Private equity in Latin America

Practical Law UK Articles 9-503-3821 (Approx. 14 pages)

Private equity in Latin America

by Orlando Fernández, PLC Cross-Border

Recent developments

Although international private equity houses are currently showing increasing interest in Latin America, this is not their first incursion into the region. As Richard Cooper, a partner at Cleary Gottlieb Steen & Hamilton recalls, "we were already advising private equity firms in Latin America back in the mid-1990s. For instance, in 1995, we acted for TPG Capital (then called Texas Pacific Group (TPG)) on the establishment of the US$300 million (about EUR233 million) Newbridge Capital's Latin America Fund (TPG was an original co-founder and co-owner of Newbridge)".

"By the mid-90s", Cooper continues, "there were several big private equity sponsors active in Latin America, including Carlyle, KKR, CVC International, HM Capital Partners (then called Hicks Muse Tate and Furst (Hicks Muse)) and Advent International (Advent). However, due to economic turmoil in the region in the late 1990s and early 2000s, the returns on many of these sponsors' Latin America funds were unsatisfactory, which caused some of them to leave". For instance, Argentina's economic meltdown in 2001 led to bankruptcies and defaults in several of Hicks Muse's portfolio companies in that country, which undermined investor confidence. As a result, Hicks Muse's second Latin America fund raised US$150 million (about EUR120 million) out of an initial target of US$1.5 billion (about EUR1.2 billion) at its first closing. These setbacks caused Hicks Muse to partially retreat from the region in August 2001.

As Cooper explains, between late 2001 and 2008, private equity activity in Latin America was sporadic and mostly confined to a couple of players such as Advent. However, in the past two years, sponsors have rekindled their interest in the region.

Key characteristics of market and regional trends

Although some jurisdictions have a larger and more developed market than others, Latin American private equity has some key common characteristics. These include:

The way funds are structured and the jurisdictions where they tend to be domiciled.
The kind of transactions taking place.

Fund structures

The Cayman Islands limited partnership is the most popular structure among foreign private equity firms looking to invest in more than one Latin American jurisdiction. Examples of funds that have been set up as Caymans limited partnerships include:

All five of Advent's Latin American private equity funds (LAPEFs).
A US$1.3 billion (about EUR1 billion) fund raised by GP Investments in 2007.

According to Martin Litwak, head of investment funds and wealth structuring at Ferrére Internacional in Uruguay, private equity sponsors sometimes structure their Latin American funds as British Virgin Islands (BVI) limited partnerships, which can be more suitable for funds that have more than 15 investors, have a minimum subscription requirement of less than US$100,000 (about EUR79,000) and do not plan to list on an approved stock exchange (see LAVCA, Domiciling Latin American PE Funds).

Litwak further notes that private equity sponsors investing in Latin America occasionally domicile their funds in Bermuda, the Bahamas and the Channel Islands. They have also recently started looking into Ireland and Luxembourg but generally regard these jurisdictions as too expensive and heavily regulated.

In addition to the more "typical" offshore structures highlighted above, there are other alternatives. such as the Ontario limited partnership, which was used by both Aureos Capital for its US$140 million (about EUR109 million) Latin America Fund, and vSpring Capital for its recently raised US$150 million (about EUR114 million) Alta Ventures Mexico Fund I.

Over the past two decades, jurisdictions such as Brazil, Chile and Colombia have introduced legislation authorising and governing the establishment of domestic private equity and venture capital funds. These structures are popular among local private equity firms, but can also serve as pass-through entities for offshore-domiciled funds investing in a specific jurisdiction.

Institutional investors. Foreign private equity houses active in Latin America raise their capital from institutional investors in North America, Europe and, increasingly, Asia and the Middle East. Advent International's US$1.65 billion (about EUR1.28 billion) fifth Latin America fund (LAPEF V), the biggest fund ever raised for the region, provides a useful insight into the complexion of a Latin American fund managed by an international sponsor. Out of LAPEF V's reported 51 investors:

56% were North American, including the Pennsylvania State Employees' Retirement System and Washington State Investment Board.
25% were European.
19% were Middle Eastern, Asian and African.

