Selling, buying, or merging a company involves at least five distinct legal layers — and each layer can leave liabilities that surface years after closing.
Founders and managers of SMEs (small and medium-sized enterprises) typically enter an M&A (Mergers and Acquisitions) process focused on the commercial negotiation and the valuation. The legal side comes up later — often too late to prevent problems. This guide explains the stages, documents, and protective mechanisms that determine whether an M&A deal closes cleanly or generates post-closing litigation.
TL;DR
- Merger, acquisition, and “incorporação” (statutory merger by absorption) are distinct structures — choosing the wrong one changes who assumes the liabilities.
- Legal due diligence is the company’s X-ray before anything is signed: labor, contractual, tax, regulatory.
- LOI (letter of intent) sets the commercial terms; the SPA (share purchase agreement) is where the negotiation becomes a legally binding obligation.
- Earn-out protects the buyer against future performance risk — but creates disputes if the triggers aren’t well defined.
- Reps & warranties are the main protection against hidden liabilities discovered after closing.
- Brazil’s Tax Reform (“Reforma Tributária,” Constitutional Amendment 132/2023) is creating transition liabilities around IBS (Tax on Goods and Services) and CBS (Contribution on Goods and Services) that M&A transactions need to map now.
Table of Contents
- Merger, Acquisition, and Incorporação: Differences That Determine Liability
- Legal Due Diligence: What It Checks and Why It Matters
- LOI and SPA: The Role of Each Document in the Process
- Earn-Out, Representations and Warranties, and Price Adjustment Mechanisms
- Tax Reform: Impact on Ongoing M&A Deals
- Frequently Asked Questions
1. Merger, Acquisition, and Incorporação: Differences That Determine Liability
A logistics startup with about 60 employees received a proposal from a transportation group interested in absorbing its operations and technology. The buyer initially proposed a “fusão” (merger). Legal analysis showed that, in practice, what made sense was an “incorporação” — a statutory merger by absorption, where the startup would be absorbed into the group’s legal entity, which would take on all contracts, assets, and liabilities through a simplified process. The distinction mattered because the target company carried a significant contingent labor liability, and the chosen structure would determine who absorbed it and how.
Law 6,404/1976 (the Brazilian Corporations Law) and the Civil Code (Law 10,406/2002) define three distinct transactions:
| Transaction | What Happens | Who Assumes the Liabilities | Typical Use |
|---|---|---|---|
| “Fusão” (Merger) | Two or more companies combine and form a new legal entity; the original companies are extinguished | The new entity assumes all liabilities of the extinguished companies | Combination of equals or near-equals; rare in SME M&A with a strategic buyer |
| Acquisition | One company acquires an equity stake (quotas or shares) in another; the target company continues to exist | The buyer indirectly becomes responsible for the target’s liabilities — which remain with the target | Buyer wants the operating structure to keep running as-is; most common in SME and startup M&A |
| “Incorporação” (Statutory Merger by Absorption) | One company absorbs another; the absorbed company is extinguished and its assets, liabilities, and contracts transfer to the absorbing company | The absorbing company assumes everything from the absorbed one | Full integration of operations; buyer wants to eliminate the target’s legal entity |
Legal basis: merger (“fusão”) — Corporations Law 6,404/1976, arts. 228–229; statutory merger by absorption (“incorporação”) — Corporations Law 6,404/1976, art. 227; for “sociedades limitadas” (Brazil’s limited liability company structure, roughly equivalent to an LLC), Civil Code arts. 1,116–1,122.
Choosing the structure isn’t just a tax decision. It determines who carries the target’s labor, tax, and contractual liabilities — and for how long the seller remains exposed.
2. Legal Due Diligence: What It Checks and Why It Matters
Legal due diligence is the process of legally auditing the target company before closing. It isn’t a formality — it’s the mechanism through which the buyer discovers what it’s actually buying.
In M&A deals involving SMEs, legal due diligence typically covers:
- Corporate matters: capital structure, shareholders’ agreements, meeting minutes, any preemptive rights or tag-along/drag-along provisions that could hold up the deal.
- Contracts: agreements with customers, suppliers, and partners — change-of-control clauses that could give the counterparty the right to terminate or renegotiate if the company is sold.
- Labor and social security matters: open labor claim liabilities, compliance with FGTS (the government-mandated employee severance fund) contributions, worker classification (employees under the CLT — Brazil’s Consolidation of Labor Laws — versus independent contractors), and service agreements at risk of being reclassified as employment relationships.
