In the age of technology, the start-up ecosystem has attracted many people in recent decades. This is mainly due to the rapid rise of the digital economy, which has led to many success stories of companies that today represent giant players in the market, regardless of which sector they operate in. In this context of scalable entrepreneurial initiatives, startups have proved to be a huge attraction for investors around the world.

In Brazil, this technological and entrepreneurial advance has earned the attention of the legislator, who has developed specific regulations to deal with this so-called startup ecosystem, such as Complementary Law No. 155 of 2016 (Angel Investment Law) and, even more relevantly, the Legal Framework for Startups (Complementary Law No. 182).

The overwhelming majority of startups begin their operations with few or no resources. At this point, there is a need to raise external capital, whether from individual investors, Crowdfunding Platforms [1], Venture Capital or Private Equity [2]. Among these modalities, one that has been common and attracted a lot of attention is that of the angel investor, an investor who, at first, will not be part of the company, but who believes in the potential of the business idea and thus provides the capital for the company to start its activities [3]. It is from this initial point that the parties need to seek appropriate formatting and formalization of the relationship in order to protect both.

In order to make this investment viable, there are some legal instruments specifically designed to mitigate the risks arising from these operations, such as, for example, the share option contract, the participation contract brought in by Complementary Law 155/2016, the creation of a Holding Company (SCP) and the loan agreement convertible into a shareholding, which have gained prominence in this type of investment in recent years.

Unlike the loan agreement provided for in articles 586 and 587 of the Civil Code, which involves the obligation to return a fungible thing of the same kind, quality and quantity, the convertible loan agreement gives the investor the option of converting the credit granted to the startup into a stake in the company’s capital [4]. This type of contract has its origins in US convertible notes, which in this business practice represent an efficient and fast way of injecting capital into startups.

In Brazil, the convertible loan is an instrument that includes specific clauses aimed at preventing risks that end up, in a way, delaying the process of the investor joining the company.

As a result of this adaptation of the convertible loan, with various provisions and alternatives, including the impossibility of returning the investment or joining the corporate board as a result of the startup‘s eventual failure, the issue is still the subject of diverse discussions and opinions in doctrine and case law. In recent years, some courts have recognized the operation as a normal loan and not as a risky investment, establishing that the startup must return the money to the investor [5] [6].

With this in mind, it is essential to include clauses that mitigate the risk of the case going to court, such as a debt forgiveness clause, also known as a ‘write-off’, which represents a contractual provision that allows the creditor to forgive part or all of the amount borrowed if certain specific conditions are met. This debt forgiveness clause can be used both to encourage the debtor company to meet targets or milestones – for example, to achieve certain levels of revenue, profits or other performance metrics – and to protect the startup if the business fails and it has to close down.

Thus, the convertible loan agreement is currently the most widely used legal instrument to enable investments in startups in the early stages of their trajectory. Therefore, for both the investor and the startup, having specialized legal advice that understands the risks involved is essential at this time. Qualified advice can ensure that all the clauses of the convertible loan agreement are drafted in a clear and equitable manner, protecting the interests of both parties, anticipating and mitigating possible future problems, ensuring that the startup can focus on its growth and development, while the investor has the security that their investment is protected by a well-structured agreement.

[1] FEIGELSON, Bruno; NYBO, Erik Fontenele and FONSECA, Victor Cabral. Startup law. 1. ed. Saraiva: São Paulo, 2018.
[2] RAMALHO, C.; FURTADO, C. V.; LARA, R. The private equity and venture capital industry: 2nd Brazilian census. 2011. Available here.
[3] COELHO, G.T.; GARRIDO, L. G. Dissecting the contract between startups and angel investors. In: JÚDICE, Lucas Pimenta. NYBØ, Eirk Fontenele (Org.) Direito das Startups. São Paulo: Juruá, 2016.
[4] ZIRPOLI, Rodrigo Domingos. Loan agreement convertible into equity interest. São Paulo: Quartier Latin, 2023.
[5] (TJSP; Civil Appeal 1094985- 22 37.2020.8.26.0100; Rapporteur: Sérgio Shimura; Judging Body: 2nd Chamber Reserved for Business Law; Central Civil Court – 19th Civil Court; Date of Judgment: 08/11/2022; Date of Registration: 09/11/2022)
[6] (TJSP; Civil Appeal 1012467-48.2018.8.26.0071; Rapporteur: Sérgio Shimura; Judging Body: 2nd Chamber Reserved for Business Law; Bauru Court – 5th Civil Court; Date of Judgment: 08/24/2021; Date of Registration: 08/25/2021)

By: Maria Luisa Carvalho Teixeira
Corporate Law | CPDMA Team