 2004 and 2009
Note: This sample includes 25 investments (15 IPOs and 10 Trade Sales) during the period from 2004 to 2009.
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
0% 45% 90% 135% 180% 225% 270% 315% 360%
IRR
Relauve Frequency
Cumulauve Frequency
Table 5.7 Median Values for Internal Rates of Return
Highest 100 > 162%
2nd
50 99.9 66%
3rd
25 49.9 37%
Lowest
0 24.9 18%
Graph 5.9 compares returns from our PE/VC sample with Certicate of Deposit (CDI) returns, the
interbank interest rate, over the same period. We can see that 12% of the cases performed equal to or
below the CDI rate. Another 24% performed between 100% and 110% of the CDI rate. Another 32%
had returns between 110% and 150% of the CDI rate, and the other 32% remaining had returns greater
than 150% of the CDI rate, giving their investors exceptional returns. As can be seen in Table 5.7, the
results were divided into quartiles. The lowest quartile presented median returns of 100% of CDI, while
the two highest quartiles presented returns that were 140% and 271% of CDI returns respectively.
211
Chapter 5
Graph 5.9 Relative Frequency of Annual Returns in Excess of CDI for Individual Investments from
2004 to 2009
Note: Sample includes 25 investments (15 IPOs and 10 Trade Sales) during the period from 2004 to 2009.
12%
24%
32%
32%
<100% of CDI 100% - 110%
of
CDI
100% - 150%
of
CDI
>150% of CDI
Table 5.8 Median Returns Exceeding CDI
Highest 170 > 271%
2nd
130 169.9 141%
3rd
105 129.9 110%
Lowest
80 14.9
100%
Finally, when we asked managers about expected rates of return for each stage of investment their
answers were interesting. As illustrated in Graph 5.10 the Seed and Startup stages represented the greatest
required return, with managers expecting a median nominal return of 42.5%. For Private Equity this number
was between 20% and 25%. These rates represent managers expected returns for each investment, or, in
other words, gross returns.
212
Graph 5.10 Expected Nominal Annual Rate of Return for Individual Investments by Investment Stage
Note: Nominal Returns in BRL. This sample includes 133 responses, 13 for the Seed stage, 13 for the Startup stage, 14 for the VC-Early Stage, 15
for the VC-Later Stage, 27 for the PE-Growth Stage, 16 for the PE-Later Stage, 11 for the Mezzanine stage, 9 for the PIPE stage, 9 for the Greeneld
stage, and 8 for the Distressed stage. A total of 71 fund managers responded.

Fonte
42,5
35
30
26,25
19,75 19,05
25
22,5 22,5
S
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: Source: GVcepe Database Getulio Vargas Foundation
Chapter 6
Corporate Governance and Contracts (Monitoring)
217
Chapter 6
Corporate Governance and Contracts (Monitoring)
1
6.1. Introduction
A good relationship between the general partners (GPs) and the limited partners (LPs) along with a
policy of best practices in corporate governance is one of the principal pillars of success for a good private
equity fund. (Freire and Viegas, 2009)
Governance is an essential aspect and is present in the entire PE/VC cycle after the initial investment, from the
point of view of the fund manager (GP) and the investor (LP), as well as between the fund manager and investee
companies. In this way, in this chapter we will analyze the agency costs that arise in the relationship between
investors and fund managers and also discuss the potential conicts of interests between these parties, taking
into consideration the low liquidity of the investments that they make, the length of the commitment between
them and the high asymmetry of information in this relationship.
We will also discuss the costs and benets of the investor monitoring the manager and the remuneration of
fund managers. We will analyze practices in terms of holding meetings between vehicle investors and investee
companies, fundamental to laying out the investment decisions to be made and guaranteeing an effective
monitoring of the portfolio. In this context, we will analyze entrepreneurial aspects of the industry and what they
say about the forming of a board of directors, its power and role in regard to investee companies, as well as the
possibility of implementing incentives and setting goals for the entrepreneur and investee company executives.
6.2. Agency Theory
The Agency Theory (Jensen and Meckling, 1976; Fama and Jensen, 1983) states that companies
should make an effort to align the interests of shareholders and managers in such a way as to nd the costs
of monitoring management optimal point, which will be the one of maximum benet to the shareholders.
In general, in PE/VC investment vehicles the relationship between investors and fund managers is
dened by the vehicles regulations and by the investment commitment agreement. Both documents dene
the rights and obligations of the parties when the vehicle is constituted, and contain information about
investment decisions, types of capital investment, exits, the investors right of access to information about
investee companies, and share valuation methods, among others (Freire and Viegas, 2009).
1 Authors: Lucas Amorim, Lucas Cancelier, Marcelo Coura, Marcelo Kubli, Caio Ramalho, Estvo Latini, Carlos Motta, Thiago Maia and Rodrigo Lara.
218
The relationship of the principal and the agent is dened by a contract between the two parties, given
that one of them (the agent) was contracted to take decisions in the name of the principal, thus assuming
responsibility for representing the investor. In this way, the maximum utility for one of these parties should
not always, in theory, be the same as that of the other, because decisions and measures which maximize
the utility of one of these parties normally benets this party more than it does the other (Jensen and
Meckling, 1976).
The divergence in interests between these two parties is dened as an Agency Problem and actions to
minimize this problem generate expenses which are called Agency Costs.
a) Monitoring expenses:
In the relationship between the investor and fund manager, monitoring expenses (or agency costs) are
borne by the investors because they have to follow the progress of their capital investment. In terms of
the relationship between the fund manager and the investee company, the agency costs are borne by the
fund managers. In the case of monitoring investee companies, this frequently occurs through the Board
of Directors which exists to inform shareholders of the situation of the fund they invest in. This measure,
despite the fact that it has a cost is extremely important to shareholders, since this is the way they can
control and observe the investee company managers/administrators actions.
In this context, it is fundamental to establish minimum guidelines and standards for monitoring reports,
elaborated periodically elaborated by agents and made available to the principals. As a general rule,
these reports should contain information about the principals interests (nancial, commercial, and
organizational highlights and the results of investigations and negotiations).
6.3. The Relationship between Investors and Fund Managers
There are important variables in terms of governance related to the structure of each investment vehicle.
Among them we can highlight the way in which the capital ows into the company during the investment
period and how it exits, as well as the possibilities of extension for these periods and the vehicles restrictions.
This discussion is essential, because these vehicles can last more than 10 years and there is little liquidity
in this invested capital.
219
Chapter 6
6.3.1. The Structure of Investment Vehicles
When mounting the structure of a PE/VC investment vehicle, the regulations should be in line with not only the
interests of the fund manager, but of the investors as well. The regulations contain information about aspects such
as the investment and exit periods for the vehicle and the possibility of extending these periods, fund manager
remuneration, and the characteristics of investments that they seek, etc.
The structures of PE/VC investment vehicles vary from region to region and are subject to regulations specied
by each country, such as the Securities Commission (CVM) in Brazil which regulates the structure of these vehicles
and information registration requirements.
An important specication for PE/VC investment spelled out in CVM Instruction 391 is the relationship between
administrators and managers. These actors have different responsibilities: the administrator being responsible
for the control of the shares, the organization of investor reports among other comptroller work; the manager
is responsible for the management of the vehicle itself (new investments, monitoring and investment exits). The
other actor in this structure who appears in the research is the technical consultant which is an organization
or person with expertise in a specic sector provides consulting services to the fund manager (ex. information
technology, biotechnology, etc.).
Table 6.1 shows the classication of fund managers and indicates the participation of other actors for each
vehicle responding to the study. As a result, we found that most fund managers manage the vehicle themselves
and that many also administer the vehicle themselves.
Table 6.1 Participants In The PE/VC cycle
Distribution of fund managers according to actors present. It shows that most managers are the fund managers themselves. Many administrators
are also the fund managers themselves. Data extracted from a sample of 151 vehicles offered by 71 PE/VC fund managers.
Actor Doesnt Exist Fund Manager Itself Other Institutions
Administrator 20 75 52
Manager 7 126 6
Management Consultant 62 16 32
Technical Consultant 64 11 23
Other 32 1 6
Total 204 243 128
220
We should point out that according to Instruction CVM 391 it is the administrator who is responsible for
the vehicle and who can hire a manager or can personally take responsibility for the management of the
vehicle. In practice it is the manager who really creates the vehicle and who sometimes, when he or she
does not want to administrate it, seeks someone to administrate his PE/VC investment vehicle.
The general model for structuring an investment vehicle, in which there is an intermediary structure
between the investor and the investee company, as occurs with the CVM model and Limited Partnerships,
represents approximately 75% of investment vehicles in Brazil today, with Equity Participation Funds (FIPs)
being the most common, representing 40% of the total. Limited Partnerships are also common representing
19.1% of all vehicles and this is due to the inuence of foreign PE/VC investments and the presence of
foreign PE/VC fund managers in Brazil. This data can be seen in Graph 6.1.
Graph 6.1 Structure of PE/VC vehicles
Note: Responses furnished for 254 vehicles. This graph presents the number of investment vehicles in terms of their legal structures. Note the
dominance of Equity Participation Funds (FIPs CVM 391) and Limited Partnerships.
90
80
70
60
50
40
30
20
10
0
100%
90%
80%
70%
60%
59%
40%
30%
20%
10%
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Vehicles Cumulative
There is, however, another type of PE/VC investment vehicle structure in which the investor manages his
or her own nancial resources and investments. This other type transforms the model substantially, since
the investor and the manager are the same there is no need to charge fees. This is the model for Holding
Companies, Corporate Ventures, Direct Investment, Government Sponsors and Governmental Managers
(ex. BNDESPar).
221
Chapter 6
Figure 6.1. Structure of PE/VC Vehicles
This gure portrays the possible structures for PE/VC which are those listed by Security Commission (CVM) Instructions or Limited Partnerships,
Holding Companies and Direct Investment. In the case of Holding Companies and Direct Investment, there are no intermediaries so there are no
agency costs between the fund manager and the investor, as well as no remuneration fees.
Managing
Organization
Holding
Investee Company
Holding
Investors
General Partner
Vehicles
Investee Company
CVM/Limited Partnership
Managing
Organization
Investee Company
Direct Investments
The investment vehicles structure varies in accordance with the legislation regarding to fund managers and
investors in each region, or in other words, fund managers structure their vehicles in the way that will be most
convenient for their investors, seeking to minimize taxation and agency costs. In this way it is possible to identify
the most preferred vehicle structures worldwide (Caselli, 2010; EVCA, 2010).
Beginning with the United States and the United Kingdom, the preferred investment structure is the Limited
Partnership. The reason for this cited by Caselli (2010) is that it offers reduced capital gains taxes, given that
revenues and operational costs are more sensitive to taxation. Germany is another country that prefers this
structure, because its tax legislation is applicable to operational prots, while operational expenses, interest,
commercial taxes and amortizations are tax deductable.
In Italy, the preferred structure is Fondo Chiuso (Closed-end fund), because this type of structure has special
treatment. It is taxed at 12.5% of the vehicle results.
The preferred structure in France is the Fonds Communs de Placement Risques (Mutual Risk Funds),
because it is not subject to taxation. More specically, this type of organization pays no income tax. In
Spain, the preferred structures are a Sociedad de Capital de Riesgo (SCR) (Risk Capital Company) and a
Fondo de Capital de Riesgo (FCR) (Risk Capital Fund).
222
Finally, in Luxembourg the preferred investment vehicle structure is the Socit dInvestissement en Capital
Risque (SICAR) (Risk Investment Company) because of the legal system. Prot from this type of vehicle is subject to
income tax and municipal taxes. However, some things are not taxable such as: capital gains from the sale of real
estate and short term capital gains (12 months or less).
These approaches have sought to form the ideal type of fund in terms of local taxation, but in general they also
seek other things such as: (i) scal transparency, avoiding double taxation of investment capital; (ii) conforming to
basic regulatory standards to minimize the taxation differences between domestic and international investors; (iii)
avoiding having permanent bases established in countries to avoid taxation on investor capital; (iv) having control
over vehicle administrator remuneration to avoid paying value added taxes on salaries and performance fees; (v)
seek to increase competition and facilitate capital movements. Table 6.2 below indicates the positioning of these
countries in relation to these issues raised by the EVCA (2010).
Observing Table 6.2, it is possible to verify the correlation between Caselli (2010) and the EVCA(2010), proving
that the structure preferences in each country are tied to taxation and relationship issues.
Table 6.2 Preferred Structures Worldwide
Preferred structures in Europe and the United States, considering the presence or absence of characteristics principally linked to scal issues.
Countries
Fiscal transpar-
ency to domestic
investors?
Prevention of
permanent
establishment
of funds for
international
investors?
Incorporation of
investment capi-
tal / incentive for
managers?
Ability to mini-
mize the VAT
on director`s
remuneration?
Ability to mini-
mize the VAT on
the performance
rate?
Freedom on the
restrictions of
investments?
Italy (Fondo Chiuso) No (1) Yes Yes Yes Yes Yes (7)
France (FCPR) Yes Yes Yes Yes (3) Yes No
United Kingdom (Limited Parthnership) Yes (4) Yes (5) Yes Yes (6) Yes (7) Yes
EUA (8 Limited Parthnership) Yes Yes Yes Yes Yes Yes
Spain (SCF - FCR) No Yes (9) Yes (10) Yes (11) Yes (12) No
Germany (Limited Parthnership) Yes (13) Yes (14) Yes No Yes Yes
Luxembourg (SICAR) Yes (15) Yes Yes Yes Yes Yes

(1) Despite the fact that the Fondo Chiuso doesnt have a transparent tax structure, international investors benet because they are reimbursed 12.5% of their annual
earnings, or in other words the taxes levied on the fund, and this action leads to the same result as tax transparency.
(2) In regard to some regulatory provisions, there are some restrictions that apply, but under certain conditions they can be waived. .
(3) The manager can choose not to charge VAT, but in these situations he/she cannot deduct the VAT personally and must pay taxes on the salaries paid, in such a way
that in this last instance, he or she will have to increase the management fees charged on investors.
(4) For domestic investors, the Limited Partnership structure in the United Kingdom has tax transparency with respect to capital gains.
(5) Except for nancial operators, investors in a typical Limited Partnership structure should not have a structure that is itself subject to taxation in the United Kingdom.
(6) The efcient VAT structure can be put into practice.
223
Chapter 6
(7) The performance fee structure shouldnt be subject to VAT for partnership interests in the United Kingdom.
(8) In order to avoid the creation of a permanent structure for foreign investors and, also, to avoid that these same investors obtain tax benets, certain investments
such as (i) Real Estate, (ii) Originating Loans, or (iii) Organizations operating with tax transparency should be avoided.
(9) The mere fact of investing through a SCR/FCR will not create a permanent structure in Spain.
(10) The SCR/FCR standard, under current regulations does not permit the easy structuring of performance fees which are scally efcient for their sponsors. However,
in certain specic circumstances efcient structures can be implemented.
(11) These administrative fees are normally exempt from VAT in Spain. However, fees related to management consulting are not exempt from VAT, and this is normally
a cost for managers.
(12) When a scally efcient performance fee is implemented, it is normally exempt from VAT.
(13) If the Limited Partnership structure is classied as non-commercial.
(14) When a Limited Partnership is classied as non-commercial, it should not create permanent structures in Germany.
(15) The SICAR fund in Luxembourg should have companies with tax transparency (SCS) or opaque taxation (SARL, AS and SCSA).
Source: EVCA (2010)
The EVCA (2010) portrays the establishment of permanent fund structures in countries receiving
investment as disadvantageous, because normally the installation of such structures is sensitive to taxes
thus making it unattractive to investors. Thus, since it is not advantageous to have a specic business
structure from the point of view of taxation, various executives and managers in the industry strongly prefer
to have local teams and therefore there is a preference for an investment local business structure.
Comparing this situation with reality in Brazil, we see that the dominant structure in Brazil is the Equity
Participation Fund (FIP) as has been cited above. Associating this preference with taxation aspects worldwide,
we again emphasize that the preference for the Equity Participation Fund (FIP) rests on the requirement that
Brazilian pension funds invest through these funds which possess compatible regulation.
6.3.2 Characteristics of Investment Vehicles
The PE/VC investment cycle is long and it can easily take seven years before its rst liquidation. The
result is that the investor has a long commitment (rarely less than eight years with chances of extensions), a
low liquidity position, and very little control over the management of investments. In this topic well cover
governance aspects of investment vehicles such as their duration, the investment process, and the time
frames for making and exiting investments.
6.3.2.1 Paying Capital Commitments for Investment Vehicles
Investors seek to allocate their capital in investment vehicles which offer them a balanced mix of risk and
return. In this way, it will be normal for them to look for a fund manager which will offer them this mix. When
selecting a fund manager, these investors will be subject to making available pre-agreed parcels of capital
when asked to by the fund manager and to pay management fees in accordance with regulations.
224
Table 6.3 Percentage of Capital Commitment Which Should be Made Available soon after the
Signing of the Investment Agreement
Number of investment vehicles according to the percentage of capital that has to be made available soon after the signing of the investment
agreement. For those requiring a percentage, the most common percentage was 5% of the capital commitment. Not Made Available means
respondents that do not use this mechanism of asking for capital soon after the signing of the investment agreement, while No Information means
those who use this mechanism but did not specify which percentage. Data were obtained for 113 vehicles from 61 fund managers.
Possibilities Number of Vehicles %
Not Made Available 63 55.8%
0.5% 1 0.9%
2.5% 1 0.9%
3.0% 2 1.8%
5.0% 24 21.2%
10.0% 4 3.5%
15.0% 1 0.9%
16.0% 1 0.9%
100.0% 5 4.4%
No Information 11 9.7%
Total 113 100.0%
As can be seen in Table 6.3, regulations for most investment vehicles do not require that a parcel of
capital be made available soon after the investment agreement has been signed. Of the investment
vehicles requiring a percentage, most charge 5% of the capital commitment to the fund, with disposition
of the rest being treated according to each vehicle regulations.
In our study of Brazil, as can be seen in Table 6.4, it is common that all capital commitments are received upon
the investment committee approval, with 43.7%, almost half of our 119 vehicles sample, adopting this form.
Table 6.4 Paid Capital Commitments
Number of investment vehicles in accordance with when capital commitments are paid. Data for 119 vehicles from 61 fund managers.
Moment that Commitments are Paid Number of Vehicles %
When the Investment Committee approves investments 52 43.7%
When the investor decides to participate in investee com-
panies chosen by the Managers
13 10.9%
Periodic xed parcels 6 5.0%
When the Fund Manager Requests Them 46 38.7%
Other 2 1.7%
Total 119 100%
225
Chapter 6
It can occur that in specic cases an investor will not have the nancial resources available to fulll his or her commitment,
or the investor may even wish to withdraw entirely from the vehicle. In such cases, investors will be subject to penalties. For
example, among other measures, when an investor has to make nancial resources available during a determined period,
he or she can be ned in a way which results in reducing the capital gains that the investor has a right to, or diminishing
his/her participation. According to our research, few vehicles dont charge nes in these situations.
Table 6.5 Penalties When Capital Commitments are not Paid
Distribution of number of investment vehicles according to the existence of investor penalties when capital commitments are not paid or the investor
decides to withdraw from the vehicle. Data from a sample of 106 vehicles from 60 fund managers.
Penalty Number of Vehicles (%)
No 29 27.4%
Yes, the investor will have capital gains
reduced
6 5.7%
Yes, other 46 43.4%
Yes, investors participation will be
reduced proportionately
25 23.6%
Total 106 100%
It should be noted that a fund manager can choose to begin fundraising for a new investment vehicle before
closing down a current one. However, this possibility should be previously agreed to with investors of the current
vehicle so that they are not hurt by this action. In Table 6.6 we can see the distribution of which types of PE/VC
investment vehicles permit this type of event and the conditions this new fundraising is subject to.
Table 6.6. Possibility of Beginning Fundraising for a New Vehicle Before the Current One Closes
Distribution of investment vehicles according to the the possibility of beginning fundraising for a new vehicle before the current one closes. Most of
the responses afrmed that this is permitted in some situations. Data from a sample of 116 vehicles from 47 fund managers.
Possibility CVM Holding Direct Investment
Limited
Partnership
Other Total
No 7 - - 2 - 9
Yes, anytime 31 9 1 7 4 52
Yes, but only after the
investment period of the
vehicle
14 1 1 6 - 22
Yes, but only after the
vehicle has already in-
vested a certain percen-
tage of its Committed
Capital
18 1 - 12 2 33
Total 70 11 2 27 6 116
226
As we can see in Table 6.6, there are cases in which fundraising for a new investment vehicle is permitted
when the vehicle has already invested a determined percentage of committed capital; this situation occurs
principally in Limited Partnerships. In these cases, the committed capital percentage that should be invested
before a new vehicle can begin fundraising is listed in Table 6.7.
Table 6.7 Percentage of Committed Capital Necessary Before Fundraising For A New Vehicle
Can Begin
Distribution of investment vehicles grouped by legal structure according to percentage of committed capital that has to be invested before fundraising
for a new vehicle can begin. Three respondents from the previous table replied that they used a minimal percentage, but they didnt inform the value.
Data from a sample of 29 vehicles from 17 fund managers.
Percentage CVM Limited Partnership Other Total
50% - 1 - 1
70% 4 3 - 7
75% 2 8 - 10
80% 7 - 2 9
85% 1 - 1 2
Total 14 12 3 29
6.3.2.2 Life of Investment Vehicles
Delimiting the lifespan of an investment vehicle is a mechanism to protect investors, because this
predetermines a time frame for them to receive their returns. It is important to note that this varies according
to investment structures as can be seen in Table 6.8. In Brazil, the largest proportion of investment vehicles
in 2009 had a duration of 9 to 10 years, repeating the trend observed in 2004.
Table 6.8 Life of Investment Vehicles
Comparative distribution of total duration of investment vehicles. The greatest concentration was for those with lifespans of 9 to 10 years.
In some cases a pre-defined extension of this period is possible. Data for 176 vehicles from 105 fund managers.
2004 2009
Duration Number of Vehicles % Number of Vehicles %
Less than 5 0.0% 7 4.0%
5 and 6 9 9.3% 16 9.1%
7 and 8 24 24.7% 49 27.8%
227
Chapter 6
9 and 10 33 34.0% 58 33.0%
11 to 20 7 7.2% 11 6.3%
No Limit 24 24.7% 35 19.9%
Total 97 100.0% 176 100.0%
Vehicles anticipate the possibility of extending investment periods and the time until the fund is liquidated.
Once a General Assembly approval is acquired, this is a healthy practice, given the low liquidity prole of
these investments, making it possible for fund managers to arbitrage between vintage years to maximize
the vehicle`s return.
We can see that a majority of investment vehicles extending their lifespans last 9 to 10 years since the
normal extension is for 2 years.
Table 6.9 Length of Investment Vehicle Life Extensions
Comparative distribution of vehicle investment extensions. Sample is smaller than that used in Table 6.8 due to this gure not being provided in some
cases. Data for 136 vehicles run by 54 fund managers.
2004 Length of Extension
Extended
Indenitely
Total
Duration 1 2 3 4 5 6 8 10
3 and 4 - - - - - - - - -
5 and 6 1 3 2 2 - - - - 1 9
7 and 8 1 20 1 - - - - - 2 24
9 and 10 1 18 - 1 6 - - 1 6 33
11 to 21 - 1 - - - 2 - - 4 7
Duration undened - - - - - - - - 24 24
Total 3 42 3 3 6 2 0 1 37 97
2009 Length of Extension
Extended
Indenitely
Total
Duration 1 2 3 4 5 6 8 10
3 and 4 - 3 2 - - - - - 2 7
5 and 6 3 1 1 3 3 - - - 4 15
Table 6.8 Life of Investment Vehicles
Comparative distribution of total duration of investment vehicles. The greatest concentration was for those with lifespans of 9 to 10 years.
In some cases a pre-defined extension of this period is possible. Data for 176 vehicles from 105 fund managers.
228
7 and 8 8 24 8 2 - - 1 - 4 47
9 and 10 4 28 2 3 2 1 - 1 17 58
11 to 21 2 1 1 1 - - - - 2 7
Duration undened 1 - - - - - - - 1 2
Total 18 57 14 9 5 1 1 1 30 136
Source: GVcepe Database Getulio Vargas Foundation and 2005 Brazilian PE/VC Census
6.3.2.3 Investment Process
For a PE/VC vehicle, the investment process begins with the end of fundraising. In this process, there
are various determinant factors in the making of a company investment, starting with the investment
agreement. There are investment restrictions which are covered in the agreement between investment
vehicles and investors. Among other things, within these restrictions its good to outline the geographic
area where these investments will take place, the stages of the investee companies, the investment type,
and the composition and possible alterations of the management team. In Table 6.10 below you can see
the restrictions which are commonly dened in investor agreements.
Table 6.10 Restrictions Defined in Investment Agreements
Distribution of investment vehicles according to the restrictions dened in investment agreements. The sum doesnt represent the sample size, because the
question allows for more than one answer. Sample data for 82 vehicles run by 46 fund managers.
Restrictions dened in investment agreements Number of Cases %
Geographic area of investments 48 14.2%
Stage/Type of Investments 45 13.3%
Departure of Fund Manager Partners and Managing Partners 47 13.9%
Investment in foreign assets, projects or companies 40 11.8%
Investment in other classes of assets 30 8.9%
Financial resources from this vehicle cannot be invested in portfolio companies
of another vehicle run by this fund manager
25 7.4%
Entrance of new Fund Manager Partners and Managing Partners 20 5.9%
Investments (as LPs) in other vehicles run by this fund manager 17 5.0%
Investments in stockmarket securities 16 4.7%
Protection of vehicle capital 17 5.0%
Investment companies using debt instruments 12 3.6%
Table 6.9 Length of Investment Vehicle Life Extensions
Comparative distribution of vehicle investment extensions. Sample is smaller than that used in Table 6.8 due to this gure not being provided in some
cases. Data for 136 vehicles run by 54 fund managers.
229
Chapter 6
Investments (as LPs) in other vehicles run by other fund managers 11 3.3%
Investments in Leveraged Buyout operations 10 3.0%
Total 338 100.0%
In general, the fund manager is responsible for making the investment decision. It is his/her prerogative
to prospect for, analyze and present proposals to the committees. The role of investors in the participative
committees is to exercise a right of veto over proposals that are not in line with the vehicles investment
strategy and/or the investors appetite for risk. This veto power is fundamental to stop any deviations from
the original focus of the vehicle, such as, for example, operations with listed companies in non-priority
sectors (beverages, tobacco, the military, etc.), and non-innovative companies, among others.
Investment vehicles use consultative committees in the decision making process. Depending on the
vehicle conguration, investors can choose to give their opinion or not on companies which are to be
invested in or delegating it otherwise. Vehicles in which investors participate actively are classied as
vehicles with participative committees and in case of non-participation they are termed blind pool vehicles.
In this last case, they delegate almost all their powers, having just the right of veto on a few occasions.
This delegation power varies according to the quorum and the type of majority required for the decision
making process (simple majority, absolute majority, unanimity, etc.). There are also cases in which investors
have the option to participate or not in one of these consultative investment committees. In these cases,
these vehicles are termed pledge funds.
The most common form used by vehicles which invest in Brazil today is by Committee with a Qualied
Majority, which includes roughly 30% of vehicles, the opposite of the situation in 2004. The least signicant
form is the Total Control of the Investor (1% in our study). This information is listed in Table 6.11.
Table 6.10 Restrictions Defined in Investment Agreements
Distribution of investment vehicles according to the restrictions dened in investment agreements. The sum doesnt represent the sample size, because the
question allows for more than one answer. Sample data for 82 vehicles run by 46 fund managers.
230
Table 6.11 Investment Approval Models
Number of investment vehicles according to the model used for the approval of new investments. The item Others contains options such as specic
opportunities, board of directors, etc. Data for a sample of 128 vehicles run by 62 fund managers.
Level of Delegation
2004 2009
Number of Vehicles % Number of Vehicles %
Blind pool 27 28% 19 15%
Total Control of the Investor 7 7% 1 1%
Committee (Simple Majority of
Capital)
23 24% 32 25%
Committee (Qualied Majority) 17 18% 38 30%
Committee (Unanimity) 13 13% 13 10%
Pledge Fund 6 6% 8 6%
Does not apply/no information 4 4% 1 1%
Others 0 0% 16 13%
Total 97 1 128 100%
Source: GVcepe Database Getulio Vargas Foundation and the 2005 Brazilian PE/VC Census
Depending on the level of inuence of one or more investors, it can happen that they have the power
to call an Extraordinary Assembly for the resolution of any problem or problems or for a discussion in
relation to the activities of the investment vehicle. Generally, an investor achieves such inuence with a
certain quantity of capital invested in the vehicle. In Brazil, in general, as can be observed in Table 6.12,
investors are quite inuential in this regard, mainly in Securities Commission (CVM) structured vehicles, as
can be observed in Table 6.12.
Table 6.12 Right of One or More Investors (LPS) to call an Extraordinary Assembly
Distribution of investment vehicles grouped by legal structure according to whether one or more investors are able to call an Extraordinary Assembly.
Data from sample of 114 vehicles run by 63 fund managers.
The investor can
call an Extraordi-
nary Assembly
FIP (CVM
391)
Holding Direct Investment Limited Partnership Other Total %
Company Direct Invest-
ment
Limited Part-
nership
Other Total %
10 8,8%
No 3 1 - 5 1 10 8.8%
Doesnt apply 5 8 1 14 3 32 27.2%
Yes 61 3 1 5 3 73 64.0%
Total 69 12 2 24 7 114 100%
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Chapter 6
Nonetheless, for an investor to call an Assembly it is necessary for he or she to have invested a certain
quantity of committed capital in the investment vehicle. This percentage of necessary capital varies according
to the vehicles bylaws. In Table 6.13 we see the distribution of this quantity for investment vehicles with
different legal structures.
Table 6.13 Percentage of Capital Paid That is Necessary For One or More Investors (LPS) To Call
an Extraordinary Assembly
Distribution of the number of investment vehicles according to the percentage of capital received that is necessary to call an Extraordinary Assembly.
The total of responding vehicles is not equal to the number in the table above, because giving a response for this percentage was not mandatory.
Data from sample of 49 vehicles run by 39 fund managers.
Percentage of capital
paid
CVM Holding
Limited
Partnership
Other Total
Company
Limited
Partnership
Other Total - 2
75% 2 - - - 2
70% 1 - - - 1
60% 1 - - - 1
50% 1 1 2 - 4
20% 3 - - - 3
10% 1 - - - 1
5% 33 - - 3 36
0% 1 - - - 1
Total 43 1 2 3 49
In some cases fund managers promote meetings between their investors and their portfolio companies.
These meetings can be mandatory or not, depending on the structure and norms of the investment
vehicle, and can function as an important monitoring mechanism for the investor. On the other hand,
fund managers use these meetings as a way to show investors the progress of their work. Graph 6.2 shows
that in Brazil, most investment vehicles promote these meetings, except for Venture Capital vehicles, where
these meetings are less frequent.
232
Graph 6.2 Meetings Between Investors and Portfolio Companies
Comparative distribution of percentage of investment vehicles that promote meetings between investors and portfolio companies. In general, there
was an increase in the number of these meetings from 2004 to 2009. The number of responses obtained was 26 for Private Equity and 11 for
Venture Capital out of a total of 73 responses.
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Total- 2004 Private Equity-
2009
Venture Capital -
2009
Total - 2009
Yes Undetermined No
In some situations, an investor can decide to co-invest directly in one of the portfolio companies.
This initiative can or cannot be permitted by the vehicles regulations, being more accepted in Limited
Partnerships, as it can be seen in Table 6.14.
Table 6.14 Right of the investor to co-invest directly in portfolio companies
This table presents the distribution of the right of the investor to co-invest directly in portfolio companies. Data for sample of 111 vehicles run by 59
fund managers.
Right of Co-Investment CVM Holding
Direct
Investment
Limited
Partnership
Other
Total
geral
Company
Direct
Investment
Limited
Partnership
Other Total - 44
Yes, this is a fully guaranteed right 35 5 2 11 - 44
Yes, but just under certain conditions 24 5 - 9 4 36
No. It is prohibited for any investor
to co-invest
17 2 - - - 16
Other rule 13 - - 6 1 15
Total 89 12 2 26 5 111
Fonte: Base de Dados GVcepe Fundao Getulio Vargas
6.3.2.4 Investment Period
Its conventional for the vehicle regulations to establish a convenient period of the time for both sides, as
well as minimizing agency costs. This also can be considered another defense mechanism for investors and
233
Chapter 6
an incentive mechanism for fund managers. The most common situation in Brazil is that there is no xed
investment period.
As can be seen in Table 6.15, the term of the investment period increased slightly from 2004 to 2009, due
to the necessity of better analyzing investment alternatives as well as new ventures multiplied.
Table 6.15 Length of investment period
Comparative distribution of investment vehicles according to the length of their investment periods. The number of vehicles without a pre-dened
investment period decreased in 2009. No dened period of investment refers to those who declared that they have no dened period of investment,
while No information refers to those who declared they have a xed period but did not specify what it was. Data for sample of 189 vehicles run by
94 fund managers.
Investment Period (years)
2004 2009
No dened investment period 45 46.4% 62 32.8%
> 6 - - 3 1.6%
6 2 2.1% 3 1.6%
5 14 14.4% 32 16.9%
4.5 - - 2 1.1%
4 14 14.4% 35 18.5%
3.5 - - 3 1.6%
3.25 - - 1 0.5%
3 18 18.6% 23 12.2%
2.5 - - 2 1.1%
2 4 4.1% 8 4.2%
1 - - 3 1.6%
No information - - 12 6.3%
Total 97 100.0% 189 100%
There is also the possibility of extending the investment period. This decision can be taken by the
investor or by the fund manager depending on the conditions and decision making powers of the vehicle
committees. In Brazil, investment periods - if extended, run normally for one more year in the case of
vehicles with a 4 or 5 year investment period.
234
Table 6.16 Length of Investment Period and Possible Extensions
Distribution of investment vehicles and their investment period length and the possibility of extensions. Data for a sample of 124 vehicles run by 49
fund managers.
Investment Period (Ye-
ars)
Extension (Years)
No information Total
1 2 4 5
> 6 - - - - 3 3
6 - - - - 1 1
5 8 2 - 1 21 32
4.5 - - - - 2 2
4 10 6 2 1 15 34
3.5 - 3 - - - 3
3.25 - - - - 1 1
3 4 6 2 - 11 23
2.5 - - - - 2 2
2 2 1 1 - 4 8
1 - - - - 3 3
No information - - - - 12 12
Total 24 18 5 2 75 124
In the same way that there exists, in most cases, a pre-dened investment period, there is also a dened
divestiture period. This time limit also serves to protect investors, given that it establishes a time limit for
when they can exit the investment. According to our research, the most common divestiture period is a 4
to 5 years.