Notably, LAPEF V was also the first ever LAPEF fund to receive a commitment from a South American pension fund, which suggests that recent regulatory changes allowing Latin American institutional investors greater flexibility to invest in private equity are beginning to have an impact (see below).

Current trends. The effect of the financial crisis on private equity fundraising was less acute in Latin America than in other parts of the world. According to LAVCA, fundraising in the region fell by 43% to US$3.6 billion (about EUR2.71 billion) in 2009, compared to a fall of 61% worldwide.

Commentators believe that Latin America is poised to benefit from the current wave of interest in emerging economies. According to the EMPEA, private equity firms raised US$11 billion (about EUR8.4 billion) to invest in emerging and frontier markets in the first half of 2010 (H12010), US$2 billion (about EUR1.6 billion) more than in the equivalent period in 2009.

Private equity transactions

Latin American private equity transactions tend to consist of growth capital investments and mid-market buyouts of companies seeking expansion or facing liquidity or succession issues. According to LAVCA, in 2009:

Early-stage investments accounted for 17% of all transactions.
Expansion stage and development capital transactions made up 38% of investments.
Buyouts comprised 12% of deals.

The number of development capital transactions is partly due to the prevalence of family-owned businesses in Latin America's corporate landscape. For instance, over half of the 200 largest companies on the São Paulo Stock Exchange (BM&FBOVESPA) are family owned (see box, Investing in family-owned companies: structuring considerations).

The average value of a Latin American private equity transaction ranges from US$23 million (about EUR18 million) in Chile, to US$75 million (about EUR59 million) in Brazil (although buyouts in the billion dollar range have taken place in the latter (see below, Brazil)). In comparison, the value of the average UK private equity-backed buyout in the first half of 2010 was around US$141 million (about EUR111 million) according to Barclays Private Equity (BPE) (see BPE press release, UK Buyout Value Overtakes 2009 by 45% in First Half of 2010).

Low leverage. According to Cooper, the lack of highly leveraged buyouts (LBOs) is a feature of Latin American private equity: "Even in the current climate, it is not unusual for an LBO in Europe or the US to have a 70:30 gearing ratio. This is certainly not the case in Latin America where deals are leveraged very conservatively, if at all". There are a number of reasons for the inability of private equity sponsors to raise large amounts of debt finance for their Latin American acquisitions: these include smaller deal sizes, regulatory and tax obstacles making it harder to raise debt finance in certain markets and, most importantly, greater risk perceptions among lenders (without a commensurate benefit in terms of pricing, commitment and other fees).

Cooper further notes that, when debt is raised in Latin American deals, "it is often in the form of vendor finance as opposed to third-party bank loans, which tend to be subject to shorter maturities and higher amortisation than high yield deals in Europe or the US, either in the Term B loan syndication market or high yield bond market and are therefore far less prevalent. Likewise, bonds are hardly used in Latin American acquisition finance".

The relative lack of leverage has an impact on both risk and returns. Latin American private equity funds have to put more of their own equity capital at risk, usually in exchange for lower internal rates of return (IRRs) than their European and US counterparts. Conversely, notes Cooper, "the lack of high gearing gives investors greater flexibility to withstand volatility, which is always greater in emerging markets, and to cope with sudden economic fluctuations or changes to the law".

Tax considerations. As Cooper explains, funds investing in Latin America need to devise tax-efficient ways of repatriating their future profits as early as possible in the transaction, especially if there is a possibility that capital gains tax (CGT) might be levied locally. He notes: "From the outset, sponsors operating in Latin America need to think about how to structure their investments in a way that minimises the tax impact of an exit four or five years down the line, which requires consultation with local lawyers and tax specialists".

Current trends. The global economic downturn's impact on Latin American M&A was less dramatic than in Europe or the US, partly due to the region's conservative approach to leverage (see above). While worldwide private equity deal values dropped by 55% in 2009, Latin American transactions fell by 29% to US$3.3billion (about EUR2.4 billion).

