Brazil: Private Equity
In May 2015, Law No. 12,529 of 30 November 2011 (the Antitrust Law) reached its third anniversary of enforcement. The efforts of the Brazilian Administrative Council for Economic Defence (CADE) to achieve the Antitrust Law’s goals have been broadly recognised by the market and the local and international legal communities. As part of the proactive attitude adopted by the antitrust agency since the enforcement of the pre-merger control rules, the antitrust agency has acknowledged the importance of reviewing some of the mechanisms and internal rules that have been raising discussions and need to be improved in the light of practical experience.
This was the case for the rules related to private equity transactions, among others, that have been regulated by CADE since then. When the Antitrust Law came into effect, CADE adopted a conservative approach to transactions involving investment funds, especially regarding criteria and rules related to the concept of economic groups. The understanding that the investment funds’ economic group should be defined as broadly as possible, however, has changed after the approval of Resolution No. 09, issued by CADE in October 2014 (Resolution 9), which amended certain aspects of Resolution No. 02, of May 2012.
The relevance of private equity deals
Private equity, by definition,1 consists of investors and funds that make investments directly into private companies or conduct buyouts of public companies that result in a delisting of public equity. Capital for private equity is raised from retail and institutional investors, and can be used to fund new technologies, expand working capital within an owned company, make acquisitions or strengthen a balance sheet.
The majority of private equity investors are institutional and accredited investors who can commit large sums of money for long periods of time. The fund manager oversees the fund and decides which securities it should hold and in what quantities, and when they should be bought and sold.
Private equity transactions are increasing worldwide with a focus on emerging markets. This is because they provide a broader selection of investment opportunities, greater management expertise and lower investment fees than investors might be able to obtain on their own. According to the Brazilian Association of Private Equity and Venture Capital (ABVCAP), the capital commitment made by investment funds and venture capital totalled 100 billion reais in 2013.2
It is no surprise that the investments made by private equity firms, through their various investment funds, have been catching the attention of CADE. Indeed, they impose several challenges for CADE, since they involve sophisticated corporate structures which may lead to a consolidation of the markets affected by the investments.
In recent years, CADE had been looking for criteria to clarify whether investment funds’ transactions should be subject to its merger control review. As of 29 May 2012, Resolution 2 entered into force, with new rules applying also to private equity firms. In October 2014, Resolution 9 changed some aspects related to transactions involving investment funds through amendments in Resolution 2.
The Brazilian Antitrust Law and the merger review process
On 29 May 2012 the Antitrust Law entered into force. The system’s structure was modified. CADE – the surviving antitrust entity – was reorganised into the tribunal, the General Superintendency (SG) and the Department of Economic Studies. The SG’s role in the merger review process is to clear transactions or challenge them in the tribunal.
Of the changes implemented, the most significant among them is the replacement of the post-merger notification system to a pre-merger notification system for M&A transactions that fall under the submission thresholds (which have also changed). Therefore, reportable transactions shall be submitted and approved by CADE prior to their consummation, subject to respective annulment and a pecuniary penalty ranging from 60,000 to 60 million reais in the event of non-compliance with the rule.
Another important change introduced by the Antitrust Law is the establishment of a more objective and detailed list of reportable transactions. Indeed, article 90 of the Antitrust Law sets forth a list of reportable transactions (merger filings) that should be submitted to CADE’s approval prior to their consummation. As such, a merger filing will occur when:3
• two or more independent companies merge;
• one or more companies acquire, directly or indirectly, the control or a portion of another company (through the acquisition or exchange of shares, quotas, bonds or securities convertible into shares, or assets, tangible or intangible);
• one company merges into another company; or
• two or more companies establish a joint venture, a consortium or other type of association.
The Antitrust Law established only revenue criteria as submission thresholds, according to which a transaction is reportable when at least one of the groups involved reaches the 750 million reais threshold and at least one of the other groups involved reaches the 75 million reais threshold.4 Both thresholds refer to gross revenues in Brazil of the economic groups in the fiscal year immediately prior to the transaction.