235
Chapter 6
Table 6.17 Duration of Exit Period
Number of vehicles ordered by the duration of their exit periods. Almost half of all vehicles reporting did not have a pre-dened exit period. No
dened exit period refers to those that did not have a dened investment exit period, while No information refers to those who declare that they
have a dened exit period but did not specify what it was. Data from sample of 133 vehicles run by 71 fund managers.
Exit Period (years)
2009
Number of Vehicles %
No dened exit period 56 42.1%
> 6 13 9.8%
6 10 7.5%
5.5 1 0.8%
5 17 12.8%
4.5 1 0.8%
4 18 13.5%
3.5 3 2.3%
3 4 3.0%
2 3 2.3%
1 1 0.8%
Not dened 6 4.5%
Total 133 100.0%
Investors and fund managers also have the right to extend the exit period in some vehicles when
necessary. This extension of the divestiture period occurs most often in vehicles with an exit period of 5
years. The tipical extension is 2 years.
236
Table 6.18 Divestiture Period and Possible Extensions
Distribution investment vehicles according to the relationship between exit period and its possible extension. Extensions were most common in
vehicles with exit periods of 4 or 5 years. Data for sample of 130 vehicles run by 34 fund managers.
Duration of Exit
Period (years)
Extension (years)
No infor-
mation
Total
1 2 3 4 5 8
> 6 2 8 2 - - 1 - 13
6 3 - - 2 1 - 2 8
5.5 - - - - - - 1 1
5 4 9 1 - 1 - 2 17
4.5 - - - - - - 1 1
4 7 6 - 2 - - 3 18
3.5 - 3 - - - - - 3
3 1 1 - 2 - - - 4
2.5 - 1 - - - - - 1
2 1 2 - - - - - 3
1 - - - - - - 1 1
Not dened - - - - - - 60 60
Total 18 30 3 6 2 1 70 130
6.3.3. Remuneration
A PE/VC investment vehicle is subject to various factors which inuence the remuneration of fund
manager employees. The three principal factors to be analyzed are: (i) its long term nature; (ii) the need
for specialized services in the management of investments, because fund managers analyze hundreds
of proposals and can have many different companies in varying sectors in their portfolios, which makes
taking decisions that much more difcult; (iii) the costs and procedures necessary in buying participation
and, nally, the high costs of administration (especially compared to shares in the stock market).
237
Chapter 6
The remuneration of fund managers is based on two factors: the management fee and the performance
fee or carried interest. There are also factors that interfere with this remuneration and the bases on which
they are calculated, such as the hurdle rate, the timing of fee payments, the utilization of clawback clauses,
ination and opportunity costs (Kameyama, 2001).
The topic of remuneration gives rise to discussions about what is a fair value for the PE/VC fund manager
remuneration. Perhaps the 2/20 fee model no longer reects the proper value of remuneration, given
that the industry has evolved to a great extent over the past few years (Preqin, 2010). With the rise of the
Institutional Limited Partners Association (ILPA), PE/VC investors have organized themselves to lobby for
best practices in governance, and among them an adjustment in the size of fund manager remuneration.
In Brazil, it should be emphasized that Securities Commission (CVM) structures have better dened
regulations which benet investors.
6.3.3.1 Management Fees
Management fees can be xed or variable. When they are variable they may be calculated based on the
following measures: Committed Capital, Contributed Capital, Invested Capital or Net Assets among others.
Another important point regarding the structure of management fees is that the base it is calculated
on can vary even during the investment period, as opposed to the exit period. This occurs because of
the volatility these measures can exhibit over the life of the vehicle, especially if the calculation is based
on just one of them. If a fund manager charges a management fee based on invested capital, it will be
smaller during the investment period and larger during the exit period. This variation is important because
according to Metrick (2007), the costs and expenses for fund managers are higher during the rst few
years of the vehicles life.
Examples of these fund manager costs and expenses are operational expenses (ex. salaries, rent, etc.),
and the costs of analyzing and making valuations of investment proposals that end up not being approved
(due diligence), among others. Table 6.19 shows that it is common for the management fee to principally
cover operational costs and expenses (20.9%), report publishing expenses (11.1%), and the outsourcing
of the vehicles legal, scal, accounting and consulting services (9.6%).
238
Table 6.19 Costs and Expenses Paid by Management Fees
Summary of the responses of fund managers respect to costs and expenses covered by management fees. The number of responses does not correspond
correspond to the sample size, because more than one alternative was permitted. Data for sample of 110 vehicles run by 50 fund managers.
Costs and Expenses
Number
of Cases
(%)
Fund Manager operational expenses (ex.: salaries, rent, etc.) 94 22.1%
Costs of constitution, merger, dissolution or liquidation of the vehicle 30 7.1%
Costs associated with analyzing and making valuations of investments that end up not being ap-
proved (ex.: Due Diligence, etc.)
36 8.5%
Outsourcing of legal, scal, accounting and specialized consulting services for analyzing and mak-
ing valuations of investments
39 9.2%
Hiring vehicle Administrator 43 10.1%
Expenses in the preparation of vehicles accounting statements 31 7.3%
Fees and Commissions respect to vehicle investments and divestitures 20 4.7%
Fees, or federal, state or municipal taxes on vehicle goods, rights and obligations 35 8.2%
Expenses associated with the printing, publication and dissemination of reports, forms, periodicals,
correspondence and communication with the investors
47 11.1%
Specialized consulting support for the vehicle (ex.; IT consultant, Biotech consultant, etc.) 26 6.1%
Parceled payments to cover eventual losses not covered by insurance 20 4.7%
Others. Specify 4 0.9%
Total 425 100.0%
As mentioned before, in Brazil we have the peculiar phenomenon in which the manager of an investment
fund can also be the administrator of the fund. This structure is possible because of the Brazilian regulatory
body, the Securities Commission (CVM) permission. In reality, the Securities Commission (CVM) requires
in its instructions for Equity Participation Funds (FIPs) and Emerging Company Mutual Funds (FMIEEs) that
an administrator be responsible for the vehicle. What happens, however, is that the vehicle is run by the
manager, considered to be the more important gure, who ends up many times hiring an administrator
to manage the bureaucracy associated with a vehicle.
There is also a possibility permitted by the Securities Commission (CVM) that the administrator can
be the same legal entity as the manager, which lets fund managers which have support in this areas to
239
Chapter 6
be responsible for their own vehicles. And, in addition, this gives the manager more security because,
according to Brazilian legislation, the administrator can re the fund manager.
Management consultants and technical consultants have slightly less present roles, with the former
being a fund manager that wants to generate capital but hires another fund manager registered with the
Securities Commission (CVM) to administer the vehicle, and the latter is another fund manager with great
expertise in the sector in which the fund manager is investing.
Management fees can be received by all of these actors or just a few of them. It may be noted that in
Table 6.20 the Administrator and the Manager are the ones that mostly receive management fees directly
with a frequency of 86.9% and 83.1% respectively. This occurs because in Brazil most fund managers are
both managers and administrators.
Table 6.20 Actors Receiving Remuneration From Management Fees
Distribution of number of investment vehicles according to whether they do or do not award remuneration from management fees to each type of
actor. The total does not equal the sample size because more than one response is permitted. This table is based on a sample of 128 vehicles run
by 64 fund managers.
Actors Dont Receive (%) Receive (%) Total
Administrator 51 21.2% 50 27.7% 101
Manager 11 4.1% 97 57.6% 108
Management
Consultant
61 24.2% 13 7.6% 74
Technical Consultant 66 25.7% 7 3.8% 73
Others 64 24.9% 6 3.3% 70
Total 253 100% 173 100% 426
With the large expansion of the Brazilian PE/VC industry, management fees have changed over time.
Considering the US$ 5.58 billion of committed capital in the industry in 2004, management fees were
between 1% and 2% on 60.2% of this capital, while today management fees average between 2% and 3%
for administrators which are their own managers, while they are lower for those who are just managers
because they have to divide the fees with the other actors.
240
Table 6.21 Management Fees
Distribution of management fee ranges paid to investment vehicle actors during the vehicles rst year of existence. These fees were analyzed in a distinct
manner for administrators who act as managers with a sample of 15 vehicles and for actors who are just managers, a sample of 35 vehicles.
Fee
(percentage)
2004
Committed Capital (US$
billions)
%
No fee 25 27.8% 0.95 20.6%
0 < x < 0.5 3 3.3% 0.04 0.9%
0.5 <= x < 1 2 2.2% 0.25 5.4%
1 <= x < 1.5 7 7.8% 1.38 29.9%
1.5 <= x < 2 30 33.3% 1.4 30.3%
2 <= x < 3 21 23.3% 0.59 12.8%
x >= 3 2 2.2% 0.01 0.2%
No Information 7 0.0% 0.96 0.0%
Total 97 100.0% 5.58 100.0%
Fee
(percentage)
Administrator that is also the Manager 2009
Committed
Capital
(US$ millions)
%
No information on
Committed Capital
No fee 0 0.0% 0 0.0% 0
0 < x < 0.5 1 6.7% 14.37 0.7% 0
0.5 <= x < 1 0 0.0% 0 0.0% 0
1 <= x < 1.5 1 6.7% 287.36 14.4% 0
1.5 <= x < 2 5 33.3% 1,212.83 60.9% 2
2 <= x < 3 7 46.7% 470.95 23.6% 1
x >= 3 1 6.7% 6.9 0.3% 1
No information 0 0.0% 0 0.0% 0
Total 15 100.0% 1,992.41 100.0% 4
Fee
(percentage)
Manager 2009
Committed Capital
(US$ millions)
%
No information on
Committed Capital
No fee 0 0.0% 0 0 0
0 < x < 0.5 5 14.3% 1,149.43 32.1% 4
0.5 <= x <
1
3 8.6% 603.45 16.9% 2
241
Chapter 6
1 <= x <
1.5
7 20.0% 614.14 17.2% 3
1.5 <= x <
2
5 14.3% 400.86 11.2% 4
2 <= x < 3 13 37.1% 750.57 21.0% 6
x >= 3 2 5.7% 57.47 1.6% 1
No informa-
tion
0 0.0% 0 0.0% 0
Total 35 100.0% 3,575.92 100.0% 20
The base for calculating the management fee is essential to a fund manager. Even though management
fees for most traditional nancial products are charged in relation to the assets market value, there are
reasons why its impossible to do this with PE/VC investments. First of all, if fees were to be charged on
the value of the portfolio, fund manager remuneration would be very low in the rst few years and would
grow with time. Fund manager operational costs are very high in the beginning and decrease with time.
In this case, fund manager operations would not be viable because there would be insufcient cash ow.
Considering this hypothesis of calculating management fees based on portfolio market value, there would
be a reduction in the quality of investments because fund managers would seek to invest rapidly for their
operations to become viable (Metrick, 2007).
Besides this, it is very difcult to calculate the value of portfolio companies, given that they are not liquid
companies. Prices would have to be chosen in an arbitrary manner, hurting the investment as a whole as well.
The base for calculating management fees is committed capital . Nonetheless, its important to point out that
management fee characteristics can vary between the investment period and the exit period. In 2004, the rst
Brazilian Census of the PE/VC industry found that more than more than 65% of PE/VC committed capital was
subject to management fees charged on a committed capital basis during the investment period, followed by a
cost basis , which represented 17.4% of committed capital. In that year we can see that the base for calculating
management fees changed from the investment periods to the exit periods. In our research, the management
fees for managers changed from being most often charged on a committed capital basis to an investment
market value basis or a cost basis. In the case of administrators who received this fee, the predominant trend
was to change the base for the calculation from committed capital to investment costs. Note that from 2004 to
Table 6.21 Management Fees
Distribution of management fee ranges paid to investment vehicle actors during the vehicles rst year of existence. These fees were analyzed in a distinct
manner for administrators who act as managers with a sample of 15 vehicles and for actors who are just managers, a sample of 35 vehicles.
242
2009 the base for the calculation evolved from committed capital to other bases such as the market value of
investments and investment costs.
Table 6.22 Base for the Calculation of Managment Fees During Investment and Exit Periods
This table shows a comparison between the bases used to charge management fees by fund managers in 2004 and 2009. It should be noted that fund managers
charge management fees based on one base during the investment period and change this base (and many times the fee) during the exit period. Data for sample of
90 vehicles run by 48 fund managers.
Base for the Calculation 2004 2009
During Investment
Period
After Investment
Period
Committed Capital
Committed
Capital
26 37.7% 12 7.9%
Committed Capital Paid Capital 2 2.9% 2 1.3%
Committed Capital
Market Value of
Investments
8 11.6% 25 16.6%
Committed Capital
Cost of
Investments
2 2.9% 26 17.2%
Paid Capital Paid Capital 9 13.0% 1 0.7%
Cost of Investments
Cost of
Investments
6 8.7% 2 1.3%
Market Value of
Investments
Market Value of
Investments
12 17.4% 22 14.6%
Expense Budget Expense Budget 2 2.9% 0 0.0%
Others 2 2.9% 14 9.3%
No information 28 47 31.1%
Total 97 100% 151 100%
6.3.3.2 Carried Interest
A carried interest is a percentage paid to a PE/VC fund manager in case investments exceed a pre-
established hurdle rate, which in general is the opportunity cost demanded by the investor to commit
capital to an investment that has more risk and less liquidity than the stock market. This fee is considered
the best way to give the fund manager an incentive to perform, and thus it has a critical role in aligning
the interests of the fund managers and the investors. Historically, the performance fee is the compensation
form that provides most of the fund managers revenues (Metrick, 2007).
To give a brief example, an investment vehicle that has US$ 200 million of committed capital, and at the
exit manages to get US$ 300 million, will have a US$ 100 million prot (without considering management
fees). If the fund manager charges a 20% carried interest, it will receive US$ 20 million. According to
Gompers and Lerner (1996), 88% of PE/VC vehicles charge 20% for their carried interest. However, there
is no consensus about the basis for charging this amount for a carried interest. In Brazil, the fees charged
243
Chapter 6
are similar to those in the United States with 20% being the most common as we will see later. According to
Caselli (2010), carried interest vary between 15% and 40%, using a 5% to 10% hurdle rate.
There are various factors which inuence remuneration. The base on which it is calculated is the most important
of these factors, because it will indicate the value that the fund manager needs to surpass to begin to make a prot.
Most of the PE/VC industry uses the difference between the value earned at the exit and the total of committed
capital. This benets the investor, because this fee will be charged on a smaller base, because the fund manager
will receive this fee only after it has surpassed all the management fees that have been charged. The other carried
interest model that is frequently used is based on invested capital, which is friendlier to fund managers who will
receive a carried interest based on all that the investment vehicle earns (if there is no hurdle rate).
The variables in terms of carried interests explained above only dene the value of remuneration. Another
important aspect, however, is the timing of this remuneration. The most favorable method for the investor is that
he or she has all the money that has been invested returned before having to pay the carried interest (whole
basis). In this case, with a vehicle with a carried interest based on committed capital, the fund manager will
return all the committed capital and will receive the carried interest in return. The methods that favor the fund
managers are based on invested capital or net paid capital. In these cases, the LP will receive a base which will
always be less than the committed capital and thus, the GP will receive its share of the prots rst.
Table 6.23 Timing of Carried Interest Payment
Number of investment vehicles according to the timing of their carried interest payments. The most common responses were that carried interest were
paid only after all committed capital or invested capital was returned to the investors. Data for a sample of 115 vehicles run by 63 fund managers.
Timing
Number of
Vehicles
(%)
Committed Capital is totally returned to investors (LPs) before the performance fee (carried
interest) is paid to the manager (GP)
33 28.7%
Available Capital is totally returned to investors (LPs) before the performance fee (carried
6 5.2%
Invested Capital is totally returned to investors (LPs) before the performance fee (carried
33 28.7%
Net Invested Capital is totally returned to investors (LPs) before the performance fee (car-
ried interest) is paid to the manager (GP)
17 14.8%
Net Asset Value (NAV) is totally returned to investors (LPs) before the performance fee (car-
ried interest) is paid to the manager (GP)
5 4.3%
Others 21 18.3%
Total 115 100%
244
In many cases, GPs and LPs agree that there will be a preferential return. The hurdle rate will be paid to the
LP before the GP begins to receive performance fees. The hurdle rate is considered to be the cost of capital and
particularly in Brazil it is tied to price indexes such as the IGP-M, IPCA, or even the dollar, giving a rate that is
generally between 6% and 10%.
Hurdle rates in Brazil follow two main models. They can be in reais and post-xed, indexed to some
price index or they can be pre-xed with respect to the dollar. The most common hurdle rate in Brazil today
is tied to the IPCA, representing an opportunity cost of roughly 8%. The IGP-M is also used as a hurdle rate,
while the dollar has been used less and less over the last few years.
Table 6.24 Hurdle Rate
Distribution of number of investment vehicles according to price index used. The IPCA is increasingly being used for hurdle rates. Data for sample
of 105 vehicles run by 52 fund managers.
Index Rate (%)
2004 2009
Number of Vehicles Number of Vehicles
IGPM
10 or more 3 6
6 < x < 10 8 6
6 or less 19 13
IPCA
10 or more 4 20
6 < x < 10 0 25
6 or less 0 11
INPC 6 to 12 4 7
US$
10 or more 3 1
6 < x < 10 8 4
6 or less 4 1
Others 6 8
Does not apply/no information 38 3
Total 97 105
Source: GVcepe Database Getulio Vargas Foundation and 2005PE/VC Brazilian Census
245
Chapter 6
With respect to the priority of receiving money, there can also exist a Catch-up Clause. This clause is a
way for the fund manager to receive a large part of its performance fee after the hurdle rate has been paid.
In this way, once the investment goal has been attained, in some cases, before paying the investors, all of
the proceeds can go directly towards the fund managers remuneration until it reaches a pre-determined
ratio, before paying the investors. In other cases, the results will be adjusted just at the end, and thus the
fund managers will receive their catch-up just at this time (De Carvalho, Ribeiro and Furtado, 2006).
The catch-up is dened as a percentage. In the case of an investment vehicle with a 20% performance
fee, an 8% hurdle rate and a 100% catch-up, in which the base is committed capital of US$ 100 million,
considering an exit of US$ 200 million, after returning US$ 8 million in hurdle rate to the LPs, the fund
manager will receive US$ 20 million, and only then will the LPs receive the other US$ 72 million of the prot.
Catch-up clauses, which imply a minimum devolution of capital to fund managers before paying the
rest to investors, are still rare and are becoming more so. In 2009 only 8.9% of investment vehicles had a
100% catch-up clause, while 76.2% of them did not use this mechanism.
Table 6.25 Catch-up
Distribution of number of investment vehicles according to whether they have a catch-up clause and what percentage they have if they do. Most of the
sample, 76.2% did not have one. Yes, but didnt provide information refers to those who have a clause but would not specify a percentage. Data for
sample of 93 investment vehicles run by 45 fund managers.
Catch-Up Number of Vehicles %
100% 9 8.9
50% 2 2.0
20% 6 5.9
12% 1 1.0
10% 1 1.0
No 69 76.2
Yes, but didnt provide information 5 5.0
Total 93 100.0
For greater investor (LP) security, there can be a Clawback Clause. In this case, if a performance
fee is paid rapidly and the exit is not very successful because of partial losses, the fund manager will
have to return the performance fee to the LPs. To do this, the clawback clause denes how the GP will
246
assure or what guarantee there will be that the performance fee will be returned to the investors if
there is not enough prot to justify its payment.
Table 6.26 Clawback
Distribution of investment vehicles according to whether they have a clawback clause. Most did not possess this type of clause. Sample of 89 vehicles
of which 69 said they possessed one and 20 said they did not. Data for sample of 89 vehicles run by 46 fund managers.
Clawback Clauses Number of Vehicles (%)
No 69 77.5%
Yes 20 22.5%
Total 89 100.0%
With 90.9% of fund managers receiving a 20% performance fee in 2004, administrators are those who
continue to frequently receive 20% performance fees, while in some cases managers receive less than the
traditional 20% fees common in the industry.
Table 6.27 Carried Interest
Distribution of number of investment vehicles according to whether a carried interest is charged or not, by the different actors involved. The traditional
model of 20% fees is prevalent for administrators and managers. Data for sample of 114 vehicles run by 58 fund managers.
Fee
(percentage)
2004 2009
Received by
Administrator
Received by
Manager
Received by
Management
Consultant
Received by
Technical
Consultant
Received by
Technical
Consultant
%
Number of
Vehicles
%
Number of
Vehicles
%
Number of
Vehicles
%
Number of
Vehicles
%
Number of
Vehicles
%
Number of
Vehicles
%
Number of
Vehicles
%
Number
of Vehicles
%
Number
of
Vehicles
%
0 < x < 5 0 0.0% 2 5.4% 2 2.9% 1 20.0% 1 33.3%
5 <= x < 10 1 1.5% 1 2.7% 1 1.4% 2 40.0% 2 66.7%
10 <= x <
20
3 4.5% 2 5.4% 10 14.5% 2 40.0% 0 0.0%
247
Chapter 6
20 60 90.9% 31 83.8% 50 76.8% 0 0.0% 0 0.0%
20 < x < 25 1 1.5% 0 0.0% 0 0.0% 0 0.0% 0 0.0%
x >= 25 1 1.5% 1 2.7% 3 4.3% 0 0.0% 0 0.0%
Total 66 100,0% 37 100% 69 100% 5 100% 3 100%
To get a more accurate idea of how fees are used in most cases, we combined management fee data
with carried interest data. We found that despite the ILPA pressure against it, the most used model is still
the 2/20 model (Sahlman, 1990; Fen, Liang and Prowse, 1995; Metrick, 2007; Caselli, 2010). In Tables
6.28 and 6.29, its possible to see the variation in management fees and performance fees received by
administrators and managers. Note that in general the tendencies for both are similar.
Table 6.28 Management Fees Vs. Carried Interest (Received By Administrator)
This table presents management fee data along with carried interest data, as received by the vehicle administrator, in absolute numbers of vehicles
tting this scenario. Most common were management fees between 1.0% and 2.0% and a carried interest of 20%. Data for a sample of 111 vehicles
run by 60 fund managers.
Carried Interest
0.0 < x <=
10
15 20 30
No
information
Variable
Fees
Total
Management Fees
0.0 < x <= 1.0 2 1 31 34
1.0 < x <= 2.0 1 1 15 14 4 35
2.0 < x <= 3.0 7 2 9
3.0 < x <= 4.0 2 1 3 6
No information 1 8 9
Dont charge fees 1 16 1 18
Total 4 1 26 1 74 5 111
Table 6.27 Carried Interest
Distribution of number of investment vehicles according to whether a carried interest is charged or not, by the different actors involved. The traditional
model of 20% fees is prevalent for administrators and managers. Data for sample of 114 vehicles run by 58 fund managers.
248
Table 6.29 Management Fees Vs. Carried Interest (Received By the Manager)
This table presents management fee data along with carried interest data, as received by the vehicle manager, in absolute numbers of vehicles tting
this scenario. Most common were management fees between 1.0% and 2.0% and a carried interest of 20%. Data for a sample of 77 vehicles run
by 53 fund managers.
Carried Interest
0.0 < x <= 10.0
10.0 < x <=
15.0
20 30 Not available
Charge variable
fees
Total
Management Fees
0.0 < x <= 1.0 4 3 1 2 2 12
1.0 < x <= 2.0 1 7 17 1 3 29
2.0 < x <= 3.0 8 1 9
3.0 < x <= 4.0 2 2
Not available 2 2 4
Dont charge fees 1 17 18
Charge variable fees 1 2 3
Total 5 10 30 2 24 6 77
The management fee can be treated as an advance to the fund manager, which is subsequently subtracted
from the amount to be received based on performance. Or, it can also be seen as just an expense, which
is not subtracted from the gross value. If the management fee is not subtracted, the value received by
the fund manager, ceteris paribus, will be greater. We can see in Table 6.30 that in most cases this fee is
subtracted.
Table 6.30 Subtracting the Managment Fee From the Carried Interest
Distribution of investment vehicles according to whether the management fee is deducted from the amount to be received based on performance.
Most of the vehicles subtract the management fee. Data for sample of 98, 62 of which said they do subtract it, while 36 said they dont. In 2009
different alternatives were offered as compared to 2004, and thus we didnt have responses for the rst two options in 2009.
Management Fees
2004 2009
Subtract the price-index ajusted value 12 18.2% na 0.0%
Subtract the nominal value 27 40.9% na 0.0%
Subtract it 0 0.0% 62 63.3%
249
Chapter 6
Dont subtract it 27 40.9% 36 36.7%
Total 66 100.0% 98 100.0%
As can be seen in Table 6.31, the time that the performance fee is calculated reects the predominance
of the Total Return model (38.4%) in which the fee is calculated just when the vehicle ceases operations,
giving the investor more security in case the last deals arent as protable as the rst ones. The deal-by-
deal basis on the other hand is used by 21.6% of Brazilian PE/VC investment vehicles.
Table 6.31 Timing of Carried Interest calculation
Distribution of investment vehicles according to the timing of the performance fee calculation. The four that are listed under Others didnt specify
when the fee was calculated. Data for sample of 125 vehicles run by 60 fund managers.
Time Responses (%)
After the Divestiture Period 31 24.8%
After the Investment Period 7 5.6%
Deal by Deal 27 21.6%
When the Vehicle Ceases Operations (Total Return) 48 38.4%
Others 4 3.2%
Total 125 100.0%
Table 6.30 Subtracting the Managment Fee From the Carried Interest
Distribution of investment vehicles according to whether the management fee is deducted from the amount to be received based on performance.
Most of the vehicles subtract the management fee. Data for sample of 98, 62 of which said they do subtract it, while 36 said they dont. In 2009
different alternatives were offered as compared to 2004, and thus we didnt have responses for the rst two options in 2009.
250
6.3.4. Conicts of Interest
In the relationship between GPs and LPs, as with the relationship between GPs and investee companies, potential
conicts of interest should be mitigated by regulatory provisions for guidelines and standard conduct to remedy
such situations, and as a last resort the use of binding arbitration as it will be discussed in the following section.
Most conicts of interest between fund managers and investors arise when the original proposal for the PE/VC
investment has been strayed, in terms of the key personnel involved, the structure of fund manager remuneration,
the establishment of other vehicles by the fund manager which are potential competitors, the fund managers use
of more than one vehicle for leveraging operations, and transactions between funds run by the same fund manager.
Depending on the investors level of inuence in a determined investment vehicle, they can have the
right to re the manager or some member of the management team. This can be conrmed by looking at
Table 6.32, which collected data from 121 responding vehicles.
Table 6.32 Investor Right to Fire the Manager or Members of the vehicle Management Team
Distribution of investment vehicles according to whether investor has right to re the manager or members of the vehicle management team. Data
for a sample of 121 vehicles run by 61 fund managers.
CVM
Holding
Comp.
Direct Investment Limited Partnership Other Total
Yes, for just cause 15 2 - 6 33
Yes, in any situation 8 4 - - - 12
Yes, even without just cause
if qualied majority ap-
proves
13 1 2 3 - 29
Yes, by other mechanism 15 1 - 5 3 24
No 4 5 - 11 3 23
Total 50 13 2 25 6 121
251
Chapter 6
6.3.4.1. Conict Resolution
Historically, Brazil is known for its large quantity of bureaucracy and judicial system inertia. To avoid these
complications, some fund managers dene the use of binding arbitration in their shareholder agreements
to solve possible controversies. The benets are clear: greater agility in receiving a legally valid decision,
as well as a better quality judgement given that these arbiters are specialists.
We identied that 92 of the 121 respondent investment vehicles using binding arbitration, especially those
with structures governed by instructions from the Securities Commission (CVM 391), which had a large increase
in the frequency of use of this mechanism for conict resolution.
Table 6.33 Use of Binding Arbitration to Resolve Conflicts Between PE/VC Fund Managers and
Investors
Distribution of investment vehicles grouped by legal structure according to whether they use binding arbitration for conict resolution between PE/
VC fund managers and investors. Data for a sample of 121 investment vehicles.
Binding
Arbitration
2004 2009
# % CVM Holding Direct Investment Limited Partnership Other Total (%)
No 77 81.1% 15 8 - 5 1 29 24.0%
Yes 18 18.9% 63 5 2 17 5 92 76.0%
Total 95 100.0% 78 13 2 22 6 121 100.0%
6.4. Fund Managers and Portfolio Companies
In practice conicts arise in fund manager investments because of the asymmetry of information existing
between those who control them (executives) and those who own them (shareholders). This asymmetry of
information adds to the differences in the objectives of both sides results in agency costs, which include all
the costs that shareholders incur to make sure that the interests of the managers are in line with their interests
(Jensen and Meckling, 1976).
252
There are some agent objectives which diverge from the interests of principals. The objective of expanding
and creating a corporate empire can satisfy an executives ego, but can expose the company and its
shareholders to elevated and undesirable risks as well as destroy value. An opposite example could be
an aversion to risk on the part of executives: such conservative behavior can guarantee a long stay as CEO
but can hurt value creation for shareholders. Besides this, the manipulation of nancial results in order
to increase executive bonuses and trigger options is a classic example of the conict between agents and
principals.
Agency costs thus come from the attempt to align shareholder and executive interests, seeking to avoid
the examples cited above. Typical agency costs that shareholders pay are: (1) the expenses of monitoring
the management performed by executives with internal and external audits; (2) the expenses of structuring
the fund manager in such a way as to limit unwanted behavior by executives such as the naming of
external advisors to the Board of Directors; and (3) the opportunity costs resulting from reduced exibility
in decision making due to the monitoring systems implanted for corporate governance.
To reduce the agency costs in the relationships between the different stakeholders not just managers
and shareholders a group of practices and conducts will guide company management: Corporate
Governance (IBGC, 2009). Among Corporate Governances main areas of focus are: monitoring of
executives by the Board of Directors; compensation policy; internal and external audits; balances of power;
transparency requirements, etc. The importance of Corporate Governance for PE/VC activity is obvious
given the high risks involved in PE/VC investments, the great asymmetry of information, and the impact
that fund managers have on investee company operations.
Over the last few years, there has been a great movement to increase the transparency of Corporate
Governance of publicly traded companies. In 2001, the Brazilian Stock Exchange (BM&F BOVESPA) created
the Corporate Governance Stock Index (IGC), a classic method of classication for listed companies in relation
to practices of Corporate Governance. This classic method classies companies in good levels of Corporate
Governance on three different levels: New Market (or Level 3), Level 2, and Level 1 (in decreasing order of
quality of Governance) and has transparency and oat requirements.
The New Market has various requirements for companies that wish to qualify, such as, for example, that the
rm issues ordinary voting shares, that it will promote conict resolution through binding arbitration, that it
will keep at least 25% of its shares in circulation to be freely traded in the market (free oat), as well as many
others (BM&F BOVESPA, 2008).
253
Chapter 6
Table 6.34 Evolution of Number of Companies in Compliance With Each Level of the Bm&F Bovespas
Corporate Governance Classification
Level of CG Regular Level 1 Level 2 New Market Total
Year
2000 494 0 0 0 494
2001 450 18 0 0 468
2002 407 24 3 2 436
2003 374 31 3 2 410
2004 343 33 7 7 390
2005 316 37 10 18 381
2006 300 36 14 44 394
2007 293 40 18 82 433
2008 279 43 18 99 439
Source: Black, Carvalho and Gorga (2009).
Since its creation, there has been a lot of investor pressure for listed companies to comply with the New Market
(Level 3) requirements, with the result that Governance Standards have signicantly improved in BM&F Bovespa
companies, a fact that can be observed by the number of companies listed at each level of Corporate Governance
as shown in the table above.
A study of the quality of corporate governance in private companies was conducted in Brazil in 2005, and sought to
highlight the strong point points and weak points of corporate governance in Brazil. Black, Carvalho and Gorga (2009),
using a questionnaire observed that the weak points of corporate governance in Brazil are:
(i) Boards of Directors, which include, in the majority of cases, seats completely or almost completely lled with
internal members or representatives of the controlling family or group, and that generally there are no independent
members with seats on the board;
(ii) Transparency of nancial data. In this area, Brazil is behind in terms of international standards given that
Brazilian accounting standards do not meet various demands met abroad (like a Cash Flow Report and Quarterly
254
Financial Reports) in spite of the fact that there is a requirement to present reports in English. The mandatory
adoption of the IFRS to begin in 2010 should correct these deciencies;
(iii) Auditing Committees: this instrument is rarely used and the responsibility for guaranteeing the quality of
accounting information is left to the Fiscal Board.
There is also a strong tendency that these points will improve given the Brazilian Institute of Corporate Governance
(IBGC) initiatives such as the BOVESPAs New Market, the convergence towards international accounting standards,
the increased use of cross-listings, and the general strengthening and encouraging of Corporate Governance,
among others.
6.4.1. The Importance That Fund Managers Give to Corporate Governance
The economic importance of these policies is widely recognized by PE/VC industry actors as can be
observed in Graph 6.3.
Graph 6.3. Importance Attached by Fund Managers to Best Practices of Corporate
Governance at Different Stages of Investment
This graph shows the importance that PE/VC fund managers give best practices in corporate governance, and the impact that this has on the
continuity and success of investments. Data shows relative frequencies of responses received from 81 PE/VC fund managers.
Note that 36 PE/VC fund managers (44.4%) consider the existence of Best Practices in Corporate
Governance a pre-requisite for making an investment, whereas 74 fund managers (91.36%) consider
this necessary after the investment has been made. This increase in the importance given to Corporate
Governance is notable, since after the investment has been made the implementation of Corporate
Governance generates value for the fund manager which has not just nancial resources but also
255
Chapter 6
managerial expertise and the knowledge to break through the asymmetry of information. Thus, it would
be disadvantageous and a waste of resources if best practices were not to be implemented.
Proof of the value of Corporate Governance is that PE/VC fund managers are willing to pay more for
an investment if it demonstrates good Corporate Governance. This agrees with some empirical studies
done in the United States which show a great increase in the value of companies with high levels of
Corporate Governance (Brown and Caylor, 2006).
Table 6.35 shows that in general PE/VC fund managers attach great importance to good Corporate
Governance to the point that they are willing to pay 13.1% more for investments that demonstrate it.
Also in this table, we can perceive the greater importance attributed to Corporate Governance
for less developed companies; this follows the idea that Corporate Governance is more valuable
for less structured companies with more intangible assets.
Thus, Venture Capital fund managers are willing to pay 17.3% more for good Corporate Governance,
while Private Equity fund managers are inclined to pay 13% more. The difference between the two is
not, however, statistically significant.
Table 6.35 Willingness to Pay More for Good Corporate Governance
This analysis captured how much more fund managers would be willing to pay at different stages for best practices in Corporate Governance
implemented in potential investee companies, based on a sample of 49 PE/VC fund managers.
