i GENERAL OVERVIEW
After a challenging 2016, in which only US$2.31 billion was raised by private equity funds (PEFs) and venture capital (VC) funds in Latin America, PEFs and VC funds raised a total of US$4.3 billion in, indicating a significant recovery. 2 However, those figures remain well below the totals of US$10.39 billion and US$7.21 billion raised in 2014 and 2015 respectively.
In contrast to the overall trend in Latin America, fundraising by Colombian PEFs and VC funds has seen significant growth, from the US$12 million raised in 2014 to US$102 million in 2015, and US$106 million in 2016 (although, in 2017, only US$49 million was raised).3
While in 2010 there were 30 private equity funds, with only 11 of those having finalised the fundraising period and 19 at the fundraising stage,4 in June 2018, 111 PEFs were active. Of these, 86 had closed the fundraising stage and 25 were still in the process of fundraising (three more than those reported by June 2017).5 As of June 2018, PEFs with operations in Colombia had received capital commitments for a total of US$35.23 billion for investments in Colombia and Latin America, in comparison to the US$28.59 billion in capital commitments received by the end of 2017.6 In 2018, Colombian PEFs at the fundraising stage aimed to raise US$1.58 billion for investments in Colombia and in Latin America, with US$514.1 million having been raised by June 2018. Furthermore, 58.8 per cent of the funds at the fundraising stage in June 2018 expected to achieve their financial close by the end of that year.7
Of the amounts PEFs and VC funds expected to raise by June 2018, 40 per cent was expected to be raised by real estate funds, 16 per cent by venture capital funds, 16 per cent by buyout and growth financing funds, 12 per cent by environmental and social impact initiative funds, 12 per cent by infrastructure funds, and 4 per cent by natural resources funds.8
The expansion of the private equity industry in Colombia is linked to the continuous growth of the economy since the early 2000s. Moreover, in the same period, the government has introduced regulations that have been welcomed by the private equity sector, and it has supported initiatives to promote the private equity industry. This includes new regulations regarding bankruptcy procedures, the adoption of the International Financial Reporting Standards, facilitating third-party valuation processes, and changes to the pension fund investment regime. In this context, it is worth highlighting Bancoldex, an entity designated by the government to invest directly in private equity and entrepreneurial initiatives, and to provide training and networking in aspects related to the private equity industry, and to promote it. As a result of these measures, Colombia has been recognised as an attractive and safe market for private equity investments.9
The above-mentioned statistics show that, in addition to the increase in the number of funds, PEFs have diversified in terms of the types of investments pursued by them. Infrastructure is a sector that has drawn attention and interest among investors and general partners (GPs). As a result of a solid public policy carried out by the government, support from national and international financial institutions, and governmental initiatives aiming to channel private and public resources into infrastructure initiatives, infrastructure projects have become a common investment area for recently incorporated PEFs.
As at June 2018, as the principal investors in PEFs (and the largest), pension funds continue to play an important role in the Colombian private equity market, providing 41.5 per cent of the capital commitments. Corporate investors lie in second place, with a 20.6 per cent share, followed by insurance companies and banks, which account for 5.9 per cent and 5.1 per cent of capital commitments respectively. The remaining 26.9 per cent is held by other investors, such as high-net-worth individuals (4.9 per cent), family offices (4.6 per cent), multilateral institutions (4.2 per cent), funds of funds (4 per cent), multi-family offices (3 per cent), sovereign funds (2.6 per cent) and endowments (3.1 per cent).10
Regarding the country of destination of the commitments, nearly 60.6 per cent of commitments are targeted at Latin American countries other than Colombia, with the remaining 39.4 per cent expected to be invested in Colombia.11
Recent significant fundraisings include the following:
- in 2017, BlackRock opened an infrastructure PEF looking to raise 825 billion Colombian pesos;
- in 2017, the Overseas Private Investment Corporation (OPIC), a US government agency, approved a US$488 million investment in developing countries, which included investment in Colombian real estate projects through its PEF, Avenida Capital Colombia Real Estate Fund II LP (CREF II);
- in 2017, Ashmore Colombia's fund Andean Fund II achieved a final closing equal to US$248 million;
- in July 2018, OPIC committed to invest up to US$50 million in CREF II;
- in August 2018, the Colombian fund Fondo Inmoilario Colombia raised 420 billion pesos from the Canadian pension fund PSP Investments; and
- in November 2018, the Canadian PEF Caisse de dépot et placement du Québec and the governmental financial entity National Development Finance (known as the FDN) announced the launch of a fund that will invest in infrastructure projects, which expects to raise approximately US$1 billion.
ii LEGAL FRAMEWORK FOR FUNDRAISING
i Legal form and jurisdiction
Unlike in other jurisdictions, in Colombia PEFs do not have a corporate nature. Thus, they are not incorporated under a limited liability partnership or as a limited liability company. Under the Colombian regime, PEFs are collective investment vehicles, which do not have legal capacity and are governed by particular rules depending on their characteristics. PEFs have a contractual nature, which mainly consists in a private placement memorandum that sets out the fund's rules, terms and conditions, and to which the LPs adhere.
