By: Luis Alberto Harvey
Nexxus Capital, S.A. de C.V
The private equity industry, as are known internationally investments in private companies, is very important in the world. The vast majority of companies listed on developed markets stock exchanges have received private equity capital at one time or another.
Within the theory of diversification of portfolios the most important asset classes are: stocks, fixed income and cash. Investments that are not one of the Traditional Investments are known as Alternative Investments. These are more complex, have different regulations and limited liquidity.
Private equity is one of the most important types of Alternative Investments. Other important investments types are real estate, precious metals, raw materials, art and jewelry, among others.
Throughout the world, institutional investors are the most important private equity investors. They include public and private pension funds, insurance companies and development banks, such as the International Finance Corporation (IFC). Other major investors are universities, foundations and wealthy families.
During the last decade, a new, very powerful group of institutional investors was formed: the sovereign wealth investment funds. These funds are a vehicle created by countries with substantial foreign monetary reserves to obtain additional returns for those reserves. Among the most important sovereign wealth funds are Abu Dhabi Investment Authority, GIC and Temasek of Singapore, Kuwait Investment Office and China Investment Corporation.
The participation of institutional investors in Alternative Investments is small, typically totaling less than 10% of their total investible funds. The intention is to obtain higher yields than those produced by Traditional Investments, so that the average of all investments yield a higher return. They are interested in Alternative Investments since they have lower correlation with Traditional Investments.
Private Equity in Mexico
The private equity industry in Mexico has been in existence for a short time. The first investments were in the early 1990s and the industry havs developed slower than in other countries.
Private Equity investments in Mexico as a percentage of GDP has been around 0.03%. This compares with 0.2% in Brazil, 0.4% in Chile, 0.4%, and 0.5% in Peru. In developed countries these percentages are much greater. In Europe, the average has been approximately 0.8% and in the United States, more than 3.0% of GDP.
In recent years, the number of private equity funds operating in Mexico has increased, and therefore more transactions have taken place between 2000 and 2010.
In developed countries, in the Asian markets and in Brazil, private equity has been a great catalyst for the institutionalization and growth of many medium-sized companies. In many cases, they are now listed on the stock exchange, and have boosted the development of these countries’ economies.
For example, during 2009 and 2010, there were about 80 private equity transactions a year in Brazil, while in Mexico there were 25 in 2009 and 19 in 2010.
The size of the industry in Mexico is small in relation to its economy and we expect it to grow in the coming years. Mexican financial authorities took a big step in 2010, when they launched the Capital Development Certificates (CKDs). Through these certificates, the AFORES, private pension funds and insurance companies can now invest in private equity. We hope that the participation of Mexican investors – including institutional investors like AFORES, private pension funds and insurance companies – increases substantially and reverses the trend of the past, when more than 70% of the private equity investment in Mexico was made by foreign investors.
Overall, private equity investments in Mexico operate in the same way as in other countries. Each private equity fund has its own peculiarities, but they all follow similar procedures.
In the private equityindustry, investment activities can be broken down into several areas, including the following:
Venture Capital – Investments in new companies or start- up operations.
Early Stage – Investments in established, but young companies.
Late Stage – Investments in well-established companies and with a good market position.
Industry Specific – Investments in companies of a particular industry.
Investments are also made in accordance with the financial situation of the company and the destination of the resources. There are funds that specialize in buying financially troubled companies: they solve their problems and then sell them. Other funds invest in companies to help them put their finances in order so they can eventually grow. Funds also invest in what is known as expansion capital, with the idea that the amount invested will be used exclusively for growth.
Private equity funds can also be used to buy a percentage of a company or the entire firm. Some funds will only start with a minimum purchase of 51% of the company. In many cases, in addition to funding the growth of the company, the original shareholders need liquidity and they sell part of their actions to the fund, which is known as a secondary sale. Capital increases are commonly known as primary investment.
Although funds may have their investment preferences, many investments are a combination of the options we have just mentioned. It is very common for a fund to make a primaryinvestment and at the same time a secondary sale to provide liquidity to the original shareholders.
Nexxus Capital has been managing this type of investments for more than 12 years. We define ourselves as a generalist fund that invests in growth capital for companies Late Stage companies.
The investment process is divided into four key stages:
1. Search and Analysis of Investment Opportunities
In the first stage, the investment opportunities presented to the fund are analyzed as are the opportunities generated by the fund’s executives who communicate directly with companies that have the potential to receive a private equity investment.
Each fund determines its investment guidelines, in which they define the industries of interest, the size of the target companies, the amount of investment, the share of the company they want to acquire, and the preferred expectations for divestiture.
Many investment opportunities are examined to find those with the greatest growth potential, according to the fund’s preferences. At this stage, continual talks with the owners of the company are maintained.