Stage
Arithmetic Average
(%)
Standard Deviation
(%)
Minimum (%) Maximum (%)
Total/In General 13.12 9.17 0.00* 32.00
Venture Capital 17.33 11.35 0.00 32.00
Private Equity 13.00 10.28 0.00 30.00
Venture Capital and Pri-
vate Equity
11.00 7.46 0.00 20.00
Stage not specied 13.17 6.18 5.00 20.00
256
In any event, in the analysis of the 48% of fund managers that would pay more for good Corporate
Governance in their negotiations, the average premium paid is 16.8% (See Table 6.36).
52%
48%
No
Yes
Avg.
Standard
Dev.
Median Max. Min
16,8% 9,4% 20,0% 30,0% 0,0%
Table 6.36. Corporate Governance
Paid in Fact
This analysis captured, through a sample of 12 PE/VC fund
managers, how much fund managers believe they have
paid for best practices of Corporate Governance in poten-
tial investee companies.
Graph 6.4. Fund Managers that Paid
for Governance
Graph presents the proportion of fund managers that they
have paid more for good corporate governance in negotia-
tions that have already been conducted. Responses from 21
PE/VC fund managers.
When we examined the Levels of Corporate Governance found in proposals received, and those in
successive phases of investment, and after the investment we found that, as the process envolves, higher
Levels of Corporate Governance are expected by PE/VC fund managers. Using a zero to ve scale
the average Level of Corporate Governance of proposals received was 1.60, for analyzed proposals it
was 2.41 and for proposals selected for investment it was 2.67. Then we see a large jump in expected
Corporate Governance for companies after they have received investment, with an average of 4.15. Also
note that 71.5% of investee companies showed low or medium levels of governance before investment
and just 18% presented high levels. Table 6.37 below illustrates these observations.
257
Chapter 6
Table 6.37 Level of Corporate Governance During the Investment Selection Process
Analysis presents the Level of Corporate Governance perceived by PE/VC fund managers in a sample of 82 potential investee companies during the
deal ow process and after the investment is made.
Level of
Governance
attributed to
proposals
received
Very Low
Level of
Corporate
Governance
Low Level of
Corporate
Governance
Medium Le-
vel of Corpo-
rate Gover-
nance
High Level
of Corporate
Governance
Very High
Level of
Corporate
Governance
Avg. Stnd. Dev.
Considering
all proposals
received
48.1% 39.0% 9.1% 3.9% 0.0% 1.60 0.86
Considering the
proposals that
are effectively
analyzed among
those that are
received
11.7% 39.0% 41.6% 9.1% 1.3% 2.41 0.97
Considering
investee companies
before the fund
manager makes the
investment
11.7% 27.3% 44.2% 18.2% 2.6% 2.67 1.04
Considering
investee companies
after they have
become portfolio
companies
0.0% 5.2% 11.7% 45.5% 42.9% 4.15 0.94
The fact that fund managers are creators of standards of Corporate Governance in investee companies is
proven when we compare companies that received PE/VC fund manager investment and those that didnt
receive this investment.
PE/VC investee companies listed in the Brazilian Stock Exchange (BM&F Bovespa), present better
quality accounting information, better Corporate Governance structure, better earnings management
at less aggressive levels, and Boards of Directors that are less dependent on investee company
management, etc. (Gioielli, 2008).
6.4.2. Formalization of Governance
The structure of a company determines the rights and obligations of partners, and consequently the
Corporate Governance of each one. Elements such as the Board of Directors, the Executive Board,
and the Fiscal Board, for example, have different characteristics depending on whether it is a Limited
Company or a Publicly Traded Company. To examine this, it is a good idea to analyze the structure of
investee companies as a rst step towards evaluating their governance.
258
Among the 60 responding companies, most were Private Corporations (68.3%), while Limited Companies
represented 21.7% and Publicly Traded Corporations represented 10%. The preponderance of Corporations as
opposed to Limited Companies can also be explained by the changing of Limited Companies to Corporations
with corporate governance mechanisms after receiving PE/VC investment.
Table 6.38 Categories of Company Structure
The table presents the absolute and relative frequencies of company structures of investee companies, from a sample of 58 investee companies
represented by 30 PE/VC fund managers, separated into the Limited, Private Corporation, and Publicly Traded Corporation classes.
Corporate Structure Absolute Frequency Relative Frequency
Limited Company 13 21.7%
Private Corporation 41 68.3%
Publicly Traded Corporation 6 10.0%
Total 60 100.0%
The free oating of capital brings diverse interests, that, even though they may be convergent in terms of the
constitution, participation and objectives of a corporation, can be quite different or even divergent in terms of
other aspects. Notably in corporations, the individual interests of partners should be controlled in such a way
as to avoid and regulate possible conicts. The Shareholder Agreement is the instrument used to control many
of these interests (Koury and Lopes Advogados, 2008). Of the companies included in this study, 45 (or 76.3%
of the total) possess a Shareholder Agreement, indicating a high level of formalization of partner interests.
The investments in companies were made using various nancial instruments and the proportions for each
one are shown in Graph 6.5. Common Shares which have voting rights with or without restrictions were
the most common (34 companies, or 65.4% of all respondents used this mechanism). Preferred stocks (30.8%
of all respondents) confer priority to the holder in the receipt of dividends and capital reimbursements, and
sometimes, they offer the right to more dividends than common shares. Debt Instruments were used by 15
companies or 28.8% of respondents.
259
Chapter 6
Graph 6.5 Distribution of Financial Instruments Used by Investee Companies
This graph shows the most commonly used nancial instruments used by PE/VC investee companies. Data reects relative frequency that these
instruments were used by investee companies over the total of instruments used. Reponses furnished by 25 PE/VC fund managers for 52 investee
companies. In this analysis the respondents could use more than one instrument for each investee company.
2%
4%
8%
29%
31%
65% Common Stocks
Preferred Stocks
Debt Instruments
Others
Redemable Stocks
Common Stocks with Warrants
It is important to emphasize that preferred stocks may or may not be converted into common stocks. In the
case of investments nanced by Preferred Stocks, their most common characteristics were redeemability (79%)
and convertibility to common stocks (78%) see Graph 6.6. Just a minority of respondents (32%) announced
they use preferred stocks just for the receipt of dividends.
Graph 6.6 Characteristics of Investments Financed by Preferred Stocks
Graphical representation of investments in which preferred stocks were used, according to their various possible characteristics. Responses furnished by 13
fund managers which responded for 22 investee companies.
32%
68%
79% 78%
53%
68%
32%
21% 22%
47%
0%
25%
50%
75%
100%
Just to receive
dividends?
Have voting
rights?
Are redeemable Can be converted
to common stocks
Have warrant
rights?
Yes No
260
In the case of investments nanced by debt instruments, there are some characteristics which stand out
based on the companies surveyed (see Graph 6.7). Convertible Debentures, for example, were used in 65% of
these cases and debentures with warrant rights were quite common as well (46% of total). On the other hand,
promissory notes were not popular among the companies surveyed, with just 10% saying they used them.
Graph 6.7 Characteristics of Investments Financed by Debt Instruments
Graphical representation of investments nanced by debt instruments according to their various possible characteristics. Responses furnished by 12
PE/VC fund managers which responded for 19 investee companies.
20%
10%
20%
65%
46%
80%
90%
80%
35%
54%
0%
25%
50%
75%
100%
Yes No
Sellers Notes Promissory Notes Debentures Convertible
Debentures
Debentures with
Warrant Rights
6.4.3. Human Capital in Investee Companies
Analyzing the composition and characteristics of human capital in investee companies claries important
questions such as whether relatives occupy positions in the company, if there is an above average
compensation for team members, the balance between entrepreneurial and private contexts, along with
various others which are strongly related to Agency problems limiting value creation and burdening the
PE/VC fund manager and consequently the investors.
In this context, the organizational dynamic of investee companies was analyzed and it was perceived
that, on average, 69% of investee companies have changed CEOs after the investment has been made.
And of the cases where there was a change of CEO, in 46.2% such a change was not expected, in 38.5%
one had already been agreed to and in 15.4% it occurred during the act of investment.
261
Chapter 6
Graph 6.8 Characteristics Related to the CEO of the Investee Company
Graphs show whether CEO was changed after the investment and whether he or she was the entrepreneur. Reponses for rst analysis furnished
by 24 fund managers representing 46 investee companies. Responses for the second analysis furnished by 23 fund managers responding for 42
investee companies.
69%
31%
CEO was not
changed after
the investment
CEO was
changed after
the investment
CEO was the
entrepreneur
CEO was not
the entrepreneur
52%
48%
Entrepreneurs held, on average, 26% of share participation. However, when we split this data by
type of investment, we perceived that Venture Capital entrepreneurs have more diluted holdings than
Private Equity entrepreneurs. Entrepreneurs who received investments from VC fund managers had on
average 19% share participation, while those who received investments from PE fund managers had
52% share participation on average. This data is presented in Table 6.39.
Table 6.39 Entreprenuer and CEO Share Participation
This table presents participation data for entrepreneurs (or relatives/heirs) in a sample of (*) 21 investee companies represented by 12 PE/VC
fund managers and participation data for CEOs in a sample of (**) 22 investee companies represented by 12 PE/VC fund managers with
data divided by the fund managers in Venture Capital and Private Equity totals in each case. In each case Venture Capital fund managers dealt
exclusively with Venture Capital and Private Equity fund managers dealt exclusively with Private Equity. The two classes together do not equal the
sample total because it also included Real Estate, N/Ds, etc.
Total Venture Capital Private Equity
Data presented in percentage points (%) Average
Standard
Deviation
Average
Standard
Deviation
Average
Standard
Deviation
Share participation of Entrepreneur (or relative/
heir of entrepreneur) in Company*
26.05 30.95 19.00 15.43 52.00 46.07
Share participation of CEO in Company (includ-
ing Options)**
14.59 21.76 11.75 15.63 27.00 45.90
In terms of presence of relatives in investee companies, in 55% of the cases there were new management
professionals, while in the other 45% there were family members in the structure (see Table 6.9). The
262
company positions more frequently given to relatives were: CEO (67%), Commercial Director (29%) and
Administrative/Financial Director (24%).
Graph 6.9 Presence of Relatives of Entrepreneur in Different Positions in Investee Companies
This analysis presents the proportion of PE/VC fund manager investee companies that employ relatives of the entrepreneur. Next are listed the relative frequency
with which positions are occupied by relatives of the entrepreneur (including himself or herself) when there are family members present. Reponses furnished by 23
PE/VC fund managers which responded for 47 investee companies.
55%
45%
There are no family
members working in the
investee company
There are family
members working in the
investee company
0%
0%
10%
19%
24%
29%
38%
67% CEO/President
Other
Commercial Director
Administrative/Financial Director
Industrial Director
Investor Relations Director
Director of Human Resources
Controller
Given their strategic importance, the members of the Executive Board and the CEO should have
succession/replacement plans for the long term so that the investee company can proceed smoothly
in case changes need to be made. However, just 18% of companies have such plans in place.
Graph 6.10 Existence of Succession/Replacement Plans for CEOs and Executive Officers
Graph presents the proportion of investee companies which have succession/replacement plans for their CEOs and other key personnel. Responses
furnished by 24 PE/VC fund managers which responded for 49 investee companies.
18%
82%
There is a Sucession Plan
There is no Sucession Plan
263
Chapter 6
The members of the Board of Ofcers, given the great responsibility and impact inherent to their positions,
are legally liable to sanctions if they act in a fraudulent manner. These liabilities can exceed their performance
bonuses and even their xed compensation. However, companies can have insurance policies which limit the
responsibility of their executives called Directors and Ofcer Liability Insurance (D&O).
Among PE/VC fund manager in investee companies, 48% have D&O, of which 67% cover the CEO
and members of the Board of Directors, and 62% cover the members of the Executive Board (see
Graph 6.11 below).
Graph 6.11 Investee Companies That Have Directors And Officer Liability Insurance And The
Positions Insured
The analysis shows the proportion of companies invested by PE/VC fund managers that have D&O insurance. Then are ranked the positions most frequently
favored, with a relative frequency given by companies that have used the D&O insurance in certain positions on the total respondents in this analysis.
Responses furnished to the rst analysis come from 24 fund managers, representing 42 investee companies.
Responses furnished to the rst analysis come from 21 fund managers, representing 21 investee companies.
48%
52%
Has D&O
Insurance
Members of the Board
of Directors
CEO/President
Executive Board
Others
Does not have
D&O Insurance
19%
62%
67%
67%
6.4.4. Instruments for Implementing Corporate Governance
6.4.4.1 The Board of Directors
The main responsibilities of the Board of Directors, among other things, are: the approval and monitoring
of decisions involving strategy, business strategy, capital structure, risk exposure and tolerance, independent
auditor choice and evaluation, relationships with interested parties, human resources management policy, and
codes of conduct (McNamara, 2008).
264
The participation of representatives of the PE/VC fund manager on the Board of Directors is a fundamental
factor for the success of implementing Corporate Governance and adding value. The mission of the Board of
Directors is to protect and increase the value of the company, to maximize long term investment returns for all
shareholders and to seek to balance the interests of all parties in such a way that each one receives appropriate
benets proportionate to the partys ties to the company and the risk the party has been exposed to. Keeping
in mind the great importance of this body, most surveyed companies have a functioning Board of Directors in
place (81% of 59 investee companies represented by 29 fund managers).
Graph 6.12. Formal Board of Directors and Board of Directors that also Meet Informally.
Graph analyzes Board of Director activity. The rst analysis presents PE/VC fund manager investee companies that have formal Boards of
Directors, while the second analysis shows the number of investee companies which have Boards of Directors that also meet informally. Responses
furnished in rst analysis by 29 fund managers which represent 59 investee companies. Responses furnished in second analysis by 24 fund
managers which represent 41 investee companies
81%
19%
Has formal
Board of Directors
Doesnt have
formal Board of
Directors
Board of Directors
Meets Informally
Board of
Directors
Doesnt Meet
Informally
95%
5%
The Boards of Directors meet, on average, every 1.27 months and in almost every meeting - 97.7% of the
time in a sample of 43 investee companies represented by 25 fund managers there is a pre-dened meeting
agenda. Besides formal Board of Directors meetings, the members of these groups meet informally in 95.1% of
these cases every 1.09 months, on average.
Table 6.40 Formal meetings of the Board of Directors and informal discussions
This table presents the absolute and relative frequencies of formal meetings of the Board of Directors and informal meetings of members of the
Board of Directors for investee companies of PE/VC fund managers. The data about formal meetings (*) was collected for a sample of 42 investee
companies represented by 24 PE/VC fund managers, while the data about informal discussions (**) was for a sample of 38 investee companies
represented by 22 PE/VC fund managers.
Frequency of Formal Meetings
of the Board of Directors*
(%)
Frequency of Informal Meetings of
Members of the Board of Directors**
(%)
Monthly 28 66.7% 25 65.8%
Bimonthly 6 14.3% 1 2.6%
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Chapter 6
Quarterly 5 11.9% 3 7.9%
Biannually 2 4.8% 0 0.0%
Annually 1 2.4% 0 0.0%
Other 0 0.0% 9 23.7%
Total 42 100% 38 100%
Frequency Meetings every 1.27 months***
Meetings
every 1.09
months***
Meetings every 1,09 months***
*** Respondents which t in the category Other were not included in this calculation.
Hermalin and Weisbach (1988) investigate the factors causing changes in the composition of the Board
of Directors in American publicly traded companies. Their nal conclusion was that the composition of the
Board is mainly inuenced by: (i) internal promotions and the CEO succession process, (ii) bad company
performance, and (iii) company participation in diverse product markets. Hermalin and Weisbach (1988)
believe that during the years before the change of a CEO, more internal members are added to the Board,
given that the new CEO tends to be chosen from these new members even though more established
members of the Board are also usually in the running for promotion to CEO. After the CEO is selected, the
losing candidates frequently resign from the Board and the new CEO, perhaps because he or she needs new
advice, substitutes many internal members with external members.
Suchard (2008) states that the Boards of PE/VC investee companies have a higher percentage of independent
board members and a higher percentage of independent directors with relevant industry experience, consistent with
the idea that PE/VC fund managers create Boards with greater independence and supervision. Suchard (2008) also
states that fund managers use their social networks to recruit independent specialist Directors who have experience
in the same company sector. In the United States, PE/VC nanced IPOs had 36.9% independent members. In
Australia, this percentage was 55.3% (Suchard, 2008). In Brazil, Gioieli (2008) studied the Board of Directors of
companies that went public between 2004 and 2007 and found that, among PE/VC investee companies, 64.42%
of Board members have a monitoring function. This percentage is lower for companies without PE/VC investment
(44.09%) which shows that PE/VC investee companies have more independent Boards of Directors.
Table 6.40 Formal meetings of the Board of Directors and informal discussions
This table presents the absolute and relative frequencies of formal meetings of the Board of Directors and informal meetings of members of the
Board of Directors for investee companies of PE/VC fund managers. The data about formal meetings (*) was collected for a sample of 42 investee
companies represented by 24 PE/VC fund managers, while the data about informal discussions (**) was for a sample of 38 investee companies
266
Among surveyed companies, however, the participation of independent members on the Board wasnt
as elevated as cited in previous empirical studies. In the 40 sample companies, there were a total of 110
internal members cited along with 57 external members and 32 independent members (see Table 6.41). In
this case, independent members represented 16.08% of all members. A possible explanation for this fact is
that the surveyed companies were predominantly private and the above cited studies were done on publicly
traded companies. Its probable that these companies are under more pressure to establish a greater level
of corporate governance before going public, and consequently, when the IPO occurs, they already have a
structure for the market with more independent members. Besides, a comparison with companies without
PE/VC investment wasnt done during this study (a reference sample) which doesnt mean that conclusions
cant be drawn in terms of which of these groups will tend to have a more independent Board of Directors.
We can see that there is no great difference between the categories in terms of the average age of Board
members. As it can be seen in Table 6.41, internal members are on average 46.1 years old and external
members are on average 42.11 years old.
Table 6.41 Characteristics of Board Members
Table describes the makeup of the Board of Directors for a sample of 40 investee companies represented by 24 fund managers, classied by
Internal, External and Independent members, indicating the percentages and average age of each category.
Category Number of Members (%) Average Age
Internal 110 55.28% 46.11
External 57 28.64% 41.27
Independent 32 16.08% 42.11
Total 199 100% 44.08
Source: GVcepe Getulio Vargas Foundation
For the Board responsibilities to be carried out in the best possible manner, it is important to nd among
their members complementary characteristics and experiences such as being members of other Boards of
Directors, being ex-executives of companies similar to the one in question, having experience in identifying and
controlling risk, managing people, having knowledge of nance and accounting and having contacts useful to
the company. It is in the effort to concentrate all of these competencies in the Board of Directors that a PE/VC
fund manager demonstrates its importance, because he or she has the required experience and knowledge, or
knows professionals that can ll these needs.
Surveyed companies in fact conrm this search for a diversied and experienced Board as shown in Table
6.42. Its important to note that external and internal members have essentially different backgrounds.
267
Chapter 6
Among external members, 33.3% of them are members of the PE/VC fund manager. Other relevant
groups that make up the external members are representatives of co-investors (13.7%), members of some
PE/VC investor (11.8%) and Professional Advisors (11.8%). The group of independent members is made
up mainly of advisors and/or lawyers with no professional connection to the company (37.1%). Other
signicant categories within the group of independents are: Professional Advisors (25.7%), members of
Mezzanine Funds (14.3%) and members of the PE/VC fund manager (14.3%). The lack of a professional
link to the company these professionals and/or lawyers have is essential to the task of external impartial
supervision, a quality greatly sought in an independent advisor.
Table 6.42 Background of External and Independent Members of the Board of Directors
Table describes the Board of Directors, characterizing its members by their professional backgrounds and dividing them by those who are external
and those who are independent. Background data is presented in percentage terms and was drawn from a sample of 104 investee companies
External Independent
Professional Advisor 11.8% 25.7%
Consultants and/or Lawyers with no professional links to the company 9.8% 37.1%
Ex-directors or ex-employees of the company 7.8% -
Angel Investor - -
Representative or member of a Family Ofce - -
Representative or member of a Mezzanine Fund 7.8% 14.3%
Representative or members of Holders of Debt - -
Representatives or members of Banks, and Financial or Factoring Institutions - -
Representative or member of another PE/VC fund manager - 2.9%
Representative or member of the PE/VC fund manager 33.3% 14.3%
Representative or member of a Co-Investor 13.7% 2.9%
Representative or member of a PE/VC fund manager investor 11.8% -
Others 3.9% 2.9%
Total 100% 100%
When we are talking about high impact actions related to company strategy, it is normal that the CEO/
Board of Ofcers needs the approval of the Board of Directors to implement them. Graph 6.13 illustrates
which actions normally need the approval of the Board of Directors to be implemented. Mergers
and Acquisitions, for example, almost always need approval 97% and 94% of the time respectively.
The Annual Budget and the Capital Budget also stand out with approval required 92% and 89% of the
268
time respectively. On the other hand, actions related to the 100 Day Plan rarely (28%) need this kind of
approval from the Board of Directors.
Graph 6.13 Actions Which Need Approval from the Board of Directors to be Implemented (%)
Graph displays a list of actions which need approval from the Board of Directors in order of frequency of approval needed. Relative frequency data
based on number of companies that require such approval for these actions as a proportion of the whole. Responses furnished by 24 PE/VC fund
managers responding for 36 investee companies.
28%
53%
58%
69%
69%
69%
72%
89%
92%
94%
97% Merges
Acquisitions
Annual Budget
Capital Budget
Payment of Dividends
Strategy
Payment of Executives Bonuses
Taking on Debt
Hiring of Key Personel
Hiring of Upper Management
100 Day Plan
Other
The Chairman of the Board of Directors has the responsibility of ensuring the efciency and good performance
of the body and each of its members. He or she must establish board objectives and programs, preside over
meetings, organize and coordinate the agenda, coordinate and supervise the activities of other board members,
assign responsibilities and deadlines, as well as monitor the evaluation process of the body in relation to the
principles of good corporate governance. He or she should also make sure that board members receive complete
and timely information in order to carry out their mandates.
There is a clear conict of interest when the positions of CEO and Chairman of the Board are occupied by the
same person, given that the Chairman becomes responsible for evaluating his or her own performance. This
is why the separation of these roles confers greater objectivity and effectiveness to the management evaluation
process. Among companies with Boards of Directors, the CEO was the Chairman of the Board in just 34.6%
of these instances which indicates that in general there is a good level of corporate governance. According to
Baker and Gompers (2003) PE/VC investee companies are less likely than companies that did not receive PE/
VC investment to have the same person occupying the positions of CEO and Chairman of the Board.
269
Chapter 6
Table 6.43 illustrates the relationship that the members of the Board of Ofcers have with the Board of Directors
and shareholders. Of the members of the Board of Ofcers that appear on the Board of Directors, those that appear
with greatest frequency are: the CEO (62.5%), the Commercial Director (14.0%), and the Financial Director (11.1%).
These executives are also frequently shareholders of the company; this occurs most often with CEOs (76.1%),
Commercial Directors (22.5%) and Financial Directors (14.3%). On the other hand, the Directors of IT, Investor
Relations and Human Resources rarely are members of the Board. Similarly, these directors are rarely shareholders
of the company (3%). The fact that the CEO in the majority of cases is also a company shareholder can constitute a
positive aspect in terms of corporate governance, because this will potentially align the interests of the executive
with his or her shareholders; the executive can earn more to the extent that he or she creates more value for the
company and for shareholders.
Table 6.43 Characteristics of Key Personnel (%)
Table describes the characteristics of key people in the Executive Board according to their membership in the Board of Directors and whether they
are company shareholders. Data from sample of 49 investee companies, represented by 25 PE/VC fund managers.
Key Personnel
Member of Board of Directors Shareholder
Yes (%) No (%) Yes (%) No (%)
CEO/President 62.5% 37.5% 76.1% 23.9%
Financial (or Administrative) Director 11.1% 88.9% 14.3% 85.7%
Commercial Director 14.0% 86.0% 22.5% 77.5%
Industrial Director 9.8% 90.2% 10.5% 89.5%
Director of Human Resources 2.8% 97.2% 3.0% 97.0%
Director of Investor Relations 2.8% 97.2% 3.0% 97.0%
IT Director 0.0% 100.0% 2.9% 97.1%
Others 15.4% 84.6% 17.4% 82.6%
Ofcers can be members not only of the Board of Directors, but also of some permanent committees and
subcommittees. In Table 6.44 its clear that fund manager members, members of the Board of Directors,
the CEO/President and the Financial Director dominate the various committees and subcommittees. Its
natural that people in positions that important should exert their inuence on the companys management
(and the different committees and subcommittees that offer this opportunity), just as it is natural that these
people bring their knowledge to the company decision making support structure.
270
Table 6.44 The Key Personnel Most Present in Committees and Subcommittees
Table shows which Committees and Subcommittees are most frequently occupied by the CEO/President, the Financial Director, Commercial Director,
Members of the Board of Directors, Members of the Fund Manager or External Consultants in order of frequency. Data collected from a sample of
17 investee companies represented by 12 PE/VC fund managers.
Committees and
Subcommittees
Most Common 2nd Most Common 3rd Most Common
Strategy
Members of the Fund
Manager
CEO/President Board Members
R&D CEO/President
Members of the Fund
Manager
Board Members
Risk CEO/President
Members of the Fund
Manager
-
Nomination/
Compensation
Board Members CEO/President Members of the Fund Manager
HR CEO/President Board Members Financial Director
Auditing Financial Director Board Members Members of Fund Manager
IT Financial Director CEO/President Members of Fund Manager
Legal External Consultants CEO/President Members of Fund Manager
Finance Financial Director Board Members Members of Fund Manager
Marketing CEO/President Board Members Members of Fund Manager
Acquisitions/New
Business
CEO/President Board Members Members of Fund Manager
Industrial
Operations
CEO/President Commercial Director Members of Fund Manager
According to the Best Practices in Corporate Governance of the Brazilian Institute of Corporate Governance
(IBGC), every company should have their nances audited by an external independent auditor. The function of
this auditor is to analyze if nancial statements adequately reect the companys real situation. Besides this, the
auditor is responsible for the revision and evaluation of internal business controls, which will result in a report with
suggestions for improving internal controls. It should be noted that the company can hire auditing services for
non-nancial information that it considers relevant.
271
Chapter 6
The information in this study conrmed the importance of an External Auditor for investee companies. In 62.2%
of these instances, the External Auditor reports directly to the Board of Directors while the Internal Auditor reports to
the Board of the Directors in just 15.4% of these instances. This illustrates the importance that an external auditor
has for corporate governance, and consequently this auditor reports to the body responsible for representing the
interests of the shareholders and monitoring the Executive Board: the Board of Directors.
Graph 6.14 Proportion of External
Auditors Reporting to the Board of
Directors
Graph shows the relative proportion of investee companies
where the external auditor reports daily to the Board of Direc-
tors. Responses furnished by 23 PE/VC fund managers repre-
senting 46 investee companies.
Graph 6.15 Proportion of Internal
Auditors Reporting to the Board of
Directors
Graph shows the relative proportion of investee companies
where the internal auditor reports daily to the Board of Direc-
tors. Responses furnished by 23 PE/VC fund managers repre-
senting 46 investee companies.
62%
38%
Reports directly
to Board
Does not report
directly to Board
15%
85%
Reports
directly to Board
Does not
report directly to
Board
Source: GVcepe Database Getulio Vargas Foundation Source: GVcepe Database Getulio Vargas Foundation
The External Auditor reports more frequently not just to the Board of Directors. The Internal Auditor reports
less to all key personnel, which shows that it has a more distant relationship with the Board of Directors.
272
Table 6.45 Percentage of Auditors that Report to Key Personnel
This table shows the percentages of external and internal auditors that report to key personnel and bodies in investee companies. Data obtained
from sample of 46 investee companies represented by 23 PE/VC fund managers.
Key People
Auditor reports directly to the following bodies/people
External Auditor Internal Auditor
Shareholders 52.5% 42.9%
CEO/President 20.0% 42.9%
Financial Director 10.0% 7.1%
Controller 7.5% -
Others 10.0% 7.1%
The remuneration of members of the Board of Directors varies greatly according to the category that the
member belongs to. Internal members are generally not remunerated (78.3%), and the rest are always at
least partially remunerated. External members are remunerated more frequently (50.0%) by companies.
The compensation of the members of the Board of Directors normally is not tied to company performance;
this occurs in just 33.3% of the cases. The remuneration tied to the performance of the Board is not viewed in the
same way as that of the Executive Board. While the Executive Board is evaluated by targets and performance,
mainly short term, the Board of Directors is more tied to supervision, monitoring and the long term performance
of the company.
Table 6.46 Remuneration of Members of the Board of Directors
This table reects the remuneration of members of the Board of Directors and to what extent this remuneration was tied to performance results. Data
for sample of 25 investee companies represented by 16 PE/VC fund managers.
How Many Members of Board of Directors
are Remunerated
Remuneration Tied to
Company Performance
All Members No Member
Just some
Members
Yes No
Internal 17.4% 78.3% 4.3% 33.3% 66.7%
External 43.8% 50.0% 6.3% 33.3% 66.7%
Independent 37.5% 62.5% 0.0% 37.5% 62.5%
273
Chapter 6
6.4.4.2 Extra-Judicial Mechanisms
Among the companies surveyed, the large majority establish formal extra-judicial mechanisms for the
resolution of Shareholder Agreements/Contracts (79.5%). These mechanisms have some advantages,
especially in a country in which the judicial system is slow and inefcient as it often is in Brazil. Some of
the advantages are: a set time needed to resolve the conict; the informality, exibility and swiftness of the
process; and condentiality, among others. Of these mechanisms, Binding Arbitration is the most common
(87%), followed by Mediation (22%) as can be seen in Graph 6.16.
Graph 6.16 Frequency of use of extra-judicial mechanisms for resolving company conflicts (%)
Graph shows the proportion of investee companies that use of mediation and binding arbitration to resolve company conicts. Responses furnished
by 22 PE/VC fund managers representing 39 investee companies.
22,2%
86,8%
77,7%
13,1%
0%
25%
50%
75%
100%
Mediantion Presence Arbritration Presence
Yes No
6.4.4.3 Performance Evaluation
Performance evaluations of key personnel are an essential aspect in the application of meritocracy and
operational change in a company. They make more transparent which parts of a company are doing well
and which are doing poorly, focusing on nancial and non-nancial criteria.
Despite the importance given to them by companies, performance evaluations vary greatly for different key
personnel. The CEO and the Executive Board are constantly evaluated in 69.7% and 70.6% of cases respectively.
The Board of Directors is rarely evaluated, just by 18% of companies.
274
Table 6.47 Performance evaluations of key personnel
Table presents data in relation to performance evaluations of the Executive Board, the CEO and Members of the Board of Directors collected from
a sample of 34 investee companies represented by 19 PE/VC fund managers.
Are evaluations made?
Key Personnel Formal Informal No
Members of Board
of Directors
3.60% 14.30% 82.10%
CEO 54.50% 15.20% 30.30%
Executive Ofcers 55.90% 14.70% 29.40%
For this same sample, the frequency of these evaluations is predominantly annual (in 80% for the Board
of Directors, 70.0% for the CEO and 66.7% for the Executive Ofcers). However, biannual and quarterly
evaluations are not rare.
The Executive Ofcers and the CEO have similar bases for evaluation in most cases, with the most common being
the Annual Budget. Other frequently used bases are the Strategic Plan and EBIT or EBITDA. This data is presented in
Graph 6.17.
Graph 6.17 Absolute frequency with which indicators are used to evaluate the performance of
key personnel
Graph shows a comparison between the Executive Ofcers and the CEO in terms of which indicators are used to evaluate performance. The
indicators for the Board of Directors were removed due to the rarity of performance valuations for them. Responses furnished for 19 PE/VC fund
managers which represented 34 investee companies.
0 2 4 6 8 10 12 14 16 18 20
100 Day Plan
Market Share
Annual Budget
Aquisitions
Strategic Plan
Revenues
Equity Value
Enterprise value
EBIT or EBITDA
Executive Officers CEO
275
Chapter 6
6.4.4.4 Rights of Preference and Veto Power
In just 33.3% of the companies surveyed did the PE/VC fund manager have some Rights of Preference
in terms of the return of capital invested when compared with the entrepreneur. These serve to mitigate
certain risks inherent in the operation for a example, a minimum return in case of a merger or new
nancing.
By far, the most common Right of Preference is the Right to Receive the Capital Invested plus a Minimum
Return in case of a sale, which is present in 78.5% of the companies with some Right of Preference. The
Right to Receive Dividends as well as the Right to Receive Capital Invested plus a Minimum Return in cases
of the companys sale or dissolution were cited by 35.7% of companies surveyed.
Graph 6.18 Percentage of fund managers with rights of preference and the most common of
these rights (%)
Graph present proportion of PE/VC fund manager investee companies that have rights of preference. Next the most common of these are listed
in order of relative frequency determined by the number of investee companies with this preference divided by the total of respondents for this
specic analysis. Responses furnished by 23 fund managers representing 49 investee companies for the rst analysis. Responses furnished for
second analysis from 10 fund managers representing 14 investee companies.
67%
33%
Dont have rights
of preference
Have rights of
preference
Receive capital invested plus minimum return in case of sale
Receive capital invested plus minimum return in case of sale or dissolution
In receipt of dividends
Receive capital invested plus minimum return in case of merger or corporation
Can convert preferential shares into common shares
Other
Receive capital invested plus minimum return in case of new financing
0%
14%
29%
29%
36%
36%
79%
Veto power for the fund manager when a minority shareholder is more popular than having rights of
preference (62.2%). Upper management plays an important role in analyzing risks involved in the business,
estimating the probability they will occur and elaborating contingency plans in case they do. First, it is necessary
to analyze the risks of existing alternatives before making any decision, because these may be revealed to be far
276
too great for the expected return. This is why veto power is very important to fund managers and ensures that
only investments with a good risk/return ratio do in fact go forward.
The fund manager has veto power under certain circumstances but some events stand out. In relation to mergers
and acquisitions, fund managers have veto power in 91.3% and 95.7% of the fund managers respectively. Other
circumstances such as the taking on of debt and the approval of the capital budget are usually subject to fund manager
veto power.
Graph 6.19 Veto power and circumstances in which it can be used by the fund manager when
it is a minority shareholder (%)
Graph shows proportion of PE/VC fund manager investee companies where fund manager has veto power. Next are shown the most common
occasions when that power is used. Responses furnished by 20 PE/VC fund managers representing 36 investee companies. Responses by 20 PE/VC
fund managers representing 36 investee companies.
