A Q&A guide to private equity law in Mexico.
This Q&A is part of the PLC multi-jurisdictional guide to private equity. It gives a structured overview of the key practical issues including, the level of activity and recent trends in the market; investment incentives for institutional and private investors; the mechanics involved in establishing a private equity fund; equity and debt finance issues in a private equity transaction; issues surrounding buyouts and the relationship between the portfolio company's managers and the private equity funds; management incentives; and exit routes from investments. Details on national private equity and venture capital associations are also included.
Mexican private equity funds have relatively limited access to liquidity. Private equity funds generally require some public participation through Mexican or international development banks, combined with institutional investors (such as insurance companies) and Mexican private pension funds (Administradoras de Fondos para el Retiro) (Afores), some large companies and institutions, wealthy individuals and family businesses.
Raising capital in Mexico for private equity funds is a difficult task generally requiring trust and the knowledge of organisers and managers, but mainly ample business and social relationships and networking.
International pension funds, both taxable and exempt, have traditionally been an important contributor of liquidity to the Mexican market.
A current market trend is for Afores (see Question 1), insurance companies and other qualified investors to invest, seeking more favourable yields and profitability with returns and premiums not otherwise available in Mexican fixed income securities and variable income securities on the Mexican Stock Exchange. This trend includes investing in Certificates of Capital for Development (CKDs). CKDs are hybrid securities, issued by trusts approved by the Mexican Securities and Exchange Commission, for placement with Afores and other qualified investors through the Mexican Stock Exchange. CKDs have enabled the availability of orderly and transparent, but flexible hybrid securities with the consequent generation of liquidity for development and growth in diverse economic sectors.
The Mexican private equity market is still expecting a boom in investments in real estate using Mexican real estate-linked securities (Fideicomisos de Infraestructura y Bienes Raices) (FIBRAs), which will become REIT-like structures when perfected and are expected to foster the Mexican Stock Exchange and provide liquidity to the real estate market.
The global financial crisis has had effects on liquidity and financing, but not the Mexican economy at large, to the extent that Mexican exports and Mexican foreign investments continue. Mexico has been able to avoid the more serious effects of the global financial crisis because its banking system is strong and well capitalised. Mexico's macroeconomic record is solid but is yet to result in an improved microeconomic situation.
The sources of funds raised for investment in Mexican private equity funds include:
Hybrid securities, such as CKDs.
Reserve funds of Mexican insurance companies.
Private and public pension funds.
Investment generally takes place in established businesses in the following sectors:
Niche industry exports of goods and services.
Industrial, commercial, office and residential real estate developments.
Investments in the Mexican private equity market are varied and include:
Public to private transactions.
Temporary "in-and-out" investments.
Exiting a private equity investment is generally carried out through puts and calls, and in some cases, by auctions triggered by a lack of consensus in voting.
A specific regulatory framework to establish FIBRAs in Mexico is in the process of being perfected by the Mexican tax authorities and the National Banking and Securities Commission.
Tax incentive schemes available to private equity investors in Mexico include:
Mexican companies engaged in real estate activities (sociedad inmobiliaria de bienes raíces) (SIBRAs) and their shareholders derive tax benefits. The transfer of real estate to SIBRAs defers taxation of any capital gains arising from the transfer. This deferral is tax effective to the extent that the real estate contributed to SIBRAs, or the shares they issue, remain with the company receiving the real estate and its shareholders.
Mexican capital investment trusts (fideicomisos de inversión en capital privado) (FICAPs) are transparent entities for Mexican tax purposes. Income obtained by FICAPs flows through to their investors, regardless of whether they are Mexican or foreign tax residents. FICAPs are not subject to taxation, and investors are taxed directly on the income received by FICAPs, such as dividends, interest or capital gains. FICAPs are an important investment vehicle in the Mexican venture capital industry, since transparent entities for tax purposes are not generally available in Mexico. FICAPs allow foreign tax residents and/or pensions to claim different exemption privileges and/or preferential tax rates on their Mexican-source income.
Mexican companies can invest in Mexican film production and claim a tax credit equivalent to 10% of their applicable annual income tax. This income tax credit incentive is not accruable for income tax purposes, and the investment in Mexican movie production must be approved by a special committee.
These incentives are directed at investors in Mexico, whether domestic or foreign.
Carry out real estate activities and invest at least 70% of their assets in real estate and/or related rights or loans.
Invest the remainder in registered financial instruments issued by the Mexican government or in shares issued by Mexican Investment Companies of Debt Instruments (sociedades de inversión en instrumentos de deuda).
Transfer the real estate owned by SIBRAs after a four-year period following its contribution and/or acquisition.
Be formed and managed through trusts established by Mexican financial institutions qualified to act as trustees.
Invest at least 80% of their assets in unlisted Mexican companies, and the balance in government financial instruments or shares of debt instruments issued by Mexican investment companies.
