Contributed By Basham, Ringe y Correa S.C.
As of March 2020, the COVID-19 pandemic has generated significant uncertainty in the Mexican economy. As such, measures had to be taken to prevent the spread of the virus. In this regard, sectors such as consumer, tourism, services and restaurants were the most affected by the pandemic, generating inevitable difficulties for both corporations and individuals in terms of meeting their respective credit commitments in a timely manner.
As a result, Mexican credit institutions implemented support mechanisms for those clients who found it difficult to adequately meet their respective credit commitments, such as those detailed below.
In view of the above, it is important to consider that the support offered to clients varied in accordance with the implementation mechanisms of each of the credit institutions and the conditions of each borrower.
The remedial actions taken by the Mexican government allowed the private equity M&A transactional market in Mexico to continue to grow. While growth was not to the expected rate, the sector continued to yield positive results.
As such, there has continued to be an increase in private equity M&A transactions, even with the COVID-19 situation. For example, The Rise Fund, a global impact investing fund managed by alternative asset firm TPG, acquired approximately 1 GW of solar PV projects from Changzhou, China-based Trina Solar. The solar PV projects include operational, under construction or in late-stage development status in Mexico, Chile, Colombia and Spain.
Another notable transaction was the acquisition by GSI Transporte de Valores, S.A. de C.V. and GSI Operadora, S.A. de C.V – both companies controlled by Grupo Seguridad Integral, a company focused on providing services in the field of private security – of 100% of the four Mexico-based subsidiaries of Prosegur, also a company focused on providing global security services, through Prosegur Global CIT and Prosegur International CIT 1, for a total value of approximately USD33 million.
According to the Private Equity in Mexico: Investing in a New Business Environment report by AMEXCAP, the private equity market continues to grow at a compound annual growth rate (“CAGR”) of 21.6% since 2005, allowing the private equity market to reach more than USD58 billion in committed capital in the real estate, project finance, infrastructure, energy and venture capital sectors, among others. In general, the private equity industry has grown with both domestic and international participants.
Initially, the usual operations of domestic participants were based mainly on family-owned businesses, since regulation constrained public pension funds to investing in private equity markets. In this regard, regulation that initially prevented such investments in private equity was modified in 2009. As a result, public pension funds in Mexico were permitted to execute investments in publicly traded vehicles, managed by a general partner, acting as a platform to carry out investments in the private equity markets.
As a direct result, the amount of equity injected into the private equity market was significantly increased, to more than USD6 billion, according to the aforementioned AMEXCAP report. Furthermore, the incorporation of new private equity firms in Mexico has increased, with the establishment of firms such as Nexxus Capital and EMX Capital. With the introduction of private equity firms, transactions in the industry in Mexico have increased significantly over the ten years since the modification of their regulation in 2009.
Regarding international participants, historical data has shown that investments pouring into Mexico have greatly increased despite the COVID-19 pandemic, with renowned firms such as Evercore and Southern Cross permanently establishing offices and, as such, a physical presence in Mexico. Furthermore, historical data has shown that the macroeconomic market in Mexico has been comparably stable, which in turn has allowed foreign firms to invest from their main offices abroad, resulting in investment trends in various sectors, such as venture capital and growth and leveraged buyouts (“LBOs”), focusing mainly on the healthcare, consumer products and financial industries, where market presence is usually larger and development opportunities abound. Historically, the real estate market sector has benefitted the most in past years, offering an attractive internal rate of return (“IRR”).
However, on 1 December 2018, Mexico had a change in administration with the election of the new Mexican president, Andrés Manuel López Obrador. As a consequence, the enactment of new policies and laws has generated uncertainty in the markets; investors have been forced to apportion their resources into low-risk assets and to carefully select their investments going forward due to events such as:
All these factors have put pressure on the Mexican government to take steps to lift the struggling economy.
As a direct result, the real estate market sector has seen a lower number of transactions and lower committed capital. However, the very nature of the real estate market allows it to recover over time, particularly with the new government’s projects in the southern states of Mexico, which include the Mayan Train route, a 1,525 km project crossing several Mexican states, which is intended to boost tourism in such regions and improve the infrastructure of the country.
