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 Business News | July 2005 
Regulations Discourage Venture Capital
 Benedict Mander - Financial Times
| | The flow has been stifled by laws, but proposed legislation could provide a solution. |
Funding opportunities for Mexico's small businesses are few and far between. Not only is the country's illiquid stock market dominated by a handful of big groups but inflows through venture capital an important stimulator of growth in small businesses are being stifled by over-regulation.
There is about US2 billion of venture capital in Mexico, where the nascent industry suffered a major setback with the Tequila crisis of 1994-95. Although Latin America receives just 1 percent of global venture capital, Mexico receives only 10 percent of that within the region, in spite of attracting 40 percent of the region's foreign investment.
What little venture capital there is is channeled towards bigger deals, where higher profits can offset the costs of setting up funds.
Most of these deals choose to incorporate in Canada, partly because of a quirk in Mexico's tax law as well as better prospects of a successful exit.
‘BEST CONDITIONS POSSIBLE’
"The current regulations don't help very much, but it's not a reason not to invest we can find ways to invest properly in the best conditions possible," says Jaime Salinas, managing director of Darby Overseas, which has more than US60 million in Mexico and is expecting an internal rate of return of 30 percent in its newest fund.
However, it is hoped a new capital markets law under debate in Mexico's Congress will go some way to improving the situation, by strengthening corporate governance and the rights of minority shareholders in particular. Alfredo Alfaro, a partner of big local player Advent International, says control over his investments is critical: "Majority ownership is important because unfortunately Mexico's legal system needs to evolve to guarantee the protection of the rights of minority shareholders." Harry Krensky, a founding partner of Discovery Capital, says the market is the opposite of the United States, where he believes there is too much capital chasing too few opportunities.
He says fundraising within Mexico is a serious problem, with 80 percent of venture capital coming from foreign investors. "There's a lack of interest in putting money to work by Mexican investors, so funds are raising much less than you might expect," says Krensky. "In Mexico there is a lack of a venture capital culture. There is a very marked preference for investing in liquid short-term instruments," adds Luis Perezcano, who runs the Nafta Fund, which was set up in 2003 to invest in companies exporting to the United States and Canada.
The fund succeeded in raising US50 million, only half of the target. Luis Tellez, who runs the Carlyle Group's investments in Mexico and was chief of staff for Ernesto Zedillo's government in the 1990s, sees the problem in "more profound terms."
LACK OF ENTREPRENEURIAL SPIRIT
With a few small exceptions, "there is not the entrepreneurial spirit that exists in the United States" as many medium-sized companies are family owned and conservatively run. The new law will create a special opt-in regime, which would follow international best practice through a "sapi" (investment promotion vehicle). This would allow funds to list on the stock exchange gradually, with up to three years to comply with the requirements of publicly traded companies providing much more realistic prospects for funds to achieve an exit from their investments profitably. This is a problem, particularly for small deals. "I would love to do small deals, as the returns can be much higher, I just don't see the exits," says Krensky. Initial public offerings in Mexico are rare with mergers and acquisitions providing the best prospects for exits. But the new capital markets law is no panacea. Arturo Saval, who runs ZN Mexico which successfully executed one of just five venture capital-backed Latin American IPOs in 2004, with developer Homex believes fiscal transparency for investors is the main problem.
Unlike Canada-incorporated funds, U.S. and offshore funds are not considered fiscally transparent, and are subject to double taxation for both the fund and the investor. A recent study of best practice in the industry by Eduardo Mapes Sánchez of Nafinsa, Mexico's development bank, highlights the lack of an appropriate vehicle for incorporating venture capital funds in Mexico. It says funds should be able to incorporate in Mexico as limited liability partnerships, rather than being forced to do so in Canada. Saval agrees this is a serious flaw, although "we can live with that." It has not prevented ZN Mexico from investing some US200 million in Mexico and tripling the original investment of its first fund.
OPENING TO AFORES
The most significant change to boost the market would be to allow pension funds known as Afores to invest in venture capital. In the United States it is the most important source of venture capital funds, providing about half of all such funding over the past 20 years.
Perezcano says the Mexican market, which has about 30 funds, is roughly the same size now as the U.S. market was in the 1970s before pension funds had access. There are now almost 1,000 funds in the United States with some US250 billion, more than 40 percent of which is from pension funds.
Afores manage about US45 billion, 99 percent of which is invested in debt, mostly government bonds. A new law was passed last year allowing them to invest 15 percent in equity although so far this accounts for only 1 percent of their investments. If just 1 percent of their funds was invested in venture capital, Perezcano says the size of the industry could easily double. |
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