As in the case of fundraising, commentators believe that Latin America stands to benefit from the emerging market M&A rally that has been taking place during 2010. According to Dealogic, as at September 2010, there had been US$575.7 billion (about EUR441 billion) worth of emerging market M&A transactions accounting for 30% of global deal volumes (and, for the first time, surpassing Europe, whose share fell to 29%). LAVCA president Cate Ambrose predicts that Latin America private equity-backed M&A could reach a three-year high by the end of 2010.

According to Cooper, "most deal activity continues to take place in Brazil. However, jurisdictions like Peru and Colombia, which are on an upward trajectory in terms of opening up to private investment and GDP growth, are also attracting increasing interest". In addition, regulatory initiatives in Mexico such as the introduction of SAPIS (Sociedades Anónimas Promotoras de Inversion) and CKDs (Certifcados de Capital de Desarollo) may, over time, hasten the development of a more active private equity market, as international investors seek to raise capital from Mexico's pension funds (AFORES) (see box, Recent reforms to the Mexican pension system). Conversely, there has been a decrease in activity in Argentina lately, partly as a result of various interventionist initiatives by the current government. Cooper believes that, depending on the outcome of the October 2011 presidential election, Argentina could, once again, attract overseas private equity money in the near future.

Latin American private equity-backed businesses span a wide array of sectors including agribusiness, retail and real estate. But as Cooper explains, with the exception of some sector-specific investors like Ashmore's AEI and First Reserve, private equity sponsors tend to stay away from heavily regulated industries such as utilities, where there are often additional layers of complexity and risk to be considered, such as the possibility of political intervention or a sudden shift in tariffs, which can make it complicated to time an exit.

Brazil, Chile and Colombia: legal and market developments

The remainder of this article examines market and regulatory developments in the following jurisdictions:

Brazil, which combines the region's most dynamic private equity market with a favourable legal and tax regime.
Chile, which, according to LAVCA, has the best business environment in the region.
Colombia, where recent reforms have stimulated the emergence of a domestic private equity market and attracted increasing interest from overseas investors.

Brazil: a vibrant market

Brazil has the most active and mature private equity market in Latin America. As Francisco Müssnich, senior partner at BM&A - Barbosa Müssnich & Aragão, notes: "Due to economic growth and unexpected performance during the crisis, Brazil has received substantial private equity capital from non-resident investors over the past few years. In addition, the prospective infrastructure boom arising from the sports events that Brazil will host over the next six years (the 2014 World Cup and 2016 Olympic Games), which JP Morgan Brazil's Investment Trust estimates could reach US$50 billion (about EUR39 billion) by 2014, has further increased the potential for new private equity investment". BM&A - Barbosa Müssnich & Aragão recently acted as Brazilian counsel for Carlyle in the Qualicorp buyout and Apax in its Tivit investments.

Based on data by the Brazilian Venture Capital Association (Associação Brasileira de Private Equity & Venture Capital) (ABVCAP), as at late 2008, there were 132 active private equity funds in Brazil. Although many are managed by foreign entities, domestic firms such as GP Investments and Gávea Investimentos are as active as overseas players.

In terms of recent private equity-backed M&A activity, in 2009, Brazil accounted for:

79 of the 176 private equity transactions that took place in the region.
US$2 billion (about EUR1.6 billion) of the US$3.27 billion (about EUR2.6 billion) invested by private equity funds in the region.

The first nine months of 2010 have witnessed several buyouts of Brazilian companies by foreign sponsors. These include:

The Carlyle Group's acquisitions of Qualicorp, a Brazilian health services provider, for US$1.2 billion (about EUR912 million) and Scalina, Brazil's largest manufacturer of women's lingerie, for US$160 million (about EUR125 million).
Apax Partners's US$921 million (about EUR720 million) acquisition of a 54.25% stake in Tivit, a Novo Mercado-listed IT and outsourcing company, the first Brazilian deal by a UK-based private equity firm since 1995.
Actis's acquisition of a minority stake in Companhia Sulamericana de Distribuição (CSD), a supermarket chain operator, for US$58 million (about EUR45 million).

