Decrease font Decrease font
Decrease font Decrease font
Enlarge font Enlarge font
Enlarge font Enlarge font

By Cate Ambrose
Executive Director, Latin America Venture Capital Association


An Agenda For Private Equity And Venture Capital In Latin America

At the same time that US policymakers aim to increase oversight of private equity, in Latin America fund managers and regulators are working together to expand private capital investment in the region within a framework of flexible and transparent rules. 

Over the last decade, political leaders in Brazil, Mexico, Chile, Colombia and Peru have demonstrated their commitment to sound macroeconomic policies and market-driven growth. At the same time, companies have seen new opportunities to serve expanding global and domestic demand for goods and services.

Latin American businesses have traditionally been starved for capital, with bank credit tight and shallow public markets. Today, financial investors are stepping in to fund mid-sized companies seeking growth capital. 

In this environment, a number of political leaders have recognized private equity and venture capital as a means to create, finance and professionalize businesses, and have launched campaigns to cultivate domestic fund industries.

A fundamental distinction between developed world private equity and the investments that are steadily increasing in Latin America is the relative lack of leverage in Latin American deals. Access to debt financing has been highly restricted in the region, and was just beginning to expand when the credit crisis first hit in 2007.

As a result, the region’s policymakers view private capital flows from global firms as a form of foreign direct investment. And local funds are often raised with commitments from high net worth sources and then invested in firms with high growth potential, efficiently reallocating capital within the economy.

An industry takes root

One of the earliest efforts to establish a domestic private capital industry took place in 1994 in Brazil when the head of the CVM, the country’s securities regulator, ushered in rules to create fundos mutuos de investimento em empresas emergentes (FIEEs), a fund vehicle for investing in smaller companies and start ups. This framework also provided a mechanism for local pension funds to allocate to venture capital, and by 1996 one or two pioneering Brazilian managers had secured the first commitments from local institutional investors. 

When fund managers found the FIEE structure cumbersome, they worked with the CVM to design a more flexible vehicle, which was better suited to later-stage private equity investments. The CVM finally approved the creation of fundos de investimento em participacoes (FIPs) in 2003, coinciding with the country’s economic expansion and paving the way for the creation of dozens of new private capital funds. The Brazilian pension funds have participated by increasing their allocations to venture capital and private equity – a 2001 decision by the National Monetary Council allows for investing up to 20% of total assets – consolidating a vital source of institutional capital for the local industry. 

Tapping local pension funds has also been a cornerstone of recent efforts in Colombia and Peru to develop domestic private capital industries. In Peru, four private pension funds have invested approximately $200m with Peruvian managers since enabling rules were in put in place in 2004.
Last December the country’s Superintendent of Banking and Insurance (SBS) passed landmark regulation allowing pension funds to diversify their private equity portfolios to international asset management firms looking to invest in Peru (in contrast to Brazil, where only locally registered firms are permitted to raise capital from domestic pension funds).

The SBS specifically cited the benefits of technology transfer and international competition in opening up the Peruvian market to global firms, and worked closely with emerging markets PE managers to design the December regulation. Previous rules were geared towards the mutual fund industry, and required non-Peruvian firms to have a minimum of $10bn under management globally, effectively barring mid-market growth capital firms from raising capital in Peru. 

Getting regulation right

Throughout Latin America, the problem of designing regulation that will work in practice has been resolved through what is in effect a trial and error process, with fund managers educating local regulators on the asset class. The Latin American Venture Capital Association (LAVCA) has played an active role on this front, with board members engaging with regulators in the policy revision process.

In Colombia, where political commitment from President Uribe’s office has focused attention and resources on nurturing a domestic private capital industry, managers worked together to reverse 2005 rules that required firms to report portfolio valuations daily, again imposing a mutual fund framework on private capital firms.

They presented their recommendations for adapting the regulation to a special unit within the Colombian Stock Exchange, which then worked with the Financial Superintendent to implement changes. A separate chapter was created for private equity in 2007. While there are still improvements to be made, all local funds operating in Colombia have adopted the new structure.

Mexican authorities have yet to create an efficient legal framework for registering private equity funds, despite ongoing efforts and political commitment. A 2004 report issued by state development bank Nacional Financiera (Nafinsa) highlighted recommendations for fund formation, authorization for pension funds to invest in alternative assets, and changes to corporate law.