Participate in the management of the unlisted Mexican investee companies.
Keep the investment in shares of unlisted Mexican companies for at least two years following their acquisition.
Private equity funds used to attain liquidity and assets include:
Limited liability companies for the promotion of investment (sociedades anónimas promotoras de inversión) (SAPIs).
Capital investment companies (sociedades de inversión de capitales) (SINCAs).
SAPIs, SINCAs and SIBRAs are subject to income tax on a worldwide basis at a rate of 30%. Any dividends distributed out of their net after-tax profit account is tax free for the recipients. Otherwise, distributions are subject to Mexican income tax.
FICAPs' income distributed to their investors can be taxed differently depending on the nature (individuals or entities) and tax residency of the investors. The applicable Mexican income tax withholdings range between 4.9% and 30% and increases to 40% for preferential tax regimes (tax havens). If investors are Mexican corporations, no withholding tax is applicable. However, Mexican corporations must accrue the FICAPs' received income, as appropriate.
All of these structures are taxed. Trusts can be transparent and SINCAs can have some tax advantages when carrying out investments.
Most structures used for private equity funds in other jurisdictions are known to the Mexican tax authorities, and classified as transparent or non-transparent with regard to their legal and tax treatment in their jurisdiction. Mexican tax authorities are very sophisticated in ascertaining the difference between transparent and non-transparent structures. In addition, Mexico has an extensive web of international tax treaties.
The average life of private equity funds ranges between seven to ten years and, depending on the type of investors, yields can currently range between 18% to 25%.
Generally, no licensing is required, except for investment advisors (asesores en inversiones), who must be qualified by an entity recognised by the National Banking and Securities Commission.
No specific regulation exists for private equity funds, and general corporate law and commercial law principles apply.
The public offering of securities is specifically regulated. Any offer not falling within the definition of a public offering would be a private offering, and is therefore subject to lighter regulation.
There are no investment restrictions for private equity funds, unless the economic activity to be invested in is restricted under the applicable provisions of the Foreign Investment Law and Regulations.
Foreign investors can participate in the economic activities and entities listed below in the following percentages:
Up to 10% in industrial co-operative societies.
Up to 25% in domestic air transport, air taxi transport and specialised air transport.
Up to 49% in:
money exchange houses;
financial factoring enterprises;
limited purpose finance companies;
corporations referred to in Article 12 of the Law of the Securities Market;
retirement fund managers;
manufacture and marketing of explosives, firearms, cartridges, ammunition and fireworks (not including the acquisition and use of explosives for industrial or mining activities, or the preparation of explosives for these activities);
newspaper printing and publishing for circulation exclusively in Mexico;
series T shares of corporations having title to land for agriculture or for animal husbandry, or to forests, fishing in fresh or in coastal waters or in the exclusive economic zone (but not including aquaculture);
integral port administration;
port services such as pilotage of vessels for interior navigation;
shipping companies engaged in commercial exploitation of vessels for interior and coastal navigations (except for tourism cruises and for exploitation of dredges and naval artefacts for construction, conservation and operation of ports);
supply of fuel and lubricants for vessels, aircrafts or railway equipment; and
companies with telecommunications concessions from the Mexican government.
Foreign investment in excess of 49% in the following areas requires the prior authorisation of the Foreign Investment Commission (Comisión Nacional de Inversiones Extranjeras):
Port services such as pilotage, dock services, mooring and lighterage of vessels in interior navigation.
Naval companies engaged in exploitation of vessels used exclusively for high-seas traffic.
Corporations holding concessions or permits for airports for public service.
Private services of pre-school, primary, secondary, junior-high, higher and combined education.
Credit information companies.
Institutions for categorisation of securities.
Cellular telephone services.
Construction of pipelines for the transportation of oil and its derivatives.
Oil and gas well drilling.
Construction, operation and exploitation of railways constituting general ways of communication, and rendering of public services of railway transportation.
There are no statutory limitations on maximum or minimum investment periods, amounts or transfers of investments in private equity funds.
Investors generally seek minority protection, enabling them to veto, or at least be aware of, resolutions that can be damaging to their investment. These include exit clauses such as puts and calls, withdrawal rights and others. These can be set forth in prospectuses or included in shareholders' agreements, preferential rights agreements and similar arrangements, including contractual agreements with the private equity fund's management.
There is great diversity in how private equity funds participate in a portfolio. Some investors can choose an initial debt position to be converted to equity at an appropriate time, but investors generally participate in equity.
Debt participation can have certain exit benefits, as claims and recovery stem from collection and interest is taxed at regular Mexican income tax rates (or other rates arising from tax treaties entered into by Mexico).
The disadvantage of holding debt is the lack of participation in further gains of the company that equity participations enable.
Share transfers can be restricted by covenants in partners' or shareholders' agreements, administration trusts or charters and bye-laws of companies where investments are carried out.