When a company meets the requirements that the fund is looking for, a letter of Terms and Conditions is negotiated with the owners. This letter defines the principal terms of the investment, which includes a preliminary valuation, although the company’s financial situation has not yet been verified in detail.
During the analysis of the company, possible ways to divest in the future will begin to be identified.
2. Structuring and Closing the Investment
At this stage, the investment is structured according to the terms and conditions negotiated in the previous stage. The executives of the fund conduct a thorough analysis of the financial situation and operations of the company. Auditors are hired to verify the accounting and fiscal information of the company and, on many occasions, industry specialists are called on to analyze its operations in more detail.
According to the results obtained in the operational, accounting and financial review, and an analysis of the industry and the competitive situation of the company, it is determined if the valuation and the terms of association or purchase are appropriate. Given that the information provided by the company has been validated, a new negotiation with the owners generally follows. If both parties are in agreement, the lawyers prepare a stock subscription agreement and a shareholders agreement in the event of a partial purchase or a capital increase of the company, or a purchase agreement in the event of a total acquisition of the company.
When the contracts are ready, it is time to close the transaction. The time that elapses between the first talks with the owners of a company and the closing of a transaction is approximately between four and eight months.
3. Operation and Growth of the Company
During the negotiation of the transaction, the analysis of the company’s operations will identify what areas need to be strengthened and whether the quality of the management must improve. Many companies do not have the right personnel to enter a phase of accelerated growth. Therefore, it is important to determine what management needs to be hired to improve and enhance the operations of the company.
The areas that generally require rapid changes are finance, sales and marketing. The area of operations must be reinforced, taking care not to affect the day-to-day operation of the company.
Under normal conditions, medium-sized companies do not have the appropriate capital structure or debt. Once the investment is made, the capital structure of the company improves substantially because the investment always includes an injection of capital. The debt structure of a company almost always has to be modified. Usually, these companies are financed by suppliers or with short-term debt. It is important to obtain a reasonable amount of medium term debt and restructure the relationship with suppliers to obtain adequate suppliers financing without affecting them. If the plan is to increase the company’s operations, it is important to have suppliers that can satisfactorily cover the growing needs of the business.
This phase is paramount because growing businesses face greater chances of losing control of the main operational variables. In many cases, after a period of growth it is necessary to dedicate some time to consolidate operations before starting a new period of growth.
4. Divestiture
Private equity funds are structured to receive funds from investors, invest them in companies, help these companies grow and then sell them at a higher price in order to give back to the investor the amount originally invested, plus the return. Normally, this cycle lasts between six and twelve years. At the end, the funds always divest, so an important part of the analysis prior to investing involves the examination of the possible ways to divest from the company.
The main forms of divestment are:
Sale to a consolidator
Sale to another private equity fund
Sale to the original shareholders
Company’s Initial Public Offering (IPO)
It is always an alternative to sell to another company that will consolidate the operations of the business in which the fund invested. There are companies that seek to consolidate industries by acquiring smaller players. They are willing to pay reasonable prices because it means buying market share.
In the same way, there are private equity funds that are already invested in an industry and are looking for smaller players in order to increase their investment in this sector. By increasing the volume of operations, they hope to be able to sell a larger company in the future or make an Initial Public Offering of the company in which they invested.
On many occasions, the shareholder agreemens include clauses with terms that allow the original shareholders to acquire the shares of the company owned by the private equity fund. In these cases, the original shareholders get bank financing and leverage the company to buy back the shares.
Finally, one of the most attractive ways to divest is through an Initial Public Offering of shares on a stock market. It is an interesting alternative because the private equity fund sells all or part of its stake in the company in the secondary portion of the public offering. Given that the company receives fresh resources with the primary portion of the offer, many times the private equity fund sells only a portion of its shares, with the expectation that the company will grow and they will be able to sell their remaining shares at a higher price.
What is required for a business to have access to private equity investors?
Entrepreneurs interested in obtaining capital to finance the growth of their company should focus on certain points to draw the attention of private equity fund managers.
The company must have the potential to grow. If not, the fund will be reluctant to invest in the company because it is looking for a return on its investment. This means the company needs to grow so that when the fund sells its stake, it will be able to do so at a higher price.
The size of the company is important when determining which type of fund to look for. If the company is small, there is no need to search for funds that invest in Late Stage. Likewise, a mature company is not going to be interested in Venture Capital or Early Stage funds.
The company should be prepared before contacting a fund. It is important to have the adequate corporate structure and appropriate accounting. If those are missing, the process will be much slower. Funds prefer to work with companies that are better prepared. They receive many investment requests each year, but they closely examine less than 30%, and invest in 2% or 3% of them. If a company is well prepared before beginning the process, it facilitates the fund’s analysis of the company’s merits.