In September 2010, the US$4 billion (about EUR3 billion) acquisition of Burger King by 3G Special Situations Fund II (a vehicle controlled by New York-based private equity fund 3G Capital) was announced. Although not a Brazilian acquisition as such, 3G is backed by several Brazilian investors.

Some market participants predict that an influx of foreign capital over the coming years will give further impetus to Brazil's private equity industry. For instance:

Respondents to the EMPEA survey expect Brazil to experience the largest increase in new investors of all emerging markets over the next two years.
ABVCAP president Sidney Chameh believes that Brazil-based private equity funds could raise up to US$15 billion (about EUR12 billion) by mid-2011 (see Reuters, Private equity sees Brazil fund raising at $15 bln).
The Private Equity Research Center at the Getúlio Vargas foundation (GVF-CEPE) estimates that private equity could account for 3.5% of Brazilian GDP in six years' time (compared to 1.7% as at 30 June 2008).
Smith & Williamson, a UK financial services advisory company noted in a recent report commissioned by UK Trade & Investment (UKTI) that, despite the recent surge in Brazilian deal activity, the country's potential for private equity investment remains relatively untapped (see UKTI press release, Brazil private equity reaches critical mass, but many opportunities untapped).

Legal and regulatory landscape

The 2010 edition of the LAVCA Scorecard, an annual ranking of the business environment in 12 Latin American jurisdictions from a private equity perspective, ranked Brazil in second place, one point behind Chile (see below, Chile) (see LAVCA Scorecard 2010).

Some of the most appealing aspects of the Brazilian legal landscape include:

A number of tax-efficient domestic fund structures.
Access to domestic institutional investors.
A wide range of exit options, including initial public offerings (IPOs).
Increased commitment to transparency and international best standards.

Domestic fund structures. As Luís Loria Flaks, a lawyer at BM&A - Barbosa Müssnich & Aragão notes, non-resident private equity investors can either acquire the shares of a Brazilian company directly or invest in units in a Brazilian private equity fund, the most common of which are:

Venture capital funds, known as fundos mútuos de investimento em empresas emergentes (FMIEEs).
Private equity funds, known as fundos de investimento em participações (FIPs).

FMIEEs are governed by Normative Instruction 209 (Instrução Normativa 209/94), which was issued by the Comissão de Valores Mobiliários (CVM), Brazil's financial markets regulator in 1994. FMIEEs are generally used for seed capital to second-stage expansion investments and have the following key characteristics:

They are closed-ended partnerships.
They are limited to 35 investors and subject to a ten-year term, renewable once for a further five years.
They can be managed by authorised individuals or legal entities.
They can only invest in companies (public or private), which cannot:
- have an annual net revenue above BRL150 million (about US$75 million) on the date of the first investment; or
- be part of an economic group whose consolidated net worth exceeds BRL300 million (about US$150 million).

FIPs, which are regulated by Normative Instruction 391 (Instrução Normativa 391/03), have the following features, according to Müssnich and Flaks:

They are closed-ended investment funds.
They can only be managed by legal entities.
They can invest in any company, regardless of its revenue or net worth, but must participate in its decision-making.

To be eligible for investment by an FIP, companies must abide by certain governance standards (for example, referring all corporate disputes to arbitration).

As Fabiana Gouveia, a tax lawyer at BM&A - Barbosa Müssnich & Aragão notes, "investing in an FIP can give rise to several tax benefits. For instance, FIPs are exempt from tax on acquisitions and disposal of Brazilian assets".

In addition, Law 11312 (Lei 11312//06) reduced the rate of withholding tax on "income distributions" (which includes both distributions and capital gains earned on the sale of an interest in the FIP) by an FIP to non-resident investors to zero. To benefit from this exemption, non-resident investors and the FIP must comply with certain requirements. For example, 67% of the FIP's portfolio must be in shares, convertible debt instruments or subscription bonuses. Non-convertible debt instruments cannot make up more than 5% of the portfolio.