As mentioned in 1.1 M&A Transactions and Deals, the real estate sector has benefitted the most in recent years. However, the venture capital, growth & LBO, infrastructure and energy sectors have also presented large accumulated capital commitments in Mexico.
During 2019, the venture capital sector registered approximately USD700 million in project finance, which represented an approximate growth of 86% between 2016 and 2019.
These commitments have translated into an estimated growth for 2020 in several industries, such as financial technology institutions ("fintechs”), e-commerce, financial services, retail and consumer goods, healthcare, and infrastructure and energy.
The most relevant legal developments in recent years include the creation of publicly listed vehicles, such as fiduciary certificates of capital development (certificados bursátiles de capital de desarrollo – “CKDs”) and fiduciary investment project securitisation certificates (certificados bursátiles fiduciarios de proyectos de inversión – “CERPIs”), which have greatly increased their presence in the Mexican financial markets.
CKDs were created in 2009 by their inclusion in the Securities Market Law (Ley del Mercado de Valores – “LMV”) and the general provisions applicable to securities issuers and other participants in the securities market (Disposiciones de Carácter General aplicables a las emisoras de valores y a otros participantes del mercado de valores – “CUE”), in response to a growing demand for investment funds specialising in retirement funds (“SIEFOREs”) to be able to have more flexibility in their investments (SIEFOREs invest the resources of retirement fund administrators – “AFORES”) by means of diversifying investment portfolios in different assets, such as private corporations, acquiring an even larger base of institutional investors given the acquisition option by SIEFOREs.
CKDs must be issued through public tenders, and must be registered before the National Registry of Securities (Registro Nacional de Valores – “RNV”), with the offering and registration being authorised by the National Banking and Securities Commission (Comisión Nacional Bancaria y de Valores – “CNBV”), whilst being listed in an authorised security market, either the Mexican Stock Exchange (Bolsa Mexicana de Valores – “BMV”) or the Institutional Securities Market (Bolsa Institucional de Valores – “BIVA”).
Furthermore, CKDs aim to boost a project's performance by being linked to their underlying assets, generally in connection with the following industries:
Ever since their conception in 2009, CKDs have been issued by corporations in several industries; according to the Mexican Stock Exchange, 74% were aimed at infrastructure transactions and the remaining 26% were in private equity transactions. Their popularity in private equity transactions quickly gained recognition throughout the Mexican financial market, to the extent that, by 2015, the total amounts issued through CKDs were focused primarily on financing corporations committed to private equity and infrastructure transactions, with figures totalling approximately MXN53 billion and MXN46 billion, respectively.
On the other hand, CERPIs were created in 2015 through an amendment to the LMV and CUE, as an equity-aimed security that must be registered before the RNV and authorised by the CNBV, whilst also being listed in either the BMV or BIVA; they are required to be issued via restricted public tenders.
Mexican law defines CERPIs as certificates whose issuance resources are destined to finance projects, and to invest in stock or business interests, or to finance corporations, either directly or indirectly through one or several investment vehicles.
CERPIs and CKDs represent a relatively new investment opportunity in Mexico, enabling the Mexican financial markets to adapt to the operating mechanisms they provide. Furthermore, CERPIs and CKDs almost doubled their presence in the Mexican financial markets during fiscal year 2018 compared to fiscal year 2017; almost 92% were apportioned by private equity, and 50% were issued via CERPIs.
However, during fiscal year 2019, a lower issuance of CERPIs was observed compared to fiscal year 2018, mainly due to the record issuances of CERPIs in 2018.
In this sense, accumulated capital commitments for fiscal year 2019 rose to USD2.3 billion, totalling five CKDs and 13 CERPIs.
As previously mentioned, amendments to the LMV and CUE have generated a direct impact on private equity transactions in Mexico, by providing the rules for the issuance of both CKDs and CERPIS. Furthermore, the LMV was further amended in 2014 in order to establish and create additional regulations pertaining to CKDs, based on the existing rules in the CUE.
Additionally, Basham, Ringe y Correa, S.C. assisted Mexican asset management firm Arago Gestión with the issuance of the first CERPI of 2020 in the BMV, for an amount of up to MXN150 million. Arago Gestión intends to carry out investments by creating a broadly diversified portfolio in the private market, through international alternative asset funds, local funds whose investment strategy is mainly focused on Mexico, and joint ventures with emphasis on Mexican companies. This is a clear illustration of the fact that, despite the COVID-19 pandemic, opportunities in the Mexican private equity market are still rising.
