- 1.What are the most common types of private equity transactions in your jurisdiction?
Mexico increasingly sees the full array of private equity transactions structured and consummated. Most international private equity investors with a presence in Mexico tend to favour majority or control acquisitions, while local investors tend to be more flexible and open to acquire minority stakes. Transactions involving convertible debt and hybrid instruments are less prevalent.
- 2.What types of investors are most active in the private equity market of your jurisdiction?
Private equity deal volume in Mexico, particularly the larger deals, continues to depend greatly on foreign private equity investors (ie, funds raised outside of Mexico and managed by international fund managers). However, with the advent of CKD funds, which are managed by Mexican fund managers and in some case local affiliates of international managers, domestic private equity is fast becoming a popular source of equity financing.
- 3.What historically have been the main target industries and what trends were noticeable throughout 2010? What trends do you expect to see in the next 18 months?
Real estate, consumer products and infrastructure remain popular industries for private equity. A significant number of CKD funds raised in the last 18 months are expressly focused on real estate and infrastructure. However, funds have increasingly focused on diverse sectors including education, healthcare and hospitality.
- 4.Please describe the main features, size and activity levels of local private equity funds. Are there any regulatory or market restrictions or incentives to the development of such funds? Have any begun to participate significantly in transactions out of their local jurisdiction?
Since 2008, 15 funds have been raised in Mexico under the CKD rules. Through the second quarter of 2011 in aggregate, these funds have raised approximately US$3.5 billion in institutional money, the vast majority of which comes from the Mexican pension funds (SIEFORES). The CKD funds, which include funds raised and managed by Prudential, AMB, ProLogis, Macquire, Wamex, Neexus, I2, and Vertex Capital have been increasingly active in pursuing transactions, some of which have been ‘club deals’ with other private equity investors. Some CKD funds invest in conjunction with parallel funds raised primarily outside of Mexico and managed by the same fund managers. A large number of the CKD funds are managed by the local affiliates of international fund managers such as Prudential, AMB (now ProLogis) and Macquire, but a new group of Mexican funds managers has emerged.
- 5.Are there any private equity funds listed in your jurisdiction? Are there any special regulations or requirements applicable to the listing and public offering of securities by such funds or any reform initiatives that are under discussion?
All 15 of the existing CKD funds are listed on the Mexican stock exchange (Bolsa Mexicana de Valores, S.A.B. de C.V.). As a matter of law, CKD funds must be listed and securities in the funds offered publicly in order for SIEFORES to be entitled to invest in such funds. There exists a specific legal framework governing the offering and listing of CKD funds, which includes the Mexican Securities Law (Ley del Mercado de Valores) and the rules and regulations enacted by CONSAR, the pension fund regulator, which establish the investment regime for SIEFORES. The process to raise CKD funds and to offer securities in such funds to the investor public is substantially identical to the process applicable to corporate issuers, and the corporate governance applicable to CKD funds is substantially based on the corporate governance applicable to Mexican publicly traded companies, including the need to have independent directors. Private equity funds that do not raise capital from local pension funds are not listed.
- 6.What are the main issues in connection with the liability of fund managers?
Except for managers of CKD funds, which are subject to certain requirements of Mexico’s securities laws, generally fund managers are not subject to enhanced or special liability standards. Fund managers are subject to normal commercial law performance requirements.
- 7.What are the main remuneration schemes for fund managers and have there been any recent shifts observable in the market? Are there any limitations or reforms under discussion regarding the same?
Mexican funds managers, including CKD managers generally receive management fees ranging from 1.5 to 2 per cent of the committed capital or invested capital (after the expiration of the investment period). In addition, funds generally contemplate the payment of a carried-interest once the investors or limited partners receive a certain preferred return.
- 8.Please describe any legal considerations of particular importance in your jurisdiction in connection with executing leveraged buyouts and similar strategies.
The main consideration in structuring LBOs in Mexico depends on the ability of the target companies to pay dividends and make distributions to its shareholders on a current basis to service acquisition loans. Hence, when structuring LBOs in Mexico, it is paramount to incur the acquisition financing at the level of the operating target companies, or to somehow restructure the debt after the closing in a manner where the operating entities can actually service the debt without having to deal with the tax and other timing restrictions applicable to dividends under Mexican law. Also, in pricing acquisition financing, investors have to consider applicable withholding taxes on interest payments made to foreign lenders, and the potential incremental cost they represent in terms of gross-up provisions.
- 9.What are the main organisational forms used in your jurisdiction to channel private equity investments? Has there been any change over time in the types of organisational forms used? What are the main formation requirements?