"The popularity of FIPs among non-residents has grown in recent years due to their tax advantages", notes Gouveia. FIPs and FMIEEs account for 39% of private equity and venture capital funds in Brazil by committed capital. Limited partnerships account for 34%. Other types of fund and corporate entity make up the remaining 27%.

Access to local institutional investors. Brazilian pension funds play a major role in Brazilian private equity fundraising, accounting for nearly a quarter of the capital raised by such funds.

In September 2009, the National Monetary Council (Conselho Monetário Nacional (CMN)) adopted Resolution 3792 (Resolução 3792), which allows closed pension funds (Entidades Fechadas de Previdência Complementa (EFPCs)) to invest up to 20% of their assets in structured CMN-approved investment funds, such as private equity and venture capital funds (if they are investing in either real estate or overseas-based funds, the cap is set at 10%).

Range of exit options. According to Fabíola Augusta de Oliveira Bello Cavalcanti, a finance and capital markets partner at BM&A - Barbosa Müssnich & Aragão, the fact that the BM&FBOVESPA is the world's tenth largest stock exchange by market capitalisation gives Brazil a competitive advantage, as it gives investors an exit route that is not commercially feasible in other Latin American jurisdictions (14% of respondents to the EMPEA survey identified "weak exit environments" as one of the reasons deterring them from investing in Latin America). The existence of the Novo Mercado, a listing segment in the BM&FBOVESPA where companies must adhere to strict corporate governance standards, can be particularly appealing to venture-backed companies.

Proposed code of best practice. At the time of publication, ABVCAP and the Brazilian Association of Financial and Capital Market Entities (Associação Brasileira das Entidades dos Mercados Financeiro e de Capitais (ANBIMA)), a national association representing financial services businesses, were developing a code of best practice for private equity funds (Código de Regulação e Melhores Práticas de FIP e FIEE (Fundos de Investimento em Empresas Emergentes)) (Code). The Code will establish guidelines and transparency rules to be observed by Brazilian private equity players in line with internationally recognised best practice. As Müssnich and Flaks explain, "the Code's key purpose is to facilitate oversight of private equity funds, which will strengthen investor protection". They hope that adherence to the Code, which will be mandatory for ABVCAP and ANBIMA members carrying out private equity-like activities, will further boost the industry's reputation in Brazil and attract further investment.

Chile: strong business environment

According to the 2010 LAVCA Scorecard, Chile has the best business landscape for private equity investment in the region. However, despite Chile's regulatory and judicial probity, its private equity market remains modest. Chile accounted for just 8% of the region's investment in 2009. Practitioners attribute these relatively low levels of activity to several factors, and in particular to:

Smaller average deal sizes and, correspondingly, exit options.
A smaller population (16 million) than Brazil (191 million), Colombia (45 million) or Mexico (111 million).
High taxes levied on non-resident investors.

Legal and regulatory landscape

Law 19.705 (Ley Nº 19.705 Regula la Oferta Pública de Adquisición de Acciones (OPAS) y establece régimen de Gobiernos Corporativos), known as the takeover law, established an umbrella term investment fund (fondo de inversion), which can be public or private. Federico Grebe, a partner at Philippi Yrarrázaval Pulido & Brunner emphasises that there are some important differences between private and public investment funds. These include:

Public funds must register with the Superintendencia de Valores y Seguros (SVS), Chile's financial regulator.
Unlike private funds, public funds can list their securities on the Santiago Stock Exchange (Bolsa de Comercio de Santiago) and issue debt.
Public funds must be made up of either at least 50 private investors or at least one institutional investor. Conversely, private funds must have less than 50 investors.
Chilean pension funds can only invest in public funds.

Foreign private equity funds (fondos de inversión de capital extranjero de riesgo) (FICERs) are governed by Law 18.657 (Ley 18.657 Autoriza la creación de fondos de capital extranjero). FICERs obtain their capital from natural or legal persons outside of Chile but are authorised to invest in unlisted Chilean securities. They are administered through Chilean special purpose vehicles (SPVs) set up by administrators such as Celfin Capital which, like the FICER itself must register with the SVS and are subject to its supervision.