The primary financial regulators for private equity funds and transactions under Mexican law include:
Mexican law does not provide specific regulation for M&A activities, per se. However, much will depend on the type of structure that each M&A transaction will intend to carry out, so the following regulators may apply, among others:
Over the years, Mexico has become an important party to foreign investment in most economic sectors and, as such, has been advancing its foreign investment framework. In general terms, foreign investments are regulated by the Foreign Investment Law (Ley de Inversión Extranjera – “LIE”) and its regulations. As per the LIE, and as a general rule, foreign investments in Mexico should be reported to the Foreign Investment Registry (Registro Nacional de Inversiones Extranjeras), which is a governmental registry that keeps a record of the Mexican entities operating in Mexico with foreign shareholders and capital.
The LIE provides the following definition of foreign investment:
In addition, pursuant to Article 7 of the LIE, there are particular sectors in which the percentage of foreign investment is legally regulated and limited, as follows:
In addition, the above-mentioned restrictions on foreign investment as set forth in the LIE must not be exceeded indirectly or directly through other agreements or trusts, nor through indirect foreign participation.
Furthermore, special authorisation from the CNIE is needed when foreign investment will exceed 49% in the following industries:
Antitrust matters are regulated under the Federal Economic Competition Law (Ley Federal de Competencia Económica – “LFCE”) and its regulations. Antitrust regulators, COFECE and IFT, have authority to clear transactions that exceed any of the thresholds provided in the LFCE. Note that a transaction will not have legal effects until it is authorised.
The LFCE provides exemptions to the pre-merger notice requirement, under specific circumstances – for instance, when the transaction is a corporate restructure or if it implies the incorporation of a trust whereby an economic agent transfers its assets, stock, etc, without the purpose or necessary consequence of transferring them to a company other than the trustor and the fiduciary institution.
In Mexico, legal due diligence exercises for private corporations are typically carried out on a broad basis, so as to avoid any present or future contingencies and liabilities. However, much will depend on the target entity, the type of activities it carries out, or the sector or industry of such target entity, and the legal due diligence will generally cover the following:
On the other hand, legal due diligence for publicly traded corporations is commonly limited to publicly available information, due to the standard confidentiality provisions.
Vendor due diligence is a common feature that provides full disclosure to potential investors, allowing vendors to maintain even greater control throughout the due diligence process, whilst paying close attention to any potential hidden defects or environmental matters, specifically pertaining to the real estate sector. On a more general level, activities carried out in Mexico must comply with the necessary governmental licences and authorisations and are subject to any potential remediation action.
Advisers may issue a legal opinion providing credibility to the private equity transaction, based on the documents reviewed and applicable law, which further speeds up the sale process.
Acquisitions by private equity funds are typically initiated through an initial deal evaluation by the buyer. Consequently, the buyer will approach the seller with an initial negotiation, most likely a year or less before an investment is agreed upon, and where assurances will be made regarding the intention of the buyer.
Consequently, if both parties come to an agreement, a broad legal due diligence process (as detailed in 4.1 General Information) will be carried out, in order to avoid any present or future contingencies or liabilities. The scope of the legal due diligence process will rely on the activities the potential private equity seller carries out, including the market sector it belongs to, financials and corporate matters.
Once the legal due diligence process is carried out, final negotiations between the parties are common, where final terms and conditions are agreed upon and the parties may then proceed to the signing of the legal documentation.
In Mexico, purchase agreements or subscription agreements of private equity transactions are common practice. It is important to consider that private equity transactions in Mexico are subject to both commercial and financial law.
Private equity-backed buyers generally carry out their acquisitions by means of special purpose vehicles ("SPVs"), which in many cases include limited partnerships, CKDs, trusts or private entities. In rare cases the private equity-backed buyer participates directly in the acquisition documentation.
Private equity deals are generally straightforward. In practice, most deals are financed through capital contributions by way of a shareholders' meeting of the target corporation, and the buyer will concurrently enter into a shareholders’ agreement with the target corporation, which sets forth the terms and conditions.
