Mexico: Venture Capital A Rare Commodity

07/13/2005

Author:
Benedict Mander
Miami Herald
Miami, FL
United States
www.herald.com

Categories:
Federal Programs
Industry Regulation
Venture Capital

Preview:
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.

Article:
Finding money for small- and mid-sized businesses in Mexico is a challenge as over-regulation stifles capital flow.

Posted on Wed, Jul. 13, 2005 -- 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 $2 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 only 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 channelled 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.

''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 $60m in Mexico and is expecting an internal rate of return of 30 percent in its newest fund.

HELP FROM THE LAW

It is hoped, however, that 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 U.S., 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,'' Krensky said.

''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 to invest in companies exporting to the U.S. and Canada.

The fund succeeded in raising $50 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.''

BUSINESS SPIRIT

With a few small exceptions, ''there is not the entrepreneurial spirit that exists in the U.S.'' 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,'' Krensky said. 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 Sanchez 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 $200 million in Mexico and tripling the original investment of its first fund.

The most significant change to boost the market would be to allow pension funds -- known as Afores -- to invest in venture capital. In the U.S. it is the most important source of venture capital funds, providing about half of all such funding over the past 20 years.

Perezcano said 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 U.S. with some $250bn, more than percent of which is from pension funds.

Afores manage about $45 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 1 percent of their funds was invested in venture capital, Perezcano says the industry could easily double.

By BENEDICT MANDER for the Financial Times