Over the past decade, Chile has reformed its capital markets legislation on several occasions. One of the key drivers behind these reforms is the government's desire to stimulate the development of the country's private equity industry.

Law 19.769 (Ley 19.769 Flexibiliza las inversiones de los fondos mutuos y compañías de seguro, crea administradora general de fondos mutuos, facilita la internacionalización de la banca y perfecciona leyes de sociedades anónimas y de fondos de inversiones (known as MK1)), adopted in 2001, introduced several reforms including:

The creation of a listing segment for emerging companies (known as the Mercado de Empresas Emergentes) (MEE) in the Santiago Stock Exchange. Shareholders of companies that were listed in this segment after the enactment of the law and before 31 December 2006 were exempt from capital gains tax (GGT) for up to three years after the company's initial public offering (IPO). The 31 December 2006 deadline was later extended to 31 December 2014 (see below).
Allowing mutual fund managers and insurance companies to invest in private equity funds.

Law 19.795, known as the Ley de Multifondos (multi-funds law), passed in 2002, allowed private sector pension management companies to establish funds with varying levels of risk, and invest up to 2.5% of their assets in private equity funds.

This was followed by Law 20.190 of 2007 (Ley 20.190 Introduce adecuaciones tributarias e institucionales para el fomento de la Industria de Capital de Riesgo y continua el proceso de modernización del mercado de capitales (known as MK2)), which introduced the following improvements:

It allowed the government's development corporation (Corporación de Fomento de la Producción de Chile) (CORFO) to directly invest in up to 40% of a private equity fund's capital. As Grebe notes, CORFO has subsequently become a key institutional investor in Chilean private equity funds. As at January 2010, there were 30 CORFO-backed funds with a total commitment of US$584 million (about EUR455 million).
It allowed banks to allocate the equivalent of up to 1% of their asset base to venture capital funds and to set up their own funds.

Notably, MK2 also created a new form of corporate entity, the Sociedad de Responsabilidad Limitada por Acciones (SpA). As Grebe highlights, SpAs, which are increasingly popular among local private equity sponsors, combine the flexibility of a partnership with the probity of a limited company. For instance:

They can be owned by a single shareholder.
The liability of shareholders is limited to their stake in the company.
Management can raise equity and debt without obtaining shareholder approval or disapplying pre-emption rights, if authorised by the SpA's articles.

From a tax perspective, the main reforms introduced by MK2 include:

Extending the CGT moratorium on corporations listed on the MEE until 31 December 2014.
Establishing CGT exemptions for angel, seed and venture investors.
Creating CGT exemptions on gains from disposals of shares in emerging companies.

To benefit from the above exemptions, the fund, the portfolio company and the securities being sold must satisfy certain requirements. These include, for instance, that the company must have been incorporated for seven years or less at the time of the investment by the private equity fund. It must be unlisted, domiciled in Chile and conduct most of its activities in the country. It cannot be part of a group, have annual revenues above US$16 million (about EUR12 million) or operate in certain sectors such as casinos or financial services.

According to the 2010 LAVCA Scorecard, subjective enforcement of these requirements by the Chilean tax authorities has, however, made these exemptions "difficult to impossible to access" in practice.

Law 20.448 (Ley 20.448 Introduce una serie de reformas en materias de liquidez, innovación financiera e integración del mercado de capitales), which came into force on 13 August 2010, introduced additional measures relevant to private equity. These include:

Reducing the minimum number of investors needed to qualify as a public fund from 50 to 25.
Allowing private fund managers to administer FICERs.
Reducing the minimum period for a FICER to be allowed to remit capital abroad from five to three years.
Allowing FICERs to raise debt.
Removing a previous limitations to the CGT exemptions caused by breaching the maximum level that the investment in a particular company could have within the portfolio of the fund. Under the new rule, if such breach is caused by the partial liquidation of the fund, the CGT exemptions are not lost, thus giving sponsors greater flexibility to partially liquidate a fund).