61%
39%
There is Veto Power
Ther is no
Veto Power
23%
41%
50%
55%
68%
86%
86%
91%
95%
95% Acquisitions
Merges
Capital Budget
Annual Budget
Taking on Debt
Strategic Planning
Emitting Dividends
Payment of Executive Bonuses
Hiring of Key Personel
Others
6.4.4.5 Incentives and Penalties
The fund manager has a dominant role in executive compensation policy which has a multiplying
effect on the companys value (Edmans, Gabaix and Landier, 2009). One way to align executive
interests with those of the fund manager is through variable compensation, tied to meeting short term
and medium term targets (results based compensation).
277
Chapter 6
Performance based compensation has some implications that at rst can pass by unnoticed. One is that
CEOs with contracts featuring performance incentives are more susceptible to being dismissed than those
with xed salaries. This is because companies and (PE/VC fund managers) learn more about an executives
capacities by observing his or her performance. In this way, companies have a better chance of dismissing
executives who do not perform well (Subramanian, Chakraborty and Sheikh, 2002).
Besides the greater risk of being dismissed for executives who accept this kind of contract, there is a signaling
aspect to variable compensation. The willingness of an executive to accept performance based compensation serves
as an indication of his or her level of ability. This happens because a variable compensation contract will be worth
more to those who usually do well than for others. This is why all intense incentives also serve as signals (Gilson and
Schizer, 2002). On the other hand, performance based compensation brings with it a greater risk of bankruptcy,
since executives will have greater incentives to manage more aggressively (Sundaram and Yermack, 2005).
Incentives and/or penalties related to the performance of the investee company executive are
relatively common: they occur in 32% of the cases shown in Graph 6.20. They are: stock options as
part of compensation (56%), earn-out provisions for meeting/surpassing operational targets (44%)
and the substitution of key executives when these operational/nancial targets are not met (19%).
Graph 6.20 Performance based incentives and/or penalties for entrepreneurs (%)
Graph presents the percentage of PE/VC fund manager investee companies that have performance based incentives and/or penalties for
entrepreneurs. Next the most common incentives/penalties are listed in order of relative frequency. Responses furnished for rst analysis by 24
fund managers representing 44 investee companies. Responses furnished for second analysis by 14 fund managers representing 16 investee
companies.
68%
32%
Do not have performance based
incentives and/or penalties
Have performance based
incentives and/or penalties
6%
6%
19%
44%
56%
Adjustment in share
participation at exit
Loss of Control by
Entrepreneur
Substitution of Key
Executives
Earn-out
Stock options
278
The incentives listed in the graph serve many times as a way of compensating for the reduced share participation
of portfolio company executives (mainly in publicly traded companies). Baker and Gompers (1999) nd that
PE/VC investments before IPOs reduce CEO participations in half, going from an average of 35% to 19%. PE/
VC fund managers usually compensate for this difference through stock options, reducing secondary sales and
reducing the dilution of primary stock, but a gap in post-IPO capital participation for the CEO continues to exist.
Its not a surprise that the share price is an important factor in the compensation of the executives surveyed.
This is in line with a study done by Core, Guay and Verrecchia (2000). For 65% of the CEOs sampled, the
variations in changes in compensation which can be explained by the returns that these shares offer are at
least 10 times greater than the variations that cannot be explained by the returns of these shares.
Another study of compensation in PE/VC fund manager investee companies was done by Kubli (2010), a
researcher at GVcepe. It looked at the compensation of the Executive Board in all companies that had IPOs in the
Brazilian Stock Exchange (BM&F Bovespa) after 2004. Of these companies, 99 released data about the amount of
Fixed Compensation, Variable Compensation and the amount based on stock. These companies were classied
into 2 groups: those that received PE/VC investment and those that didnt. After eliminating 4 companies as being
inappropriate for the study, a sample of 95 companies was obtained (35 with PE/VC investment and 60 without). .
The result shows a considerable difference between the levels of compensation for these 2 groups. As
can be seen in Table 6.48, companies that received PE/VC investment were much more aggressive in using
performance based compensation, especially in terms of stock. In 2009, while other companies paid 8% of
executive compensation based on stock, the PE/VC investee companies paid almost twice: 15%. This difference
persisted in 2010, a year in which PE/VC investee companies intended to pay 13.1% of compensation in
instruments based on stock, while the other companies paid just 5.6% with this type of compensation. There
is also a considerable difference between xed compensation between the two groups, with PE/VC investee
companies using less of this type of compensation (58% vs. 66% in 2009; and 50% vs. 65% in 2010).
279
Chapter 6
Table 6.48 Distribution of executive compensation for companies that held iPOs on the BM&F
BOVESPA after 2004 (%)
Fixed Compensation Variable Compensation Stock Based
PE/VC 57.8% 27.1% 15.0%
Others 65.7% 26.3% 8.0%
Diff. (PE/Others) -11.9% 3.2% 86.8%
Fixed Compensation Variable Compensation Stock Based
PE/VC 50.5% 36.4% 13.1%
Others 64.7% 29.7% 5.6%
Diff. (PE/Others) -21.9% 22.6% 132.4%
Source: Kubli (2010)
6.4.4.6 Anti-Dilution Protection
Anti-dilution protection clauses are very common in the companies surveyed (they are present in 59.5%
of the rms as shown in Table 6.49). They mitigate, for example, risks associated with the asymmetry
of information between executives and PE/VC investors. The most common types of clauses are cited in
Graph 6.21, including the right to pro-rata participation in future rounds of company nancing (30%) and
the full ratchet right to acquire new company shares issued at a conversion price equal to that of the newly
emitted stock, thus maintaining the shareholders participation percentage (15%).
Table 6.49 Anti-dilution protection clauses and stock transfer rights and restrictions
Table shows the relative frequency of anti-dilution protection clauses (*) for a sample of 37 investee companies represented by 26 PE/VC fund
managers and stock transfer rights and restrictions (**) for a sample of 33 investee companies represented by 24 PE/VC fund managers.
Frequency (em %)
Anti-dilution Protection * 59.50% 40.50%
Stock Transfer Rights and Restrictions ** 75.80% 24.20%
Rights and Restrictions on Stock Transfers ** 75,80% 24,20%
280
Graph 6.21 Protection clauses in the shareholder agreement
Graph shows the proportions of different types of protection clauses in Shareholder Agreements between PE/VC fund managers and their investors,
based on a sample of 20 investee companies, represented by 16 PE/VC fund managers.
10%
30%
15%
10%
35%
Direitos de informao sobre a
gesto
Direito de participar pro-rata nas
futuras rodadas de capitalizao da
empresa
Direito de adquirir novas aes
emitidas pela empresa a um preo
de converso igual ao preo das
novas aes emitidas (full-ratchet)
Direito a subscrio a um preo de
converso ajustado ao tamanho
das emisses anteriores e da atual
(waited average antidillution)
Outras
10%
30%%%%%%
155555 155555555555 111 %%%%%%%%%
1000%%%%%%%%%
35%
Direitos de informao sobre a
gesto
Direito de part tttttiiic iii ipar pro-rata nas
futuras rodadas de capitalizao da
empresa
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Clauses related to stock transfer rights and restrictions are present in 75.8% of companies surveyed. The
most common of these clauses are: tag along rights favoring the fund manager (75.7%), drag along rights
(48.6%), and the right to participate in an offer for the price that has been offered to any other party (45.9%).
In the case of lock-up clauses, the most common time frame is up to 1 year (46% of all cases); and from 1 to
2 years (31% of all cases).
A tag along clause, or the right to joint sale, guarantees that anyone can sell their shares in a company for the
same conditions as other sellers when other shareholders resolve to sell their shares. This measure guarantees
that, besides exiting, the PE/VC fund manager can abort the investment together with other shareholders. If the
investment is being made by the entrepreneur, this is an essential aspect for the fund manager.
A Drag along clause guarantees the right to require other existing shareholders to sell their equity participation
when a beneciary selling shareholder decides to sell its stock participation. This practice frequently means that
more is paid for shares, because this mechanism makes the selling of control more viable and easier. However,
it should be emphasized that this clause is less likely to be accepted by entrepreneurs and other shareholders,
and is even less likely to be accepted by a fund manager who is a minority shareholder.
6.4.5. Monitoring
A study done of companies that went public in Eastern Europe sought to relate investment results with
best practices of corporate governance performed by PE/VC fund managers. It noted two distinct types of
281
Chapter 6
practices: those of a nancial nature which sought non-organic growth in the value of investee companies,
and those of an operational/strategic nature, which sought improvements in operations, management,
positioning and strategy on the part of investee companies, which would reect organic growth in their value.
An analysis of successful investments or those that present the highest returns reveals that they are most
often associated with organic growth, or are in other words of an operational/strategic nature. It makes
sense then that PE/VC fund managers which invest in companies with greater returns usually, during
their rst 100 days, make changes in upper management, including even changing the CEO, and also
make investments that are much more intently monitored and have more hired external support (such as
consultants) than do companies with lower returns.
On the other hand, stimulating the management team through remuneration tied to cash ow, has been
shown to have a negative correlation with performance in investee companies, given that these measures are
more common in low return companies than in high return companies (Acharya, Hahn and Kehoe, 2010).
6.4.5.1 100 Day Plan
After investments have been made, PE/VC fund managers keep in very close contact with investee companies.
This period generally takes three to four months and during this time a so-called 100 Day Plan is implemented,
which restructures the company operationally and strategically, and this is when the investee companys
administrative and operational teams get together with the PE/VC fund manager team for the rst time.
To carry out a well structured 100 Day Plan, many fund managers submit the functional areas of the investee
company to a detailed evaluation. In the investee companies that responded, 84.2% of the time the nancial/
comptroller area was analyzed, 63.2% of the time the sales/marketing area was analyzed and 42.1% of the
time the IT area was analyzed. These 100 Day Plan analyses were carried out by task forces including people
from the investee company and the PE/VC fund manager 42% of the time, by partners or managers of the PE/
VC fund manager 29% of the time, and by external management consultants 14% of the time.
282
Graph 6.22 Those responsible for 100 day plan analysis performed in various areas of the
company and which areas were studied
The rst graph shows those responsible for 100 Day Plan analyses performed in various areas of the country, while the second graph shows
which areas were most often studied. Responses furnished for rst analysis based on a sample of 17 fund managers representing 17 investee
companies. Responses furnished for second analysis based on sample of 13 fund managers representing 19 investee companies.
Frequently the targets presented in the business plan are revised before the investment is made. A total of 69% of
fund managers revised their targets, and in 91% of these the executives of the investee companies were involved. Those
responsible for the revisions were most often partners or managers of the PE/VC fund manager responsible for the deal
(54.2%), followed by dedicated First 100 Day task forces with members from the investee company and the PE/VC fund
manager (29.2%), and others with 16.7%.
283
Chapter 6
The main reasons for these revisions were the need to propose more challenging targets, cited by 42.9% of
respondents, followed by changes in the competitive environment, listed as the main reason by 28.6% of respondents,
and nally the need to involve all the hierarchical levels, listed by 19% of respondents. This data can be seen in Graph
6.23 below.
Graph 6.23 Characteristics of target revisions made during the 100 day plan
First graph shows if the administrator participated in the target revisions. The second graph shows the main reasons for the target revisions. The third graph
shows who was responsible for these target revisions. Responses for rst analysis furnished by 18 fund managers representing 32 investee companies.
Responses for second analysis furnished by 15 fund managers representing 21 investee companies. Responses for third analysis furnished by 17 fund managers
representing 23 investee companies
63%
6%
31%
Target Revisions
Administrator
participated
Partner or manager
of PE/VC fund responsible
for deal
First 100 Day task
force members from investee
company and PE/VC
fund manager
Other
Change in competitive
environment
Need to involve all
hierarchical levels
Others
Administrator did
not participate
No
10%
19%
29%
43%
Main Reasons
57%
30%
9%
4%
Responsibles
Necessity to propose more
challenging targets
One of the topics covered by the 100 Day Plan is management discontinuity, when a whole strategic
area is remodeled to make it more efcient and integrated into the companys activities. Among investee
companies, 41% had no management discontinuities during the First 100 days. Of the other 59%, the
most frequent interventions were in management control which occurred in 63.2% of these discontinuities,
57.9% were in nancial strategy, and 57.9% occurred in HR/administration. This data can be found in
expanded form in Graph 6.24 below.
284
Graph 6.24 Characteristics of management discontinuities during first 100 days
The rst graph shows the proportion of companies that had management discontinuities, while the second graph shows which areas were most often
affected. Responses furnished for 18 PE/VC fund managers responding for 32 investee companies.
41%
59%
There were
management
discontinuities
There were no
management
discontinuities
11%
26%
32%
32%
37%
53%
58%
58%
63% Management Control
HR/Administration Structure
Financial Strategy
Marketing/Commercial Strategy
Resolution of Fiscal, Labor, and/or Retirement...
Entire remodeling of Business Plan
Industrial Operations/Supply Chain Strategy
Resolution of Environmental Issues
Other
During the rst 100 days, or even while the deal is being closed, key executive personnel may be
changed, putting more qualied and experienced professionals in place who know how to deal with the
expansion phase and the changes that the company will pass through. These changes can lead to the
partner/manager of the PE/VC fund manager assuming a key position, or someone else that he or she
has nominated.
Note that 68% of investee companies went through changes in key positions. Of the positions most
frequently changed, the CFO/Comptroller was the most frequent, occurring in 73.7% of companies that
experienced turnover, the CEO was second with 52.6%, and Director of Sales was third with 26.3%. This
data can be seen in Graph 6.25, and great parallels can be seen between the strategic areas that went
through management discontinuities.
285
Chapter 6
Looking at Graph 6.8 again, we can compare the percentage of CEOs changed after investment (31%)
with the percentage of CEOs changed during the 100 Day Plan (52.6% of 68% = 35.7%) in Graph 6.25.
This small difference, leaving aside sample differences, can be explained in large part by the fact that some
changes in the CEO position can occur after the rst 100 days, a fact that still underscores that the vast
majority do occur during the 100 Day Plan.
Graph 6.25 Changing of key personnel during the 100 day plan
First graph presents the percentage of investee companies where key personnel were changed during the 100 Day Plan. The second graph shows
which positions were changed most often in investee companies where change took place. Responses furnished by 16 PE/VC fund managers which
responded for 28 investee companies.
68%
32%
Key personnel were changed
Key personnel were not changed
0%
5%
11%
11%
16%
21%
26%
53%
74% CFO/Controller
CEO
Director of Sales
Director of Industrial Operations/Supply Chain
Director of Human Resources
Other Directors
Director of Marketing
Director of IT
Director of Logistics
Another thing that happens during the rst 100 days is that the PE/VC fund manager provides new
contacts to its investee company. In 79% of our sample, investee companies received contacts from fund
managers. Contacts with other portfolio companies were provided 30.8% of the time, contacts with potential
suppliers 46.2% of the time, and contacts with banks and nancial agents 65.4% of the time.
286
Graph 6.26 Contacts furnished by fund manager to investee company during the 100 day plan
First graph presents the proportion of investee companies which received new contacts from fund manager. Second graph shows contacts most
frequently furnished by fund managers. Responses furnished by 16 fund managers responding for 28 investee companies.
21%
79%
Contacts furnished
No contacts furnished
23%
31%
46%
54%
65% With banks or financial agents
With potential clients
(outside of PE/VC fund manager portfolio)
With potential suppliers
(outside of PE/VC fund manager portfolio)
With other portfolio companies
Other
During the rst 100 days, besides implementing strategic measures and restructurings, the investee
company has to be monitored to verify that these measures are being well implemented and that the
process is being well supervised. Just 3% of investee companies were not submitted to monitoring during
the rst 100 days. 97% were and various monitoring tools were used.
In order of frequency, periodic progress meetings were held 61.3% of the time, the allocation of PE/VC
fund manager partner/manager on a part time basis with decision making/intervention powers occurred
38.7% of the time, the same situation with just powers of supervision occurred 22.6% of the time, and the
allocation of a PE/VC fund manager analyst on a part time or full time basis occurred 19.4% and 3.3% of
the time respectively.
287
Chapter 6
Graph 6.27 Monitoring of changes implemented during the 100 day plan
Graph presents the proportion of investee companies that underwent monitoring during the rst 100 days. Next are listed the most common forms of
monitoring that took place. Responses furnished for 17 PE/VC fund managers responding for 32 investee companies.
61%
97%
3%
Ocorreu monitoramento nos 100 primeiros dias
No ocorreu monitoramento nos 100 primeiros
dias
19%
23%
26%
39%
Alocao de um analista da organizao gestora em
tempo parcial empresa investida
Alocao de um scio ou gestor da organizao gestora
em tempo parcial empresa investida somente com
objetivo de superviso
Outra
em tempo parcial empresa investida com poder de
deciso/interveno
Somente reunies peridicas de acompanhamento entre
empresa investida e organizao gestora
3%
Ocorreu monitoramento nos 100 primmei mmmmmmmm ros dias
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dias
19% 19% 19%
233%
226%%%%%%%%%%%
39% 39 3339 39 339
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Source: GVcepe Database - Getulio Vargas Foundation.
6.4.5.2 Continual Monitoring
Once the rst 100 days have elapsed, the fund manager does not abandon its portfolio companies, but
rather continues or even intensies the monitoring begun during the 100 Day Plan. This is the day to day
tool used to control investee company results and to generate value for the company.
This monitoring is of great value to the PE/VC fund manager to the degree that it manages to observe
the development of its investment, if it is generating value or not, if it needs greater intervention, if it needs
new rounds of nancing, or if it should even be abandoned. This monitoring will be done by the routine
and systematic collection of information about the investment, which in turn is classied and evaluated,
with the goal of continually improving the investee company (Mller, 2008).
288
Graph 6.28 shows how much time on average PE/VC fund managers spend monitoring per month,
broken down by participation in Board of Directors meetings, in Technical Committees of the Board of
Directors, and the allocation of members of the PE/VC fund manager at the investee company.
It may be observed that the average time spent monitoring by fund managers diminishes as the investee
company matures.
Graph 6.28 Average time that fund managers spend monthly (in hours) monitoring each
portfolio company
Graph shows average time that fund managers spend monthly (in hours) monitoring each portfolio company. Data separated by type of monitoring
activity and type of fund manager. Responses furnished by 19 PE/VC fund managers responding for 33 investee companies.
7
41
144
193
8
7
42
58
12 12
39
63
6
69
80
000
050
100
150
200
250
Participation in
Board of Directors
Participation in
Techincal Committees
of the Board of Directors
Fund Managers Members
allocated to the investee company
Total
Venture Capital Private Equity
Private Equity and Venture Real Estate and others respondents
6
For each portfolio company, Venture Capital fund managers spend around 7 hours a month in Board of
Director Meetings, 41 hours a month in meetings of Technical Committees of the Board of Directors, and
289
Chapter 6
144 hours a month in the allocation of fund manager members at the investee company. Thus they spend
an average of 193 hours per company in these three principal monitoring activities.
Private Equity fund managers dedicate roughly 8 hours per month to each portfolio company in Board
of Director Meetings, 7 hours in meetings of Technical Committees of the Board of Directors, and 42 hours
per month in the allocation of their team members at the investee company. Thus they spend an average
of 58 hours per company in these three principal monitoring activities.
The amount of time that fund managers spend monitoring outside of meetings of the Board of Directors
and their technical committees was also analyzed and separated by the type of contact.
In terms of each portfolio company, they dedicate, as expressed in Table 6.50, an average of 8.09 hours
per month in personal visits and reunions, 5.75 hours in contacts by telephone and teleconference, 3.97
hours per month using electronic messages and 2.28 hours using other types of communication, totalling
20.09 hours per month with investee companies outside of meetings with the Board of Directors and their
technical committees.
Table 6.50 Average time spent monthly in different types of contact with portfolio companies
Table shows how much time, on average, that PE/VC fund managers spend in different types of contact with portfolio companies outside of meetings
with the Board of Directors and their technical committees. Responses based on sample of 104 investee companies represented by 30 fund
managers.
Average Amount of Contact with Portfolio Companies (hours/month)
Type of contact Average
Standard
Deviation
Minimum Maximum
Personal visits and meetings 8.1 17.9 0,0 80.0
Contacts by telephone and
teleconference
5.8 12.7 0,0 50.0
Electronic messages 4.0 9.0 0,0 40.0
Others 2.3 7.8 0,0 40.0
Total 20.1 25.0 - -
Besides this, 52.8% of PE/VC fund manager portfolio companies held conferences with their CEOs and
other portfolio company CEOs, with thus 47.2% not holding such conferences in a sample of 36 investee
companies represented by 20 fund managers.
290
To perform these monitoring activities, fund managers had direct access to the Executive Board Ofcers
in 100% of these portfolio companies, based on a sample of 38 investee companies represented by 20
fund managers. Within this group, the most frequent contact was with the CEO, which occurred 97.4% of
the time, next was with the Financial/Administrative Director which occurred 86.8% of the time, and then
with the Commercial Director which occurred 39.5% of the time.
Graph 6.29 Frequency of direct contact between fund managers and the executive officers for
monitoring purposes
Graph shows frequency with which executives of investee company were contacted by the fund manager for purposes of monitoring. Relative
frequency data based on responses from 38 investee companies represented by 20 PE/VC fund managers.
16%
16%
18%
24%
26%
29%
32%
39%
87%
97%
Diretor de Marketing
Diretor de RH
Diretor de TI (CIO)
Outro
Diretor Industrial
Diretor de Novos Negcios/Expanso
Diretor de Controladoria
Diretor Comercial
Diretor Financeiro (Adm)
CEO/Presidente
Controller
The most frequent functions affected by actions of fund managers in their portfolio companies were,
as shown graph 6.30, denition of business strategy, nance, management control and audit, human
resources and compensation, and operational planning.
291
Chapter 6
Graph 6.30 Functions most affected by direct fund manager involvement
Graph shows proportion of companies whose functions were directly affected by fund manager involvement. Next the most affected operational
activities are listed by relative frequency in companies where operational activities were affected. Responses furnished for 20 PE/VC fund managers
responding for 38 investee companies.
87%
13%
Houve
envolvimento
operacional
em atividades
rotineiras
No houve
envolvimento
operacional
em atividades
rotineiras
58%
64%
67%
79%
88%
Marketing / Comercial
Planejamento operacional
Recrutamento, Remunerao
Financeiro, controle gerencial e auditoria
Definio da estratgia empresarial
87%
13 11111111 %
Houve
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envolvimento
operacional
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Direct involvement of fund managers in support of operating activities of investee companies were in
the great majority of the cases (89% of respondents) related to professional services provided by tax and
legal consultants (88%), negotiations with banks and nancial institutions (64%), negotiation with key
clients (45%) and suppliers (36%), as well as aquisition (64%) and sales of subsidiaries (21%) of the investee
companies.
292
Graph 6.31 Involvement of fund managers with stakeholders of the investee companies
regarding operational activities
Graph shows what proportion of investee companies had their operational activities with stakeholders affected by fund managers. Next the kinds
of activities affected are listed by relative frequency. Responses furnished by 19 PE/VC fund managers which responded for 37 investee companies.
Further rounds of nancing provide another important monitoring mechanism. This instrument doesnt have
such high costs as traditional monitoring. The mechanism is based on the PE fund manager providing further
rounds of needed nancing conditional upon the investee company performing according to previously agreed
operating and nancial targets. (Gompers, 1995).
293
Chapter 6
Out of a total of 338 initial investments surveyed, there were 59 second round follow-ons (17.5% of the
initial investments), 21 third round follow-ons (6.2%), 9 fourth round follow-ons (2.7%), 4 fth round follow-
ons (1.2%) and 2 sixth round follow-ons (0.6%). Graph 6.32 illustrates this scenario.
Graph 6.32 Rounds of financing in investee companies
Graph shows the funneling affect of rounds of nancing in investee companies. Responses furnished by 66 PE/VC fund managers responding for
investments made between January 1, 2001 and December 31, 2010 in 338 investee companies.
0,6% (2)
1,2% (4)
2,7% (9)
6,2% (21)
17,5% (59)
100% (338)
nmero de investimentos follow-on 5 rodada
nmero de investimentos iniciais
The practice of making co-investments is intended to balance the risk of the initial PE/VC fund managers as
well as improving the quality of investment selection and the availability of funds for future rounds..
Conceptually, one can understand co-investments as instruments of dilution and minimization of business
and nancial risks, as well as tools to reduce the asymmetry of information and of pooling the knowledge that
each rm contributes (Lockett and Wright, 2001). Graph 6.33 indicates the proportion of investments which
involved co-investments in the industry.
294
Graph 6.33 Proportion of investments which involve co-investments
Graph presents the proportion of investments which involved co-investments. Responses furnished by 55 PE/VC fund managers responding for 332 investments in 261
investee companies from January 1, 2001 to December 31, 2010.
Houve
coinvestimento
No houve
coinvestimento
26%
74%
Ho Hooou ooo Hoooo ve
coinvestimento
No houve
coinvestimento
26%
74%
6.5. Strategic Repositioning
After the rst 100 days of the initial PE investment have elapsed, high impact decisions may be made which stand
apart from ordinary monitoring, operational involvement and management discontinuities. These are decisions
dealing with strategic repositioning (turnarounds), joint ventures and acquisitions.
Of PE portfolio companies surveyed, 22% had been submitted to restructurings or turnarounds and 9% had taken
part in joint ventures. Predominantly, nance, marketing and sales were the areas restructured. These restructurings
were frequently led by an investee company internal team (30.76% of the time), by a PE/VC fund manager team
(also 30.76%), by a joint investee company - PE/VC fund manager team (23.07%), or an interim management team
or external consultants (15.38%). This analysis was based on responses from 12 PE/VC fund managers responding
for 13 investee companies.
295
Chapter 6
Graph 6.34 Restructuring of investee companies and areas restructured
Graph presents proportion of investee companies that went through restructuring. Then the areas restructured are listed in order of those most
commonly affected given as a percentage of those that specied which area over all specifying an area.
Responses for rst analysis furnished by 22 fund managers responding for 46 investee companies. 11 fund managers indicated areas of 12 investee
companies that were restructured.
22%
78%
Ocorreram reestruturaes
No ocorreram reestruturaes
0%
8%
17%
33%
42%
Outro
RH (estrutura inadequada,
falta de capacitao dos
Operao (falta de capacidade
produtiva, baixa qualidade
Marketing/Vendas
(competio, demanda no
Finanas (estrutura financeira
inadequada,...)
22% 2222
78% 777
Oco Oco Oco Oco OOco Oc OOOc Oc cc Oc Oco Oc co co ooo Oco Oco Occo cc Occcco co ccooo OOOc cccco cccoooo Occo OOc rre rrre re rre ree rre rrrrr ee rrrre eee rrr rr rre eee rrrre eram ram ram rrram am aam mm ram ram am am am ammmmmmmmm am am am mm am mmm ammmmmmmmmmmm ree ee ree ee eee reeee ee eeee eee eeeeeeee re eeeee eee eeee re reee eeee e str str sssst tr t st str st strr sstr s rr s rr strrrr st st ttt sttt utu utu utu utu utu ttt utu utu utu utu utu uutu ttu utuu utu utu utu uut ttuuuu utu tu tu tuuu utu tttu tuuuu utuu ttttttuuuurrra rrrrrrrrrrrrrrrr es
o o No NN NNNo No No NNNNNNo o oo oco oco o oco co ooo oooccco e rrr rre e rrrrrr ram rrram ram ra rrammmmmmmmmmmm ree ee ee ee ree reee eeeestr t str str str tt sssst utu uutu utu t utu ttttuuuraes
0%
% 8888% 8% 888%%%%%%%%% 8888% 88% 88%%%
17%%%%%
33%
42%
Outro
RH (es (((eees eess (es ((es (((eeeesstru tru tttru tru tru rru tru ru tru truu ttru rru ru ru uu tttrrru ru uu ru u tttru ruuuuuuutur tu tttuuuuur uurr tu ttuuuurr tttuuu turr t r ttttt aaaaaaaaa ina in nna na na aaaaa ina in nnnna n iiinnnnnna a na ina na na nn in na aaaa i deq de de deq deq e deq eq eq deqqq ddddeq deq eeq deq dddeeq deeeeeeeqqqqqqqqqqquad uuuad uad uad uuad ad uad ua uad d uad uad uad uad uuuad ddddd uuuaadddddd uuuadddd uu da, aaaaaaaaaaaaaaaaaaaa
falta de capacitao dos
Ope pp OOOOOp rao (f (fa ffff lta lll a de ddddddd capaci ciiid d d d d d daddd d d d dde
produtiva, baixa qualidade
Marketing/Vendas VV
(competio, demanda no
Finanas (estrutura financeira
na iinnnn ina nna na na aa nnnaa na na na nnnnnaa nnna nnna nnaa nnaaadeq ddeq ddde dee deeq eq eq deq deq ddddddddeq deq deqqqqqq dd qqqq deq eq dd qquad uad uad uad uad uad ua ua uad uad d ad uad ad uad ua uad ddd ua ua ad uad uad uad adddddd aaad ad dd uad uad uad uad ad uad uaad a uad d u d uaa uadd a a,. aaa,. .. aaaaaaa, aaaaaa, , ..) ..) .))))) .))))))))))))))))))) .))
Graph 6.35 Frequency of investee company joint ventures and reasons for them
Graph shows the proportion of PE/VC investee companies which took part in joint ventures. Next the main reasons for the joint venture are listed
in order of relative frequency for those respondents that cited a reason. Responses for rst analysis provided by 22 fund managers representing
46 investee companies. Responses for second analysis provided by 4 fund managers responding for 4 investee companies.
9%
91%
Ocorreram Joint Ventures
No ocorreram Joint Ventures
25%
75%
Necessidade de
preparar a
empresa para
desinvestimento
Necessidade de aumentar o
mercado de alcance,
incrementando nmero de
canais, fora de venda,...
9%
91%
Ocorreram Joint VVVVVVVVVVVVVVVVVVVVen ent ent nnnt t ent nt nt nt eeentt eeenntt eeenntures
No ooooooooo oooooooc oco ooc rrerram Jo JJo Jo oi Joi oi ooi ooi oooooi iint nnnnnnnnnnnt nnt Ventures
25%
75%
Necessidade de
preparar a
empresa para
des dddd inv nnnnn est eee imento
Necessidade de aumentar o
mercado de alcance,
incrementando nmero de
canais, fora de vennnnnnnnnnnnnnnnda, dda ddaa, aa, a, da, a, a, a, ddaaaaa da da da da da, da, da, da, dda ddda, ddddaa, a, a, a dddda, a, ,,,,... ... .. .. .. .....
The main reasons for taking part in joint ventures were the need to increase market reach, increasing the
number of sales channels, the sales force, etc. (3 responses representing 75%) and the need to prepare the
company for exit (1 response representing 25%).
296
6.6. Conicts
Even though fund managers and investee companies surround themselves with various instruments for the
conciliation of their interests and a legal apparatus for the formalization of their relationship, sometimes they
have strong divergences of opinion and can potentially have conicts.
83% of PE/VC fund managers have reported conicts with their investee companies. Of these, the contractual
aspects most associated with these conicts were representation and voting rights (53.85%) and non-
competition agreements (38.46%), shareholding (31%), incentives to managers (23%) and incentives to the
entrepreneur (23%) and restrictions on the transfer of shares (23%).
Graph 6.36 Conflicts between fund managers and investee companies
Graph shows proportion of PE/VC fund managers that have had conicts with their investee companies. Next are listed the most common sources
of this conict as a proportion of all sources specied divided by responses specifying sources. Responses furnished for rst analysis provided by 82
fund managers. Responses for second analysis provided by 13 fund managers.
83%
17%
J enfrentou
conflitos
Nunca
enfrentou
conflitos
15%
23%
23%
23%
31%
38%
54%
Clusulas vinculantes do dire ito de venda (Tag along /
Drag along)
Restrio na transferncia de aes
Incentivos para manter o empreendedor/empresrio
(ex. Opes de Aes)
Incentivos para manter a equipe de gesto da empresa
(ex. Opes de Aes)
Instrumentos financeiros (Ttulos Mobilirios)
Acordos de no-competio
Clusulas contingentes relacionadas aos direitos de
representao e de voto
83% 3% 3%%%%%%%%%% 33%%%
17% 11
J enfrenttou ttttttttttttttttt
conflitos
Nun NNNNNNNNNNNNNNNNNNNNNNNN ca
enf eeeeeeeeeeeeee rentou
con n con cccccccoon conflitos
15% 15% 15%
23%
23%
23% 23%
31% 31%
38%
54%
Clusulas as aas aaaas as ass aassss aass a vin vin vvvvvin vvinnnnnnn in vin vinnnnn vvi viinnnnn ii cul cccul uuuu cu ccul uuul ccccu ul uuuuuul uuuul uuuuuu ant ttt aaan ant nnntttt ant aaant an nt nnnt nt aaaaan aaaannn es es eeesss eesss eeeeess es es es es ess do dddddoo do ddo dooo ddddo ddo ddddo dddoo ddddddddddoooo dddoo ddddoooo d dir dir di di ddir ddir dddi diirrr dir dddddddir dirr d rreeeeeeeeeeeeeeeeeeeeeeeeeeee itooooo t iito tttooooo itttt ittttttt de de de ddde dee ddddde deee dde ddde deeeee de ddee de d ven ven ve venn ven ven ven vven en en e ven eennnnnn ve vveen eeennnn vvvvveeen eennn vvvveee da dda da dda dda daaaa dddaaa dddddaaa d (T (((T (T (TT (TT (TT (((TTTTT ((((TTTTTTT (T (TTTTTag aaaag ag ggggg ag ag ag ag ag gggg aaag gggggg aagggggggggggggggggg TTTTTTTT alo oooo alo alo alloooo llo loooong ng ng ng ng ng ng ng ng ng nnng g ng ng ng nnngggg nnnggg ng ggg ng ggggggggggggggg /
Drag along)
Restrio na transferncia de aes
Incentivos para manter o empreendedor/empresrio
(ex. Opes de Aes)
Incentivos para manter a equipe de gesto da empresa
(ex ((e (ex ex ee (ex ((ex ex ex ex ex e (ex ex ex ee (exx exxxxxxxxxxxxxxxxx... Op p Op Op Op Op OOp Op OOp Op pp p Op Op Op Op OOp OOOp Op Op Op p p Op Op pp OOOOOp p p Op p Op OOpp OOp OOOpes es e e es es es es ees es s es es eeees ss es ees sssss de dde de ddddde de de de ddeeeeeee de de de dee de A A AA AA AAA A A A AA A AA AAA A A A A A AA A AA es) ssss es) es) es) ss)) ees) ees) eees) s) s) es) es) es) es) es) ees ess es)) s)))) sss) sss
Instrumentos financeiros os ooosssssssssss T (T (T (T ((T (T (T TTTT T TT ((TTTT (T (((T ((T tu tu ttul ttul tul tul ul uul ul uul uuuul uuuul uuu ooooooos ssss ooo Mob Mob MMob MMMob MMob Mob Moob ob ob Mob b Mob MMMMMMMMMMMMMMMMMMMMMMMMob ob ob obb MMMob Mobili ili li li li lllllli lliii liri ri ri ri i r r ii ri iii i ios os oos) os oos) os os s) ) s) ) os))) os oos oos oooos ooossss
Acordos de no-competio
Clusulas contingentes relacionadas aos direitos de
representao e de voto
In these conicts between investee companies and their PE/VC fund managers, 73.3% of fund managers
used binding arbitration to resolve the conict and just 26.7% began legal action to resolve the conict
297
Chapter 6
(this is based on responses from 15 PE/VC fund managers). And as a last resort, 50% have had conicts
which ended with the fund manager selling its participation or the entrepreneurs leaving the business.