Acquiring private companies by auction is not common, unless the target is large. Auctions are generally organised by investment bankers. There are no specific rules for auctions of private companies.
Acquisitions of listed companies are carried out either by trading in a securities market or by a direct acquisition. There are no specific legal provisions or rules on the acquisition of listed companies, other than those applicable to insider trading and similar legal provisions.
The principal documents produced in a buyout are:
Share purchase agreements or social participation agreements.
Shareholders' or partners' agreements, where necessary.
Generally, private equity funds seek contractual protections from management to enforce:
Compliance (especially tax and environmental compliance, if applicable).
Clear corporate documents.
Good commercial relations.
Representations and warranties by sellers of shares or social participations in Mexican private companies generally refer to:
Legal authority to sell the shares and social participations.
Appropriate formation, operation and standing of the corporation or the company from which shares or social participations are being sold.
Certification that the shares or social participations being sold are free and clear of liens, encumbrances or ownership limitations.
Compliance with the charter and bye-laws of the corporation or company, and with applicable laws.
Managers have a duty of care, requiring them to exercise their authority in good faith and in the best interests of the corporation and its subsidiaries, and a duty of loyalty that bars directors from competing with the corporation and doing business with it on unfair terms.
Generally, management is required to agree to confidentiality and a minimum employment term. Investors also typically require non-compete agreements from managers and other selected executives. However, a minimum employment term and non-compete agreements may not be specifically enforceable due to constitutional protections. Instead such covenants may be strengthened by specifying damages in the case of default.
Private equity funds participating in portfolio companies generally seek protection through:
Veto powers combined with exit provisions.
Voting trusts where shares or social participations are conveyed to trusts to assure voting and exit.
The use of SAPIs.
Protection can also be sought through shareholders' or partners' agreements, although such protection is best reflected in the charters and bye-laws of portfolio companies.
Depending on the type of investment, private equity funds are generally equity financed, but, in certain instances, a combination of equity and debt is used, as debt can be repaid at an agreed schedule and cash can be used for specific purposes.
Lenders seek loan security through mortgages, pledges and guarantee trusts.
Debt subordination is not uncommon and generally takes place whenever the underlying assets allow it. For instance, debt is typically contractually subordinated in a construction investment where constructors' and suppliers' debt is paid first and lenders' debt paid second.
There are no rules preventing a company from giving financial assistance for the purpose of assisting a purchase of its own shares. Financial assistance for such a purchase of shares must not affect the granting of security to lenders, except where assets are committed toward guaranteeing the financial assistance and observance of general Mexican corporate law provisions.
The order for payment of creditors' claims is, in order of priority:
Creditors of the estate. These include salary or severance due to employees for the period of two years before the date of issuance of the judicial resolution declaring the debtor's bankruptcy, expenses incurred in connection with the administration of the estate and judicial and non-judicial expenses incurred for its benefit.
Singularly preferred creditors (acreedores singularmente privilegiados). These include funeral and illness expenses where the judicial resolution is issued after the death of the debtor.
Secured creditors (acreedores con garantía real). These are creditors having a mortgage or pledge granted to secure their corresponding debt.
Tax and labour-related debts. These are debts due to tax authorities and employees, other than salary and severance debts above.
Priority creditors (acreedores con privilegio especial). These are creditors with a priority right under applicable provisions of the Code of Commerce of Mexico (Código de Comercio) (a seller has a priority right over other creditors to retain possession of a good sold until the corresponding purchase price is paid).
General creditors (acreedores comunes). These are creditors that do not fall into one of the categories above.
Lenders can request conversion rights into warrants or equity.
Generally, management incentives take the form of bonuses, phantom share participations and actual share participations.
No tax reliefs or incentives are available for investment in portfolio companies by their managers.
There are no specific legal limitations regarding dividends, interest payments and other payments by a portfolio company to its investors other than compliance with the General Law of Business Organisations (Ley General de Sociedades Mercantiles) and the applicable tax laws.
Private equity funds use initial public offerings (IPOs), auctions and sale of participations. IPOs are the preferred route. If listing is not generally possible, secondary buyouts are also a possible exit route. Exits from companies are dependent on the appropriate puts and calls provisions, withdrawal of variable capital (retiro de capital variable) and similar structures.
An IPO is the preferred route, as auctions and sales are subject to the interest of participants, and puts and calls subject to observance of participants, which can lead to disputes.
In the event of the investee's insolvency, private equity funds can also exit from their investments under pre-pack agreements or liquidations in insolvency proceedings where recovery is possible.
Sales and trade-offs are preferable to recoveries in insolvency.
Status. A non-governmental organisation.
Membership. Membership is by invitation only.
Principal activities. AMEXCAP's principal activities include:
Status. A non-governmental organisation.
Membership. Membership is by invitation only.
Principal activities. AMFII's principal activities include:
Areas of practice. M&A; energy; real estate; PPPs; private client.