In Mexico, equity commitment letters may be used in order to provide certainty of funds from a private equity-backed buyer. Furthermore, most private equity deals in Mexico are commonly owned by the private equity fund and management executives.
Deals involving a consortium of private equity sponsors are allowed but are not common. In most cases, a single private equity firm will carry out the transaction.
Co-investment by other investors alongside the private equity fund is common. Furthermore, such investments are commonly passive stakes which, by nature, do not allow for voting rights in investment decisions.
Consideration structures will vary on a case-by-case basis, considering the size of the transaction, the investor profiles and the current market conditions.
Earn-out provisions are common, since they encourage an owner to remain active in their business for a specific period. This allows the private equity firm to purchase at a lower price and the owner to generate considerable revenue if the target corporation achieves a certain level of performance.
It is common for a seller to provide representations and warranties regarding their corporate purpose, liquidation procedures, spin-offs, insolvency events, bankruptcy or corporate restructuring, or any other representation or warranty that may provide further comfort to the buyer, as well as legal certainty, that may affect the private equity transaction in any way. In certain cases, bonds or personal guarantees may be granted in favour of a buyer, in order to provide further assurances.
The buyer will generally provide documentation regarding incorporation documents, powers of attorney, its intent on utilising the committed capital, and assurance that it has no knowledge of any actions, claims or procedures by any court, government agency or arbitrator affecting the legality, validity or enforceability of the pertinent private equity documents. In general, the buyer will provide assurances to the seller in connection with the origin of the funds that will be used for the acquisition, and its track record.
The charge of interest on leakage in locked-box consideration structures will vary on a case-by-case basis. Leakage clauses, by their very nature, provide legal certainty and protection on a locked-box (or fixed price) consideration in private equity transactions. Other than permitted leakage, which is agreed upon by the parties in a private equity transaction, said parties may establish an interest rate charge if a leakage occurs, upon mutual consent.
Dispute resolution mechanisms will usually be agreed upon by the parties in a private equity transaction if leakage takes place. The parties will also, upon mutual consent, come to a consensus as to what constitutes leakage and, as mentioned above, permitted leakage. Generally, these types of transactions will include an arbitration clause, as explained below.
It is common to include a typical level of conditionality, such as the condition for closing, but such conditions tend to vary depending on the size of the private equity transaction. Furthermore, market conditions and investor profiles tend to set the pace for certain levels of conditionality, alongside obtaining the necessary approvals from COFECE, including third-party consents such as key contractual counterparties.
Material adverse change/effect provisions are common in private equity transactions, particularly when financing is involved, as they directly influence fund certainty. They allow for each party to notify the other in cases of financial stability, insolvency events and disruption of services, among others.
It is common for a buyer to accept a “hell or high water” clause in Mexico.
Moreover, these types of clauses are generally aimed at buyers who are assuming all risk on antitrust matters in a private equity transaction. However, if the deal raises concerns, it is common for the commitments offered to the authority to be previously agreed by the parties.
Break fees are allowed and commonly used in Mexico and have no legal limits. Reverse break fees are allowed but are rarely employed.
In private equity transactions, the parties will generally agree upon mutual terms to terminate the acquisition agreement if the private equity seller or buyer refuses to carry out the actions necessary for the fulfilment of their obligations, or if the corresponding party fails to make payments of committed capital, notwithstanding the obligation of the investor to pay the non-compliance penalty usually set forth in the acquisition agreement.
The return on investment in a private equity transaction is uncertain by nature. Furthermore, the seller and buyer must fully commit to the nature of the investments carried out and the risks they entail, which even exist when decision-making is based on prudent criteria and best corporate practices by the seller. Both parties in a transaction will expressly accept that the return on investment cannot be guaranteed under any circumstances. In any case, the allocation of risk does not change according to the nature of the buyer or seller, except in very specific cases.
The main limitations on liability for the seller usually include limitations for indemnity clauses, a cap for damages and certain thresholds – this is to limit any potential liability for the seller that may emerge from their corresponding representations and warranties.
