August 25, 2023
By Anibal Manzano, Esq.
Yesterday, Latitud released its form convertible instrument for Brazilian companies looking to raise capital named MISTO (Mútuo para Investimento Simplificado com Termos Otimizados).
In short, it’s a Safe-like contract for Brazilian startups that have not yet conducted a corporate reorganization transaction to create a holding company in a foreign jurisdiction (i.e., a flip into a Delaware LLC or Cayman Islands holding company).
Kudos to the Latitud team and the collaborating law-firms on this initiative. Standardization, smoother transactions, and free resources are worthy goals. In general, I believe the MISTO will be a net positive to the Brazilian startup and VC community, but startups and investors should note the following:
The business terms of a MISTO vs. a YCombinator Post-Money Valuation Cap Safe are very similar — they are both based on a post-money valuation cap standard, but there are a couple of key differences.
With respect to the post-money valuation cap standard, this is helpful to startups and investors because it helps parties easily understand what percentage of the company they are selling (upon conversion at the Equity Financing round). For example, if an angel invests $100,000 at a $1,000,000 post-money valuation, then that angel has purchased 10% of the company (upon conversion at the Equity Financing).
However, this can dilute founders significantly because it passes on all risks relating to dilution prior to the Equity Financing to the founders. Some solutions to this are: (1) pre-money valuation caps and (2) post-money valuation caps that are diluted by convertible instruments with higher post-money valuation caps. Ultimately, one of the most important thing founding teams can do is take the time to understand your cap table and how each cent you take impacts your percentage. You want to be sure you’re not selling such a large percentage of the company prior to your Equity Financing such that it will be difficult to close your Equity Financing round.
Two of the key differences between the YCombinator Safe and the Latitud MISTO are that:
An investor can elect to receive repayment of the loan amount or to convert its MISTO into shares of the company on the Maturity Date that is agreed to by the parties. With a YC Safe, an investor cannot do so, which is a key advantage of the Safe over a MISTO for startups because it does not allow investors to benefit from stockholder rights until the closing of the Equity Financing. This is usually a good thing for all parties because it allows the company to focus on developing its business instead of attending to stockholder requests under applicable law at such an early stage, which require both legal fees and founder time to attend to.
Although the MISTO is drafted for Brazilian companies operating in Brazil, it should be noted that the reach of the United States securities laws and regulations are far reaching beyond its borders. Even though the parties may not think US securities laws apply to the transaction, they can easily do so if a US nexus is established, which can occur if the investor is a US person or the transaction (or portion of the transaction) takes place in the US.
Under US law, a private sale of securities (like a MISTO or a Safe) requires an exemption from registration from the US Securities Act of 1933. Failure to qualify for an exemption can grant investors a right of rescission (i.e., the right to demand 100% of their money back). Although the MISTO grants investors the right to demand repayment of their money following the Maturity Date, automatic extension is also an option under the form agreement. For startups, they should be careful to understand the risks associated by not including reps and warranties relating to US securities laws such as “accredited investor” status (under Rule 506(b) of the Securities Act) or offshore transactions (for Regulation S transactions). For investors, they should understand the risks associated with these types of claims when investing in startups.
The MISTO is denominated in Brazilian Reals (BRL), not United States Dollars (USD). However, the agreement leaves open which BRL to USD conversion rate the parties would use for purposes of calculating the number of shares issuable upon conversion of the MISTO — by default, the parties can elect for the BRL/USD rate to be set at the time of the MISTO investment, or the time of the flip transaction. Both parties should consider the economics related to these decisions.
Ultimately, I believe this is a step in the right direction. Again, I commend the Latitud team on this milestone and believe it will be a net positive for the industry. Still, I would advise startups to (1) make sure they understand the risks and commercial terms before engaging in capital raising transactions and (2) push back on terms that are labelled as “industry standards” as a reason to accept a commercial term — it ultimately comes down to 2 or more parties agreeing to a set of terms under a written agreement (i.e., a contract).
Anibal Manzano is a corporate lawyer who specializes in venture capital and startup law, mergers and acquisitions, and cross-border transactions connected to the United States and Latin America. He is based in Boca Raton, Florida and regularly represents startups and investors in connection with venture capital financing transactions and related corporate and securities matters.