One should note that in case a private equity firm performs a corporate transaction that has effects in Brazil and that fits under one of the merger filing’s hypothesis described above, CADE’s approval would be required, provided that the turnover thresholds are met. This means that the Antitrust Law applies for private equity firms, and the tricky question is to define their economic groups and respective annual turnover, as further detailed below.
The merger review process was also modified owing to the changes in the system’s structure. Under this new merger review system, the Antitrust Law created the SG, responsible for analysing and approving merger filings that fit into the fast-track procedure (or even the non-fast-track procedure, in certain situations). CADE’s Tribunal, in turn, is responsible for reviewing a merger filing in those cases in which the SG decides to challenge a transaction (ordinary cases) after considering it harmful to competition. CADE’s Tribunal may approve the transaction without restriction, approve it subject to conditions or also issue a non-approval decision.
The statutory time to review a transaction submitted to CADE is 240 days. However, for complex transactions, this can be extended by 60 days, upon request of the parties, or 90 days, through a reasoned decision by CADE’s tribunal. If CADE does not comply with such terms, the merger filing is tacitly approved. One should note that merger filings that fall under the fast-track procedure have been approved by CADE in fewer than 30 days, on average.
Private equity funds under CADE’s new antitrust regime
The merger review process of transactions involving investment funds is not a new subject to CADE and raises important challenges. Indeed, the focus of the antitrust authority is to identify who is taking the commercial decisions of the different funds and to what extent relevant information of the invested companies is shared.
As anticipated, CADE had been looking for criteria that would clarify whether investment funds’ transactions should be subject to merger control review. This was not a simple task. On the one hand, the revoked regime did not provide legal certainty in this regard. On the other, those transactions are, in many cases, carried out by investment vehicles located outside Brazil, which are part of complex corporate structures.
As a result, one challenging question faced by both the authorities and practitioners when assessing whether a given transaction triggers the need for an antitrust filing in Brazil was how to define the economic group applying to investment funds for the purposes of assessing the turnover threshold established in the Antitrust Law.
This question, although simple at a first glance, was never properly answered under the revoked antitrust regime. In some cases, CADE decided to look to the quotaholders of the funds; in others, the concern seemed to be within the portfolio companies, while the manager always played an important role in the analysis. The relevant influence was always the focus of the analysis.
However, following the approval of the new Antitrust Law – which is silent in this regard – CADE had the chance to address the controversial discussion by means of the creation of a new and more objective disposition. This is the context in which CADE’s Resolution No. 2, of 29 May 2012 (CADE Resolution 2/2012) was amended. At that time, CADE decided to adopt an approach whereby the concept of an economic group of investment funds was defined as broadly as possible. However, Resolution 9 has changed this concept significantly. Before, there was a single criteria for defining an economic group used both for calculating the turnover of the group (to verify the filing thresholds) and for filling out the filing form and providing information to CADE. With the new rules in place, there are now two different criteria, as further detailed below.
Investment fund economic groups
For the purpose of defining the concept of economic groups in general, and not only as regards investment funds, CADE Resolution 2/2012 as amended by Resolution 9/2014 establishes as follows:
Article 4, §1º: Economic group shall mean, for purposes of calculation of the revenues set forth in article 88 of Law No. 12,529/2011, on a cumulative basis: (as provided by Resolution No. 9, of October 1, 2014)
I – the companies under common control, either internal or external; and
II – the companies where any of the companies in item I holds, either directly or indirectly, at least twenty percent (20%) of the voting or total capital.