Colombia: up-and-coming

The burgeoning Colombian private equity market has started attracting international attention in the past few years. According to Cate Ambrose, this has been partly due to the government's "commitment to the local funds industry", which has been "among the strongest of any Latin American country". The 2010 LAVCA Scorecard rewarded the government's commitment to the development of private equity by ranking Colombia in fifth place.

According to media reports, local private equity fund managers have already invested US$1 billion (about EUR766 million) and are in the process of raising a further US$2 billion (about EUR1.5 billion). Infrastructure funds are particularly active. Examples include:

Toronto-based Brookfield Asset Management, which recently announced the first closing of its US$400 million (about EUR306 million) Brookfield Colombia Infrastructure Fund, the largest private equity and infrastructure fund ever raised in the country.
Darby Overseas Investments in partnership with Mercantil Colpatri which, as at September 2010, had raised US$90 million (about EUR69 million) of its proposed US$150 million (about EUR115 million) transport-focused infrastructure fund (Fondo de Inversiones en Transporte (FINTRA)).

The Brookfield and Darby funds both raised capital from Colombian institutional investors. According to Alessia Abello, a partner at Posse Herrera & Ruiz Abogados, this highlights a wider trend where "funds domiciled abroad seek to attract Colombian pension commitments". Abello also notes that, at present, due to a lack of relative local fund management expertise, most funds (with some exceptions like Altra Investments) are managed by foreign GPs or local ones with access to international expertise.

Recent investment transactions include the provision by ACON Latin American Opportunities Fund (managed by US-headquartered ACON Investments) of a US$25 million (about EUR19 million) capital injection to Credivalores, a leading non-banking provider of consumer loans.

Legal and regulatory landscape

In 2007, the government adopted Decree 2175 (Decreto 2175 del 2007 por el cual se regula la administración y gestión de las carteras colectivas). According to Abello, "in general terms, the adoption of Decree 2175 was the key event in the regulation of Colombian private funds". Prior to Decree 2175, explains Abello, the Superintendencia Financiera de Colombia (SFC), the country's financial regulator had adopted Resolution 470 (Resolución 470), which amended Resolution 400 (Resolución 400) and authorised the creation of private equity funds (fondos de capital privado) (FCPs). This resolution led to the establishment of some pioneer Colombian-domiciled funds, such as the Small Enterprise Assistance Fund's (SEAF) Fondo Transandino.

However, as Abello notes, Resolution 470 created some areas of uncertainty. Unlike other fund vehicles, Colombian FCPs are not corporate structures, they are contractually-created, closed collective investment portfolios. As such, they need to be administered by a management company (sociedad administradora) such as a stockbroker, which performs the fund's regulatory reporting and back-office functions. Unlike in the case of limited partnerships, the role of the general partner (known as a gestor profesional (GP)) is not expressly recognised in the FCP structure. Although Resolution 470 expressly allowed management companies to hire GPs to manage a fund's investments, liability for those investments originally remained with the management company. This issue deterred many businesses from becoming the management companies of FCPs. Indeed, the establishment of the Fondo Transandino required SEAF to set up its own management company to ring-fence any potential liabilities.

As Abello notes, "Decree 2175 set out the responsibilities of the different stakeholders much more clearly. The decree notes that, while the management company and its board have fiduciary duties towards FCP investors, if the management company appoints a GP, its liability will be limited to the actual appointment and subsequent supervision of the GP".

Since decree 2175, the Colombian government has continued fine-tuning the country's regulatory framework. Recent measures include:

Law 1328 on Financial Reform (Ley 1328) which established minimum capital requirements for FCP fund managers and allowed Colombian commercial banks to provide finance for the acquisition of companies, provided that these companies are not regulated by the SFC.
Decree 4938 (Decreto 4938 del 2009), adopted in December 2009, which requires GPs to prepare annual reports for FCP investors.
Decree 2555 (Decreto 2555 del 2010) passed in July 2010 a landmark piece of legislation which consolidates the previously scattered financial services, capital markets and the insurance sector laws into a single normative framework.