During and after these conicts, the investee company can pass through times of economic or operational
instability, or can even become stronger. These consequences can be graver if the entrepreneur leaves.
Among fund managers surveyed which had conicts with their investee companies, none of them
thought that these conicts caused the protability of these businesses to decline substantially, 64.29%
thought that the protability of these businesses declined somewhat, 21.43% thought that the conicts
didnt alter the protability of these businesses, 7.14% thought that the protability of these businesses
improved, and 7.14% thought that the protability of these companies improved substantially. This data
is illustrated in Graph 6.37.
Graph 6.37 Profitability of investments after conflicts with investee companies
Graph shows affect of conicts on protability of investments after conicts between PE/VC fund managers and investee companies. Data based on
a sample of responses from 14 PE/VC fund managers.
0%
64%
21%
7% 7%
,00%
10,00%
20,00%
30,00%
40,00%
50,00%
60,00%
70,00%
Declined
Substanally
Declined
Didnt Change Improved Improved
Substanally
In terms of the impact of conicts in which the entrepreneur left the company, none of the fund managers
which passed through this situation thought that the protability of the business declined substantially,
9.09% thought that protability had declined somewhat, 36.36% thought that these conicts had not affected
the protability of the business, 36.36% thought that protability had improved, and 18.18% thought that
protability had improved substantially. These responses were based on a sample of 11 PE/VC fund managers.
Chapter 7
Private Equity and Venture Capital in the Context of Sources
of Long Term Financing in Brazil
301
Chapter 7
Private Equity and Venture Capital in the Context of Sources
of Long Term Financing in Brazil
1
7.1. Introduction
The stability and growth of the Brazilian economy are recent phenomena and were only possible due to
the control of ination through the Real Plan, the institutionalizing of scal responsibility, the adoption of the
exible exchange rate regime and the adoption of the ination targeting. The unpredictability of the economy
before 1994, when the Real Plan was implemented, discouraged private banks from making long term loans,
besides the fact that short term interest rates were extremely high due to tight monetary constraints and there
was little leeway in terms of scal policy.
The virtual absence of a long term credit market created a large gap between the nancial needs of
companies, especially micro-, small and medium-sized companies, and the nancial resources available. This
limitation of the Brazilian economy led Brazilian authorities to broaden the lines of long term nancing available
only in state banks and without a doubt mitigated two problems: 1) a lack of long term nancing, and 2) high
interest rates which prevented most long term projects from being viable. This public policy option created a
long term interest rate structure for certain types of real sector investments subsidized by the National Treasury,,
below the short term interest rates in the nancial markets.
This chapter intends to clarify the principal concepts related to long term nancing problems faced
by companies, especially micro-, small and medium sized companies, their principal causes and examine
PE/VC investments in this context as alternative investments of great interest to certain types of companies.
7.2 Private Equity and the Stock Market
7.2.1 The Stock Market
Despite the pessimistic expectations created by the international nancial crisis intensication during the
second half of 2008, by 2009 it was already clear that the economy had surpassed these pessimistic expectations.
Even though the Brazilian government took action to minimize restrictions on credit and liquidity, great
1 Authors: Rafael Roldo, Diogo Kudo, Caio Ramalho, Rodrigo Lara and Lucas Cancelier.
302
difculties were expected in terms of company access to capital, given that there was little idea of how long or
how bad the crisis would be.
During the second half of 2008, as could be expected, there was a decline in the amount of stocks and
debentures issued, both of which are very sensitive to the state of the economy. At the time, the procedure
adopted by companies was to opt for promissory notes, which have greater acceptance among investors
because of their shorter maturity.
In 2009 this situation ended up turning around due to a market perception that the crisis in Brazil would be
weaker than in other developed countries and to a return of exibility in monetary policy. Thus, there was an
increase in the quantity of debentures issued compared to 2008.
Taking a broader perspective, there was a signicant increase in the amount of debentures in the market due
to the heating up of the Brazilian economy and international liquidity at the time, making long term nancing
more available to public companies as can be seen in Graph 7.1. The same favorable scenario can be seen
by examining the volume of primary and secondary stocks issued mainly in 2007, a time when the Brazilian
economy was doing well, exhibiting high liquidity, with ination under control, declining interest rates and
expanding credit.
Graph 7.1 Monetary value of debentures issued
R$
R$
R$
R$
R$
R$
R$
R$
i
n
M
M
R$ 0
10.000
20.000
30.000
40.000
50.000
60.000
70.000
80.000
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Source: CVM and ANBIMA (2011)
303
Chapter 7
Graph 7.2 Monetary value of primary and secondary stock issued
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
R$ 160.000
R$ 140.000
R$ 120.000
R$ 100.000
R$ 80.000
R$ 60.000
R$ 40.000
R$ 20.000
R$ 0
i
n

M
M
Source: CVM and ANBIMA (2011)
Observing the performance of the Ibovespa, the index of the Brazilian Stock Market (BM&F Bovespa),
its possible to identify a rise in the index and in volume traded (not shown) similar to that which occurred
before with the heating up of the Brazilian economy. Despite the fall that occurred during the second half
of 2008, the recovery in 2009 was rapid and shows favorable tendencies.
Graph 7.3 BM&F Bovespa index from 2005 to 2009
80000
70000
60000
50000
40000
30000
20000
10000
0
P
o
i
n
t
s
Days (03/01/2005 to 30/12/2009)
Source: BM&Fbovespa (2010b)
7.3 Sources of Long Term Financing
The sources of long term nancing available in Brazil for companies, as well as their main characteristics
and functioning will be covered in this section. For a broader treatment, we will cover the capital markets
and private sources as well as the public sector in Brazil.
304
7.3.1. Securitization of Receivables
Fundraising using nancial claims issued by those taking loans has become increasingly common in recent
years. Among operations which involve these types of issues is the securitization of receivables. This is the sale
of a portfolio of short term receivables from a determined company to a Special Purpose Company (SPC) which
issues shares tied to the receivables acquired. The majority of companies that opt for this type of nancing have
a decentralized portfolio of receivables with none representing a relevant portion of the total (Assaf Neto, 2010).
Note that this type of source is useful for medium to large companies with a substantial volume of receivables
which can nance the permanent component of the companys net working capital.
7.3.2. Forfaiting
This market involves negotiations with securities and export contracts made by Brazilian companies.
The security accepted by the importer is acquired by a nancial institution which passes on to the seller the
value of the sale with an appropriate discount. This operation is very similar to factoring, but deals with
securities of longer maturity (Assaf Neto, 2010).
7.3.3 Financing of Working Capital
This type of nancing is done by many commercial banks and investment banks with the object of
fullling companies cashow needs. The duration of these operations varies from 6 to 24 months and
the collateral required is normally equal to those in commercial and endorsement operations and the
mortgage of real assets.
In the case of corporations, a widely used security is commercial paper. This security can be considered
a short term promissory note, with a maximum duration of nine months. If a company decides to issue
commercial paper, it does not necessarily need a nancial intermediary, or in other words those who take
out the loan can negotiate directly with investors (Assaf Neto, 2010).
7.3.4 The Bond Market
In Brazil, bonds or debentures act in a similar fashion to bonds abroad, which represent an important
form of long term nancing for the international nancial markets. We can consider them long term xed
income securities issued directly by the those taking on the nancial resources, or in other words, the
issuer is the one who does the fundraising together with intermediary creditors for nancial institutions to
305
Chapter 7
put them on the public market. These debentures normally pay interest periodically and the principal is
amortized at the end of this period.
The issuing of private debentures occurs when the buyers are already dened, since public debentures
use nancial intermediaries to coordinate the placing of these debentures on the market. The problem
with the issuance of debentures is that small and unknown companies normally cant attract investors to
buy these securities, besides the high cost inherent in this type of public issue (Assaf Neto, 2010).
The primary issue of stocks, on the other hand, is a way for companies to raise funds for an indeterminate
period. The launching of these stocks is done through market accredited nancial institutions in an isolated
fashion or through a consortium. The problems with primary stock issues are related to the high issuing costs,
and other costs of maintaining adequate investors relations and corporate governance, required of a public
company, as well as the occurence of a window of oportunity in the Market.
7.3.5. Leasing
A Leasing operation occurs when a client rents a good from a leasing company. This happens when a
leasing contract and the client can use the good while paying for the lease. Companies normally opt for
this type of nancing to allocate a greater volume of internal nancial resources towards cash ow, given
the scarcity of long term nancial resources in Brazil. The risk for the leasing company is relatively low
because the goods remain the property of the leasing company and, if the client does not pay, getting the
goods back from the client through legal action is a relatively simple and rapid process.
The types of leasing currently available are nancial leasing, leaseback and operational leasing, each
of which has its own characteristics and addresses different nancing needs for Brazilian companies (Assaf
Neto, 2010).
7.3.6 Capital Markets
The capital markets play an important role in providing medium and long term nancing for companies to
meet their xed capital and permanent cash ow needs as well as liquidity for stocks. The capital markets also
offer nancing for indeterminate periods through the primary issue of stocks (Assaf Neto, 2010).
306
7.3.7 Public Sector Sources
The Brazilian government has adopted public policies to stimulate the PE/VC industry as a way to
further entrepreneurship, innovation and the capitalization of small and medium sized companies, as
well as the functioning of large companies to compete in the international market. Even though the
actions of the Brazilian government are more focused on the fundraising phase, they have a positive
effect on the whole cycle. Public policy is more concerned with emerging companies and startups and
the growth of their importance to the whole value chain.
Despite the significant growth of the local PE/VC industry, the role of the public sector as a PE/VC
manager is not quantitatively significant. BNDESPar is an arm of a state owned development bank
(BNDES) which acts as a PE/VC fund manager in one of its organizational units and possesses US$ 0.935
billion of invested capital, 2.6% of the industrys total commited capital, as of 2009.
Further more, the participation of the Brazilian public sector as an investor has been extremely
important for the promotion of the PE/VC industry. The perception that innovative startups and MSMEs
were not finding adequate mechanisms to finance their growth in the traditional financing system
led the Financer of Studies and Projects (FINEP - The Brazilian Innovation Agency) in partnership with
the Inter-American Development Bank (IDB) to create the INOVAR (Innovate) Program in 2000 and
the INOVAR SEMENTE (Seed Innovation) Program in 2006. Since then, FINEP has put more and more
resources under the control of INOVAR and INOVAR SEMENTE. The Brazilian Support Service for Micro
and Small Companies (SEBRAE) is another governmental agency which has invested in PE/VC, promoting
entrepreneurship and the development of MSMEs.
307
Chapter 7
Table 7.1 Portfolio companies (June 2008)
Sectors
BNDES as
a Fund Manager
BNDES (1) as an
Investor
FINEP (1) (2) as an
Investor
Total Portfolio
Units % Units % Units % Units %
IT and Eletronics 13 33 21 33 13 42 109 23
Miscellaneous Industries 9 23 6 9 5 16 61 13
Civil Construction / Real Estate - - 1 2 - - 60 12
Communications - - 2 3 1 3 32 7
Energy and Oil - - 10 16 - - 29 6
Agribusiness 1 3 4 6 1 3 21 4
Financial Services - - - - - - 20 4
Biotechnology 6 15 4 6 4 13 20 4
Retail - - 1 2 - - 19 4
Foods and Beverages 5 13 1 2 - - 17 4
Medicine and Beauty 2 5 3 5 3 10 15 3
Telecom 4 10 2 3 3 10 13 3
Transports - - 5 8 - - 13 3
Logistics/Distribution - - 1 2 - - 12 2
Education - - - - - - 9 2
Others - - 3 5 1 3 31 6
Total 40 100 64 100 31 100 481 100
Note: Sum differences due to rounding
(1) Includes 12 companies (5 IT and Electronics, 3 Miscellaneous Industries) through 6 vehicles featuring co-investment with FINEP.
(2) Programs INOVAR and INOVAR SEMENTE.
Source: Ramalho (2009)
308
Besides the capital committed by governmental agencies and state banks, public PE/VC investment policy
also has a presence in state pension funds, including the largest pension fund in Brazil, the Pension Fund of Banco
do Brasil (PREVI). Both international and domestic pension funds represent an important part of committed
capital and play a crucial role in the Brazilian PE/VC industry, especially when we look at committed capital in
investment vehicles structured in accordance with Securities Commission (CVM) instructions.
In this way, public policy incentives for PE/VC generate positive results and meet part of the nancing needs
in Brazil, especially for MSMEs which present business models compatible with PE/VC requirements, promoting
innovation and entrepreneurship with great potential positive impact.
7.3.7.1. BNDES National Bank of Economic and Social Development
BNDES is a state owned company linked to the Ministry of Development, Industry and Foreign Trade (MDIC) which
aims to nance projects with regional, social and environmental dimensions. Currently it is the main institution of long
term nance for investments in the Brazilian economy, given that it also supports the acquisition of equipment and
the exporting of goods and services. The nancial resources for BNDES come from its own capitalization, the Workers
Support Fund (FAT) and the National Treasury.
Its primary offerings for long term credit are its Products. These dene general rules in terms of nancing
conditions and operational procedures and are complemented by the specic rules of the Line of Financing
for a given beneciary, sector and venture. Independent of the Product or the Line of Financing collateral is
required and all projects must pass through the same bank approval process.
BNDES has several lines of nancing for MSMEs, which we will now examine.
The Innovative Capital line: this line supports innovative companies in the development of their entrepreneurial
capacity, investing in tangible and intangible assets according to the Plan for Investing in Innovation (PII). The capital
offered ranges from R$ 1 million to R$ 200 million per economic group. There is no limit to the banks participation
and the nancing should be paid in up to 12 years with interest rates equal to the Long Term Interest Rate + BNDES
basic remuneration (0.0% annually) + a Credit Risk Fee (up to 3.57% annually). Graph 7.4 shows Long Term Interest Rate
charged by BNDES from 1995 to 2010. The Entrepreneurial Capital line is a source of nancing with a much reduced
accessible cost.
309
Chapter 7
Graph 7.4 Long term interest rates charged by BNDES (annual %)
30,00%
25,00%
20,00%
15,00%
10,00%
5,00%
0,00%
1
9
9
5
1
9
9
6
1
9
9
8
1
9
9
9
2
0
0
0
2
0
0
1
2
0
0
2
2
0
0
3
2
0
0
4
2
0
0
5
2
0
0
6
2
0
0
8
2
0
0
9
2
0
1
0
Source: Federal Income Tax Service (2010)
As can be seen, long term interest rates have fallen greatly over the 15 years since the Real Plan began
and are currently stable at 6% annually which implied a maximum interest charge of 9.57% in December
2009.
The Technological Innovation line seeks to promote products or processes which involve technological
risk and technological market opportunities. The minimum value for nancing is R$ 1 million with
interest rates of 4.5% annually, amortized in up to 14 years. For nancing of less than R$ 10 million no
collateral is required.
The BNDES Innovation Card is a way to nance investments for MSMEs which is very similar to a credit
card. MSMEs that can use this assistance are those that have gross annual revenues of up to R$ 90
million, have their headquarters in the country, comply with the Operational Policies of BNDES Credit
and are up to date with their payment of federal retirement and workers compensation contributions
and taxes. Purchases with the card can only be made at the Operations Portal of BNDES and every item
is exhibited in the Product Catalog which offers more than 125 thousand products. The card is issued by
the following banks: Bradesco, Banco do Brasil, Caixa Econmica Federal and Banrisul.
There are three nancial conditions for access to this source of credit: the rst is that there is a credit
limit of R$ 1 million per card per issuing bank, the second is that payments can be parceled into 3 to 18
monthly installments, and third a pre-xed interest rate will be used which is listed on the portals home
page. This cards advantages are that there is pre-approved rotating credit, payments are equal and
xed, and interest rates are extremely attractive.
310
7.3.7.2. BNDESPar
BNDESPar is a state owned publicly traded company founded in 1982, under the full control of BNDES.
Its activities follow strategic guidelines formulated jointly with BNDES oriented towards supporting the
capitalization and development of Brazilian companies. It does this mainly through transitory minority
shareholdings and by strengthening and modernizing the stock market.
On January 13, 1998 BNDESPar became a publicly traded company enabling it to issue stock on
the over the counter market.
BNDESPar issued debentures three times in the years 2006, 2007 and 2008 in the amounts of
R$600 million, R$ 1.35 billion and R$ 1.25 billion, and recently on Nov. 4, 2010 it announced that it will
make another public offer of debentures not convertible in stock, without preferential rights and with a
guaranteed oating rate. The issue is expected to be R$1.5 billion with an option to augment this by 35%.
The rst two offers of R$ 2 billion were made for its rst security distribution program, and including the
second program the value could reach up to R$ 6 billion.
Tables 7.2, 7.3 and 7.4 show the composition of BNDESPars portfolio from 2007 to 2009. In tables
7.3 and 7.4, we can see a rm and progressive investment in stock (198 companies), investments in funds,
and investments in debentures issued privately by companies in strategic sectors of the Brazilian economy.
Table 7.2 Composition of BNDESPar* portfolio
Note: BNDESPar (2010)* includes investments in publicly traded and private companies within the Entrepreneurial Capital Area, and publicly traded
companies within the Capital Markets Area.
Year Portfolio Companies
Investments in Stocks
(R$ billions)
Portfolio Funds
Portfolio Estimated
Value (R$ billions)
2007 180 18.86 24 84.80
2008 186 25.17 29 52.74
2009 198 33.82 31 92.89
Source: BNDESPar (2010)
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Chapter 7
Table 7.3 Sectoral breakdown by percentage of stock, debentures, and funds for BNDESPar
from 2007 to 2009
Sector
2007 2008 2009
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Oil 35.6 3.7 0.0 34.8 30.8 1.8 0.0 27.7 27.8 3.5 0.0 25.4
Mining 24.9 0.0 0.0 24.3 21.6 6.3 0.0 19.9 24.3 14.0 0.0 23.1
Eletricity 12.6 23.9 0.0 12.8 20.5 13.8 0.0 19.5 18.3 0.0 0.0 16.5
Food 1.4 0.8 0.0 1.5 6.3 27.2 0.0 8.0 6.2 27.6 0.0 7.8
Paper and Celulose 3.5 11.6 0.0 3.7 8.2 0.1 0.0 7.4 6.7 2.8 0.0 6.3
Telecom 2.8 0.0 0.0 2.7 3.2 0.4 0.0 2.9 4.2 17.9 0.0 5.2
Iron & Steel 7.4 1.1 0.0 7.3 0.3 27.5 0.0 2.6 3.0 0.3 0.0 2.7
Commercial Banks 2.8 0.0 0.0 2.8 2.0 4.4 0.0 2.2 2.9 0.0 0.0 2.6
Transport 2.1 31.8 0.0 2.8 1.4 5.0 0.0 1.7 2.1 3.1 0.0 2.2
Metallurgy Not Specied 1.8 0.0 0.0 1.6 0.3 21.0 0.0 2.0
Private Equity Fund -
PIQ
Not Specied
0.0 0.0 81.9 1.4 0.0 0.0 88.8 1.4
Chemical and Petro-
chemical
Not Specied
0.9 0.0 0.0 0.8 3.4 9.8 0.0 0.7
Others 6.9 27.1 100.0 7.3 3.0 13.5 18.1 4.2 3.4 9.8 11.2 4.1
Table 7.4 Sectoral Breakdown of the Market Value of Stocks, Debentures and Funds for
BNDESPar from 2007 to 2009 in thousands of Reais (R$ 1.000,00)
Setor
2007 2008 2009
Stocks Debentures Stocks Debentures Stocks Debentures
Oil 30,194 92 16,244 92 26,114 210
Mining 21,119 - 11,392 322 22,826 840
Eletricity 10,687 592 10,812 705 17,190 -
Food 1,187 20 3,323 1,390 5,824 1,656
Paper and Celulose 2,969 287 4,325 5 6,294 168
Telecom 2,374 - 1,688 20 3,945 1,074
Iron & Steel 6,276 27 158 1,405 2,818 18
Commercial Banks 2,375 - 1,055 225 2,724 -
Transport 1,781 787 738 255 1,973 186
312
Metallurgy Not Specied 949 - 282 1,260
Private Equity Fund
- PIQ
Not Specied - - - -
Chemical and Pet-
rochemical
Not Specied 475 - 3,194 588
Others 5,852 671 1,582 690 3,194 588
The year 2010 presented a novelty in terms of linked xed income securities: the remuneration for one of the
series paid to those holding debentures is be set every three months based on short term interest contracts
in the Brazilian market. Their distribution will be mainly oriented towards retail investors with the idea of
developing the domestic capital market. The nancial resources raised will be used to complete BNDESPars
investment budget and regular operations (Brasil Econmico, 2010).
There are two organizational units within BNDESPar oriented toward different segments of the market,
based on company size and access to the stock market. The Entrepreneurial Capital Area is focused on
Brazilian MSMEs, and participates in the promotion, structuring, investment, monitoring, and exit phases;
and the Capital Markets Area works with convertible debentures, stock and other variable income
instruments issued by large companies in BNDESPars portfolio. Table 7.5 presents the investments made
by these areas and their market value.
Table 7.5 Investments by Entrepreneurial Capital Area and Capital Markets Area of BNDESPar
Areas 2006 2007 2008
Entrepreneurial Capital Area
New Investments Approved 9 12 17
Market Value (millions of Reais) 143.00 265.00 377.00
Capital Markets Area

Number of Companies 182 181 186
Number of Investment Funds 19 24 29
Table 7.4 Sectoral Breakdown of the Market Value of Stocks, Debentures and Funds for
BNDESPar from 2007 to 2009
313
Chapter 7
Market Value (billions of Reais) 59.00 87.80 59.00
Its important to emphasize the contribution made by BNDESPar in the area of private debentures
subscriptions Debentures issued by private companies. Thus, BNDESPar has become an alternative
place for private companies to raise capital and convertible long term debt, characteristics of Mezzanine
PE funds. In Table 7.6 the contribution of BNDESPar in private debentures can be seen from 2007 to 2009
where a clear expansion is evident.
Table 7.6 Issuing of Debentures for Publicly Traded and Private Companies by BNDESPAR
(in billions of Reais)
Type of Issue 2007 2008 2009
Issuing of Debentures for Publicly Traded Companies 1.32 3.66 4.41
Issuing of Debentures for Private Companies 1.15 1.45 1.59
Total Debentures in Portfolio 2.48 5.11 6.00
7.3.7.3. Caixa Econmica Federal (CEF)
CEF was founded in 1861, and since then it has played a major role in the federal governments public
policy by encouraging savings and offering loans based on collateral. It is a 100% state owned company,
which attends the needs not just of its clients but also of all those formally employed in Brazil through its diverse
programs. Its focused on housing, sanitation, basic infrastructure and the providing of services. In 1986 CEF
assumed the role of the manager of the Employee Severance Fund (FGTS).
The FGTS was established to make it easier to re or lay off workers and substituted the job stability that was
previously guaranteed by law. The objective of the fund is to act as a fund for the retirement, death, disability and
unemployment of workers. It requires a compulsory deposit of 8% of a workers monthly wage in a worker`s
individual account. FGTS remuneration, according to Technical Note 13 (DIESSE, 2006) is the Reference Fee
+ interest (3% annually) without taxation and the fund is administered by the Caixa Econmica Federal (CEF).
Table 7.5 Entrepreneurial Capital and Capital Markets Investments at BNDESPar
314
FGTS is used to nance public housing, including the My House, My Life program, basic sanitation, and
urban infrastructure that benets society, and is aimed mainly at those with lower incomes.
The Investment Fund of the Employee Severance Fund (FI-FGTS) was created by the Securities Commission
(CVM) Instruction 462 in 2007 with the objective of creating value and applying it to the construction,
reform, extension, or implementation of ventures in highway, port, waterway, railroad, energy and sanitation
infrastructure. For this purpose, the FI-FGTS receives FGTS nancial resources when it is so authorized by the
Governing Board and it is administered, managed and represented judicially and extra-judicially by the CEF.
7.3.7.4. Financer of Studies and Projects (FINEP) The Brazilian Agency for Innovation
FINEP is a state owned company linked to the Ministry of Science and Technology (MCT) which acts in
all areas of the innovation chain, and is focuses on strategic and structural acts that have an impact on the
sustainable development of Brazil. It seeks to nance science, technology and innovation by encouraging
innovative activities that are essential to increasing the entrepreneurial sectors competitiveness.
FINEP acts together with companies and institutions that invest in the research and development of new
products and processes in the search for innovation and technological leadership. Those eligible for FINEP
support are: universities, teaching and research institutions, technological research institutes and centers,
emerging technological companies, technology incubators, technological parks, small, medium and large
companies, and other non-governmental organizations.
The Financer of Studies and Projects (FINEP) has some lines of nancing oriented towards innovative MSMEs
and also acts as an investor in PE/VC investment vehicles in a way similar to the SBIC (Small Business Investment
Company) in the United States.
The Zero Interest Rate program is oriented towards innovative micro and small businesses (with annual
revenues below R$ 10.5 million), and offers nancing ranging from R$ 100 thousand to R$ 900 thousand
corrected by the Broad Consumer Price Index (IPCA) for payment in up to 100 installments, with no grace
period. To make it easier to take out these loans, FINEP permitted some strategic partners to help it operate this
program. Since there is no collateral required, this program is ideal for new companies.
Another nancing program that FINEP has is Inova Brasil which supports the federal governments Productive
Development Policy (PDP). One of the principal goals of the program, which operates with xed subsidized
315
Chapter 7
fees between 4% and 5% annually, is to contribute to an increase in the amount of research and development
(R&D) activity taking place in the country. Projects in the pre-investment phase which are not tied to priority
governmental programs are handled by another line which has a xed annual fee of 8%.
Table 7.7 depicts the history of both programs from 2007 to 2009 in terms of the number of projects and
the amount of money invested. It can be noted that the Zero Interest Rate program has declined relatively while
the Inova Brasil program has expanded strongly.
Table 7.7 Number of Projects and Values of Finep Programs (R$ millions)
Programs 2007 2008 2009
INOVA Brasil
Projects 47 50 69
Value 557.80 864.10 1,676.95
Zero Interest Rate
Projects 30 14 5
Value 17.00 8.00 2.80
Source: FINEP (2009)
In all its nancing, FINEP participates with up to 90% of the value required for the project. Each
company can request up to R$ 100 million, with R$ 1 million being the minimum amount for each
nancing. All companies that accept this nancing have up to 100 months to pay off the loan and start
off with a 20 month grace period followed by 80 months of amortization.
In 1999, FINEP created the INOVAR (Innovate) program in partnership with the Multilateral Investment
Fund (FUMIN) and the InterAmerican Development Bank (IDB), with the objective of supporting innovative
companies through a structured Venture Capital program. Thus, the INOVAR I program was born in 2000 and
is known for its role in the Brazilian Association of Private Equity and Venture Capital (ABVCAP) creation, its
partnerships with pension funds and agents promoting funds investments, and the various forums it has
held to bring companies and investors together. In July 2008, it started INOVAR II, with the goal of promoting
actions to consolidate the PE/VC industry and contribute to the structuring of the seed capital segment in
Brazil.
316
Considering its accumulated results from 2001 through 2009, FINEPs portfolio has 22 approved funds (12
of them being Venture Capital, 4 Private Equity and 6 Seed funds) of which 13 are in operation, 8 are in the
fundraising stage and 1 has closed. The total amount of nancial resources in these funds is R$ 2.97 billion
with an average FINEP participation of R$ 281.9 million (9.5%). This represents a market resource multiplier
on the order of 9.32 or in other words, for every R$ 1.00 that FINEP has invested in PE/VC investment vehicles,
R$ 9.32 has been invested by other investors in innovation. Table 7.8 gives a summary of PE/VC investment
vehicles supported by FINEP.
Table 7.8 Investment Funds Supported by FINEP (R$ millions)
FINEP Funds Category Status Committed Committed / FINEP
GP Tecnologia Venture Capital Closed 115.00 5.75
RB Investech II Venture Capital Disinvestment Stage 35.30 5.00
FIPAC FMIEE Venture Capital Investment Stage 102.02 14.00
RB Nordeste II Venture Capital Investment Stage 137.80 15.00
SPTec FMIEE Venture Capital Disinvestment Stage 24.00 3.20
Novarum FMIEE Seed Capital Disinvestment Stage 12.75 3.80
CRP Venture VI Venture Capital Investment Stage 61.50 10.00
JB VCI Venture Capital Investment Stage 100.00 10.00
Stratus GC Venture Capital Disinvestment Stage 24.05 4.80
Stratus GC III Venture Capital Investment Stage 60.00 12.00
FIR Fundotec II Venture Capital Investment Stage 77.40 14.00
CapitalTech Venture Capital Investment Stage 31.40 9.00
HorizonTI Seed Capital Investment Stage 20.00 8.00
Terra Viva Private Equity Investment Stage 300.00 20.00
Fundo SC Seed Capital Fundraising 15.00 7.35
Performa Seed Capital Fundraising 15.00 6.00
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Chapter 7
Brasil Governana Private Equity Investment Stage 600.00 30.00
RB Investech III Venture Capital Fundraising 200.00 20.00
FCSRec Seed Capital Fundraising 20.00 8.00
FINTECH I Seed Capital Fundraising 15.00 6.00
CRP VII Private Equity Investment Stage 200.00 30.00
Brasil Agronegcio FIP Private Equity Investment Stage 800.00 40.00
Total 2,966.22 281.90
Source: FINEP (2010)
7.4 Private Equity and Venture Capital: Private Sector
7.4.1. The Financing Gap
Brazil has continually stood out in terms of its large number of entrepreneurs as revealed in GEMs annual
reports (GEM, 2010). However, the proportion of entrepreneurs per opportunity people who create a business to
meet a market need is still low in comparison with countries which have a strong entrepreneurial culture. This low
proportion is caused in part because of a lack of long term nancing in Brazil, mainly for MSMEs.
The three principal factors that may inhibit company fundraising are: 1) High interest rates charged by nancial
institutions; 2) The lack of more collateral to offer creditors; and 3) the lack of familiarity of many entrepreneurs with
alternative sources of nancing. Thus, the quantity of companies that effectively manage to get nancial resources
from third parties is much lower than the number that seek it, leaving the nancial resources of the partners themselves,
acquaintances, and company cash ow as the principal sources of business nance.
Creditors also can feel insecure and consequently reject nancing requests from MSMEs because of a lack of
credit history and the difculty that entrepreneurs have in correctly lling out correctly all the information requested
on a loan application. For medium size companies, the lack of credit history is the main reason for rejection.
In relation to sources of nancing to begin a new business, most companies use their own capital (their own
nancial resources, retirement funds, loans from relatives, indemnities, inheritance, etc.) There are few entrepreneurs
who begin a new business using third party capital.
Table 7.8 Investment Funds Supported by FINEP (R$ millions)
318
The last aspect that raises suspicion on the part of creditors and makes it more difcult for MSMEs to receive loans
is the amateurism that dominates this area. Most entrepreneurs dont differentiate between their personal nances and
company nances, utilizing company cash ow to nance personal acquisitions which can compromise the companys
activities in the long run (Carvalho, Ribeiro, Furtado, 2005).
7.4.2. The Absence of Private Banks in Long Term Financing in Brazil
In Brazil it is unusual for private banks to offer long term nancing for companies; only government banks and organizations
operate in this area. Brazilian companies, especially MSMEs, suffer from this segmentation of credit and, as described in the
previous topic, this fact can be viewed as a limiting factor for Brazilian entrepreneurship.
Graph 7.5 Average lenght of credit operations in Brazil
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Average Lenght (days) - consolidated total for all companies
Source: Bacen (2010b)
Graph 7.5 conrms empirically our inferences about the duration of credit operations in Brazil. We can see
that the average lenght is very short in comparison to other countries, around 1.5 years, even though this
represents an increase over the last ten years. Besides this, credit operations for cash ow are the principal
companie`s credit operations, as shown by the high correlation between these two curves.
Even though the offers of long term credit in Brazil are very low in relation to demand, the trend will be
that they will increase, mainly because of the good prospects for economic growth over the next few years.
This trend can clearly be observed in Graph 7.6.
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Chapter 7
Graph 7.6 Composition of terms for corporate credit
100%
90%
80%
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50%
40%
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20%
10%
0%
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Over the last few years, especially after the subprime crisis and the resumption of Brazilian economic
growth, BNDES, the principal source of long term nancing has appeared overloaded and close to
its loan limit for companies. This has drawn the government attention to an urgent need for the
private sector to offer credit lines for companies. Graph 7.7 shows exponential growth in the credit
operations of BNDES over the last ve years which have made it necessary for the National Treasury
to inject record quantities of capital in that development bank.
Graph 7.7 BNDES Credit Operations
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Source: Bacen (2010)
320
The discussion about possible changes that should take place so that private banks can begin to
provide companies with long term nancing is the topic of the moment and probably some changes in
macroeconomic policy will be implemented to try to solve this issue for the Brazilian economy.
7.4.3. Fundraising by Investment Funds
The investment fund industry, in terms of fundraising and net assets, declined sharply in 2008 and
recovered in 2009. Looking at the evolution of net fundraising and net fund assets, the 2008 crisis
and the 2009 recovery are obvious as is a notable increase in net assets. Analyzing horizontally,
there was an increase of 90% in net assets from 2005 to 2009, leading the Brazilian Investment Fund
industry to rise from 12th to 6th place in the world (ICI, 2010).
Graph 7.8 Net Fundraising and Net Fund Assets in the Domestic Market
N
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F
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2005 2006 2007 2008 2009
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1.200
950
700
Source: ANBIMA (2010)
Chapter 8
The Economic Impact of the PE/VC Industry
325
Chapter 8
The Economic Impact of the PE/VC Industry
1
8.1. Introduction
The current economic scenario in Brazil is very promising. The country has never been in a more solid
economic position and today it is one of the countries with the greatest potential for growth and the best
economic fundamentals in the world. Its expected that in 2025 this nation will be one of the ve largest
economies in the world (Preqin, 2010; Goldman Sachs, 2003).
The GVcepe questionnaire basically covered three aspects to understand the impact of the PE/VC
industry on the Brazilian economy. This chapter covers these three aspects: innovation, socioeconomic
performance and sustainability, which are central elements for leveraging growth in this country.