With respect to investment funds, CADE’s Resolution 2/2012 as amended by Resolution 9/2014 defines as follows:
Article 4, §2º: In case of the investment funds, the following shall be considered as members of the same economic group for purposes of calculation of the revenues referred to in this article, on a cumulative basis: (as provided by Resolution No. 9, of October 1, 2014)
I – The economic group of each quotaholder directly or indirectly holding a stake equal to or above 50% of the quotas of the investment fund involved in the transaction, through individual interest or any type of quotaholders’ agreement; (as provided by Resolution No. 9, of October 1, 2014)
II – The companies controlled by the investment fund involved in the transaction and the companies where the aforementioned investment fund holds, either directly or indirectly, a stake equal to or above twenty percent (20%) of the voting or total capital; and (as provided by Resolution No. 9, of October 1, 2014)
§3º. The definition of economic group herein shall apply only for purposes of calculation of the revenues so as to determine the triggering of the objective criteria set forth in article 88 of Act No. 12,529/2011, and shall not be binding upon Cade’s decisions with respect to the request for information and analysis of merit of the ongoing cases. (as provided by Resolution No. 09, of October 1, 2014)
It is important to note that with the new criteria already approved, there will be one criterion to define economic group for the purposes of calculating the turnover,5 and, thus for verifying if the parties achieve the filing thresholds, and another criterion for the purposes of filling out the filing form for submitting the transaction to CADE.6 Under such context, the definition of economic group to provide information and documents to CADE should consider:
• the funds involved in the transaction;
• the funds under the same management of the funds involved in the transaction;
• the manager;
• the groups of the quotaholders that hold, directly or indirectly, more than 20 per cent of the quotas of the funds involved in the transaction;
• the companies controlled by the funds involved in the transaction and the companies in which such funds hold, directly or indirectly, equity interest equal to or greater than 20 per cent; and
• the companies controlled by the funds that are under the same management.
The turnover thresholds and private equity groups
Once the economic group of an investment fund is defined, the second challenge is to assess the exact turnover of this group in order to conclude whether any of the turnover thresholds established in the Antitrust Law are met.
In practical terms, as private equity transactions are usually performed by investment vehicles or funds created for the specific purpose of holding the investment to be made, such entities tend to have no turnover. Therefore, one should consider cumulatively, as part of the turnover of the group:
• the joint turnover of the quotaholders in Brazil that hold directly or indirectly 507 per cent of the quotas; and
• the joint turnover of the portfolio companies in Brazil controlled by the investment fund or in which the equity stake held by the fund is of at least 20 per cent directly or indirectly.
One should note that, regarding the quotaholders and portfolio companies, 100 per cent of their turnovers must be considered, irrespective of the percentage held. This means, for example, that if the interest of an investment fund in the portfolio company is of 20 per cent, 100 per cent of its turnover shall be considered for the purposes of the filing threshold.
If such entities, individually or jointly considered, reach the turnover threshold established in the Antitrust Law, a filing
may be required, depending on the turnover of the other group involved.
Acquisition of minority interest by private equity firms
Rather than take control, private equity groups take more minority stakes in companies as they face up to the shortage of bank debt available to finance full takeovers, and this situation also brings challenges for antitrust authorities worldwide, including Brazil.
While under the revoked regime, a control test (voting and veto rights) was always performed to assess the need for a filing in Brazil; the new regime moved this analysis to a more objective and straightforward approach.
In fact, and in accordance with the Antitrust Law, a corporate transaction would trigger the need for a filing in Brazil not only when leading to acquisition of control but also when meeting the de minimis rules, a new concept brought by CADE Resolution 2/2012 and which remains unchanged after Resolution 9/2014.
Indeed, according to de minimis rules, if the private equity group is not a competitor of the target or operates in vertically related markets, a filing would be required only when the investment is higher than 20 per cent, in the case of a first investment; or in every increase of 20 per cent (acquired from one individual seller). On the other hand, where the private equity group is a competitor of the target or operates in vertically related markets, a filing would be required only when the investment is higher than 5 per cent, in case of a first investment; or in every increase of 5 per cent. One important change established by Resolution 9/2014 is that consolidation of control by the sole controlling entity does not require notification as merger filing.
Finally, CADE’s approval of private equity deals would be required when:
• the transaction entails direct or indirect effects in Brazil;
• either the target of the transaction or the private equity fund or the economic group to which they belong have at least a 750 million reais turnover in Brazil and the other party and the economic group to which it belongs have at least a 75 million reais turnover in Brazil (for the fiscal year preceding the transaction);
• the transaction leads to acquisition of sole or joint control of the target; or
• the transaction fulfils the de minimis rule of 20 per cent or 5 per cent, as the case may be, irrespective of control rights.
A quick assessment of the third year of the Antitrust Law
More than three years into the implementation of the Antitrust Law, a quick analysis of the filings submitted in this period may help to give a better sense of which kind of transaction involving private equities is falling under CADE’s merger control role.
