[co-authors: Jorge León Orantes B., César G. Cruz Ayala, Diego R. Acosta Chin]*
World Law Group member firms recently collaborated on a Global Venture Capital Guide that covers more than 30 jurisdictions on investment approval processes, typical investment sectors and investment structures on Venture Capital deals (and more!).
The guide does not claim to be comprehensive, and laws in this area are quickly evolving. In particular, it does not replace professional and detailed legal advice, as facts and circumstances vary on a case-by-case basis and country-specific regulations may change.
This chapter covers Mexico. View the full guide.
Santamarina y Steta S.C.
- In your jurisdiction, which sectors do venture capital funds typically invest in?
Venture capital activity in Mexico has been less dynamic compared to other jurisdictions in Latin America, and therefore, sector participation is not clearly defined in Mexico. However, according to the Mexican Association of Private Capital (AMEXCAP, as per its acronym in Spanish), in recent years those key sectors attracting venture capital investments in Mexico include consumer services, consumer goods, technology, and FinTech.
- Do venture capital funds require any approvals before investing in your jurisdiction?
There is no approval requirement per se for venture capital investments; however, there are certain sectors and activities that require approval from the National Foreign Investment Commission regardless of the vehicle for the investment. Such approval is required when the investment exceeds a certain percentage of equity or the assets of the target entity exceed a certain value. Some of those sectors and activities are private education, legal services, and shipping companies with deep sea vessels, among others.
Venture capital funds incorporated under Mexican law may be subject to approvals depending on the type of structure that will be adopted for the venture capital fund. For example, if the fund is created under the Investment Funds Law, the fund would require the authorization of the National Banking and Securities Commission (CNBV, as per its acronym in Spanish).
- Are there any legal limitations to an offshore venture capital fund acquiring control or influencing the business, operations, or governance of an investee entity?
As any other private entity, offshore venture capital funds cannot participate in those activities that are reserved to the Government or Mexican individuals and companies (for example, nuclear energy, mints, operation of ports, airports, and heliports, domestic land transportation, and development bank activities, among others).
Additionally, and also as any other private entity, there are certain activities/companies in which foreign investment’s participation has been restricted up to certain percentages, such as: (i) production cooperative companies; (ii) manufacturing and marketing of explosives, firearms, cartridges, and fireworks; (iii) printing and publishing newspapers for exclusive distribution in the national territory; and (iv) supply of fuel and lubricants for ships and aircraft railway equipment, among others. Foreign investment restriction may vary from 10% to 49%.
Note that foreign investment may exceed this percentage to the extent such is carried out through neutral investment in terms of the Foreign Investment Law. Although this type of investment does not compute as foreign investment, an authorization of the Ministry of Economy would be needed.
- Would an investor be required to undertake an antitrust analysis prior to investment? When would such a requirement be triggered?
Yes, antitrust analysis and pre-merger clearance is required prior to carrying out the investment. Although Mexican law provides certain exemptions to mandatory pre-merger clearance, they are limited to investment funds participating in a target with limited rights and exercising no control, either de “iure” or “de facto”.
The statutory 2020 thresholds requiring pre-merger clearance are as follows, regardless if the investment takes place as a result of a single or a series of acts:
- Value of the transaction: if there is an accumulation in Mexico, directly or indirectly, that exceeds approximately USD 80 million (regardless of the place of execution).
- Value of the assets/sales of the target: if there is an accumulation of 35% or more of the assets or equity of a target, whose assets located in Mexico or annual sales originated in Mexico exceed approximately USD 80 million.
- Accumulation of Mexican assets & value of the annual sales of the economic groups participating in the transaction: if there is an accumulation in Mexico of assets or equity that exceeds approximately USD 37.5 million and the transaction is between two or more economic agents whose annual sales or assets in Mexico (either jointly or separately) exceed approximately USD 214 million.
- What are the preferred structures for investment in venture capital deals? What are the primary drivers for each of these structures?
Venture capital deals in Mexico are usually structured as a trust, a Mexican company, or a fund under the Investment Funds Law.
Generally, the primary driver to choose one structure over another is associated with tax efficiency, protection mechanisms that can be implemented for the investor (such as right of first refusal, drag-along, tag-along and preemptive right, among others), complexity of the transaction, and the number of investors.
These venture capital vehicles usually invest by acquiring shares of the target entity, Capital Development Certificates (CKD) issued by Mexican trusts, and/or other instruments issued by the target entity as a result of the issuance of debt.
- Is there any restriction on rights available to venture capital investors in public companies?
Under Mexican Securities Market Law, venture capital investors have no restrictions, although other restrictions may be applicable depending on the type of fund. For example, retirement funds have strict investment regimes.
- What protections are generally available to venture capital investors in your jurisdiction?
The protections available to venture capital investors depend on the type of entity in which they invest and the way in which the investment is structured (i.e., by acquisition of shares or by issuance of debt).
Mexican law contemplates rights that are available to shareholders or partners of Mexican companies, which include, among others, preemptive rights, supermajority resolutions, and deadlock mechanisms. Also, statutory protections are available to minority shareholders or partners, which include the possibility to appoint a member of the administration body of the company, appoint an examiner of the company, and oppose by means of a judicial proceeding those resolutions adopted at the general shareholders’ meeting.
Mexico is party to 12 free trade agreements which incorporate common international standards to protect investments such as national treatment and most-favored-nation.
Finally, standard clauses can implement other protections for investors to ensure preferential rights over dividends or exit rights such as drag-along and tag-along.
- Is warranty and indemnity insurance common in your jurisdiction? Are there any legal or practical challenges associated with obtaining such insurance?
Warranty and indemnity insurance is a relatively new product in Mexico of which use in M&A transactions is certainly not as enthusiastic as in to other jurisdictions. This may be explained in part by the Mexican culture considering that, generally speaking, Mexico’s insurance activity represents 2.2% of Mexico’s GDP compared to the average of 8.9% of the OECD countries (as of 2018). Also, there are many global transactions in which the Mexican target is indirectly acquired and for which it is reasonable to assume that when warranty and indemnity insurance is to be contracted, the placement of the policy will occur outside of Mexico to cover the whole transaction. Legally speaking there are no challenges, but as mentioned above, currently the implementation of this type of insurance is not very common in Mexico.
- What are common exit mechanisms adopted in venture capital transactions, and what, if any, are the risks or challenges associated with such exits?
The most common exit mechanism adopted in venture capital transactions in Mexico is the strategic sale, which according to statistics published by AMEXCAP, represents 63% of the exits of venture capital that occurred from 2008 to 2018.
In addition to drag-along and tag-along, in the event of deadlock that would be triggered upon certain events, there are other standard mechanisms used by venture capital firms less frequently such as a recapitalization, sponsor-to-sponsor transactions, and liquidation.
Although we do not see many legal risks associated with adopting a strategic sale as an exit mechanism, a common challenge that we typically see is finding a buyer and agreeing on the exit price, especially if the target is underperforming.
- Do investors typically opt for a public market exit via an IPO? Are there any specific public market challenges that need to be addressed?
Although the use of an IPO as an exit mechanism is viable from a legal perspective and even agreed upon as a possibility in transaction documents, this exit method is rarely used as it would require further financial analysis about the attractiveness of the target entity and the existence of the proper environment in the markets for an IPO to occur. Perhaps this is explained in part by the size of the Mexican stock market and number of private equity transactions, as well as the costs and time associated with this exit mechanism.
*Santamarina y Steta, S.C.