As the buyer will become the owner of the target corporation, it is common for the buyer to request the following warranties from the seller:
Additionally, please note that the seller is bound to comply with all the warranties that it provides to the buyer and will be liable to pay damages and losses that any default may cause the buyer. However, it is common to establish a penalty clause that will limit the responsibility of the seller in the event of default of any of the provided warranties; the amount established in the penalty clause is often the amount of the transaction (acquisition of the shares or the amount of the investment).
It is also important to note that the management team does not provide any direct warranties to the buyer, since the seller shall guarantee that the management team can carry out the daily activities and management of the target corporation. Moreover, under Mexican law, the management team is directly responsible for certain actions that they carry out in the target corporation.
Finally, if the limitation of liability is not contemplated, the seller will be liable for any damages and losses that it may cause the buyer, which will have to be proven to a competent judge in a court procedure, and the competent court by its own discretion will establish an amount for such losses and damages.
In most cases, both the seller and the management team will provide indemnities for the buyer. In some cases, personal guarantees are included to entice the buyer. W&I insurance is not common in Mexico. However, it is common to have an escrow or retention in place to back the obligations of a seller; this it can be used if the parties agree.
In Mexico, litigation is not common in private equity transactions. More often, disputes between the parties will be settled via arbitration or mediation, or some other form of conciliation.
Bodies such as the International Chamber of Commerce (Cámara de Comercio Internacional), the Mexican Arbitration Association (Centro de Arbitraje de México) and the American Arbitration Association are the preferred entities to rule on an arbitration.
Public-to-privates are not common in private equity transactions. To provide context, there are approximately 145 public companies listed in the BMV and BIVA, all of which have a high shareholder concentration and are not open to be sold.
As discussed in 7.3 Mandatory Offer Thresholds, material shareholding disclosure thresholds must be set for publicly listed corporations, as per Article 98 of LMV. This does not apply to private corporations.
Furthermore, as per articles 109, 110 and 111 of the LMV, publicly listed corporations should make the following information public:
The foregoing does not apply to private entities, and there are no disclosure thresholds under Mexican law.
Under Article 98 of the LMV, a mandatary offer must be made if a person or group of persons intends to acquire or achieve by any means, directly or indirectly, the ownership of 30% or more of the common shares of a corporation registered in the RNV, inside or outside of a stock exchange, by one transaction or several successive transactions; such entity will be obliged to carry out the acquisition by means of a public offer, as set forth in Article 97 of the LMV, and in accordance with the following:
The LMV does not currently provide for a specific type of consideration, but cash is more commonly used for the target shareholders in the acquisition processes for both public and private corporations.
Shares, negotiable instruments or cash with the option to re-invest all or a portion of the cash proceeds in other securities may also be offered as consideration.
As mentioned above, Article 98 of the LMV provides that the consideration offered must be equal, regardless of the class or series of the target's shares.
It is important to consider that a minimum level of consideration is not required under Mexican law, although the CNBV may issue an opinion with regards to the fairness of the consideration.
The regulators allow offer conditions, which are necessary in certain specific situations. In some instances, as previously explained, an approval from COFECE is necessary to close an acquisition, so the parties include a condition that requires the authorisation from COFECE, otherwise the transaction will be retroactively voided. Conditions that require the bidder to obtain financing are not common, but have occurred in the past, and the regulators will not restrict the use of such a condition. Other security measures include break fees (as explained above), and rights of first refusal.
The bidder may seek control of the board of directors or another governing body in an entity. Furthermore, in the case of investment promotion in limited liability stock companies, all of the governance rights may be carried in a minority stake (such as appointing members of the board and voting on day-to-day matters, among others). Squeeze-outs are not common and, as provided below, are prevented by minority rights set forth in the applicable laws.
Irrevocable commitments are uncommon in Mexico. When they are used, there are generally outs available for the seller if they receive a better offer. Generally, the irrevocable commitment ends through the passage of time.
Hostile takeovers are permitted under Mexican law, mainly the LMV.
However, it is important to consider that the relatively low number of public corporations mixed with a high shareholder concentration tends to discourage hostile takeovers in Mexico, which are uncommon, with there being just two attempts at hostile takeovers in the past.
During 2015, the Mexican Supreme Court ruled that any provisions in the company by-laws aimed at deterring or limiting hostile takeovers must be in accordance with Article 48 of the LMV in order to be valid. This is almost always the case in Mexican publicly traded corporations.
