When structuring an investment through a convertible loan agreement in Brazil, investors’ attention is often focused on financial protection mechanisms, such as valuation caps and potential dilution.
However, effective protection of invested capital transcends financial terms and fundamentally depends on the governance structure established from the outset of the relationship, preventing founders from depleting their investment through unprofessional management.
Although the loan does not grant equity ownership, it is prudent for the investor to establish, in their contract, means of oversight and control over the execution of the business plan and the allocation of invested resources.
Below, we present five governance points that should be present in the convertible loan agreement in Brazilian business.
1. Delimitation of Use of Resources: it is essential that there is prior and formalized agreement on the allocation of invested capital. Formalizing a business plan, specifying the investment fronts, whether in asset acquisition, staff hiring, or market expansion, is essential. This clause links the investment to the achievement of tangible goals, allowing for objective monitoring of the Brazilian company’s progress.
2. Right to Information: regular access to information on the company’s performance is an essential tool for monitoring the investment and in Brazil it will happen trough a clause. The contract should stipulate the obligation to submit periodic financial reports, operational metrics (KPIs), and a report on management activities. This practice allows for continuous analysis of the investee’s financial and operational health and the early identification of any deviations from the established plan.
3. Management Limits: it is recommended that management limits be established. The goal is not to interfere with day-to-day management, but rather to protect the investment against high-impact decisions that could compromise the investment thesis. Requiring prior investor consent for actions such as assuming significant debt, divesting strategic assets, or amending the articles of association constitutes an essential safeguard and it is totally allowed in Brazil.
4. Exclusive Dedication Clause: requiring exclusive dedication from founders ensures management’s focus on executing the business plan. It ensures that the startup’s main asset, the founders’ human capital, remains fully dedicated to the business, in line with investor expectations.
5. Preliminary Structuring of the Future Shareholders’ Agreement: this point is sensitive, but it is a precautionary measure that mitigates the risk of future disagreements at the time of loan conversion. It is highly recommended that the loan agreement already establish the mandatory premises of the future Shareholders’ Agreement or, preferably, that a draft of this document be included as an annex. This advance of terms simplifies and expedites the transition to the definitive corporate structure and provides greater legal certainty for all parties involved.
The inclusion of these provisions transforms the Brazilian Convertible Loan Agreement from a simple financial instrument into a true governance pact. For the investor, it represents the foundation of a safer and more transparent partnership, establishing the foundation for the protection and appreciation of their capital.