8.2. Innovation
This topic can be understood as the exploration of new ideas with success (Instituto Inovao). The result
of this process can be observed from various angles, from the point of view of signicant improvements
in processes, products, and company indicators among other things, and at the same time the creation of
new opportunities, tools and business models.
Law 11196/2005 is regulated by Decree 5798/2006, and is known as the Good Law because it
offers positive incentives. It is considered a legal landmark for innovation in Brazil, offering scal incentives
to companies that conduct technological research and innovative technological development. It denes
innovative technology as the conception of a new product or fabrication process, as well as the aggregation
of new functionalities or product or process characteristics which imply incremental improvements and
effective gains in quality or productivity.
Since its third edition, the Oslo Manual (OECD, 2005) has been responsible for the denitions of
innovation which have been adopted worldwide by authorities such as Eurostat (Statistical Ofce of the
European Community), the body responsible for the Community Innovation Survey (CIS), the principal
ofcial statistical report about the processes and effects of innovation in European companies (Eurostat,
2009). It brought with it an important modication: it expanded the concept of innovation, including the
1 Authors: William Luk, Gabriel Felisoni, Caio Ramalho and Rodrigo Lara.
326
service sector and removed the word technology from its denition. In other words, it is possible to
extend the concept of innovation to products, services, marketing and organizational systems.
However, the denitions in Decree 5798 mentioned above are based on the Frascati Manual and not the
Oslo Manual. The Frascati manual is one of a series of manuals dened by the Organization for Economic
Cooperation and Development (OECD) and the National Experts on Science and Technology Indicators
(NESTI) over the last 40 years. Among these manuals, Frascati covers research and development (R&D),
Oslo covers innovation, Bogot measures innovation in developing countries, and Canberra measures
human resources (Oslo Manual, 2005; Frascati Manual, 2002).
Among the most important institutions that stimulate innovation globally is the World Intellectual Property
Organization (WIPO). It is an agency of the United Nations (UN) and it develops the worlds intellectual
property system, stimulates innovation and contributes to economic development in accordance with the
public interest. In the 21st century, intellectual property is no longer seen as an autonomous area and has
become an important instrument in the formulation of public policy with socioeconomic, technological
and cultural repercussions (WIPO, 2001).
8.2.1. Concepts of Innovation
We will now present the basic concepts of innovation according to Oslo (2005).
U Innovation: is the implementation of a new or signicantly improved product (good or service),
process, or marketing method, or a new organizational method for business practices, the workplace
or external relations.
U Innovative activities: are scientic, technological, organizational, nancial and commercial steps
which lead to or seek to lead to the implementation of innovations. Some innovative activities
are innovative in and of themselves; others are not new activities but are necessary for the
implementation of innovations. Innovative activities are also part of R&D which is not directly related
to the development of a specic innovation.
U Innovative company: An innovative company is one which implements an innovation during the
period of analysis.
U Innovative company in products/processes: is a company that implemented a new or signicantly
improved product or process during the period of analysis.
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Chapter 8
U Product innovation: is the introduction of a new or signicantly improved good or service in terms of
its characteristics or expected use. This includes signicant improvements in technical specications,
components and materials, incorporated software, ease of use and other functional characteristics.
U Process innovation: is the implementation of a new or signicantly improved method of production.
This includes signicant changes in techniques, equipment and/or software.
U Marketing innovation: is the implementation of a new method of marketing with signicant changes
in the conception of the product or its packaging, in the products positioning, in its promotion or
its pricing.
U Organizational innovation: is the implementation of a new organizational method in the business
practices of the company, in the organization of the workplace or its external relations.
U Actively innovative company: is one that conducted innovative activity during the period of analysis,
including activities that are continuing and those that have been abandoned.
8.2.2 Obstacles to Innovation
Currently, for a company to be considered a highly innovative, it must not just distance itself from its
competitors, but must also do so in the perception of its clients. The results of the innovation process
are characterized by competitive advantages, temporary or not, putting the company in a better
situation in relation to its competitors. According to Sebrae (2008), 52% of companies considered
innovative increased their production, 46% increased their revenues, 39% increased their productivity
and 24% increased their workforce.
However, innovation doesnt happen naturally. Diverse factors inuence the creation of this attribute,
among them the environment in which the company is situated and the resources that it has at its disposal.
According to Michael Ryan (De Castro, 2005), director of the CIEC (Creative and Innovative Economy
Center), Brazil has positive points in innovation such as studies conducted by universities, highly qualied
human resources, and publications. However, there is an unfavorable environment in terms of bureaucracy,
taxation, and a time-consuming process of enforcing protection for intellectual property rights which
negatively inuence Brazilian innovative activity. Ryan further states that this could be one of the factors
that has kept the country behind other emerging countries such as China and India.
From this point of view, the PE/VC industry is the most interested party, given that even though
companies have great potential for growth, success is not always guaranteed. This is where the
328
government can play an important role by contributing in various aspects such as supporting
entrepreneurs with greater protection of intellectual property, providing scal incentives, and educating
qualied professionals, among others (IHS Global Insight/NVCA, 2009).
In the United States, PE/VC investments were responsible for leveraging businesses that currently
represent the most valuable companies in the world market. Google, Apple, Microsoft, Netscape,
eBay, and Amazon, among others are concrete examples of these investments (Bygrave and Timmons,
1992; Gompers and Lerner, 2001b). In reality, all of these companies began with a group of youths
who had a good idea and needed incentives (along with, of course, capital) to leverage their business.
From this point of view, the PE/VC industry plays a fundamental role. In Brazil the scenario is no
longer the same. According to the IBGE, 56% of new companies close their doors after the rst
year of operations due to problems in management and administration. Many of these businesses
have promising potential for growth, but they do not have the nancial, managerial or intellectual
resources to turn these expectations into concrete growth. Even though it is growing and is much
greater, there still isnt an entrepreneurial culture in the country as there is in the United States, with
the ideas of youths receiving investment from angel investors, seed capital funds and venture capital.
This represents a paradox, because Brazilians stand out in the world rankings of entrepreneurship
(GEM, 2009). It highlights that 18 to 34 year olds head 6 million companies created in Brazil in 2008
(61% of the total).
. PE/VC investments can benet startups which normally face difculties in access to credit (because
they have a low quantity of real assets, not enough to guarantee a loan), a lack of condence in R&D,
and also in terms of human resources (Premus 1985; Gompers, 1994; Gompers and Lerner 2001a;
Gompers and Lerner 2001b; Hall 2002; Smith and Smith 2002; Leeds 2003). Because of this, they
operate at a loss for many years and this is the reality of these investee companies at the beginning,
with many of them becoming part of the IBGE statistic cited above. In this way, unlike bank loans,
PE/VC fund managers can divide the risk of the investment with the entrepreneur by buying part of
the company. Thus, the Venture Capital manager becomes a partner with the company, committed to
its strong and sustainable growth (Engel, 2002; Gompers, 1994). Moreover, this type of investment,
besides offering capital, also contributes to the management and governance of the investee company,
and a commitment to creating value and transforming it into money when the exit occurs. Investment
vehicle managers participate actively in the decision making process, guiding companies toward the
road to success. This participation can occur through various forms: monitoring and performance
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tools, a professionalization of management, participation on the Board of Directors, the promotion of
networking, and the selection of company managers, etc.
In the past, bringing in a partner or considering seeking control of the company was considered a
dishonor or insult to the founder. Over the past few years, various companies have opted for this path
and have demonstrated that, on the contrary, it can offer an alternative with sustainable growth and
longevity for the business, while the other path can lead to destruction through bad management,
or worse, family disputes. Various entrepreneurs have begun to look favorably upon partnerships
with private equity fund managers which bring with them capital, management and experience in
managing the right side of the balance sheet. The entrepreneur Augusto Savio Cavalcanti, founder of
Zatex in 1997, believes that his business could have had much higher growth if it had had the support
of PE/VC investment. It is very clear in the international literature how much the PE/VC industry can
accelerate the economy of a country through giving incentives to new ideas and entrepreneurship.
Implementing public policy, the government plays a fundamental role in this process by granting scal
incentives, like those that exist for foreign investors in Equity Participation Funds (FIPs) for example.
8.2.3. Innovative Activities
According to a study made in Brazil (IBGE, 2003), most companies in 2003 attributed great importance to
the acquisition of machines and equipment, followed by training and industrial plans as is indicated in Graph
8.1. The preference for the acquisition of capital goods matches the prole of small companies for which the
access to technology is important.
Graph 8.1 Importance of Innovative Activities in Brazil
1998-2000 and 2001-2003
Acquisition of Machines and
Equipment
Industrial Plans and Other
Technical Preparations
Internal R&D Activities
Introduction to Innovative
Technologies in the Market
Acquisition of Other External
Knowledge
Acquisition of External R&D
Knowledge
Training
2001-2003
1998-2000
0,0% 20,0% 40,0% 60,0% 80,0% 100,0%
Source: IBGE (2003)
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8.2.4 Trademarks, Patents, and Intellectual Property
The protection of intellectual property rights is important to making innovation, economic development,
and value creation possible. In the 21st century, trademarks and patents are no longer viewed separately,
but as part of a whole. They are part of a much broader context which includes the social, economic and
political environment (WIPO, 2001).
Looking at an older study (WIPO, 2001) shown in Table 8.1, we can see that the value generated by the
authorial rights industry is considerable. In Argentina, Brazil, Chile, Paraguay and Uruguay, it generated
a total of US$ 61 billion. Brazil was responsible for 75% of the value in the group. In relation to Mercosul,
approximately 5.6% of its GDP came from these activities.
Table 8.1 Value Added by Authorial Rights Industries in Mercosul (1998)
Country Value Added (US$ Thousands) % of Mercosul GDP
Argentina 6,440,000 0.59
Brazil 53,034,026 4.82
Chile 1,243,000 0.11
Paraguay 98,654 0.01
Uruguay 705,000 0.06
Total 61,520,680 5.59
Mercosul GDP 1,100,644,816 100.00
Source: WIPO (2001)
According to the WIPO (2009), there has been a continuous growth in the number of patent processes
initiated around the world. Graph 8.2 reects data up until 2009, a year which witnessed a small decrease
to 155,900 when compared with the value of 164,000 of the year before. This decline occurred principally
because of the decline in the world economy due to the nancial crisis of 2008. It is important to underline
that this was the rst decline in the number of these processes in the last 30 years and it only fell because
the world passed through a nancial crisis comparable to the Great Depression of 1929 (Eichengreen
and ORourke, 2009). Note the high correlation between the patent process and the rhythm of economic
activity. In the year 2002, after the terrorist attacks of September 11, 2001, the growth in these processes
declined greatly but remained positive.
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Chapter 8
Graph 8.2 Quantity of Patent Processes Initiated Around the World (Countries Which Adhere to
the Patent Cooperation Treaty)1978 - 2009
1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
6.000.000
5.000.000
4.000.000
3.000.000
2.000.000
1.000.000
0
50,00%
40,00%
30,00%
20,00%
10,00%
0,00%
-10,00%
42,90%
9,90%
9%
8,20%
17,70%
29,10%
11%
17,80%
31,20%
33,50%
18,70%
15,60%
11%
14,70%
17,40%
20,50%
18,40%
17,50%
13,80%
22,10%
16,10%
2%
4,40%
6,40%
11,50%
9,40%
6,90%
2,10%
-4,50%
Annual Growth (%) Total number of processes (patent cooperation treaty)
Source: WIPO (2009)
Even though short term disturbances have had little effect on the patent creation process, the world crisis
of 2008/09 did have a large affect and will have consequences. The fall in demand and the depreciation
in the value of company assets had a negative effect on company cash ow and results. At the same
time, the access to credit was limited. In this way, R&D investments such as the costs of acquiring and
maintaining patents were limited for nancially healthy and troubled rms alike.
The second effect of the crisis was an adjustment in costs and the levels of investment in line with world
market projections. This being true, many companies adjusted their strategies to the new reality making
the recession deeper.
332
Besides this, the crisis did not affect countries equally as can be seen in Graph 8.3 which shows that
emerging markets were least affected.
Graph 8.3 Variation in GDP between 2008 and 2011
8
6
4
2
0
-2
-4
V
a
r
i
a
t
i
o
n

i
n

G
D
P

(
A
n
n
u
a
l

%
)
2008
2009
2010 2011
Advanced Economies
World Average
Emerging and Developing Countries
Source: WIPO (2011)
Through the increase in the number of patent processes, we can infer that this growth demonstrates,
to some extent, the growing preoccupation with defending intellectual property and the creation of
intangible assets as well as the greater development of ideas associated with innovative technologies.
Currently most patents belong to the latter group, or more specically in the microstructure, nano-
technology, semiconductor and digital communication segments.
It still hasnt been possible to create an index comparing the growth of the patent process for companies
that received PE/VC investment with Brazilian companies in general, but there are strong indications
that the former group has a higher rate of testing of these patents. PE/VC investment provides better
conditions for patent creation, because it provides a large amount of capital as well as legal and
governance help for their realization. Moreover, patents create competitive advantages through barriers
to entry and offer the possibility of accelerated growth if the venture is very successful. Companies that
do not have this support can face greater difculties in registering their patents for various reasons. The
main reason is that entrepreneurs in general dont know the legal side of the process, and besides this,
the cost of obtaining a patent can be very high and this may not t within the budget of a company
which is just beginning its activities in the market.
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The fact that PE/VC investee companies have the highest rates of patent testing is consistent with
what was said before about the world crisis. A lack of resources has become a great impediment to the
creation and maintenance of patents (WIPO, 2009).
Various international studies have made a positive correlation between investments made, mainly
Venture Capital investments, and an increase in performance in terms of innovation. Consequently,
these capital investments inuence the growth in the number of patents.
Romain and Pottelsberghe (2004) and Kortum and Lerner (2000) studied the correlation between
Venture Capital and the propensity to create patents with data collected from 530 companies (some
with VC support and some not) in the United States from 1965 to 1992. The results corroborate the
hypothesis that VC activity signicantly increases a companys propensity to create patents. Tykvova
(2000) studied companies in Germany, nding even more robust results to corroborate the results of
the two previous studies.
In this study we asked whether the degree of protection of intellectual property rights was considered
an obstacle to PE/VC industry fundraising. Table 8.2 shows that more than 70% of PE/VC managers in the
country disagree or are neutral in terms of this obstacle, indicating a satisfaction with the level of protection
afforded the companies in which they invest.
Table 8.2 Obstacles to Fundraising and Investment in Brazil The Protection of Intellectual
Property Rights
Degree of relevance, in percentage, of protection of intellectual property rights for fundraising and investments. Responses based on sample of 80
PE/VC Fund Managers (56% of total).
Totally Disagree
Partially
Disagree
Neutral Partially Agree Totally Agree Total
Relative
Porcentage
7.5% 20.0% 43.8% 23.8% 5.0% 100%
Source: Getulio Vargas Foundation Gvcepe Database
Comparing the table above with Graph 8.4, which shows the stages of investee companies in the sample,
we can see that 47% of the PE/VC portfolio companies are in the initial stages of development (seed, startup or
venture capital early-stage) and 38% are in the Private Equity Growth stage. These companies are, in the great
majority, those which have higher levels of innovation and this data provides some condence in regard to the
hypothesis that fund managers believe the existence adequate legal protection for patents in Brazil.
334
The innovation factor is much more present in companies which are in the initial stages of investment, because
they generally deal with ideas which confer competitive advantages in the market. In this way, the protection of
intellectual property rights is much more important for these companies than companies in more advanced stages
of investment (Private Equity Later Stage) which are more established in the market and depend less critically on
innovation.
Graph 8.4 Stages of Portfolio Companies
Note: data obtained based on information provided about 137 portfolio companies in 31/dez/2009, corresponding to 37% of total.
*Others refers to stages of Mezannine, PIPE, Distressed e Greeneld
Private Equiry Growth
Venture Capital Early Stage
Venture Capital Later Stage
Others*
Start-up
Seed
38%
4% 4%
6%
11%
14%
23%
Often large capital investments are made to develop a new product or new idea to be launched on the
market. If the necessary patents have not been secured for this product, any competitor can simply copy
the new product without any kind of investment and obviously obtain competitive advantages in terms of
cost in relation to the company that originally had the idea.
The argument made by Paulo Arruda (UNICAMP, 2010), a researcher at the Biology Institute, reinforces
the importance that companies in the initial stages of investment give to protecting intellectual property
rights. According to Arruda, Allelyx, one of the largest biotech companies in Brazil, driven by venture capital
investment (Votarantim Novos Negcios), invested a large quantity of money in this type of protection.
Arruda also states that one must always be vigilant, paying attention to the list of registered patents. He
comments that it is extremely rare that professionals in Brazil know the legal protection area as well as they
know their own profession.
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Chapter 8
TABLE 8.3 Global Ranking in Technological Innovation 2009 - 2010
Country Position Country Position Country Position
Iceland 1 Spain 30 Montenegro 59
Swedem 2 Malta 31 Thailand 60
Hong Kong, China 3 Cyprus 32 Ukraine 61
Switzerland 4 Kuwait 33 Tunisia 62
Denmark 5 Portugal 34 Kazakhstan 63
Finland 6 Qatar 35 Russia 64
Singapore 7 Hungary 36 Oman 65
Netherlands 8 Slovakia 37 Panama 66
New Zealand 9 Italy 38 Turkey 67
Norway 10 Lithuania 39 Brazil 68
USA 11 Bahrain 40 Mexico 69
Canada 12 Costa Rica 41 Jamaica 70
Japan 13 Chile 42 Vietnam 71
United Kingdom 14 China 43 Indonesia 72
Luxembourg 15 Latvia 44 Mauritius 73
Germany 16 Croatia 45 Egypt 74
Belgium 17 Greece 46 Argentina 75
Australia 18 Poland 47 Filipinas 76
Ireland 19 Brunei 48 Macedonia 77
Republic of Korea 20 Bulgaria 49 Mauritania 78
Austria 21 Barbados 50 Sri Lanka 79
France 22 South Africa 51 Suriname 80
Israel 23 Romania 52 Albania 81
United Arab Emirates 24 Uruguay 53 Armenia 82
Taiwan 25 Saudia Arabia 54 Kenya 83
Slovenia 26 Trinidad and Tobago 55 Georgia 84
Czech Republic 27 India 56 Dominican Republic 85
Malaysia 28 Azerbaijan 57 Botswana 86
Estonia 29 Jordan 58 Mongolia 87
The case cited by Paulo Arruda (UNICAMP, 2010) shows that companies in the initial stages of growth
need greater access to protection for intellectual property rights and that venture capital investment (in any
of its stages) and ties to technological parks and incubators help solve this type of problem.
336
TABLE 8.3 Global Ranking in Technological Innovation 2009 - 2010
Table 8.2 looks beyond Brazil towards the world seen by PE/VC managers. By the global index of
innovation, we can conclude that Brazil would benet greatly if the protection of intellectual property rights
were broader and more accessible. In March 2010, Brazil fell from 50th place to 68th place in terms of
the most innovative nations in the world. This same ranking classies Iceland, Sweden, and Hong Kong as
the three most innovative nations/areas in the world (BBC, 2010).
8.2.5. R&D vs. Revenues
Investments in R&D are crucial to the launch of new products and services to the extent that companies
manage to meet existing demand. The lack of available capital for these investments is a type of barrier
that can be overcome by PE/VC activity, if the business has the necessary characteristics for this type of
investment.
Graph 8.5 refers to a study of the Indian PE/VC industry, demonstrating its impact on innovation, which shows
how a lack of resources compromises the introduction of new products and services. Besides this, 79% of those
interviewed for this study said that part of the nancial resources from investments would be allocated to R&D.
Peru 88 Pakistan 103 Benin 118
Ivory Coast 89 Kyrgyzstan 104 Cameroon 119
Colombia 90 Ghana 105 Bangladesh 120
El Salvador 91 Senegal 106 Algeria 121
Namibia 92 Mali 107 Burkina Faso 122
Lesotho 93 Uganda 108 Ethiopia 123
Morocco 94 Libya 109 Venezuela 124
Guatemala 95 Gambia 110 Madagascar 125
Nigeria 96 Zambia 111 Ecuador 126
Malawi 97 Honduras 112 Paraguay 127
Tanzania 98 Guyana 113 Burundi 128
East Timor 99 Chad 114 Bolivia 129
Mozambique 100 Tajikistan 115 Nepal 130
Serbia 101 Bosnia and Herzegovina 116 Zimbabwe 131
Cambodia 102 Nicaragua 117 Syria 132
Source: Global Innovation Index
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Chapter 8
Graph 8.5 Allocation of Financial Resources Invested in Indian Companies
Marketing
P&D
Capex 29%
21%
50%
Source: Venture Intelligence (2007)
Based on the data from a study done in the United States (NVCA, 2009), we can see better than average
performance for PE/VC investee companies in terms of revenues as can be seen in Graph 8.6. The
difference is undeniable which indicates to some extent that investments in R&D can have a strong nancial
impact on companies. Besides this, according to the same study, from 1970 to 2008, for every US$ 1
invested in Venture Capital, US$ 6.36 was generated on average in revenues for investee companies.
Graph 8.6 Comparison of Revenue Growth Between Companies that Recieved Venture Capital
Investment and the Overall Company Average
6,00%
5,00%
4,00%
2,00%
1,00%
0,00%
Companies Receiving Venture Capital
Investment
Overall Company Average
Source: NVCA (2009)
338
In the high tech sector, companies receiving venture capital investment obtained, in some cases, more
than half of all the revenues received by companies receiving this kind of investment. Among these were
electronics (67.00%), semiconductors (55.04%), telecommunications (51.05%), biotechnology (47.15%) and
computers and peripherals (44.29%) (NVCA, 2009).
Another factor that distinguished Brazil in the beginning of the decade (IBGE, 2003) was the decrease in
the money spent on innovation as a share of revenues. There was a fall of 1.3 percentage points (3.8% in
2000 to 2.5% in 2003). In terms of innovative activities, the greatest declines occurred in: the acquisition of
other external knowledge (from 0.20% to 0.08%); the acquisition of machines and equipment (from 2.00% to
1.22%); industrial plans (from 0.57% to 0.35%); with internal R&D activity being the mildest of these declines
(from 0.64% to 0.53%). Based on this information illustrated in Graph 8.7, its possible to better understand
the changes that took place over the period analyzed. Despite the fact that there was a decrease overall in
expenditures, we can see that the greatest decrease was in the purchase of machines and equipment, while
the smallest decrease was in training.
Graph 8.7 Percent of net sales revenues allocated to innovative activities in brazil (2000/2003)
Training
Acquisition of External R&D
Acquisition of Other External Knowledge
Introduction to Innovative Technologies on the Market
Industrial Plans and Other Technical Preparations
Internal R&D Activities
Acquisition of Machines and Equipment
Total
0,0 1,0 2,0 3,0 4,0 5,0
2003 2000
0,05
0,07
0,11
0,08
0,15
0,24
0,35
0,57
0,53
0,64
1,22
2,45
3,83
0,07
0,2
2

Source: IBGE (2003)
Based on the conclusions above and graph 8.7, we can infer that Brazil is heading in the same direction as
developed countries. The countrys industry is currently more consolidated in terms of factories, machines, and
operational and transport equipment and now is investing more in research and development. This situation
is very propitious for the expansion of the PE/VC industry, because it deals with a link in the value chain that is
less intensive in terms of physical capital and more intensive in terms of intellectual capital. Even today in Brazil
%
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Chapter 8
the area of research lacks adequate valuation by governmental entities and a large part of time innovators face
impediments in this area. Private investment will play a great role and presents great opportunities for high
returns in R&D.
8.2.6. Effects of Innovation
According to William F. Miller (Simes, 2009), co-director of the Program on Regions of
Innovation and Entrepreneurship at Stanford University, new products and services arise when
there is a propitious environment for them to develop. To him, they come from scientific research
and investments in human capital, communications and global connections.
Graph 8.8 shows that new products appeared in just 31.5% of companies studied during the
IBGE study from 2001 to 2003. According to this study, the principal effects of innovation were
an improvement of product quality, the increase or maintaining of company market share, an
increase in productive capacity, a reduction in work costs, the opening of new markets and a
reduction in environmental impacts.
Graph 8.8 Effects of Innovation on Brazilian Companies 1998-2000 And 2001-2003
Conforming to Regulations Related to the External Market
Reduction of the Consumption of Energy
Reduction of the Consumption of Raw Materials
Opening of New Markets
Conforming to Regulations Related to the Internal Market
Broadening the Range of Products Offered
Reduction of Work Costs
Reduction of Environmental Impact and Related Aspects
Increase in Flexibility of Production
Increase in Productive Capacity
Increase of Companys Market Share
Maintaining Companys Market Share
Improvement of Product Quality
0 10 20 30 40 50 60 70 80 90
6,9
10,4
11,6
23,7
13,2
23
14,5
44,6
27,2
35,3
31,5
48
33,6
53,1
36,6
43,4
43,3
64,8
52,9
69,6
53
71
61
79,6
63,5
78,3
2001-2003 1998-2000

Source: IBGE (2003)
340
8.2.7. Examples of Methodology
In order to measure the degree of innovation in a country or a region, many institutions like the World
Intellectual Property Organization (WIPO) use statistics related to patents issued. Even though this is not
the ideal measure, the issuing of patents is a reliable indicator and is widely used to monitor innovative
activity and the development of new technologies. Its incompleteness can be perceived when we look
at innovations in productive processes or services, which arent necessarily patented. According to the
Community Questionnaire about Innovation (GPEARI, 2006), performed in Portugal, innovation can be
measured in various forms. They are:
U Information about the number of companies, the volume of business, and the number of people
employed.
U Innovative Activities: information about (i) companies introducing product and/or process
innovations; (ii) the types of activities performed by companies with the goal of introducing product
and/or process innovations; and (iii) innovative activities that were abandoned/interrupted (without
introducing the innovation) or incomplete.
U Markets and degree of product innovation: information about the degree of novelty (novelty for
the market or just the company) of product innovations introduced and the sales volumes of these
innovations as a proportion of the companys overall sales.
U Innovation expenses and governmental nancial support: information about the intensity of
innovation (measured by the companys nancial effort) and governmental nancial support for
innovation.
U Source of information for innovation: the identication of sources of information that companies
consider most important for the implementation and realization of innovative projects.
U Cooperation for Innovation: information about the active participation of companies in innovation
projects in cooperation with other companies or institutions and the identication of the partners
considered to be the most important.
U Effects of Innovation: the presentation of effects of innovations in products and/or processes that
companies consider to be the most important.
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Chapter 8
U Obstacles to Innovation: main difculties/factors that impede innovative activities in companies.
U Intellectual Property: information about the ways that companies protect their intellectual property
rights.
U Organizational and Marketing Innovation: presentation of data about (i) how companies introduce
organizational innovations and their effects; (ii) how companies introduce marketing innovations
and their effects.
Figure 8.1 The J-Curve and the Need for Financial Resources
100
80
60
40
20
0
(20)
(40)
(60)
(80)
(100)
%
Cumulative Cash Flow
Drawdowns
Distribuitions
1 2 3 4 5 6 7 8 9 10
Year
Source: Venture Choice (2010)
In Figure 8.1, the line below the horizontal axis represents this gap mentioned above. Specically it is the
period when companies generally still have negative cash ow due to high initial costs. This is why this phase
can be called the nancing gap. Venture Capital investments reduce the risk that companies (with growth
potential) will close their doors before they consolidate their positions. This is the phase in which seed capital
is invested which serves to give the company resources to leverage its operations toward a positive cash ow.
In this way, the Venture Capital model is quite attractive to companies because it provides sufcient capital
and management so that they do not need to stop operations during the nancing gap because of a simple
lack of funds (Saito, 2008).
Besides offering capital to invest in companies, PE/VC also offers help in taking the decisions that will lead
them to the road to success. According to IHS Global Insight (2009), PE/VC investee companies generated
342
revenues of around US$ 3 trillion and employed more than 12 million people in the United States just in the
year 2008.
The greatest challenge of any company is to keep growing and achieve and maintain competitive advantages.
The ability to integrate different types of resources (human, technological, capital, information, etc.) is a very
important skill that a company needs to be able to innovate and gain competitive advantages over its competitors
(Porter 1979; Barney 1986; Prahalad and Hamel 1989; Hamel and Prahalad 1993; Teece and Pisano 1994; Mahoney
1995; Teece et al 1997; Bartlett and Ghoshal 2002). According to Christensen and Overdof (2000), three factors
inuence innovation in companies: resources, values and processes.
Hardagon and Sutton (2000) propose that innovative companies hire people with complementary abilities
and innovation is easily stimulated if legal incentives and compensation are given to these people. Through
PE/VC its possible to leverage the kind of growth that companies experienced at the beginning of their life
and this enables them to become more lucrative through innovation (Sahlam, 1990).
According to Gompers (1994), Gompers and Lerner (2002) and Metrick (2007), PE/VC provides capital
to nance innovation, especially high risk projects that offer high potential returns. In fact, various companies
that today are the largest in the world received this leverage from the PE/VC industry (see topic VIII.2.2 for
a listing of some of these companies). However, besides powering companies in the high risk high return
and basic technology sectors, the PE/VC industry also plays a role in leveraging ventures in more traditional
services such as Staples, Starbucks, FEDEX, and Home Depot, among others (Gompers, 1994; Gompers
and Lerner, 2001b; Gompers and Lerner, 2002; Metrick, 2007), which shows that the PE/VC model can
transform small traditional businesses with small revenues into large multimillion dollar chains.
One of the most important paradigms in Brazil is that the PE/VC industry is fundamental to the areas of
innovation and research, and this is illustrated by the story of Allelyx in Brazil. This was the largest deal in
Brazil history involving a biotech company developed with entrepreneurial capital. The company received an
investment of 40 million reais during the Seed stage from the fund manager Votorantim Novos Negcios.
In November 2008, the company was bought by the multinational rm Monsanto for the equivalent of R$
616 million (FAPESP, 2008).
The Allelyx case teaches us the fundamental role that the Venture Capital stage in its various levels (Seed,
Startup, and Early Stage) represents for open innovation. A group of biotech researchers discovered a
completely innovative phenomenon in the sequencing of the genome of Xyllela fastidiosa a bacterium
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that causes yellowing and decay in citrus trees through research nanced by FAPESP. After receiving an
investment of R$ 40 million from the Votarantim fund, they created Allelyx (which is Xyllela written backwards),
as well as another company CanaVialis later on. Today, the companies developed by the fund are not just
institutes of company research but in fact are companies that research products to improve agriculture and
the latter is the largest private company in the world dedicated to improving sugar cane (FAPESP, 2008).
8.3. Socioeconomic Performance
Hiring people is healthy not just for the economy but for society as a whole. Those employed, like
those that employ them, pay large quantities of taxes that should, at least in theory, be allocated to
improving the well-being of society. Besides this, they produce goods which will create goods that will
generate value later and will spend their salaries according to their needs, thus helping the economy.
Following this logic, the creation of jobs is of great importance to countries, especially in times of high
unemployment and process automation (Mnnist, 2009).
First of all we can cite the United States where up till 1980 job creation was led by large corporations.
However, after this date, a new economic paradigm arose: an increase in job creation in small companies
reaching 13 million jobs annually and greater indices of innovation in small companies than in large
ones. In this way, the rate of job growth in the PE/VC industry became noticeable. Investments, mainly
those in new companies (Seed and Startup) made this growth possible and made hiring necessary.
Besides this, PE/VC investee companies in the United States had revenues of US$2.9 trillion annually
and created more than 12 million jobs, and this was the results of investments totalling US$ 25 billion
per year (VPB, 2010).
However, we need to consider the increase in the number of the employed in two ways: (i) a newly
formed or consolidated company expands its operations and this is why it hires more employees or (ii)
there are job cuts, after investments are made, and then new employees are hired.
In addition, we must point out that venture capital investments are made in new companies with high
potential growth making hiring really necessary. In selecting companies, the investors end up inuencing
the indices. Besides this, it should be emphasized that the latter type of increase aims to restructure the
company, but can inate possible statistics about the effects of PE/VC activity. According to Shapiro and
Pham (2009) their behavior is similar to a J Curve, where initial cuts are followed by subsequent hiring
slowly at rst but accelerating with time.
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Table 8.4, sought to answer this J-Curve question. However, the small sample size makes this table
inadequate for this task. Note that the 141 investee companies employed 91,464 employees in 2009.
Table 8.4 Number of people employed per year as reported by fund managers
Table based on data furnished by fund managers. The great disparity between values is result of lack of information. Of the 502 investee companies
listed, 171 answered question, corresponding to 34% of total. Note: * indicates a lack of statistical signicance.
Year Number of Employees Number of Companies Responding
2009 91464 137
2008 3408* 14*
2007 2042* 9*
2006 904* 5*
2005 8480* 3*
In buyout operations exactly the aforementioned phenomenon occurs. Companies lose on average 3%
of their workforce. However, in subsequent periods the average growth was 19.6%. Among the respondents
of this study, just 19% had net job losses (CMBOR/EVCA, 2008).
Various studies have addressed the impact of PE/VC and with rare exceptions they indicate lower indices
in various specic segments. However, it should be remembered that these studies have their limitations
as presented by WEF (2008), such as: (i) incomplete questionnaires (partial responses), (ii) a difculty in
maintaining a control group and dealing with changes in the number of jobs in these cases, (iii) suspect
characterizations of PE/VC investments, (iv) problems in segregating organic growth from acquisitions,
exits and reorganizations, and (v) an inability to determine where jobs were created and eliminated.
In another study (BVCA/IE CONSULTING, 2007), approximately 50% of those interviewed stated that
job growth was greater due to VC investments. This is mainly because the industry selects and invests in
companies with high potential growth.
Additionally, a study conducted by Coopers and Lybrand (1997), it was observed the inuence of the Venture
Capital managing organizations have regarding the employment and sales quantity.
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Chapter 8
In respect to employment levels, the difference reached 28% in the United States of America in the
period between 1989 and 1993 and regarding sales, the difference reached 39% in the same country
and period.
Finally, we should consider that jobs by themselves do not guarantee economic growth. There have been
observed cases in which the number of jobs remained constant or declined, yet there was an increase in industry
production. That being so, productivity, which has to do with the capacity and abilities of workers, is another
important factor (Mnnist, 2009).
Table 8.5 Comparison of increase in employment and sales in companies that did and did not
receive venture capital investment
Country/Region Increase Employment Increase Employment Increase in Sales Increase in Sales
With VC invest Without VC Invest With VC Invest Without VC Invest
Europe, 1991-1995 15 2* 35 18*
US, 1989-1993 25 -3** 41 2**
Australia, 1993-1996 20 2*** 42 6***
Notes: * 500 Most Lucrative ** Fortune 500 *** Top 100
Source: Coopers and Lybrand (1995); Coopers and Lybrand (1997)
8.3.1. Quality vs. Quantity
Quality, without a doubt, should be more important than quantity. The restructuring of the workforce,
like the hiring of new workers is done from the perspective of their potential.