- Tax matters: outstanding tax debts, installment payment plans, tax assessments (autos de infração), standing with the Receita Federal (Brazil’s federal tax authority), state-level SEFAZ (state finance departments), and the municipality. For companies transitioning between tax regimes (for example, from Simples Nacional, the simplified regime for small businesses, to Lucro Presumido, a presumed-profit regime), check for discrepancies in how taxes were calculated.
- Regulatory matters and intellectual property: licenses, permits, trademark and patent registrations, software license agreements, and sector-specific compliance (ANVISA — Brazil’s health regulatory agency, ANATEL — the telecommunications regulator, CVM — the securities and exchange commission, depending on the sector).
- Litigation: ongoing lawsuits and arbitration proceedings, accounting provisions, and risk estimates (classified as probable, possible, or remote).
The due diligence findings inform three decisions: (a) whether to proceed with the deal; (b) whether to adjust the price for identified liabilities; (c) which specific representations and warranties to require regarding the risks found.
3. LOI and SPA: The Role of Each Document in the Process
LOI — Letter of Intent
The LOI is the document that formalizes agreement on the fundamental commercial terms before due diligence begins: deal structure (equity purchase, asset purchase), base price, conditions precedent, exclusivity of negotiation, and confidentiality.
Generally, the LOI is non-binding as to the final price — which depends on the due diligence findings — but binding as to exclusivity and confidentiality. That distinction needs to be explicit in the text. A founder who signs an LOI without a properly drafted exclusivity clause may find the buyer negotiating with other targets in parallel.
SPA — Share Purchase Agreement
The SPA is the definitive contract. It consolidates: price and adjustment formula, conditions precedent to closing, the seller’s representations and warranties, post-closing indemnification mechanisms, earn-out provisions (if applicable), non-compete and non-solicitation obligations regarding employees, and the transfer timeline.
The SPA isn’t boilerplate. Every clause reflects a negotiation over risk allocation. Experienced buyers arrive with drafts favorable to them — which is legitimate and expected. Having the seller’s legal counsel review the SPA isn’t a cost — it’s part of the negotiation.
Typical timeline in SME M&A:
NDA → LOI (commercial terms) → Due Diligence (4–12 weeks) → SPA (negotiation) → Closing → Post-closing price adjustment4. Earn-Out, Representations and Warranties, and Price Adjustment Mechanisms
Earn-Out
An earn-out is a mechanism under which part of the purchase price is paid in the future, conditioned on the target company’s post-closing performance. It protects the buyer against the risk of paying for performance that doesn’t materialize.
When it makes sense: when there’s uncertainty about the sustainability of the target’s growth — common in startups with revenue concentrated among a few clients, or companies dependent on contracts up for renewal.
Risks for the seller: the earn-out becomes a source of litigation when performance triggers aren’t precisely defined — which metric (EBITDA, gross revenue, MRR?), what the measurement period is, who controls the decisions that affect the metric during the earn-out period, and what the dispute resolution mechanism is.
A poorly drafted earn-out turns buyers and sellers into litigants. The earn-out clause needs to define: (a) the exact metric and its calculation methodology; (b) the buyer’s obligations not to artificially interfere with the metric; (c) the seller’s audit rights; (d) the dispute resolution mechanism (mediation, arbitration).
Representations and Warranties (Reps & Warranties)
Representations and warranties are the seller’s statements about the state of the company as of the closing date — that the disclosed liabilities are the only liabilities that exist, that contracts are valid, that there’s no litigation beyond what’s listed, and that the balance sheet reflects reality.
If a statement turns out to be false — an undisclosed tax liability, a lawsuit that wasn’t disclosed — the indemnification mechanism requires the seller to compensate the buyer for the damage caused by the inaccuracy.
Typical negotiation points: (a) basket (minimum threshold below which there’s no indemnification); (b) cap (ceiling on the seller’s liability); (c) survival period for the representations (usually 12 to 36 months after closing, except for tax and labor liabilities, which may have a longer period).
Price Adjustment Mechanisms
The price announced in the LOI is rarely the final price paid. The most common adjustments:
| Mechanism | How It Works |
|---|---|
| Locked-box | Fixed price set based on a balance sheet from a past date; the seller can’t extract value between the balance sheet date and closing |
| Completion accounts | Price adjusted after closing based on the calculated closing balance sheet; creates a period of post-closing uncertainty |
| Working capital adjustment | Buyer ensures the company is delivered with a minimum level of working capital to operate; deviations trigger a price adjustment |
| Net debt adjustment | Price starts from the equity value; net debt identified in due diligence reduces the amount to be paid |
5. Tax Reform: Impact on Ongoing M&A Deals
Constitutional Amendment 132/2023 (EC 132/2023) approved the tax transition that replaces PIS, COFINS, IPI, ICMS, and ISS (the current federal, state, and municipal taxes on goods, services, and industrialized products) with the IBS (a state and municipal-level tax) and the CBS (a federal-level contribution), with a transition period running from 2026 to 2033.