The owner of the company has to be very clear about what he expects from a fund. Does he want some capital to grow? Does he intend to do what is necessary to maximize its development? Is he lacking capital or is he searching for a partner to help him grow? He must know the amount of capital he needs to change the future prospects of the company. There are many cases in which owners want less capital than the company really needs because they want to sell a lower percentage of the business. This is a fundamental issue for the funds because if the appropriate amount is not injected into the company, it is often impossible to make the investments and carry out the projects required for the company to grow.
It is important to have realistic expectations in relation to the time the investment process in the company will take. Approximately 60% of the transactions take between four and eight months; 25% require more and 15% less than four months.
Conclusions
Private equity may boost the growth of a company, provided that the owner is willing to make the necessary changes to support it.
Venture capital and Private Equity funds seek companies with committed and capable operators who they can count on to “institutionalize” the company and prepare it for a new stage of growth.
There are sufficient private equity funds in Mexico. Companies should look for funds that share common interests and objectives. ?
Private Equity Capital Investments
By: Luis Alberto Harvey
Nexxus Capital, S.A. de C.V
The private equity industry, as are known internationally investments in private companies, is very important in the world. The vast majority of companies listed on developed markets stock exchanges have received private equity capital at one time or another.
Within the theory of diversification of portfolios the most important asset classes are: stocks, fixed income and cash. Investments that are not one of the Traditional Investments are known as Alternative Investments. These are more complex, have different regulations and limited liquidity.
Private equity is one of the most important types of Alternative Investments. Other important investments types are real estate, precious metals, raw materials, art and jewelry, among others.
Throughout the world, institutional investors are the most important private equity investors. They include public and private pension funds, insurance companies and development banks, such as the International Finance Corporation (IFC). Other major investors are universities, foundations and wealthy families.
During the last decade, a new, very powerful group of institutional investors was formed: the sovereign wealth investment funds. These funds are a vehicle created by countries with substantial foreign monetary reserves to obtain additional returns for those reserves. Among the most important sovereign wealth funds are Abu Dhabi Investment Authority, GIC and Temasek of Singapore, Kuwait Investment Office and China Investment Corporation.
The participation of institutional investors in Alternative Investments is small, typically totaling less than 10% of their total investible funds. The intention is to obtain higher yields than those produced by Traditional Investments, so that the average of all investments yield a higher return. They are interested in Alternative Investments since they have lower correlation with Traditional Investments.
Private Equity in Mexico
The private equity industry in Mexico has been in existence for a short time. The first investments were in the early 1990s and the industry havs developed slower than in other countries.
Private Equity investments in Mexico as a percentage of GDP has been around 0.03%. This compares with 0.2% in Brazil, 0.4% in Chile, 0.4%, and 0.5% in Peru. In developed countries these percentages are much greater. In Europe, the average has been approximately 0.8% and in the United States, more than 3.0% of GDP.
In recent years, the number of private equity funds operating in Mexico has increased, and therefore more transactions have taken place between 2000 and 2010.
In developed countries, in the Asian markets and in Brazil, private equity has been a great catalyst for the institutionalization and growth of many medium-sized companies. In many cases, they are now listed on the stock exchange, and have boosted the development of these countries’ economies.
For example, during 2009 and 2010, there were about 80 private equity transactions a year in Brazil, while in Mexico there were 25 in 2009 and 19 in 2010.
The size of the industry in Mexico is small in relation to its economy and we expect it to grow in the coming years. Mexican financial authorities took a big step in 2010, when they launched the Capital Development Certificates (CKDs). Through these certificates, the AFORES, private pension funds and insurance companies can now invest in private equity. We hope that the participation of Mexican investors – including institutional investors like AFORES, private pension funds and insurance companies – increases substantially and reverses the trend of the past, when more than 70% of the private equity investment in Mexico was made by foreign investors.
Overall, private equity investments in Mexico operate in the same way as in other countries. Each private equity fund has its own peculiarities, but they all follow similar procedures.
In the private equityindustry, investment activities can be broken down into several areas, including the following:
Investments are also made in accordance with the financial situation of the company and the destination of the resources. There are funds that specialize in buying financially troubled companies: they solve their problems and then sell them. Other funds invest in companies to help them put their finances in order so they can eventually grow. Funds also invest in what is known as expansion capital, with the idea that the amount invested will be used exclusively for growth.
Private equity funds can also be used to buy a percentage of a company or the entire firm. Some funds will only start with a minimum purchase of 51% of the company. In many cases, in addition to funding the growth of the company, the original shareholders need liquidity and they sell part of their actions to the fund, which is known as a secondary sale. Capital increases are commonly known as primary investment.
Although funds may have their investment preferences, many investments are a combination of the options we have just mentioned. It is very common for a fund to make a primaryinvestment and at the same time a secondary sale to provide liquidity to the original shareholders.
Nexxus Capital has been managing this type of investments for more than 12 years. We define ourselves as a generalist fund that invests in growth capital for companies Late Stage companies.