From a total of 1,075 transactions submitted to CADE’s review in the first three years of the new regime, at least 147 involved private equity funds (both national and international ones), accounting for near 13 per cent of the total number.8 The positive aspect, though, is that approximately 85 per cent of the transactions involving private equity deals were cleared under the fast-track procedure in fewer than 30 days. With the amendments approved last year, such numbers are expected to change, with CADE becoming less involved in private equity transactions.
The statistics also show that real estate seems to continue the hot market for private equity firms in Brazil, as illustrated in chart 1, below:
Chart 1: private equity transactions by sector of activity
Sector of activity
Source: CADE website, accessed in May 2015.
Since Resolution 9 changed the thresholds for the mandatory notification of transactions involving investment funds, CADE has already recognised that two cases involved the submission of non-mandatory transactions:
Chart 2: CADE past cases – the Antitrust Law
One of the groups did not meet the turnover thresholds, because after Resolution 9 the calculation for investment funds no longer considers the funds under the same management.
The acquiring vehicle, Bidco, was a whole owned subsidiary of Fund XI (Bain Capital), an investment fund that did not have quotaholders with more than 50%, neither participation over 20% in any company with activities in Brazil. Thus, the economic group had no turnover in Brazil and did not meet the thresholds.
Part of the market argued that the rules applying to investment funds, particularly those related to the economic group concept and turnover threshold, were very restrictive, flooding the authorities with numerous filings that would not require, in theory, CADE’s review as they don’t have any potential to raise antitrust concerns. According to these critics, besides the cost burden this places on private equity firms, CADE’s staff could be focusing on other relevant matters.
CADE has changed its regulations. Not only has the Antitrust Law revised the filing thresholds, increasing the amounts involved and requiring a minimum turnover threshold to the second group involved, but also CADE has revised the economic group concept applicable since the new regime, thus reducing the number of filings subjected to its review, in comparison to the revoked regime. Moreover, the efficiency of CADE in these first two years of the new antitrust regime seems to have eliminated any concerns the market had with respect to the possibility of the prior approval affecting the closing of simple transactions; indeed, some fast-track cases have been approved in fewer than 20 days.
CADE may have already identified concerns in at least two sectors. Indeed, following the analysis of numerous filings affecting the educational and health sectors in Brazil in the past two years, CADE realised that private equity groups may be behind such acquisitions, consolidating the markets through sophisticated corporate structures, but difficult to identify.
In addition and partially in line with the market understanding, as referred, CADE has recently approved an amendment to the applicable rules to investment funds, changing the way it assesses the economic group of investment funds, streamlining the antitrust review.
Controversies aside, the message is to reinforce that Brazil is indeed a safe country for investments and that, in the event a private equity transaction may demand an antitrust approval, CADE is committed to reviewing it in as short a time as possible and eliminating any possible concerns from the start.
- www.investopedia.com/terms/p/privateequity.asp, accessed May 2013.
- When the bill to reform the revoked Antitrust Law was under discussion by the Brazilian Congress, it included a proposed disposition excluding certain transactions from obligatory approval by CADE, namely: transactions and exchanges of shares, quotas or other securities, by parties themselves or through third parties, of a temporary nature, or equity shares acquired for purposes of resale, provided that the acquirers:
- I: do not hold the power to determine, directly or indirectly, or the capacity to influence the competitive behaviour of the acquired company; or
- II:only exercise the right to vote with the exclusive objective of preparing for disposal, in whole or in part, of their assets or these equity stakes, a disposal that must occur within the regulatory time limit.
If this disposition was to be approved by the Brazilian Congress, the situations listed above that would not be considered merger filings would have had a direct impact on the deals entered into by private equity funds. The final text, though, excluded the mentioned disposition.
- In accordance with the Ordinance MJ/MF issued on 30 May 2012.
- This criterion will be used to verify if the parties achieve the objective criteria of turnover to submit transactions to CADE’s approval.
- This criterion will be used to enable the analysis of the impacts of the transaction on competition in the relevant markets involved (merits analysis).
- The threshold was increased from 20 per cent to 50 per cent.
- This number may vary, since certain corporate structures that may involve private equity firms are protected by CADE confidentiality rules.