For M&A transactions, the most immediate impact falls into three areas:
1. Regime transition liabilities
Target companies operating with ICMS or ISS tax incentives need to have those incentives mapped during due diligence. As these taxes are progressively phased out, the incentives disappear — and the buyer needs to know whether the company’s valuation was pricing in tax revenue that won’t exist going forward.
2. Outstanding tax credits
Companies with PIS/COFINS credits still to be recovered hold those credits in a system that will be phased out. Supplementary Law LC 214/2025 and LC 227/2026 — supplemented by Decree 12,955/2026 — set out how these credits migrate to the new IBS/CBS system, but the settlement isn’t automatic and may require specific registration. Ongoing transactions need to map these credits and contractually define who owns them after closing.
3. Adjustment of contracts with tax-linked clauses
The target’s long-term contracts that reference specific taxes (clauses like “plus ICMS,” “plus ISS”) may trigger adjustment disputes during the transition. The SPA should include a specific representation regarding the existence and treatment of these clauses.
The Tax Reform doesn’t make M&A deals unfeasible — but it adds a layer of tax due diligence that was less relevant before 2026.
6. Frequently Asked Questions
What’s the difference between a merger and an acquisition under Brazilian law?
In a “fusão” (merger), two or more companies are extinguished and form a new legal entity (Corporations Law 6,404/1976, art. 228); in an acquisition, the buyer acquires an equity stake in the target company, which continues to exist as a separate entity. The practical difference is who assumes the liabilities: in a merger, the new entity absorbs everything from both companies; in an acquisition, the target’s liabilities remain with the target — and the buyer becomes responsible for them indirectly, in proportion to the stake acquired. For SMEs, acquiring quotas or shares is the most common structure because it preserves contracts, licenses, and permits that might otherwise require third-party consent in the case of a merger or statutory merger by absorption (“incorporação”). The choice of structure should take into account the liability profile, the risk allocation between buyer and seller, and the post-closing integration goals. This is general information and does not replace consulting a lawyer for analysis of your specific case.
What is an earn-out, and when is it used in startup M&A deals?
An earn-out is a clause that splits payment of the purchase price into two parts: a fixed portion paid at closing and a variable portion paid in the future, conditioned on the company’s post-acquisition performance. It’s used when the buyer and seller have different expectations about future performance — the seller believes the company will grow; the buyer wants to pay for growth that has already happened, not for a projection. In startups, it’s common when revenue is concentrated among a few clients or depends on contracts not yet renewed. The risk for the seller is that the buyer, after closing, makes decisions that hurt the earn-out metric (cutting sales investment, changing the product). For this reason, the contract should define the metric precisely and include protections against interference. This is general information and does not replace consulting a lawyer for analysis of your specific case.
What are the main legal protections for the seller in an M&A transaction?
The main protections for the seller in an M&A transaction are: (a) an exclusivity clause in the LOI, preventing the buyer from negotiating with other targets and signaling commitment; (b) precise definition of conditions precedent to closing, preventing the buyer from walking away for reasons not foreseen; (c) a cap and survival period on the representations and warranties, limiting the seller’s post-closing exposure; (d) an independent dispute mechanism for post-closing price adjustment (locked-box rather than completion accounts reduces uncertainty); (e) non-compete clauses with a reasonable scope of geography and duration — overly broad clauses can be challenged in court. In addition, the seller should ensure that due diligence is conducted within a defined timeframe and that the SPA contains a closing deadline after which any party may walk away without penalty. This is general information and does not replace consulting a lawyer for analysis of your specific case.
Disclaimer and Next Steps
The information in this article is general and educational in nature. It does not constitute legal advice for any specific situation and does not replace an attorney’s analysis of your particular case. M&A, corporate, and tax legislation and regulations are evolving — always verify that the cited rules are in force as of the date you’re applying them.
If you’re evaluating a purchase, sale, or corporate restructuring transaction and want to understand the legal risks in your specific case, the process starts with a conversation.
Alessandra De Paula Souza — OAB/PR 31.133 (licensed attorney, Bar Association of the State of Paraná) Practice focused on M&A, corporate restructurings, and mergers.