The investment process is divided into four key stages:
1. Search and Analysis of Investment Opportunities
In the first stage, the investment opportunities presented to the fund are analyzed as are the opportunities generated by the fund’s executives who communicate directly with companies that have the potential to receive a private equity investment.
Each fund determines its investment guidelines, in which they define the industries of interest, the size of the target companies, the amount of investment, the share of the company they want to acquire, and the preferred expectations for divestiture.
Many investment opportunities are examined to find those with the greatest growth potential, according to the fund’s preferences. At this stage, continual talks with the owners of the company are maintained.
When a company meets the requirements that the fund is looking for, a letter of Terms and Conditions is negotiated with the owners. This letter defines the principal terms of the investment, which includes a preliminary valuation, although the company’s financial situation has not yet been verified in detail.
During the analysis of the company, possible ways to divest in the future will begin to be identified.
2. Structuring and Closing the Investment
At this stage, the investment is structured according to the terms and conditions negotiated in the previous stage. The executives of the fund conduct a thorough analysis of the financial situation and operations of the company. Auditors are hired to verify the accounting and fiscal information of the company and, on many occasions, industry specialists are called on to analyze its operations in more detail.
According to the results obtained in the operational, accounting and financial review, and an analysis of the industry and the competitive situation of the company, it is determined if the valuation and the terms of association or purchase are appropriate. Given that the information provided by the company has been validated, a new negotiation with the owners generally follows. If both parties are in agreement, the lawyers prepare a stock subscription agreement and a shareholders agreement in the event of a partial purchase or a capital increase of the company, or a purchase agreement in the event of a total acquisition of the company.
When the contracts are ready, it is time to close the transaction. The time that elapses between the first talks with the owners of a company and the closing of a transaction is approximately between four and eight months.
3. Operation and Growth of the Company
During the negotiation of the transaction, the analysis of the company’s operations will identify what areas need to be strengthened and whether the quality of the management must improve. Many companies do not have the right personnel to enter a phase of accelerated growth. Therefore, it is important to determine what management needs to be hired to improve and enhance the operations of the company.
The areas that generally require rapid changes are finance, sales and marketing. The area of operations must be reinforced, taking care not to affect the day-to-day operation of the company.
Under normal conditions, medium-sized companies do not have the appropriate capital structure or debt. Once the investment is made, the capital structure of the company improves substantially because the investment always includes an injection of capital. The debt structure of a company almost always has to be modified. Usually, these companies are financed by suppliers or with short-term debt. It is important to obtain a reasonable amount of medium term debt and restructure the relationship with suppliers to obtain adequate suppliers financing without affecting them. If the plan is to increase the company’s operations, it is important to have suppliers that can satisfactorily cover the growing needs of the business.
This phase is paramount because growing businesses face greater chances of losing control of the main operational variables. In many cases, after a period of growth it is necessary to dedicate some time to consolidate operations before starting a new period of growth.
4. Divestiture
Private equity funds are structured to receive funds from investors, invest them in companies, help these companies grow and then sell them at a higher price in order to give back to the investor the amount originally invested, plus the return. Normally, this cycle lasts between six and twelve years. At the end, the funds always divest, so an important part of the analysis prior to investing involves the examination of the possible ways to divest from the company.
The main forms of divestment are:
It is always an alternative to sell to another company that will consolidate the operations of the business in which the fund invested. There are companies that seek to consolidate industries by acquiring smaller players. They are willing to pay reasonable prices because it means buying market share.
In the same way, there are private equity funds that are already invested in an industry and are looking for smaller players in order to increase their investment in this sector. By increasing the volume of operations, they hope to be able to sell a larger company in the future or make an Initial Public Offering of the company in which they invested.
On many occasions, the shareholder agreemens include clauses with terms that allow the original shareholders to acquire the shares of the company owned by the private equity fund. In these cases, the original shareholders get bank financing and leverage the company to buy back the shares.
Finally, one of the most attractive ways to divest is through an Initial Public Offering of shares on a stock market. It is an interesting alternative because the private equity fund sells all or part of its stake in the company in the secondary portion of the public offering. Given that the company receives fresh resources with the primary portion of the offer, many times the private equity fund sells only a portion of its shares, with the expectation that the company will grow and they will be able to sell their remaining shares at a higher price.
What is required for a business to have access to private equity investors?
Entrepreneurs interested in obtaining capital to finance the growth of their company should focus on certain points to draw the attention of private equity fund managers.
Conclusions
Private equity may boost the growth of a company, provided that the owner is willing to make the necessary changes to support it.
Venture capital and Private Equity funds seek companies with committed and capable operators who they can count on to “institutionalize” the company and prepare it for a new stage of growth.
There are sufficient private equity funds in Mexico. Companies should look for funds that share common interests and objectives.
?