Funds, and most specifically CKD funds, are formed as Mexican trusts (Fideicomisos) established with a Mexican trustee. In turn, the funds are managed by a fund manager also incorporated in Mexico, typically as an SA (Sociedad Anónima) or SRL (Sociedad de Responsabilidad Limitada). Trusts are also commonly used to raise funds from other domestic investors (ie, not pension funds). Foreign funds are typically channelled through foreign pass-through entities established and domiciled in jurisdictions with which Mexico has entered into a treaty to avoid double taxation (ie, US, Canada, the Netherlands, Belgium, Spain, among others).
As far as investments are concerned, the preference is to have target companies incorporated as SAPIs (Sociedades Anónimas Promotoras de Inversión). However, US investors may often insist on having target companies incorporated as SRLs, which the US Internal Revenue Service considers eligible for pass-through treatment in the US.
- 10.What are the most important legal issues arising in the operation and governance of local companies in your jurisdiction?
Since the creation of SAPIs, many of the legal hurdles that private equity investors confronted in structuring corporate governance arrangements in Mexico, have been eliminated or mitigated. However, in the case of privately held corporations, perhaps the greatest legal issue still facing private equity investors is the controlling nature and precedence the by-laws of a Mexican entity take vis-à-vis the shareholders or partners agreement. This issue requires parties to replicate the corporate governance arrangement normally designed for the shareholders agreement in the by-laws of the target company, and therefore be forced to include sometimes commercially sensitive corporate governance provisions (eg, drag-along and ROFR mechanics, non-compete undertakings) in a document that is available publicly through the applicable Public Registry of Commerce. In the case of publicly-traded companies, pre-emptive rights and veto rights generally are challenging to deal with and implement, and like in the case of closely-held companies, the effectiveness of a shareholders agreement vis-à-vis the by-laws is also an issue.
- 11.Are there any issues to be considered in connection with the limitation of liability under the laws of your jurisdiction?
Except in the case of fraud in which a shareholder actively participates, or in the event that the Mexican company is not properly registered with the Mexican tax authorities or maintains fraudulent books and records, Mexican law does not allow for the piercing of the corporate veil in the case of commercial entities that are incorporated as limited liability entities in accordance with the General Law on Commercial Companies (Ley General de Sociedades Mercantiles).
- 12.What are the most common minority protection rights, whether granted by operation of law or contractual agreement ? Are there any special issues to be considered under the laws of your jurisdiction?
In Mexico private equity transactions typically contemplate the establishment of specific governance rights for the applicable minority, such as the right to appoint a specific number of board members and members to applicable committees, the right to approve a negotiated list of so-called ‘major decisions’ at the board or the shareholders meeting, and the right to receive periodical financial information. Shareholders agreements also include provisions dealing with pre-emptive rights, and transfer restrictions, the most common of which include rights of first offer, rights of first refusal, tag-along rights and drag-along rights, and in some cases, registration rights (eg, demand registration and piggy-back rights). These rights are in addition to certain statutory minority rights, which include the right to appoint board members based on a certain percentage of shares held (eg, 10 per cent in the case of a SAPI), and the need to obtain a supermajority vote in the case of certain decisions (eg, admission of new partners to an SRL).
- 13.What are the main exit strategies used by private equity investors in your jurisdiction? Are there any limitations to the enforceability of exit arrangements? Have you seen a shift away from or towards certain exit strategies over the past year?
Mexico has seen the full-spectrum of exit transactions for private equity investors. The type of exit depends on the prevailing economic cycle in Mexico and globally, as well as the industry and target company in question. There are many examples of exits through the capital markets as part of a global primary and secondary offering of shares, most often through a public offering in Mexico and a placement outside of Mexico pursuant to Regulation S and Rule 144A of the US Securities Act 1933. Likewise, there exist many and varied examples of private equity investors exiting through buy-outs, in some cases by another private equity investor and more commonly by a strategic buyer. With the SIEFORES now authorised to invest in IPOs, as well as the potential tax efficiency of selling through a recognised stock market, exits through secondary offerings and block-trades are likely to become more and more commonplace.
- 14.What are the key legal issues to be considered when appointing or replacing directors and officers?
The most significant issue considered when appointing and removing directors is limiting a director’s liability for pre-appointment periods in the case of new appointees, and releasing departing directors from any liability while in office. Although not found in all transactions, D&O insurance is increasingly a demand of foreign private equity investors. Some foreign private equity investors elect not to appoint board members, and structure their governance rights through shareholder participation and shareholder vote alone. Although this may give rise to uncertainty on outcome and enforcement, some investors with little experience in Mexico insist on having the shareholders agreement governed by foreign laws despite the requirements that the by-laws of the target company be governed by Mexican law, thereby potentially creating conflicting provisions and giving rise to legal uncertainties.