In relation to recently formed companies, for those seeking employment there are opportunities in all
segments, from the simplest to the most complex. Besides this, according to Carvalho, Calomiris and
Matos (2005), since VC investee companies are new and dont have experience with human resources,
VC fund managers end up getting involved in the selection, recruiting and compensation for their key
personnel.
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However, large companies based on IT, life sciences and clean technologies require highly qualied
professionals to ll so-called green color jobs which involve protecting the environment and sustainable
development (IHS Global Insight/NVCA, 2009).
In regard to the Brazilian environment, there is a certain difculty (40 to 50% of managers disagree)
in nding qualied personnel. Note rst of all the similarity between the search for professionals by fund
managers and by investee companies as shown in Tables 8.6 and 8.7 below:
Table 8.6 Obstacles to Fundraising and Investment in Brazil Fund Managers Difficulty in
Recruiting Professionals
Degree of relevance of Fund Managers Difculty in Recruiting Professionals as an Obstacle to Fundraising and Investment. Responses based on
sample of 78 PE/VC Fund Managers (54% of total).
Totally
Disagree
Partially
Disagree
Relative Percentage 11.5% 23.1% 21.8% 37.2% 6.4% 100.0%
Table 8.7 Obstacles to fundraising and investment in Brazil Investee companys difficulty in
recruiting professionals
Degree of relevance of Investee Companys Difculty in Recruiting Professionals as an Obstacle to Fundraising and Investment. Responses based on
sample of 78 PE/VC Fund Managers (54% of total).
Totally
Disagree
Partially
Disagree
Relative
Percentage
8.8% 22.5% 20.0% 41.3% 7.5% 100.0%
Source: Getulio Varga Foundation Gvcepe Database
8.3.2. Total Quantity vs. Stage and Sector
Based on Table 8.8 we can see the diversity of investments made and the employment of investee
companies. However, the sectors that most generated jobs were Miscellaneous Services, Education,
Infrastructure, and Transport and Logistics. The largest number of investee companies came from the IT
and Electronics, Agribusiness, and Energy and Fuel sectors.
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Chapter 8
Table 8.8 PE/VC investee companies as of dec. 31, 2009: Number of employees reported by
fund managers per sector
Table based on data furnished by fund managers. Sample of 137 investee companies ( 27.3% of total) responding on December 31, 2009 out of a
total of 502. portfolio companies.
Sector
Number of
Employees
Relative %
Number of
Companies
Relative %
Food and Beverage 4834 5.29 6 4.38
Retail 6490 7.10 5 3.65
Miscellaneous Services 15502 16.95 8 5.84
Education 13991 15.30 8 5.84
Infrastructure 8892 9.72 6 4.38
Transport Services and Logistics 7764 8.49 1 0.73
Pharmaceuticals, Medicine and Beauty 6512 7.12 6 4.38
IT and Electronics 5302 5.80 31 22.63
Agribusiness 3953 4.32 11 8.03
Energy and Fuel 3885 4.25 14 10.22
Civil Construction 3602 3.94 3 2.19
Others 3090 3.38 8 5.84
Communications 2880 3.15 8 5.84
Chemical Industry 1878 2.05 3 2.19
Financial Services 1043 1.14 5 3.65
Metallurgical, Mechanical and Electric Material
Industries
806 0.88 2 1.46
Entertainment//Tourism 505 0.55 3 2.19
Real Estate 452 0.49 3 2.19
Biotechnology 83 0.09 6 4.38
Raw Materials Industries 0 0.00 0 0.00
Total 91464 100.00 137 100.00
Based on the stage of investee companies, we can see in Table 8.9 that in 2009 the largest number of
jobs were created during the Private Equity-Growth stage (48.68%), followed by PIPE (16.67%), Private
Equity-Later Stage (11.26%) and Venture Capital-Later Stage (10.65%). Note, however, that these values
are compatible with company development, with the new companies having few employees and the
consolidated ones having more employees.
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Table 8.9 PE/VC Investee companies as of dec. 31, 2009: Number of employees reported by
fund managers per stage
Number of employess reported by fund managers per company`s stage. Table based on data furnished by companies. Sample based on 137
portfolio companies (27.3% of total) responding on December 31, 2009 out of a total of 502.
Stage
Number of
Employess
Relative %
Number of
Companies
Relative %
Seed 32 0.03 6 4.38
Start-up 92 0.10 9 6.57
Venture Capital Early Stage 1.416 1.55 32 23.36
Venture Capital Later Stage 9.745 10.65 18 13.14
Private Equity - Growth 44.521 48.68 52 37.96
Private Equity - Later Stage 10.301 11.26 4 2.92
Mezzanine 8.862 9.69 7 5.11
PIPE 15.245 16.67 5 3.65
Greeneld 175 0.19 3 2.19
Distressed 1.075 1.18 1 0.73
Total 91.464 100 137 100
Based on the data in Tables 8.8 and 8.9, we can infer that PE/VC activity has a great effect on the level of
employment in each sector. Besides this, the job creation power in new sectors is clear, or in other words,
investments not only develop these sectors but also increase the number of those employed. Note, moreover,
that the sectors with the highest levels of employment in descending order were Miscellaneous Services,
Education and Infrastructure.
8.3.3. Organic Growth vs. Growth through Acquisition
Organic growth arises when companies manage to expand their operations using internal nancial
resources instead of growing through mergers and acquisitions. According to the WEF (2009), investee
companies dont grow due to restructuring and/or acquisitions but rather organic growth.
According to BVCA and IE CONSULTING (2007), growth has most of the time been organic. Besides
this, in the private sector, 21% of PE/VC investee companies basically grow organically.
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Chapter 8
8.3.4. Formal and Informal Employment
According to the IBGE (2009), Brazil had 54.3 million workers in 2009, and of these, 59.6% were
formally employed, 28.2% informally employed, and 12.2% were employed by the state or the military.
The main reasons for the large informal market are the large amount of bureaucracy and the high taxes
involved with roughly 25.1% of the expenses in hiring an employee ending up in the public coffers.
Based on the results of this study (as shown in Tables 8.10 and 8.11) 75.6% of fund managers consider
bureaucracy a great barrier to PE/VC activity in Brazil. Besides this, as seen before, the high level of
taxation is even more of an obstacle from the point of view of 89.5% of the sample total.
Table 8.10 Obstacles to fundraising and investment in Brazil Bureaucracy
Degree of relevance of Bureaucracy as an Obstacle to Fundraising and Investment. Responses based on sample of 83PE/VC. Fund Managers (58%
of total).
Totally
Disagree
Partially
Disagree
Relative
Percentage
3.6% 3.6% 16.9% 54.2% 21.7% 100.0%
Source: Getulio Vargas Foundation GVcepe Database
Table 8.11 Obstacles to fundraising and investment in Brazil high taxation rates
Degree of relevance of High Taxation Rates as an Obstacle to Fundraising and Investment. Responses based on sample of 83PE/VC Fund Managers
(58% of total).
Totally Disagree
Partially
Disagree
Relative
Percentage
2.4% 2.4% 6.0% 39.8% 49.4% 100.0%
Source: Getulio Vargas Foundation - GVcepe Database
According to Sinhorini (2006), from the nancial point of view, the informal market can be tempting
for the employer as much as the employee given that less tax is paid. However, collateral problems
arise, such as social security, labor lawsuits, lower efciency, poor qualications, and a lack of worker
benets, among others.
Through the Monthly Employment Report, a study developed by the IBGE which covers Recife, Salvador,
Belo Horizonte, Rio de Janeiro, So Paulo and Porto Alegre, we can see the evolution of formal employment.
350
As can be seen in the graph below, despite declines during various short periods, formal employment
shows a steady tendency towards growth with the difference between the initial index and the nal one
being 40.77%. We also see less informal employment with a strong tendency for it to fall given the rise
in formal employment.
Graph 8.9 Formal and informal employment in Brazil March 2002 to June 2010
145,00%
140,00%
135,00%
130,00%
125,00%
120,00%
115,00%
110,00%
105,00%
100,00%
95,00%
m
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r
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2
d
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c
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2
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2
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0
Formal
Informal
Source: IBGE (2010) 2
Finally, we can reinforce the importance of rethinking public policy given that 69% of fund managers
in Brazil consider informal employment an impediment to their operations (Table 8.12).
Table 8.12 Obstacles to fundraising and investment in Brazil informal employment
Degree of relevance of Informal Employment as an Obstacle to Fundraising and Investment. Responses based on sample of 81PE/VC Fund
Managers (56% of total).
Totally Disagree
Partially
Disagree
Relative
Percentage
6.2% 9.9% 14.8% 51.9% 17.3% 100.0%
Source: Getulio Vargas Foundation - GVcepe Database
Over time, a new kind of phenomenon has become more and more common in the Brazilian economy,
namely outsourcing. Outsourcing can be characterized as a way for companies to get work done through
2 The graph 8.9 data is based on (100%) March 2002 index..
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Chapter 8
buying the rights to service providers. In other words, it can be considered an activity that separates work into
two fronts: the economic relationship and the labor law which corresponds with it (Schnell, 2005). It offers,
most of the time, gains in productivity, quality and competitiveness given that the services are provided by
specialized rms. Besides this, having other parties perform auxiliary services helps maintain company focus.
8.3.5. Compensation
In Graphs 8.10 and 8.11, data is presented to support the hypothesis that just as it does with employment,
PE/VC activity favors increases in salaries. In part, this is due to new practices in compensation, such
as offering share participation in the company and variable compensation according to employee
performance. Besides this, stock options are also used to attract qualied human capital for the key
positions of directors and managers of investee companies.
Graph 8.10 Companies in expansion phase during post-investment period Changes in
compensation
3
Dimminished
Remained Constatn
Increased
Others
Middle Management
Upper Management
0% 20% 40% 60%
Source: NUBS/EVCA (2002)
3 Middle Management employees are those who have to monitor organizational activities and operations while reporting to Upper Management. Upper
Management refers to those professionals who have positions such as CEO, Director, Vice-President, etc.
352
Graph 8.11 Companies in seed/startup stage during post-investment period - Changes in
compensation
4
0% 20% 40% 60%
Dimminished
Remained Constatn
Increased
Others
Middle Management
Upper Management
Source: NUBS/EVCA (2002)
Another study done by the WEF (2009) states that PE/VC investee companies have productivity gains
up to 2% more than the control group in the rst two years after the investment. Most of this difference
is due to the better allocation of resources and performance of tasks as chosen by better managers. In
any event, investee companies are not the only ones that present gains in productivity. The control group
presents gains as well, but these have a lesser correlation between gains in productivity and increased
compensation.
8.3.6. Labor Relations
Changes in company leadership usually make employees worry, and they can react positively believing
that this may bring them new opportunities, or negatively thinking that they could lose their jobs, could feel
greater pressure at work or could be relocated to areas that do not interest them. That being so, the CEO has
to ensure not only that the company grows, but also that it retains its talent, and maintains (or even increases)
its productivity.
In relation to PE/VC operations, CMBOR/EVCA (2008) measured the impact of these operations in relation
to workers, analyzing compensation, retirement plans, training programs, consultations, the recognition of
work councils and worker participation in unions.
This study was conducted with 190 PE/VC investee companies and yielded results indicating a neutral or
positive impact on: (i) making decisions regarding labor relations, (ii) the evolution of compensation and
retirement plans, (iii) the extent to which companies seek commitment through their administrative practices,
4 Middle Management employees are those who have to monitor organizational activities and operations while reporting to Upper Management.
Upper Management refers to those professionals who have positions such as CEO, Director, Vice-President, etc
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Chapter 8
and (iv) continued recognition of unions and their involvement in worker consultations and informational
procedures.
(i) Making decisions regarding labor relations:
Data about the inuence of PE/VC investors on investee companies indicates that they spend most of their
time monitoring nancial and operational performance as well as company strategy, directly inuencing
worker activity. Besides this, immediately after an acquisition, the number of employees decreased 3% on
average, but grew 19.6% during the period that followed.
In terms of reducing the workforce, the main reasons are: increasing competitiveness (64.7%), reorganizing
work methods (58.8%), exits (21.6%) and mergers (17.6%). In this step, more than one response could be
chosen, thus the sum of the alternatives is over 100%. However, most of these companies offer help for
those who lose their jobs through better severance pay, counseling and relocation assistance.
(ii) Evolution of compensation and retirement plans:
The data shows that average compensation rose, with more than half of all those interviewed receiving raises
in comparison to the pre-investment period. This raise was largely due to the need to attract/retain professionals
and better company performance.
In regard to retirement, the percentage of companies offering this benet increased by 5 percentage points,
from 76% to 81%. As to which type, there was a decline in those that were closed and those which were tied
to salaries and vice-versa.
(iii) The extent to which companies seek commitment through their administrative practices:
On this point, the results showed that PE/VC fund managers have a tendency to use forms of compensation
that try to tie employee pay to the employees commitment to the company and its results. Compensation
linked to results and prots increased an average of 6%.
(iv) Continued recognition of unions and their involvement in worker consultations:
Despite the fact that the attitude of administrators towards unions and the number of members in
their companies has not shown much change, the same study indicated a greater union presence in
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negotiations, consultations and the dissemination of information. This improvement was measured in
terms of hours worked, salaries, training, vacation, and opportunities, among other things.
Besides, this, comparing the post-investment period to the pre-investment period, there was a signicant
increase in the number of consultative committees, which increased in frequency from 50% to 63%, as well
as a greater inuence of these committees on future plans, worker training, payments, and exible hours,
among other things.
Finally, according to Table 8.12, 70.4% of fund managers do not approve of the restrictions imposed by
labor laws. That being so, this subject needs to be handled from a legal point of view.
8.3.7. Importance of Public Policy in the United States
The American PE/VC models embryonic phase began after the Stock Market Crash of 1929 with the creation
of the Reconstruction Finance Corporation (RFC) promoted by then President Herbert Hoover. This agency
aimed to ameliorate the effects of the coming Depression and promote economic growth through nancial
loans to various institutions.
Soon after this, in 1942, a new agency was created, the Smaller War Plants Corporation which aimed to nance and
provide resources to small companies which were having difculties during the Second World War. Eleven years later,
the Small Business Administration (SBA) was created, an institution which tries to help, counsel, provide assistance
and protect the interests of small companies, and it perceives the importance of small companies to the growth of the
American economy. It is the largest company nancing institution in the United States, and during its existence it has
supported more than 20 million companies. In 2010, it had a portfolio of 219 thousand loans totalling US$45 billion
(VPB, 2010).
In 1958, the SBA licensed the creation of Small Business Investment Companies (SBICs) which to some was
the beginning of Venture Capital activity in the world. SBICs were invented to ll the gap that existed between
entrepreneurs need for capital and the traditional forms of nancing which according to the United States
government was doubly benecial because it stimulated the economy and provided more tax income than
spending. The SBIC program in 2008 generated more than 36 thousand jobs by supporting 1,386 companies
with an average of 1 job created for every US$ 36 thousand invested. Several large corporations that we know
today took part in the program, such as Apple Computer, Federal Express, and America Online, among others.
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Chapter 8
Moreover, we should consider the structure of SBICs, considered appropriate by PE/VC industry critics. Next
we will cite some of the essential components of this structure: management fees between 2.0% and 2.5%;
minimal capital for private investors of US$ 5 million and for investments with preferential stock the minimum
value is US$ 10 million; when Venture Capital investments are the majority, the maximum amount of leverage
is 400% of private capital.
On the other hand, there are some restrictions to SBIC investments such as: they cannot invest more than 20%
of their capital in one individual small company, they cannot invest in nancial or real estate companies of any
form, and they cannot have debt totalling more than US$108.8 million. Beside this, they are prohibited from
controlling directly or indirectly portfolio companies. In order to be eligible for investment, companies must have
US$ 18 million or less in assets and US$ 6 million or less in gross prots over the previous two years. Moreover,
20% of investments have to be made in companies with assets less than US$ 6 million and prots less than US$
2 million.
Finally, an SBIC is required to present performance and valuation reports and investments are made through
debentures or prefered stock. Moreover, the cost of debt is based on SBAs liquidity preference, that is, if the fund does
not have any prot, the SBA will rst receive its fee which will be close to that of other private investors. There is also a
mechanism for SBAs participation in the prots that varies according to the degree of leverage and the cost of T-bonds
(VPB, 2010).
8.4. Sustainability
A pertinent theme in the corporate environment that is gaining more and more force is the question of
sustainability and social responsibility. Society is now more aware of its duties, and also more critical on this
subject, and a company which adopts the practices of sustainability and social responsibility is well viewed
by the market. Knowing this, it is important that companies are aware that having sustainability guidelines
will help their company attract more investment and create value for society in general. Maintaining best
practices in relation to the environment is vital, even though adhering to the Principles for Responsible
Investment (PRI) is not a mandatory condition for receiving PE/VC capital especially for new companies or
those seeking to stabilize cash ow which cannot yet absorb the costs of these procedures.
Featured in the media, the preoccupation with the future and the lifestyle in which uncontrolled
consumption and the use of non-renewable sources of energy appear to be putting the survival of the
356
human race at risk is the great focus of the 21st century. Corporations have not ignored this issue and
have spent their energies on creating processes and systems to confront this problem and have made a
prot doing so.
The constant ow of global discussions about climate and environmental issues has led corporations to focus
on sustainable growth, develop social projects, edit sustainability reports and participate actively in discussions
about this topic.
Sustainable growth is related to the industrys economic impact to the extent that it furnishes indicators
about the way a company relates to its community. It can indicate longevity, trustworthiness and identication.
8.4.1. PRI (Principles for Responsible Investment)
Lately there has been a great preoccupation by institutional investors with the environmental, social
and corporate governance4 spheres which affect the long term performance of portfolio companies.
According to the BVCA (2010), the principal factors that influence this tendency are regulation, investor
demands, opportunities in the cleantech sector, a possible increase in value added and risk management
policy (a lack of ESG, Environmental Social Governance, principles affects reputation and carries risks for
PE/VC fund managers).
This is why the Secretary General of the United Nations invited a group of the largest investors
in the world to get together in 2005 and develop the PRI. The principles contained within it reflect
the values that this group of institutional investors judged essential, and are based on long term
investment. These principles are voluntary and can be approached in the following manner:
1. Applying these principles to investment analysis, decision making and policy;
2. Applying these principles to investee company management and internal policy;
3. Looking for investee companies to conform to these principles when they are controlled;
4. Promoting and encouraging the adoption of these principles in the industry and in investments in
general;
5. Cooperating in the search for efciency and the plans to implement these principles;
6. Communicating the progress that has been made in implementing these principles.
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Graph 8.12 adapted from the PRI (2010), shows in a clear manner the great expansion and broad
acceptance of its principles worldwide as indicated by its 785 signatories who controlled US$ 22 trillion
in July 2010.
Graph 8.12 Evolution of the number of PRI signatories and assets under management July
2009 to July 2010
900
800
700
600
500
400
300
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17
16
Number of Signatories
Assets under Management (US$ trillions)
Source: PRI (2010)
According to the PRI (2010), PE/VC investments were the area most affected by its principles. Between May
2008 (the year of the rst discussions about the topic) and the present day, there has been an increase from
2 to 81 signatories currently controlling more than US$ 300 billion in assets. Of these 81 signatories, 7 are
Brazilian fund managers which corresponds to 8.64% of the total. Besides this, looking at Graph 8.13 we
can infer that Brazilian fund managers are more advanced than many countries considered to be rst world,
placing Brazil in fourth place in this world ranking.
358
Graph 8.13 Private equity fund manager signatories of the PRI
France
United Kingdom
United States
Brazil
Switzerland
Hong Kong
New Zealand
South Africa
Australia
The Netherlands
Canada
Thailand
Oceania
Belgium
Spain
Estonia
South Korea
India
Italy
Estonia, Latvia and Lithuania
Singapore
Turkey
United Arab Emirates
France, Italy
0
2 4 6 8 10 12 14 16 18
17%
13%
9%
7%
5%
3%
3%
3%
3%
3%
3%
2%
1%
1%
1%
1%
1%
1%
1%
1%
1%
1%
1%
1%
Source: PRI (2010)
PE/VC investments received so much attention that the PRI decided to create a guide about how investors
should incorporate these proposed ideas in this context. This case is an opportunity to create value through
best practices which affect environmental, social and governance policy.
We found in the report (UNPRI, 2009), suggested actions which cover the most general aspects including
pre- and post-investment scenarios. The rst of these is to disseminate, develop and communicate these
principles and seek stakeholders with the same ideology. The second is to verify that these principles
are included in company analysis, due diligence and the review of contracts. The last is to apply these
principles to monitoring and PE/VC fund manager activities.
A similar study conducted by the BVCA (2010), sought to divide this process into four steps: (1) pre-
investment, (ii) immediately after investment, (iii) post-investment and (iv) exit. In this last step we can
observe the ESG economic effect in which future shareholders can attribute a greater value to the company
due to these types of characteristics.
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KPMG (2010) sought out opinions in relation to the ESG model of investment. As a result, they veried
that LPs do in fact believe that following these principles of social responsibility lead to higher returns and
more secure investments while keeping the companys reputation intact.
For the fund manager, if the entrepreneur has adhered to PRI it makes him or her stand out. In any
event, if the entrepreneur has not adhered, it is not viewed poorly because adhering to these principles
should not negatively affect business revenues. Moreover, for each of these criteria LPs should look for
efcient sources of energy in terms of the environment, health and security in terms of social issues, and
efciency on the part of the Board of Directors and risk management in terms of corporate governance.
8.4.2. Dimensions and Criteria
This topic is also treated by the Center of Sustainability Studies of FGV-EAESP (GVCES), which seeks
to develop this topic to make people aware of its importance, and in particular corporate management
professionals. These activities are based on an exchange of information, education and the dissemination
of sustainable practices. Besides this, in partnership with the BM&F Bovespa, it created the Entrepreneurial
Sustainability Index (ISE).
This is an index which seeks to serve as an instrument to analyze BM&F Bovespa listed companies.
Today there is a great tendency for investors to apply their nancial resources in companies that are not
only lucrative but also socially and environmentally responsible.
These are called socially responsible investments and are considered to be long term. This thesis
is based on the assumption that these companies will have fewer difculties in dealing with nancial
problems as well as environmental and social problems. There arises in this context the utility of being able
to measure company commitment to these criteria, which gave birth to the ISE.
The ISE, through questionnaires distributed to BM&F Bovespa listed companies, treats this topic from
various perspectives, such as: (i) in general, (ii) the nature of the product, (iii) corporate governance, (iv)
economic/nancial, (v) environmental and (vi) social. Besides this, to measure each of these the following
criteria are used: (a) policy, (b) management, (c) performance and (d) legal compliance. We will now
consider each of these, covering the most pertinent points in the analysis.
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8.4.2.1. General Aspects
In general terms, we rst deal with the basic principles that should guide company operations. From this
point of view, we see evidence of companys fundamental commitment to these principles in their corporate
vision (their expectations for the future and which direction they want to go), mission (the companys goals,
the actions that will accomplish them and who will be affected) and values (the principles that will guide
the company toward the future). In any event, these commitments are not always taken with free and
spontaneous will and these days there is great societal pressure to do so. That being said, discovering the
extent of voluntary movements distinguishes the green companies from those that are painted green.
After identifying commitments, we have to investigate the alignment of them. First of all, there must be
a consistency in these commitments whether or not there is a department and/or activities that prove the
existence of sustainable practices. We can cite, among others, the presence of Sustainability Committees
and variable compensation in relation to reaching environmental and social targets.
In the end, extending this theme a little, we nd questions about the transparency of information in
a company, the quality and level of detail in the reports that it releases, the following of sustainability
indices, the ght against corruption (social sustainability) and the commitment of executives to the practices
proposed by their companies.
Figure 8.2 Evolution of the Release of Sustainability Reports
V
a
l
u
e
Integration with Business Process
Required Disclosure
Investors Relations
Public Relations
2005+
2002+
Late 90s
Early 90s
Low Quality and depth of information High
Source: IBGC (2007)
8.4.2.2. Nature of the Product
After covering the company, we should consider how the goods it produces affect society. We should
observe the impact that these products have on those that use them, possible excessive gains due to
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the price of these products, the degree of nancing of companies that produce these products and the
dissemination of healthy, educational and nutritional habits. Besides direct impacts, there are diffuse
ones such as products that pollute the environment and affect the whole population. In this aspect we can
identify those companies that try to decrease these effects and those that support ventures that damage
the environment such as the commercialization of fossil fuels.
Finally, the fact that companies take precautions (the Precaution Principle) during the production process
in terms of the effects of products, that they furnish consumer information that is mandatory by law, and
possess a monitoring system for consumer complaints against them should be considered criteria in
evaluating sustainability.
8.4.2.3. Corporate Governance
Its important to remember that Corporate Governance is also related to sustainability, especially
when we are talking about long term strategic aspects that have evolved over the last few decades. This
aspect includes propriety, minority shareholder rights, the transparency and symmetry of information
and legal compliance.
The composition, transparency and functioning of the Board of Directors, as well as its structure are
important since they transmit the true efciency and quality of Corporate Governance exercised in
companies. Besides this, internal and external auditing, codes of conduct and conicts of interest are
also important to this topic.
8.4.2.4. Economic/Financial
In this dimension, indicators are observed through strategic planning criteria, including socio-
environmental questions and the treatment of intangible assets such as human, organizational and
reputation capital. Besides this, we have the risks and opportunities that companies have to deal
with, crises and contingency plans, intangible assets and performance.
In relation to this last point, we have the accounting of the companies themselves and their
publication of results. Finally, we also have the regulatory aspects of the economic dimension, if
companies are the objects of lawsuits because of irregularities and/or fraud.
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8.4.2.5. Environmental
Considering all the problems that uncontrolled consumption together with non-sustainable operational
practices have caused the environment over the long term, this is a topic that is becoming more and more
relevant to consumers and consequently investors.
First it should be seen whether the company possesses a well-documented environmental policy. This
policy should take into consideration indicators such as commitment, breadth and publication. After this
policy is stipulated, how it is managed should be taken into consideration. In this way, the companys
environmental responsibility, the way it monitors and manages, its management systems, the way it
communicates with interested parties and its level of global commitment (preoccupation with changes in
climate and biodiversity) should be evaluated.
Next it is necessary to evaluate the environmental performance of the company, or in other words, what
is the minimum reference value of environmental performance for the company. For this, the quality of all
efuents (in all physical states) emitted by the company should be evaluated.
Another important topic is to know the companys situation in terms of critical residues (heavy metals,
ozone layer destroying polluting agents, etc.). Its also necessary to know if the company has some type of
environmental insurance which provides protection for any type of accident that may occur at work.
The last criteria that the ISE evaluates is legal compliance. For this topic the company is evaluated
based on the following indicators. First it is observed whether the company possesses environmental
areas or preserves. Second is the evaluation of any existing environmental liabilities and then whether
the company has fullled its environmental obligations (i.e. some areas require environmental licenses in
order to operate). The next indicator analyzes the companys administrative procedures in relation to the
environment (to know whether the company has environmental administrative sanctions, for example) and
nally, legal proceedings (inquiries and nes among other environmental irregularities that the company
may have).
Thus we may perceive that through these detailed criteria the environment has become a very relevant
subject for the market and for consumer buying decisions.
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8.4.2.6. Social
The social dimension deals with the commitments that companies take on to always improve social
well-being (inside and outside of the company).
First a company should establish policies related to labor relations, the condentiality of information
and participation in public policy.
These policies must be managed in some way. The Management criteria evaluates how the adopted
policy indicators are applied. Thus the application of these labor relations, and community, supplier and
client/consumer commitments are veried.
That said, its necessary to verify the performance of this policy. To do this, indicators such as diversity/
equality, supplier management and the resolution of customer demands are used.
Lastly, companies are observed based on the legal compliance of their operations. In this way indicators
permit the evaluation of (i) legal compliance in terms of the internal public, (ii) clients/consumers, and
(iii) in terms of society. In relation to the rst indicator, it should be noted whether the company hires
handicapped workers, for example. In relation to the second, it should be noted whether it monitors
lawsuits brought against it by consumers or outsourcers. It should also have a monitoring system in
terms of lawsuits dealing with child or forced labor in any area of the company, or in other words, it
should be determined if the company doesnt act in accordance with what is accepted by society.
8.4.3. Types of Investment Vehicles with Sustainability Prole
In terms of investments, different types of vehicles have their own characteristics and there are some that
are relevant to sustainability.
8.4.3.1. Forestry (Timber) Funds
Investments in these funds support the planting of forests that will be harvested and sold to consumers
of wood products in the future. Commercial forests, as they are also known, are principally directed
at companies that work with the cellulose, iron and steel, and furniture sectors, among others. In this
case, the diversity of species cultivated should be examined to make sure it is not restricted to pines and
eucalyptus trees.
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This investment model has existed for 25 years in the United States, while in Brazil it began in 2000.
However, it has been gaining space among Brazilian and foreign investors due to the need for basic
materials and good climatic, geographic and geological conditions. Moreover, there has been a fall
in returns on forestry investments in countries where this activity is already well established. Finally,
the Subprime Crisis of 2008 caused considerable losses in this sector which favored the acquisition of
companies in nancial difculties.
With the fall of interest rates and satisfactory rates of return, this becomes a type of investment that
is favorable for large investors in Brazil. These investments are characterized as long term investments
because the trees planted must mature before they become commercially viable.
Most of these funds seek to maintain investments far from Amazonia, because this area carries with
it important political risks. Besides this, in terms of international investors, bureaucracy is an important
barrier in this area, because investments must be made through an institution established in Brazil.
Graph 8.14 Number of PE/VC vehicles in forestry
Note: From the 144 fund managers sample, 6 asserted to have forestry oriented vehicles as of dec. 31, 2009
2004 2005 2006 2007 2008 2009
7
6
5
4
3
2
1
0
N
u
m
b
e
r

o
f

V
e
h
i
c
l
e
s
From Graph 8.14 we can infer that the number of forestry vehicles reects, to some extent, the good
prospects that this sector offers. In relation to committed capital, of the 6 investment vehicles mapped, 1
vehicle was still in the fundraising stage and another did not report any data. In relation to the rest, they
held US$ 970 million in committed capital as of December 31, 2009.
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8.4.3.2. Cleantech Funds
Cleantech funds seek to invest in activity that will reduce the negative effects of man in relation to the
environment. In this aspect they are principally oriented towards reducing greenhouse gas emissions.
These are investments with high potential returns, which in Brazil nd themselves in a favorable
environment because the country has experience in renewable energy, a high quality agricultural
industry and a high degree of technological innovation. Besides these factors, we can also cite everyday
environmental problems as investment opportunities. The question of the recycling of chemical residues,
for example, is directly linked to new regulatory limits which can increase their relative importance. In this
sense, along with its importance to the environment, we have its economic value. Moreover, this activity
includes sectors related to the environment, renewable resources, sustainability and recycling.
According to Graph 8.15 there has been a great increase in the number of cleantech vehicles which
have caught the attention of investors.
Graph 8.15 Number of Cleantech Vehicles in the World per Vintage Year
120
100
80
60
40
20
0
Before
2004
2004 2005 2006 2007 2008 2009 Jan-Mar
2010
Source: Preqin (2010)
The principal characteristic of Cleantech vehicles is the use of innovation as a tool to overcome the problems that
we face. Technological advances, as well as R&D investments, are in this sense fundamental to the development
of this activity. On the other hand, new technologies lead to the creation of new types of residues, increasing the
variety of opportunities.
According to the Cleantech Group (2009), since 2002, the year of its founding, there was a constant increase
in the number of cleantech deals up till 2009, when preliminary gures indicated a decline. However, we expect
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an increase of between 5 and 10% in the number of ventures and the amount of money invested. That same year,
the majority of these ventures were in the solar energy, transport and energy efciency sectors, corresponding to
59% of the total (Table 8.15).
Table 8.13 Annual venture capital investments in cleantech in North America, Europe, Israel,
China and India
Note: * Indicates preliminary data.
Year Deals Value of Deals (US% millions)
2002 164 908
2003 301 1,260
2004 333 1,322
2005 381 1,994
2006 409 4,519
2007 488 6,053
2008 567 8,465
2009* 557 5,641
Total 3.200 30,163
Source: Cleantech Group (2010)
Table 8.14 Largest sectors in Cleantech venture capital in 2009
Technological Sum Invested % of Total
Solar $1.21 bi 21
Transport $1.1 bi 20
Energy Efciency $1.0 bi 18
Biofuels $0.554 bi 10
Intelligent Networks $0.414 bi 7
Water $0.117 bi 2
Total $4.385 bi 78
Source: Cleantech Group (2009)
Again the data shows a strong tendency towards prosperity for this type of vehicle whose investments are
largely based on the search for new sources of energy and the efcient use of this energy. The Cleantech
Group mapped the following prospects for the sector in 2010:
(i) With the post-crisis economic recovery, we can expect a record amount of fundraising
(ii) The efciency of clean forms of energy will become the focus of attention
(iii) Electric cars will become more mobile
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Chapter 8
(iv) Shortages of natural resources will take center stage
(v) Discussions regarding commodity tradeoffs will become more intense
(vi) Energy efciency will be applied to solar energy
(vii) The importance of marketing activities will increase
(viii) The inuence of Warren Buffet will bring mega-investors to the sector
(ix) Mergers and acquisitions will increase.
(x) The generation of energy from geothermic sources, chemical residues and aquaculture will increase.
In relation to Cleantech fundraising, Prequin (2010) mapped 91 PE/VC fund managers with a fundraising
target of US$ 26.7 billion in 2010.
8.4.3.3. Social Funds
Appearing during the 1980s, social investment vehicles are oriented towards development, economic
and social. Initially they served as temporary support for those suffering the negative effects of public
policies that were mostly felt by those who were less well off, especially in terms of employment. With the
passage of time, Social Vehicles have come to be seen as effective low cost solutions which has favored
the spread of this model (Tendler, 2000).
Projects dealing with social vision, the generation of employment, extending education, increasing access
to public health, protecting the environment and other factors which inuence the calculation of the Human
Development Index (HDI) are potential investments for this kind of vehicle. Thus, for areas which are not
supported sufciently by the government, these vehicles are indispensible.
In relation to nancial resources, they can come from public organizations or the transfer of funds from the
private sector through social projects that pass on part of their prots. Despite their social function, this type
of fund has received various types of criticism in regard to their real efciency in treating these problems. The
principal arguments for this criticism are that the jobs created by them are of low quality (if they are temporary),
low intellectual requirements (little or no training is needed) and low compensation. In terms of this last point,
only 30% of available capital is allocated to worker expenses, and even though the compensation is generally
minimum wage, this is not always enough to satisfy basic human necessities (Tendler, 2000).