Equity incentivisation of the management team is common in certain transactions and is generally permitted under Mexican law – this includes equity from public entities (to the extent that the terms set forth in Article 8 of the LMV are followed).
The level of equity ownership varies, depending on the private equity transaction. There is no predetermined amount used as a reference.
Mexican transactions of this nature vary from case to case; in some cases, management may receive ordinary equity, in other cases preferred equity, and in still other cases cash considerations.
The typical leaver provisions are aimed at maintaining the services of management shareholders, who by their nature are key employees. The scope of leaver provisions is focused on retaining the original management team to maximise the target corporation’s growth from the start of the private equity transaction.
The typical vesting provisions are aimed at protecting management shareholders from any contingencies and liabilities that may rise from the relationship between a buyer and seller from the very beginning of the transaction.
In Mexico, common restrictive covenants agreed to by management shareholders include non-compete and non-solicitation undertakings. The limits of enforceability will generally be mutually agreed between the parties.
The General Corporations Law (Ley General de Sociedades Mercantiles – “LGSM”) and LMV provide minority rights that have to be included in a limited liability stock corporation and an investment promotion limited liability investment corporation.
Limited Liability Stock Corporation (Sociedad Anónima)
In a limited liability stock corporation, the following applies:
Investment Promotion Limited Liability Investment Corporation (Sociedad Anónima Promotora de Inversión – "SAPI")
In an investment promotion limited liability investment corporation, the following applies:
Management may not veto any decisions where minority shareholders have voting rights. Management teams may have the right to control or influence the exit of a private equity fund, but in many cases, they will require the prior approval of the shareholders' meeting.
Typically, private equity funds will require the capacity to carry out the day-to-day operations of a portfolio company. However, the LGSM requires certain percentages of votes for decisions that may affect or alter the corporate by-laws of the company, so the other shareholders will have to vote on resolutions in that regard. Finally, in some instances a threshold for specific amounts is set; if any actions over a predetermined amount are to be taken, then a vote by all shareholders will be required.
The only circumstance in which a shareholder could be liable for its actions in a company, and where the piercing of the corporate veil could occur, is if a corporation is used with the sole intent of defrauding third parties or circumventing the law. Such action will be considered to be misuse of a legal entity, so the issue would need to examine the core of the corporation in order to locate the author of such actions (which would be a shareholder or officer of the company).
The private equity fund shareholder typically imposes its compliance policies on the portfolio companies, especially if the private equity fund requires such compliance policies to be followed in order to achieve its overall objectives.
In Mexico, private equity transactions are usually long term. The parties in a private equity transaction will usually agree upon the investment holding period, which can range from three or five years up to ten years. Furthermore, it is common practice to establish clauses allowing the extension of the holding period for up to two additional years.
The most common form of private equity exit is the sale of the target corporation to other funds or investors. IPO exits are not common in Mexico. Furthermore, private equity sellers may choose to reinvest upon exit, which will often be based upon current market conditions and seller liquidity.
Under Mexican law, drag-along right clauses (derecho de arrastre) may only be enforced in equity arrangements if such a provision is present in the targets’ by-laws; otherwise, as per Mexican law, there is no legal action to force minority shareholders into selling their shares.
Drag-along rights are fairly common in Mexico, dating back to before the enactment of the LMV in 2006. Nowadays, under the SAPI regime, it is possible to enforce compliance with drag-along rights, since Mexican law provides for additional exceptions to the free circulation of shares. However, the opposition of buying or selling would necessarily have to go through a judicial process.
Conceptually, tag-along right clauses (derecho de acompañamiento) are aimed at protecting the interests of minority shareholders, enabling them to join a transaction under the same conditions as a majority shareholder. If the private equity fund shareholders (acting as majority shareholders) sell a stake, the management shareholders (acting as minority shareholders) will enjoy tag-along rights, so long as such provision exists in the target's by-laws.
As per Mexican law, there is currently no tag-along threshold, but parties may choose to include a certain threshold in the target's by-laws.
Exit by way of an IPO is not a common practice in Mexico. In this regard, lock-ups are not commonly enforced on investors.
Although not common practice in Mexico, relationship agreements may be entered into between the private equity seller and the target company.