- 15.Please describe the most significant issues commonly considered under the laws of your jurisdiction in connection with purchase and shareholders’ agreements.
As mentioned in question 14, one of the more critical structuring issues to address is replicating and giving effect to a shareholders agreement in the target company’s by-laws (ie, in the case of dispute, the by-laws prevail over the shareholders agreement in Mexico). As far as governing law is concerned, foreign private equity investors increasingly accept Mexican law to govern the purchase agreement as well as the shareholders agreement. However, US private equity investors often insist on NY law as the governing law of the transaction agreements, and when they accept Mexican law as the governing law, almost invariably disputes are submitted to commercial arbitration outside of Mexico.
- 16.Please describe the main issues related to dispute resolutions under purchase, shareholders’ and other principal private equity agreements. What are the most common dispute resolution mechanisms selected in these agreements?
In the case of investments by Mexican private equity investors, transaction documents are governed by Mexican law, and disputes are typically submitted to the competent courts of Mexico. Foreign investors very rarely agree to resolve disputes through the Mexican courts, and normally insist on having disputes resolved through commercial arbitration, more often than not, to be held outside of Mexico. It is not common for disputes to be resolved by courts outside of Mexico. In the event that a party does not abide by an arbitral award or a foreign judgment, the award or judgment in question must be enforced through the Mexican courts. At the time of enforcement, the Mexican courts would not revisit the merits of the case, but would review the foreign proceeding to make certain basic procedural aspects where followed (eg, due process), and that the judgment does not violate Mexican public policy.
- 17.What are the most common funding structures? Are there any significant issues commonly confronted in implementing such structures?
Funding of private equity investments is relatively straightforward in Mexico. Most transactions are funded through direct capital contributions pursuant to capital increase resolutions adopted by the shareholders meeting of the target company. Such capital increase resolutions may accommodate multiple capital calls through the issuance of partially-paid shares or treasury shares. Where investors require distributions on their investment on a “current basis” and not merely rely on annual dividends, subject to applicable thin-capitalisation and transfer pricing rules, some investments provide for a combination of direct capital contributions in exchange of shares or interest in the target company, and shareholder loans. In the case of buy-outs, transactions are typically structured as stock purchases or redemption transactions.
- 18.Is there a domestic financing market for private equity deals? Has there been a shift in the sources of funding over the past few years? Where do you expect to see financing come from in the next 18 months?
As previously mentioned, since 2008, SIEFORES area allowed to take-on equity risk and exposure, thereby significantly increasing availability of funds for private equity transactions. As interest rates on debt remain low, some would argue the cost of private equity funds are high as compared to the cost of debt financing. However, despite the relatively low levels of interest rates, credit, particularly acquisition financing, is not readily available in light of the prevailing conditions in the global debt market. Overall, the amount of private equity funds available in Mexico continues to increase. Although hybrid options like mezzanine debt and convertible debt are feasible in Mexico, transactions using such structures remain few.
- 19.What are the principal accounting considerations that arise in private equity transactions? Are there any contemplated or ongoing shifts in regulatory accounting standards in your jurisdiction?
In 2012 Mexican publicly traded companies will be required to report accounts using International Financial Reporting Standards (IFRS). Although foreign investors often require Mexican companies to maintain parallel books in US GAAP or IFRS, mostly for their own domestic reporting requirements, normally the metrics used to calculate EBITDA and other relevant line-items are based in Mexican GAAP (Normas de Información Financiera) for purposes of calculating true-ups and earn-outs.
- 20.Are there any disclosure, registration or licensing requirements affecting private equity funds investments currently in effect or under consideration by regulators?
The only private equity funds subject to specific disclosure and governance regulations and requirements are CKD funds. The disclosure and reporting obligations applicable to such funds are substantially similar to those applicable to Mexican publicly-traded companies, and their governance is also similar, requiring, among others, the appointment of independent board members. Other private equity funds, including foreign funds, are not subject to any such requirements in Mexico.
- 21.Please describe any restrictions, requirements or protections applicable to foreign investors in connection with private equity investments.
Although the Mexican economy is largely open to foreign investment, few sectors remain subject to specific restrictions, which exclude foreign investment altogether as is the case in broadcasting and cargo transportation, among other industries, or limit foreign investment to specific percentages (eg, 49 per cent in the case of satellite communications and wireline telecommunications; 25 per cent for airlines). Such limitations, some of which may be waived with the prior approval of the Foreign Investment Commission (Comisión Nacional de Inversión Extranjera) apply to foreign investments generally, and not specifically to foreign private equity investors. Where a foreign investor acquires more than a 49 per cent interest in any Mexican companies whose assets have value in excess of approximately US$200 million, the transaction would be subject to the prior approval of the referred to commission.
