Startups Legal Framework Bill recognizes the importance of the sector in Brazil but leaves tax and labor issues behind

Recognition and legal personality for startups are among the key developments, but industry sources don't believe the proposal is enough to address what the ecosystem needs

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The Legal Framework for Startups, whose bill was sent to the Brazilian Congress by the federal government this week, aims to boost the ecosystem of startups in the country, making the sector more competitive.

According to the President’s office, the draft seeks to simplify the creation of innovative companies, stimulate investment in innovation, encourage research, development and innovation and facilitate the hiring of innovative solutions by the State. 

Awaited for years by the Brazilian startup ecosystem, the project represents an important step for the sector, especially at a time when guidelines aimed at the economic recovery gain special attention, which may allow the bill to proceed as a priority since it has almost unanimous support from different political parties.  

“The Legal Framework legally recognizes the startup and its importance, giving it a definition. This opens room for several other actions from different spheres of public administration aimed at startups,” explains Felipe Matos, VP at Grupo Dínamo. In the draft’s definition, companies with innovative business models, which have up to 6 years of foundation and BRL 16 million in annual revenue, fit as startups. 

Felipe Matos, vice president of the startup movement Grupo Dínamo. Photo: Grupo Dínamo/ Courtesy

The Legal Framework legally recognizes the startup and its importance, giving it a definition. This opens room for several other actions from different spheres of public administration aimed at startups

Felipe Matos, VP at Grupo Dínamo.

The recognition of startups as an innovative business model and other key players for the ecosystem, such as the angel investor, is the starting point of a bill that aims to make some aspects of the legislation that impact these companies less bureaucratic. Among these topics is the recognition of the convertible loan agreement, the most common among legal vehicles for investments.

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The convertible loan agreement is a contract similar to the loan, through which the investor is able to convert the capital contributed to the startup into shares. In the modality, the timeframe is set by the investor.

“There are several proposals, which simplify business corporations, improve the legal security of investors, open possibilities for the acquisition of innovative solutions of startups by the public power, allow directing R&D investments to startup investment funds,” tells Matos. 

As for angel investors, the draft ensures that this player will not become a partner in the company and will not have management rights over it, in addition to reinforcing that they will not be able to respond with their assets for any labor or tax debts, nor debts originating from processes of closing or judicial recovery of the startups.

“The Legal Framework expands legal security, including several investment vehicles and guaranteeing the non-characterization of the investor as a partner, but it doesn’t deal with policies of equal taxation and fiscal stimulus,” ponders Anjos do Brasil, in a statement sent to LABS.

According to the organization, while other investments such as companies listed on the stock exchange with a value of up to BRL 500 million and real estate funds are exempt from income tax, investment in startups is taxed as fixed income, reaching up to 22,5%. This makes the investor give preference to these types of investments, since they have less risk and greater liquidity over startups.

“Most developed countries apply tax incentives to investment, while here we are fighting over previous issues, such as the possibility for angel investors to offset any losses when calculating the tax on capital gains or even for an equal tax treatment given to other investments, such as in stock exchanges,” Matos adds.

For Cassio Spina, president of Anjos do Brasil, despite the recent advances in the startup ecosystem, the country is still far behind other more developed economies. “If we do not take quick and effective measures, we will miss a great opportunity now that SELIC [Brazilian benchmark rate] is at its lowest historical level,” he warns. 

The bill sent to Congress also sets a new precedent for investment firms, as it allows R&D incentive funds managed by government agencies to be applied to venture capital funds. 

State programs to encourage investments in research and development in the country, which compel public utility companies, such as energy suppliers, to invest part of their revenues in R&D projects, generate every tear around BRL 3 billion in investments – which may now be partly directed towards investment funds in startups. For Matos, this is the main advance of the bill for venture capital players. 

“In addition to this, in a more indirect way, the simplification of business corporations facilitates some aspects of the investment for funds, which often only invest in this type of company,” he adds.