Nafinsa’s efforts contributed to the provision of a new corporate category for Sociedades Anonimas Promotoras de Inversion (SAPIs), included in the 2005 Securities Market Law, which reflects major advances in corporate governance and allows investors to structure shareholder rights and privileges. The SAPI structure is intended to promote private equity and venture capital, and adopts global standards and practices such as tag-along and drag-along rights.

Regulation approved the same year to register private capital funds as fiduciary trusts, or Fideicomisos de Inversion en Capital Privado (FICAP), has been less effective -- managers describe the structure as complex, highly regulated and expensive. But Mexican and global firms active in the country have the interest of President Calderon and the support of Nafinsa as they lobby for a new framework.

Public money for private capital

Across the region, the commitment to enacting enabling regulation has been complemented by a range of targeted programs to fund emerging managers and educate local limited and general partners. 

In Brazil, an agency within the Science and Technology Ministry has been making equity investments in VC and PE funds since 2002 as part of a project developed with the Multilateral Investment Fund (MIF), a trust fund of the Inter-American Development Bank. The program includes coaching for entrepreneurs, training for new fund managers and investors on the asset class and the creation of a consortium of investors looking together at deals and performing due diligence jointly.

The Brazilian example has inspired publicly-funded programs in Mexico, Colombia, Chile and Argentina. Nafinsa sponsors a Mexican fund of funds which has committed $173m to 13 early stage and buyout managers since its inception in 2006. Colombian development bank Bancoldex is allocating US$30m to local PE and VC managers, co-investing alongside the country’s pension funds and other investors. And in Chile, state development agency Corfo is targeting seed and VC with a program that will allow it to commit up to 40 percent of a fund’s total capital.

Associations in Brazil (ABVCAP) and Mexico (AMEXCAP) have worked towards institutionalizing incipient private capital industries, creating an important platform for communication between managers, investors and regulators. Argentine managers have been working on the creation of an association since mid-2008, and Colombia expects to establish an organization this year. 

As a regional umbrella, LAVCA monitors activity across Latin America and seeks country-level practices and standards that might provide useful regional models. One way LAVCA achieves this is through its Annual Scorecard on the Private Equity and Venture Capital Investment Environment, which since 2006 has benchmarked 13 countries on indicators including laws governing fund formation, tax treatment, restrictions on institutional investors, intellectual property rights and bankruptcy regulation. The Scorecard focuses attention on countries where laws still represent a barrier to investment.

Latin America may also offer useful examples for the rest world – today ABVCAP is working towards a system in which a board comprised of investors, regulators and legal and accounting authorities would monitor compliance by private equity firms registered with the CVM. Perhaps US regulators would benefit from looking south as they grapple with the challenge of regulating private equity.

About the Author

Cate Ambrose

CATE AMBROSE
Executive Director, Latin America Venture Capital Association

Cate Ambrose joined the Latin American Venture Capital Association as Executive Director in August 2007. Her background with venture capital and private equity investment in the region dates back to the late 1990s. She is currently a member of the US-Brazil Venture Capital Task Force hosted by the Commerce Department and the Kauffman Foundation, and speaks and writes regularly on a range of topics related to public policy and private investment in Latin America.

Prior to joining LAVCA, Cate was Chief of Advocacy for the Commission on Legal Empowerment of the Poor, a United Nations initiative co-chaired by Peruvian economist Hernando de Soto and former US Secretary of State Madeleine Albright, where she directed research projects on business regulation and property rights in Mexico, Brazil, Guatemala, India, Kenya and Tanzania. Until 2005, Ms Ambrose was Executive Director of Programs at The Economist,where she founded the first industry gathering on private equity investment in Latin America, and chaired annual roundtables with the Presidents of Mexico and Colombia. She also chaired a range of meetings on finance, economic policy and business strategy in the US and Latin America, and founded The Global Agenda, a high-level panel of economists, policymakers and business leaders.

Cate began her career as a journalist in Spain. She holds an MPA in International Economic Policy from Columbia University, and received her BA in Latin American studies from St Lawrence University and the University of Madrid.