- 22.Are there any government approvals required in connection with private equity investments in certain industries or any industry-specific regulatory schemes that can affect private equity investments? What are the main requirements to obtain such approvals? Have there been any observable trends recently in the posture of specific regulators or the regulatory environment generally in connection with the review or approval of such investments?
In addition to the foreign investment restrictions summarised above, certain sectors are also subject to specific regulatory oversight and approval requirements from the federal government. Such sectors include telecommunications, transportation and financial services, among others. Each approval process is specific to the industry, although a common feature is that the approval is not subject to a deemed approval, and must be issued in writing by the competent authority. Except for real estate transaction and for specific environmental authorisations, state or other local approvals are not normally required (ie, approvals are federal).
- 23.Please describe any antitrust approvals or other competition law requirements that may apply in connection with private equity investments.
The Mexican Competition Law sets forth certain monetary thresholds which trigger the obligation of economic agents to notify concentrations before they are consummated. A transaction will be subject to a pre-merger filing by reaching at least one of the following thresholds:
- if the transaction or series of transactions, represent within Mexico, directly or indirectly, a value greater than 1.076760 billion pesos (approximately US$89,730,000); and/or
- if the transaction or series of transactions, result in the acquisition of 35 per cent or more of the assets or shares of an economic agent which total assets or annual sales located/originated in Mexico are worth more than 1.076760 billion pesos (approximately US$89,730,000); and/or
- if the transaction results in:
- an accumulation within Mexico of assets or capital stock in excess of 502,488,000 pesos (approximately US$41,874,000), and
- two or more economic agents are involved in the concentration and their assets or annual volume of sales (on a worldwide basis), jointly or separately, are worth more than 2.87136 billion pesos (approximately US$239,280,000). Specifically in connection with the last threshold, the Mexican Federal Competition Commission (Comisión Federal de Competencia) interpreted that in order to determine the value of the assets accumulated in Mexico, the parties must consider the value of the total assets as shown in the financial statements or the price allocated to Mexico; whichever is higher.
- 24.Are there any anti-money laundering or other similar financial regulations that should be considered when structuring a private equity transaction or setting up a vehicle?
Private equity transactions and private equity funds are not subject to specific anti-money laundering or similar laws. They are subject to the general rules applicable to commercial and financial transactions generally in Mexico relating to anti-money laundering.
- 25.Are there any exchange controls that typically affect how foreign private equity investments are structured in your jurisdiction?
- 26.What are the basic tax issues affecting private equity investments in your jurisdiction?
From a due diligence perspective, investors place great emphasis on tax contingencies and tax liability of the target company, and often negotiate special indemnities dealing with any such liabilities, which have the sponsors indemnifying the investor from any and all pre-closing tax liabilities during the applicable statute of limitations.
As far as structuring the investment is concerned, significant attention is placed on ensuring that the amounts invested are recognised as basis for purposes of calculating capital gains at the time of exiting investments. Foreign investors devote a lot of time to structuring the appropriate investment vehicles, and taking advantage of favourable tax treaties to which Mexico is a signatory, potentially exempting sale transactions from taxes in Mexico. Currently dividends are not subject to withholding taxes. In the event of transactions involving shareholder loans, thin capitalisation rules must be complied with to ensure the deductibility of interest payments, and investors should be mindful of withholding taxes on interest, which may range from 4.9 per cent to 40 per cent.
- 27.What impact are recent and projected macroeconomic trends in your jurisdiction and abroad and your government’s reaction to these trends having on private equity activity in your jurisdiction? When did you start to see an impact?
The Mexican peso has not regained the levels it had prior to the 2008 global financial crisis. Hence, Mexican asset values are seemingly cheaper for investors than assets in other regional economies. As ever, the Mexican economy will follow the cycle of the US economy. With the exception of monetary and interest rate policy, the Mexican government has not actively stimulated or participated in the local economy in any significant manner.
- 28.Please describe any other regulations applicable to private equity funds and private equity investments not discussed in your answers to the above questions.
- 29.Please describe any other recent trends observed in your jurisdiction affecting how private equity transactions are conducted or how these investments are structured.
Private equity investors are generally comfortable with the legal and related risks involved in private equity transaction in Mexico. Increasingly investors focus on returns and less on country risk.
- 30.Please describe any other relevant legal considerations or new developments related to private equity investments in your jurisdiction not discussed in your answers to the above questions.
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