The simplification of business corporations, as mentioned by Matos, is another point addressed by the bill to allow that, not only startups, but all business corporations that earn less than BRL 78 million annually, can publish documents such as calls and annual balance sheets electronically – and no longer in newspapers and periodicals of great circulation – in addition to being able to maintain their records of bookkeeping in electronic format. The idea is that, with these updates, the process of opening and maintaining companies of this type will become simpler and cheaper.

Public procurement was also included in the draft, which creates the possibility of “experimental procurement of innovative solutions”, including flexibility in specific regulations, the so-called regulatory sandbox. In the current scheme, the country’s bidding law imposes a series of restrictions, making it difficult for the government to acquire innovative services from startups. If approved, the bill allows for experimental hiring, testing of solutions with technological risk, as well as allowing that after successful tests of a certain solution, the government may subsequently acquire the startup’s solution, without the need for bidding. 

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The project also foresees adaptations to the financial reality of startups, allowing the government to pay an advance installment for delivering the solution to the startup to make the test feasible, solving a possible cash breakdown situation.

“It is a great step forward for the entrepreneurial ecosystem, as it better defines some important points for the sector and brings recognition to the relationship between startups and the government,” points out the executive director of the Brazilian Association of Startups (ABStartups), José Muritiba. 

José Muritiba, executive director at the Brazilian Association of Startups (ABStartups). Photo: ABStartups/ Courtesy

It is a great step forward for the entrepreneurial ecosystem, as it better defines some important points for the sector and brings recognition to the relationship between startups and the government

José Muritiba, executive director at the Brazilian Association of Startups.

According to sources heard by LABS, although the bill presents significant advances to the sector regulation, tax and labor issues, among other topics, were not covered. An example is the possibility for business corporations to use the simplified taxation system. 

“Issues related to the development and attraction of qualified talents, one of the biggest bottlenecks in the sector, were also left out. I understand that we will still need to move forward on several points to achieve a more competitive regulatory environment for the country,” argues the vice president of Grupo Dínamo. 

In addition to the tax treatment of angel investments, labor issues such as the validation of stock option programs was another point that, that although the high expectations from the ecosystem, was left out. “This type of benefit in startups may end up being recognized under the current legislation as part of the employee’s salary, being taxed as such and bringing other risks of interpretation of the employment contract,” declared Grupo Dínamo in a memo signed in partnership with ABStartups and Anjos do Brasil.

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The startup visas – specific visas to attract foreign talent in technological areas, to work in startups in the country – was also a topic awaited by the sector.

“Unfortunately, not all of the entrepreneurs’ demands foreseen in the base draft were covered, but we already see an advance that brings recognition and legal personality to the sector,” points out Muritiba. 

Although not yet available, the bill of the Legal Framework for Startups should complement the draft that was already in progress, authored by deputy João Henrique Holanda Caldas, known as JHC. In addition, it will still need to be voted and approved by the House of Representatives and the Senate, before going for presidential sanction and coming into force. 

The number of startups registered in Brazil, according to data from ABStartups, has grown more than three times in the last 5 years, from 4,151 companies in 2015 to 13,310 this year. 

Regarding the volume of investment, in September alone, $843 million was raised by Brazilian startups, over 37 rounds – an increase of 65% compared to last year, and 803% when compared to 2018. According to data from the innovation platform Distrito, over 2020, investments in startups reached $2.2 billion, distributed in 322 rounds. 

“Although we have had a great development of the investment and startup ecosystem in recent years, we are still far behind when comparing Brazil with other countries and with the potential we have,” says Anjos do Brasil.

For the vice president of Grupo Dínamo, even though the bill brings important developments, it denotes that Brazil follows behind other countries in relation to the regulatory and business environment. “Brazilian tax complexity is still the greatest in the world – affecting the entire business framework and not just startups.”

In comparison with other Latin American countries, Matos ranks Chile as the most advanced in terms of regulatory and fiscal issues, as well as in openness for investors and exports. “Argentina has had some recent advances in Macri management with Ley de las Pymes, although it has not been able to advance on many points in the congress, in particular, specific points for tech startups. Colombia and Mexico also have some proposals along the same lines,” he adds.