The regulations governing the permissible investments of pension funds (known as Administradoras de Fondos de Pensiones (AFPs)) also regulate private equity activity indirectly to the extent that they constitute a vital source of capital for private equity funds. Pursuant to SFC Circular 8, issued in 2008:

AFPs administering mandatory pension contributions can invest 5% of their assets in Colombian FCPs and a further 5% in foreign private equity funds.
AFPs administering voluntary pension contributions and cesantías (severance pay funds) may invest up to 10% of their assets in private equity.
Insurance companies may invest up to 5% of the value of their portfolio in FCPs.

Going forward

The improved economic, political and regulatory outlook in several jurisdictions is making Latin America an increasingly appealing investment destination for foreign private equity firms. In parallel, recent legal reforms are allowing a home-grown class of venture capitalist to blossom in a number of countries.

Even in those of jurisdictions with a highly developed legal framework, there is still scope for improvement, particularly as regards taxation. In addition, local private equity sponsors and companies seeking private equity capital should ensure that they adhere to internationally recognised corporate governance standards and best practices.

In Latin American private equity transactions, returns are still driven by improving management and operational efficiency as opposed to leverage. However, if the region's economies continue to grow and restrictions on the provision of acquisition finance are lifted, this may encourage local and regional banks to make larger loans and seek syndication opportunities. If that happens, deal values could skyrocket across the region.

Investing in family-owned companies: structuring considerations

Investing in businesses with an unbroken tradition of family ownership, which are common in Latin America, can create difficulties for private equity houses, such as initial opposition by the company's majority shareholders. For instance, according to media reports, the buyout of Frango Assado (a chain of Brazilian restaurants) by the International Meal Company (IMC) (an investment vehicle controlled by Advent) took 18 months of negotiations, partly as a result of initial reluctance by the Mamprim family, Frango Assado's previous majority shareholders, to cede control of the business.

In addition, the ownership structure of most Latin American companies means that private equity investors need to ensure that the acquisition documentation clarifies the relationship between them and the original shareholder(s) regarding issues such as:

Governance and board composition.
Financial decision making.
Day-to-day management.
Dispute resolution mechanisms.
Minority shareholder protection.
Exit strategies.

The Carlyle Group's acquisition of a 63.6% stake in CVC Brasil Operadora e Agencia de Viagens (CVC), Latin America's largest tour operator, shows the kind of compromise arrangements that sponsors can enter into when making this type of acquisition. Carlyle acquired its stake in CVC from the company's founder and chairman Guilherme Paulus. The resulting deal carved up the different companies in the CVC group, enabling Paulus to retain control of an airline, hotel management business and advertising agency. Paulus also retained his position as group chairman and kept a minority stake in the holding company.

Recent reforms to the Mexican pension system

In July 2009, Mexico's pension regulator, the Comisión Nacional del Sistema de Ahorro para el Retiro (CONSAR) and the Mexican stock exchange (Bolsa Mexicana de Valores) (BMV) introduced a series of reforms enabling Mexican private pension fund administrators (Administradoras de Fondos para el Retiro (AFORES)) to invest in private equity and venture capital funds through a structure called a Certificado de Capital de Desarrollo (known as CKD or CCD).

One form of CKD (CKD-A) allows an AFORE to invest in a private equity fund CKD-A by purchasing a stock certificate, which the fund must issue on the Mexican stock exchange. The fund must be domiciled in Mexico and comply with the BMV's corporate governance requirements.

CKDs function effectively like shares, which are tied to the underlying fund's long-term success and offer no guarantee of payment of principal, interest or yields. Although there is still a lack of clarity surrounding certain aspects of CKD-As, such as taxation, they are generally seen as a welcome development in that they allow Mexican pension funds to side-step regulations restricting their investments to listed securities. In addition, the fact that CKDs are listed on a stock exchange, and therefore tradeable, gives them greater liquidity.

Private equity in Latin America | Practical Law