In terms of the macro-economic environment, there are great disparities in terms of information and
power. In the regions attended by social investment vehicles, these discrepancies are generally even
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greater. On this point, we have conicts of interest between politicians, service providers, and social
vehicle fund managers, among others. In this way, we can perceive the lack of a governmental presence,
whether as a supplier of goods and services or as a regulator. The environment described above presents
a climate that is not very favorable to the existence of Social Funds, which can be a partial explanation for
its inefciencies.
8.4.3.4. Targeted Funds
Created in the 1980s, targeted investment funds have a portfolio composed of other different types of
vehicles which in turn have portfolios which are adjusted according to the prole of the investor in terms
of the desired/expected investment period. Moreover, in terms of their operations, they tend to invest in
riskier assets which offer higher returns during the beginning of the cycle and become more conservative
as the cycle approaches its end.
Besides this, these are funds that are frequently invested in by retirees, mainly in the United States, where
in 2006 then President Bush signed the Pension Protection Act which had the effect of making a portion of all
workers automatic signatories to Target Date Funds. In 2010 the SEC acted to make information about these
funds more transparent and available to investors.
The subprime crisis made clear the volatility and differences between funds with equal target dates. American
vehicles with terms ending by 2010 had returns of -24% on average, ranging from -9% to -41%.
In overall terms, the advantages of these funds are the low initial investment required, their management
by qualied portfolio managers, and the low necessity for intervention on the part of the investor. Their
disadvantages are a possible lack of diversication and extra fees in some cases.
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Chapter 8
Chapter 9
Future Prospects: Challenges and Opportunities
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Chapter 9
Future Prospects: Challenges and Opportunities
1
9.1.Introduction
Within the larger scope of providing rigorous and realistic documentation about the Brazilian PE/VC
industry, this chapter presents a synthesis of the empirical results obtained as well as prospects for the
future. This census shows that the Brazilian PE/VC industry is progressing towards maturity in a sustainable
manner. The results presented offer a detailed prole which presents good prospects for the future.
9.1.2. The Impact of the Financial Crisis on the Global PE/VC Industry
Over the last few years, the expansion of the capital markets, international liquidity and accessible
credit have contributed signicantly to the success of the global PE/VC industry. In 2008, however, the
international nancial crisis created challenging conditions for the industry, because increased risk
aversion compromised the allocation of nancial resources in all types of alternative assets including PE/
VC. In 2009, on the other hand, PE/VC investing started to recover, especially in the emerging markets.
That crisis led to changes in the economic environment which will certainly have effects on the global
PE/VC industry over the next few decades. First of all, there is greater interest in smaller, more local
and specialized funds. Besides this, there is a growth in global diversied brands. Fundamentally, these
changes will consolidate a change that has already been seen coming, namely that emerging markets, and
especially Brazil, will receive greater attention from global PE/VC managers from now on.
9.1.3. Emerging Markets and Their Growing Importance
Emerging markets are becoming more and more important to the world economy, and more specically
to the PE/VC industry. Their economic and geopolitical importance can be conrmed by the fact that
the BRIC countries (Brazil, Russia, India and China) currently hold 40% of international reserves, are
responsible for 20% of World GDP in 2010 (World Bank, 2011), and possess 40% of the world population.
These countries will continue to attract a lot of attention and will continue to grow at an accelerated rate
over the next few years (The Economist, 2010). Moreover, the demographic tendencies of these countries
1 Authors: Lucas Martins, Gabriella Pegoraro, Alexander Appel, Rodrigo Lara and Caio Ramalho.
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are attractive to business, because they possess a rapidly growing middle class with growing earning power.
In Brazil, family consumption currently represents 60.9% of GDP. In other emerging countries such as China,
this number is signicantly lower being closer to 40% (IBGE, 2010). Emerging economies also present a lower
degree of indebtedness, and will thus recover more rapidly from the credit crisis.
Finally, the PE/VC industry in emerging markets is relatively small, representing approximately 2.3% of GDP
in Brazil, institutions are relatively recent, and the PE/VC environments are less competitive making them more
attractive to large global industry players.
This optimism in relation to emerging markets is not new and was also prevalent during the 1990s when they
were viewed as an alternative for world growth. Today, these economies signicantly inuence world growth
and have become indispensable to the global context. Besides this, BRIC economies became more receptive to
external capital and their governments more receptive to foreign investment than they were in the past.
In this way, the main beneciaries of these world trends are China, India and Brazil, the most attractive
markets for the global PE/VC industry. In two years, the portion of committed capital in the world PE/VC industry
to emerging markets should increase from 6-10% to 11-15%. Investors expect that the PE/VC industries in
emerging markets willout perform those in developed markets, based on the perspective that growth and not
leverage is driving returns. (EMPEA and Coller Capital, 2010).
9.1.4. The Rise of the Brazilian PE/VC Industry
Strong macroeconomic fundamentals like strong GDP growth (between 6 and 7% expected in 2010), a
oating exchange rate with low volatility, a successful IPO market, declining interest rates, a lowering of the
country risk rating, and large international reserves (US$ 250billion) were the foundation for the Brazilian PE/
VC industrys success from 2005 to 2009. Besides these factors, the country has an economy with low levels
of debt, mortgage loans still represent around 2% of GDP, widely available private credit growth potential
(approximately 43% of GDP) and a solid nancial system (Bacen, 2010).
There are obstacles: 17% of Brazilian homes do not have running water. This is related to the fact that
a signicant number of Brazilians live in slums, surviving in precarious conditions (The Economist, 2009).
According to Patrice Etlin of Advent International (2010), the high Brazilian tax burden (37% of GDP) and
a lack of infrastructure (ex. 41% of highways are decient) slow down the countrys development.
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Chapter 9
Among challenging factors which compromise the prospects for development in Brazil are high interest
rates, levels of corporate governance that are still low, and a lack of familiarity on the part of foreign
investors in regard to the Brazilian business environment. In fact, a third of European investors cite this
last point as the reason why they dont invest in the country, and 22% of Americans share this opinion
(The Economist, 2010). Besides this, the workforce is highly unproductive which places the country in
100th place in terms of the cost per imported container (Etlin, 2010). The informal market represents
approximately 40% of GDP. This fact compromises the collection of taxes and the mapping of the economy
(ETCO, 2009). In another country of the region, like Chile, the informality index is very low: around 5%.
Other challenges for the country are the education and health care of the population.
The real estate sector still has few companies in portfolio. However, there are great prospects for
expansion mainly with the objective of providing housing for Brazilians. In this context, the PE/VC industry
can generate jobs, and studies show that companies which receive capital from PE/VC funds tend to create
more jobs than companies which receive their nancing from other sources (Lerner and Leamon, 2007).
9.2. Fundraising
Despite the current crisis in world markets, the prospects for the Brazilian PE/VC industry are quite positive.
The fall in asset prices and the consequent adjustment in perceptions of value on the part of entrepreneurs will
stimulate investments by fund managers who have US$17.8 billion (dry powder) available to invest over the
next 3 to 5 years, conrmed by the fact that 98% of fund managers are actively looking for new investments in
Brazil. In addition, 81.5% of these fund managers hope to bring new vehicles to the Brazilian market over the
next 3 years, according to this Census data.
Investors in this market plan to increase their current allocations which range from 6 to 10% of all committed
capital in PE/VC to 11 to 15% over the next two years (EMPEA and Coller Capital, 2010). The prospects for Brazil
are quite promising. The country should experience an increase in the number of investors over the next two
years, given that 19% of PE/VC investors focused on emerging markets expect to start their activities in Brazil
during this time, while just 3% of current investors plan to reduce or cancel their participation in the country
(EMPEA and Coller, Capital 2010).
In 2009, fundraising fell around the world from US$ 636 billion to US$ 246 billion (Preqin, 2010). However,
Brazilian fundraising rose from US$ 4.6 billion in 2008 to US$ 6.1 billion in 2009. During the worldwide contraction,
Brazil represented 2.5% of world fundraising in 2009 and 80% of the fundraising in Latin America.
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Brazil represents approximately 50% of South American GDP, which makes it a key nation for the future
development of the continent (EMPEA, 2009). Despite its great representation in Latin America, PE/VC
investment in the country is very small (relative to the size of its economy) as it represented just 0,2% of GDP
in 2009. Thus, through this study we can see that the country has great potential for PE/VC investments today
and in the future.
At a recent conference, David Rubenstein, founder of the Carlyle Group, listed ten reasons to invest in
Brazil over the long term that can be seen in Table 9.1.
Table 9.1 Long Term Fundamentals Reasons why Carlyle invests in Brazil
1. A growing domestic market of considerable size
2. Space for the expansion of credit for family and companies
3. A low index of external dependence, a consumer market that represents 60.9% of GDP
4. A diversied export market and products
5. Fifteen years of economic and political stability
6. Fiscal discipline and solid macroeconomic indicators
7. Large and stable foreign reserves
8. Proactive and effective government intervention, high quality macroeconomic management
9. A sufciently capitalized nancial system
10. Abundant natural resources

Source: Rubenstein (2010), conference held at the Brazilian Private Equity and Venture Capital Association (ABVCAP) Conference in April 2010.
In this way, it is highly probable that Brazil will consolidate its position as one of the most attractive
emerging markets for the PE/VC industry mainly due to its size, growth characteristics and fundamentals.
9.2.1. SWOT Analysis of PE/VC in Brazil
A SWOT
2
analysis of fundraising in the Brazilian PE/VC industry elaborates some of the tendencies cited
above. This tool shows the internal environment of the Brazilian PE/VC industry (strengths and weaknesses)
as well as the external environment (opportunities and threats) as shown in Figure 9.1 below.
2 Strengths, Weaknesses, Opportunities and Threats, Michael Porter.
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Chapter 9
Figure 9.1 SWOT analysis of the PE/VC Industry in Brazil
Negative Aspects
Government Support for SMEs Increase in
the number of companies listed on the stock
of companies listed on the stock market
Development of an environment conducive to
PE/VC activity Demographic Bonus
High perception of corruption Slow and
cumbersome process for registering patents and
intellectual property High taxation
Positive Aspects
Corruption in the public sector with few sanctions
against those involved
Legislation favorable to PE/VC
Convenient regulations for institutional investors
Strong Entrepreneurship
PE/VC in Brazil
Source: adapted from The Global Venture Capital and PE/VC Country Attractiveness Index, 2010. Edited by GVcepe.
9.2.1.1. Strengths: Characteristics that make Brazil stand out
Government Support for SMEs: Brazil has various governmental bodies that promote and support
startups and technological companies. One company associated with the Ministry of Science and
Technology (MCT), the Brazilian Innovation Agency (FINEP) invested R$ 1.7 billion in the areas of science
and technology between 2003 and 2010 as discussed in the Ecosystem chapter.
The Brazilian Micro and Small Business Support Service (SEBRAE), on the other hand, was one of the rst
institutions to invest in PE/VC fund management organizations and invested capital for the creation of 8
investment vehicles from 1999 to 2004.
Besides this, the Brazilian Industrial Development Agency (ABDI), associated with the Ministry of Development,
Industry and Foreign Trade (MDIC), promotes the Productive Development Policy (PDP). The investments made
under this policy represented R$ 300 billion between May 2008 and December 2010 for the development of
domestic industry. (Inovao em Pauta by FINEP, 2010)
Another governmental agency that gives incentives to SMEs, investments and globalization is the Brazilian
Association of Export and Investment Promotion (Apex-Brasil), also associated with the MDIC, which since
2003 has helped Brazilian companies of all sizes, but mainly small and medium sized companies in the
international market and in attracting foreign investment.
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Increase in the number of companies listed on the stock market: at the end of 2005 the Brazilian
Stock Market (BM&F Bovespa) had 381 listed companies. Two years later, it registered approximately 450
companies negotiating on the oor. In 2010, this number had increased to almost 500, which represents
a growth of 31% in ve years. In fact, this growth could have been more signicant, but the increase in
uncertainty generated by the European economic situation frustrated the expectations related to IPOs in
2010. In any event, the President of the BM&F Bovespa anticipates a growth of 50% in the number of
listed companies by 2015, and around half of these rookies, around 100 companies, should be SMEs.
In terms of the economy in general, the percentage of Brazilian innovative companies grew 21% over the
last 8 years, which represents one of the highest rates of innovation ever registered in the country.
Development of an environment conducive to PE/VC activity: the creation of Securities Commission
(CVM) Instruction 209 in 1994 which established Emerging Company Mutual Funds (FMIEEs), and
Instruction 391 which established Equity Participation Funds (FIPs) in 2003, allowed qualied foreign
publicly traded and private investors and pension funds to invest in domestic PE/VC investment vehicles;
permitted differentiated taxation for fund shareholders; determined the duration of vehicles; made it easier
to charge management fees; made it easier to acquire tax credits; and made the exiting of investments
simpler. Another important factor which has helped the development of a favorable environment for the
industry is the consistent growth in educational opportunities in PE/VC in the country, such as the PE/
VC and Venture Capital discipline created in 1999 for the college curriculum at FGV-EAESP which was
extended to the graduate program in the years that followed.
Demographic Bonus: The Brazilian population is at a special moment in its demographics because
its population is beginning to age. This transitional phase changes the age distribution of the country in
such a way that the portion of the public that has not reached adulthood is declining relatively and the
adult (economically active) population is increasing relatively, without a relative increase in the elderly
population (something that will happen in the medium to long term future - 2012 - 2032). This situation
signies a diminishing of the need for government spending for social security, education and health. As
a consequence, more may be spent on the more productive sectors of the economy and there will be a
signicant increase in available labor, creating an unusual opportunity for economic growth.
9.2.1.2. Weaknesses: Aspects which the country can improve
High perception of corruption: there is no way to measure corruption directly. However, Brazil is
considered a corrupt country in the opinion of people who are directly or indirectly associated with
Increase in the number of companies listed on the stock market: at the end of 2005 the Brazilian
Stock Market (BM&F Bovespa) had 381 listed companies. Two years later, it registered approximately 450
companies negotiating on the oor. In 2010, this number had increased to almost 500, which represents
a growth of 31% in ve years. In fact, this growth could have been more signicant, but the increase in
uncertainty generated by the European economic situation frustrated the expectations related to IPOs in
2010. In any event, the President of the BM&F Bovespa anticipates a growth of 50% in the number of
listed companies by 2015, and around half of these rookies, around 100 companies, should be SMEs.
In terms of the economy in general, the percentage of Brazilian innovative companies grew 21% over the
last 8 years, which represents one of the highest rates of innovation ever registered in the country.
Development of an environment conducive to PE/VC activity: the creation of Securities Commission
(CVM) Instruction 209 in 1994 which established Emerging Company Mutual Funds (FMIEEs), and
Instruction 391 which established Equity Participation Funds (FIPs) in 2003, allowed qualied foreign
publicly traded and private investors and pension funds to invest in domestic PE/VC investment vehicles;
permitted differentiated taxation for fund shareholders; determined the duration of vehicles; made it easier
to charge management fees; made it easier to acquire tax credits; and made the exiting of investments
simpler. Another important factor which has helped the development of a favorable environment for the
industry is the consistent growth in educational opportunities in PE/VC in the country, such as the PE/
VC and Venture Capital discipline created in 1999 for the college curriculum at FGV-EAESP which was
extended to the graduate program in the years that followed.
Demographic Bonus: The Brazilian population is at a special moment in its demographics because
its population is beginning to age. This transitional phase changes the age distribution of the country in
such a way that the portion of the public that has not reached adulthood is declining relatively and the
adult (economically active) population is increasing relatively, without a relative increase in the elderly
population (something that will happen in the medium to long term future - 2012 - 2032). This situation
signies a diminishing of the need for government spending for social security, education and health. As
a consequence, more may be spent on the more productive sectors of the economy and there will be a
signicant increase in available labor, creating an unusual opportunity for economic growth.
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international business. The NGO Transparency International publishes a Corruption Perception Index
annually and each country receives a grade from 0 to 10, forming a ranking. In the case of Brazil, recent
scandals reported abroad have led to its deterioration in the index and in 2009 placed it 75th among
180 countries, putting it below countries with low Human Development Indices such as Ghana. In fact,
Brazils reputation has doubtful credibility on the world stage, despite this stigma being alleviated by the
recent selections of the country as the host of 2014 World Cup and Rio de Janeiro as the host of the 2016
Olympics. The fact is that combatting the perception of Brazilian corruption continues to be a challenge
and because of this, fundraising and the attraction of foreign investment can be partially compromised.
Slow and cumbersome process of registering patents and intellectual property: in Brazil, the process
of registering trademarks, patents and industrial designs is still signicantly slow when compared to other
countries in the world. In this way, the positioning of national technologies in the international market
is compromised, legal insecurity is accentuated, and company planning is hindered. Among the factors
that cause this patent approval process to be so slow is a lack of qualied personnel to examine these
applications, because the hiring of new personnel is done through a public examination process followed
by lengthy training. However, measures have been taken over the last few years and the National Institute
of Industrial Property (INPI) promises to signicantly reduce the time necessary to register patents by the
employing of an electronic system to manage patent requests.
High Taxation: The tax burden in 2009 corresponded to 33.58% of Brazilian GDP (Valor Econmico,
2010). This fact, a consequence of a large and onerous state, diminishes the chances of reducing interest
rates in the country, and thus represents an obstacle to economic growth and the development of the PE/
VC industry in Brazil.
9.2.1.3. Opportunities: What we can take advantage of
Legislation Favorable to PE/VC: CVM Instruction 209 in fact made possible the creation of a favorable
environment for the PE/VC industry in Brazil. Nonetheless, the issuing of CVM Instruction 391 in 2003
created Equity Participation Funds (FIPs) and gave PE/VC investments in Brazil greater exibility than CVM
209 had, given that: it removed the size limitation for investee companies, allowed them to be publicly
traded or private; regulated the participation of fund managers in the decision making processes of
investee companies; required information transparency for shareholders; and granted contractual liberty
between fund managers and shareholders. Recently private fund managers through their association have
instituted a Self-Regulating Code and Best Practices.
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Convenient regulations for institutional investors: the principal investors in the Brazilian PE/VC
industry are pension funds which represent 22% (GVcepe Database) of all investors and can invest up to
20% of their reserves in this category of assets. Since 1994, through CVM Instruction 209, pension funds
have been able to invest in private companies in Brazil. Besides this, many of these institutional investors
participate on the investment committees of the funds in which they place their capital, though it was the
advent of CVM 309 and the good results of PE/VC funds, associated with declining interest rates, which
really motivated pension funds to invest in PE/VC.
Strong entrepreneurship: Brazilian entrepreneurial activity has expanded greatly due mainly to government
programs supporting startups, technology rms and SMEs in general. According to GEM, (2009), Brazil is
the sixth most entrepreneurial country in a ranking of countries of comparable economic development. This
good placement is mainly due to the capacity of the country to maintain a dynamic economy during the
world nancial crisis which above all was possible due to its internal market supplied by micro and small
companies. Besides this, the country reached for the rst time the highest rate of opportunity entrepreneurship.
In this way, for every 1.6 opportunity entrepreneur we have 1 entrepreneur by need.
9.2.1.4. Threats: What can hurt the country
Corruption in the public sector with few sanctions against those involved: vote buying schemes and
illegal activities in the nancing of electoral campaigns, fraud in public bids, as well as the inefciency of
the management of public services still results in a few mild sanctions which increase the sense of impunity
on the part of those involved and can at the same time scare away foreign investors. In this way, the
political and judicial systems need structural reforms as do the systems of taxation and public safety.
However, public executives parts of the indirect administration exhibit notable competence and management
culture (if not entrepreneurial culture). For example, the state energy company Petrobras, a company indirectly
administered by the public sector, is the 4th most respected company in the world. In the same way, there is
an international perception that the Brazilian government is composed of highly competent ministers and
managers (Standard & Poors, 2010).
9.2.1.5. Consequences for Fundraising
From the SWOT analysis, we can see that the corruption and the inertia that still permeate some public
institutions, principally the judiciary, continue to compromise Brazils credibility abroad. The result of this
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is that some PE/VC investors believe that a country with such preoccupying indices of corruption is not an
ideal place for inherently risky activity such as PE/VC investments.
Nevertheless, if we compare the negative aspects with the positives, the result is encouraging and makes
the prospects look promising for the industry over the next few years. Measures are being taken, for
example, to accelerate and reduce bureaucracy in the patent and intellectual property registration process
and national authorities have gained credibility as state managers who stimulate foreign investment.
Thus with strong government support for SMEs, a consistent evolution in PE/VC legislation, regulation,
and taxation, the attractiveness of the stock market, and the development of entrepreneurship in Brazil,
investors in this class of assets tend to see the country as the leader in consolidating and broadening the
PE/VC industry in Latin America. Thus, in contrast to the pessimistic scenarios that currently exist in the
United States and Europe, investors that seek rapid growth see Brazil as the front door to Latin America.
9.3. Negotiations and Investment Structure
9.3.1. Prospects for PE/VC Investments
Fund managers who focus on economic results, on increasing the capacity for investment of their
portfolio companies, as well as productivity and scale tend to survive in the new market conguration,
internationally as well as locally. Thus, PE/VC fund managers that have well qualied local managers,
who know the markets they invest in profoundly, and above all are focused on improving the operations
of investee companies, will probably be more successful.
After the nancial crisis of 2008, company acquisitions decreased substantially. Many entrepreneurs who
were deciding whether to receive PE/VC nancial resources froze these initiatives, because they would have to
give up a larger portion of participation in their companies and in many cases control. Soon, there were an ever
increasing number of transactions based on earn-out plans. The main reasons for this mechanisms popularity
are: a reduction in the amount of money required at the beginning of the deal; a compromise between the
expectations of buyers and sellers in terms of the value of the business; and the motivation of the management
team of the investee company. Earn-outs are, many times, calculated in terms of the EBITDA of portfolio
companies, positively stimulating management based on the varying percentage of fund manager participation
in the business, according to pre-established targets. Earn-outs are thus instruments used to stimulate results,
because they are essentially tied to investee company performance and thus as a benet they tend to improve
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operational performance in the long term. Thus the tendency they have can make companies more productive
and efcient. Beyond this, considering the uncertainty of the economy at the moment, this business structure
protects fund managers from potentially paying too much for assets. In sum, considering that the earn-out
model can result in companies with better management, its possible to establish a relationship between this
practice and improving results, increasing investor returns, diminishing resources used in acquisition and
minimizing agency costs (MergerMarket, 2009).
9.4. Exits and Returns
Successful exits are of crucial importance to guaranteeing returns for investors and, as a consequence, new
fundraising on the part of the fund managers. Exit strategies inuence every aspect of the PE/VC investment
cycle, from the ability to raise funds to the types of investments that are made. In the medium term, the full
functioning of PE/VC activity will be capable of offering assets on the stock market that will certainly stimulate
domestic capital markets which, in turn, will offer more opportunities to exit, high levels of corporate governance,
and new types of businesses, and thus will promote its own activities.
With economic deceleration, many PE/VC fund managers operating in the global market have not achieved
the results expected from their portfolios. That being so, fund managers trying not to report negative results
have sought to extend the duration of their vehicles, a tendency based on the expectation of a recovery in the
capital markets (McKinsey Global Institute, 2009). That being so, they free themselves from the phenomenon
of many investors deciding not to reinvest their money in PE/VC investments, because they have been alienated
by lower than expected returns after exits which have been negatively affected by the current economic climate.
Thus, when PE/VC fund managers do have the ability to liquidate large investments again, investors will have
more money to make new investments. In this way, PE/VC activity will enter a realignment process. Thus, a
strong indicator of the recovery of the global PE/VC industry will be the return of fund exits. With a fortied
global industry, PE/VC investments will become more attractive in Brazil as well, because foreign investors will
become more optimistic in relation to this sector and make more investments in the country.
Besides this, the inuence of the government should increase. There are currently tax reform proposals in the
United States (the American Jobs and Closing Tax Loopholes Act of 2010), the United Kingdom and Australia.
Sector investment reports will improve the moment that the PE/VC industry seeks to better explain its actions. In
September, the Institutional Limited Partners Association (ILPA), a network of PE/VC institutional investors, published
a series of practices which managers should consider adopting. In general, they demand greater transparency,
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more favorable contractual terms, and a more generous division of the returns (The Economist, 2010). They also
identify the need for more transparent calculations of fees, valuations, and more detailed nancial information
about portfolio companies. LPs are becoming more demanding and more aware (Bain & Co., 2010).
Brazilian demographic conditions such as age distribution, increasing income, education and an increase
in internal consumption, make investments in agribusiness and consumer goods the focus of various PE/VC
funds that are looking for high growth opportunities associated with lower income consumers. The growing
importance of the domestic PE/VC market will give many companies a chance to develop and become more
competitive in the international market.
IPOs are natural exits for PE/VC investments and, along with trade sales, they are the principal focus of
industry exit strategies because they offer the highest potential prots. Some of the factors that inuence the
decision of whether or not to hold an IPO are the potential to impress new investors and the company valuation.
The ability of PE/VC sector professionals to evaluate the ideal moment to exit is fundamental to an investments
success, because they should look to hold an IPO when the stock is highly valued to yield a signicant return.
In Brazil, the IPO alternative is turning more viable every day considering the positive macroeconomic
environment, the fall in interest rates and a signicant increase in credit. The great challenge is to give liquidity
to IPOs for small and medium sized companies, even though there is a segment of the market specically
dedicated to this purpose on the stock market (the Bovespa Mais). Based on this, the stock market and mainly
the IPO market become more robust and become promising alternatives for liquidating PE/VC investments. A
reection of this can be seen in the fact that in 2004 the Brazilian capital markets received a strong stimulus
from IPOs launched by PE/VC fund manager portfolio companies. The 2008 crisis affected the PE/VC industry
considerably and made funds postpone their exits. However, the domestic stock market and the IPO market
have recovered rapidly to the extent that Brazil was second worldwide in IPOs in 2009.
In this way, procedures for exiting investment vehicles are mainly focused on IPOs followed by trade sales and
the Brazilian market is very promising in this area with the country showing great potential for the consolidation
and growth of the industry over the next few years.
9.5. Challenges for the Brazilian PE/VC Industry
Among the challenges for the industry over the next few years we can foresee:
a) The continual and organized availability of qualied professionals;
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b) Regulation related to investor responsibility and the assigning of liability to investee company
partners individually instead of to the company as a legal entity;
c) The consolidation of businesses in the beginning of the value chain of PE/VC investments with the
expansion of angel investor networks and Seed Capital and Venture Capital early stage vehicles.
9.6. Industrial Sectors and the Diversication of the Economy: Strategic Areas with
Great Potential
In December 2009, the capitalization of the BM&F Bovespa stock exchange reached US 1.3 trillion which
represented 73% of the Brazilian GDP. In comparison, the capitalization of the NYSE was US$ 11.8 trillion or 82%
of the GDP of the United States. There are still many companies that have a presence in the Brazilian economy
but still are not listed on the stock market. According to an analysis of high potential growth companies in ve
Brazilian cities, 52% of them intended to go public over the next three years and another 42% intended to hold
an IPO in the long term. Besides this, 33% declared that they were interested in Private Equity investment (BM&F
Bovespa, November 2010).
After the consolidation of stability and predictability in the economy, the Ministry of Development, Industry and
Foreign Trade (MDIC) created the Productive Development Policy (PDP) in 2008 with four goals for the country:
to increase xed capital formation, to increase Brazilian exports, to increase private R&D spending, and to make
private R&D spending more dynamic by focusing on micro and small exporting companies.
The Brazilian Industrial Development Association (ABDI) as coordinator of the PDP and of the innovation
environment has sought to increase access to instruments of development and innovation in 26 domestic industrial
sectors which involves promoting entrepreneurship, innovation and PE/VC. Thus, this category of investment is
present in 90% of all of the Brazilian governments priority plans for development.
Under the current economic conditions in Brazil, greater consumption by the lower income sectors of the
population is considered to be the main factor that will lead to growth in the production of goods and services
over the next few years. In this sense, we can identify eight sectors which will benet from these economic
conditions and thus should receive PE/VC investment:
a) Agriculture
b) Food
c) Education
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d) Energy (Generation and Transmission)
e) Real Estate
f) Health Care
g) Traditional Sectors
h) Retail
9.6.1. Agriculture
PE/VC fund managers are still optimistic about the Brazilian agricultural sector. They believe that consumers
will decrease their spending in other areas of consumption but not in basic areas such as agriculture based
products.
Nonetheless, there are some challenges for the sector such as the large amount of leveraged debt in the sugar
cane and soy sectors, and this is why there will be pressure to consolidate in the near future. Another problem
is protectionism such as the large barriers to the acquisition of productive land by foreign funds. However, we
believe that the principal targets of any regulatory changes will be funds engaged in land speculation rather
than PE/VC investment vehicles.
The potential for forestry investments is also evident and its expected that a large quantity of money
raised will be allocated to this segment, principally with the objective of promoting intelligent agriculture
and technological innovations in the sector.
9.6.2. Food
Over the last few years in Brazil, there has been an increase in the purchasing power of those with lower
incomes, who previously had barely any disposable income and now have entered the consumer market. In
this way, there has been an increase in demand and income in the domestic market which has strengthened
the food sector.
The food sector leads the mergers and acquisition market in Brazil. In 2009, it was responsible for 10%
of the 378 mergers and acquisitions that occurred in the country. Even with a slight decline in the quantity of
these operations in the beginning of 2009 due to the nancial crisis, there has been a signicant recovery
and currently the numbers are similar to those before the crisis (PricewaterhouseCoopers, 2010).
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The ease that these companies have in obtaining nancial resources is represented by the active participation
of PE/VC investments. Examples of this are the buying of Burger King Holdings by 3G Capital and the formation
of the International Meal Company (IMC) a holding company by the Advent International to strongly invest in
the food sector. IMC recently acquired the RA and Vienna chains, and is in negotiations to acquire others such as
Almanara, Rubayat and Amrica.
9.6.3. Education
The expansion of student credit allied with the PDP, launched by the federal government, together with
rising incomes have led to a signicant increase in the number of spaces offered by universities in response to
growing demand from lower income groups. Analyzing the Brazilian education sector from a strategic point
of view, it is attractive in terms of competitiveness and cost. Nonetheless, with the difculties that have arisen
with the crisis such as a decrease in credit, an increase in debt and indices of bankruptcy, companies in this
sector see mergers and consolidation as a way to improve, benetting educational platform companies owned
by some PE funds.
9.6.4. Energy (Generation and Transmission)
The energy sector has attracted the markets attention due to prospects for new investments, stimulated
by the growing economy and events that will occur in Brazil in the coming years, such as the World Cup
and the Olympics. Brazil continues to emerge as an important economic power and has developed a
vibrant and advanced energy industry with signicant potential for growth (Will Honeybourne, 2010).
The primary focus of the PE/VC industry in the energy sector has been is on Small Hydroelectric Centers
(SHCs) thermoelectricity and wind energy. The clean energy area suffers from congestion, brusque decreases
in basic activity and problems in the post-crisis nancial markets, which have led to a decrease of 44% in
investments compared to the period before the crisis. Currently, the energy sector is very important to PE
fund managers given that it is the second largest sector in terms of the number of portfolio companies in the
PE/VC industry.
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Chapter 9
9.6.5. Real Estate
Despite the increase in international instability after the crisis and the recommendation that investment
analyses should be conducted with better criteria, the real estate sector in Brazil has interesting opportunities
in terms of potential PE/V investment.
The Brazilian scenario is promising. Several factors have created a strong demand for housing, such as
government low income housing credits (ex. the My House My Life Program), legislative protection of creditors,
investments in housing through the Accelerated Growth Program (PAC), a decline in interest rates and an
increase in income. These examples help make the real estate sector in the country more attractive and give it
more potential.
Between 2005 and 2007, 21 companies in the real estate sector went public and became listed on the stock
market. Through fundraising these companies acquired properties to make up their land banks and currently
need more funds to develop their projects, even considering the reduction of offerings due to the nancial crisis.
At the same time, companies in this area that didnt go public are looking for alternative forms of nancing for
their activities. Within the decrease in the amount of credit available, the PE/VC sector has come to be a source
of equity nancing for these companies.
In this way, there are prospects for growth and space for further activity by PE funds in the real estate
sector which today has 69 companies in portfolio (13.7% of the total).
9.6.6. Health Care
The low volume of public investment in health and the sectors relative immunity to the nancial crisis
shows that it has potential for private sector investors. Besides this, Brazil is the second largest producer of
medical equipment and technology among emerging markets. According to the World Health Organization
(WHO), Brazilian companies sold US$ 2.6 billion of medical equipment and technology in 2009. For the
rst time, emerging markets have become actors in this trade which up until now has been dominated by
developed countries such as the United States, Germany, Switzerland and Italy. The great majority of the
companies in this sector are focused on the Brazilian market, though 30% of them are already exporting.
These factors have spurred interest on the part of equity participation funds who wish to invest in these types
of ventures in Brazil. The medical, clinical diagnosis hospital and orthodontic industry stands out as one of the
388
most attractive areas for PE/VC investors. There is great potential for this sector which currently represents 3%
of PE/VC investee companies.
9.6.7. Traditional Sectors
The PE/VC industry is not limited to the high tech sector. It searches for innovative businesses but not
exclusively in high tech. The PE/VC industry has become more diverse and frequently includes traditional
sectors. In Brazil, a large number of companies in traditional sectors that received capital investments
were intensive in innovation. This is one reason why these sectors are not just participating in the domestic
market but are seeking to participate in the international market as well.
This tendency to invest in companies with innovative potential is not restricted to their actions in the
market but extends to their inner management processes as well. Businesses with growth potential in which
quality management can make a difference have greater chances of being protable and having high
growth. In this way, these sectors hold potential for PE/VC funds. (see chapter III or IV for a breakdown
of traditional stocks sectors, i.e. Graph 4.15. Traditional funds do not include Timber, Real Estate and
Infrastructure. )
9.6.8. Retail
Despite the nancial crisis, the retail sector in Brazil has shown solid performance. It grew 5.9% in 2009,
and while the Brazilian stock market (BM&F Bovespa) fell approximately 3.8% in 2010, stocks of companies
in the sector increased more than 100% in value. Besides very favorable economic fundamentals, some
companies surprised analysts with fantastic results in the second quarter of 2010. An example was Lojas
Renner. Its total net revenues reached R$ 1.2 billion, rising 17% in the rst half of 2010 in comparison with
the same period in 2009. For the year, its stock rose 48.5%. Another example was Lojas Hering whose
stock rose 122% in 2010. Thus the growth scenario of the economy for the next few years leaves the
unstable image of retail behind and should attract more and more domestic and foreign capital.
Recently there have been a large number of mergers and acquisitions in this segment, with the consumer
segment having approximately one acquisition per day. PE/VC fund managers lead this movement, being
responsible for the majority of the deals in this area. This fact shows that there is a tendency towards greater
investment in this sector, which currently represents only 5% of all PE/VC portfolio companies.
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