Private equity funds are primarily regulated by Law 964 of 2005, Decree 2555 of 2010 (Decree 2555), which was amended by Decree 1984 of 2018 (see Section III), and the Legal Basic Circular issued by the Superintendence of Finances (SFC). Accounting rules are governed by the Accounting and Financial Circular issued by the SFC and the general accounting legal framework. In accordance with the definition of PEFs set out in Colombian regulations, these vehicles must invest at least two-thirds of their funds in assets or economic rights that differ from securities listed in the National Registry of Securities and Issuers (RNVE).
Private equity funds may be administered by three types of entities, broker-dealer firms, investment company administrators and trust companies, which are all supervised by the SFC. These institutions may decide whether to appoint a GP to manage the fund's investments, and to carry out the investment and divestment policies or to carry out those activities themselves. Market practice shows that fund administrators tend to appoint a GP to manage each fund.
The legal structure of PEFs ensures that the assets of the fund are segregated from the assets of the administrator and from those of the GP, assuring the autonomy and independence of the assets. Thus, in the event of a reorganisation or winding-up of the administrator, or of the GP, the assets of the fund will not enter into the procedures.
Choosing to incorporate the fund in an offshore jurisdiction is not an uncommon practice for PEFs that expect to operate and invest in Colombia. For instance, as at June 2018, 55 (49.5 per cent) of the 111 PEFs active in Colombia were incorporated in a foreign jurisdiction.12
Colombian regulations require the participation of parties that are not familiar to foreign investors, such as a fund administrator and asset valuator. The mandatory participation of third parties entails additional transactional costs that have to be borne by the fund, affect returns and that may be avoided if the fund is incorporated offshore.
From a foreign exchange standpoint, international investors face a double foreign exchange risk, given that the capital commitments are originally delivered in US dollars to be converted into pesos, and, when the participations are redeemed, pesos must be converted into dollars. These transactions require the foreign investment to be registered with the Colombian Central Bank and documentation to be filed with foreign exchange market intermediaries, which involves additional paperwork and costs. The registering of investments made by international limited partners (LPs) grants investors foreign exchange rights, including the withdrawal and transfer abroad of the dividends, profits and interests generated by the investments.
Finally, depending on the GP's and LPs' objectives and the allocation of the fund's investments, private equity firms may seek tax-efficient structures that may entail the incorporation of offshore funds.
It is common for GPs to be incorporated in offshore jurisdictions and, as at June 2017, 49.2 per cent of the GPs were entities located abroad.13
ii Key terms
Key concepts and common terms used in the Colombian private equity landscape are described below.
As mentioned above, PEFs must have an administrator. These entities are supervised by the SFC, and hence must comply with both the regulatory obligations imposed on them and the relevant obligations regarding the administering of private equity funds. The obligations applicable to administrators mainly consist of:
- exercising the economic and political rights of the fund's assets;
- complying with the applicable information duties of the private equity fund, especially with the reporting obligations before the SFC;
- ensuring compliance with the applicable rules by the GP and the other actors involved in the private equity fund; and
- ensuring the compliance of the fund.
Where they exist, the administrator will be liable before the SFC and the investors for due diligence in the designation and monitoring of the GP, the foreign GP and the custodian.
An external manager is usually appointed to carry out the management activity of PEFs. The management activity mainly consists of performing the investment and divestment policy of the fund, as well as identifying, measuring, controlling and handling the risks of the fund. The private placement memorandum sets out the minimum requirements that the GP must meet to be appointed as the fund's manager, which include experience, morality and suitability requirements. GPs must have the operative and technological infrastructure to manage the fund in accordance with the fund's investment policies. Additionally, GPs must execute the fund's investment policy in accordance with the private placement memorandum, the instructions provided by the investment committee and the management agreement.
The GP is a legal entity, usually a company, incorporated within Colombia or offshore, which enters into a management agreement with the fund's administrator. To certify its experience, it can resort to the experience of its partners and individuals who will perform the management activities of the fund.
Limited partnership meeting
The limited partnership meeting is composed of all the fund's investors, including the GP if it invested in the fund. Each unit issued to the LPs confers one vote. The limited partnership meeting will appoint the members of the supervision committee and approve or reject the financial reports presented by the administrator (on limited occasions), and can remove the fund's administrator and request the administrator to remove the GP.14
The members of the investment committee will be appointed by the GP. If there is no GP, one is appointed by the administrator. The investment committee is responsible for analysing investment alternatives and amounts, as well as the divestment and liquidation of investments. The private placement memorandum sets out the rules for the meetings of the investment committee, its functions and the requirements for the appointment of its members. The members of the investment committee are considered administrators for liability and fiduciary duty purposes.
The supervision committee must oversee the administrator and the GP in the performance of their duties in accordance with the private placement memorandum and the applicable regulations. The members of the supervision committee will be appointed by the limited partnership meeting. Moreover, the supervision committee is in charge of assessing and solving conflicts of interest that may arise. The meetings of the supervision committee will be held on at least a quarterly basis.
PEFs may have one or more compartments with different investment policies. If the fund decides to establish compartments, the private placement memorandum and the prospectus will provide a description of their main characteristics. In the event that compartments are set up, a compartment may be available for a specific class of investor, and may establish different fees and investment strategies. Prior to the issuance of Decree 1984 of 2018, compartments could be composed of only one investor; however, one of the main changes introduced by the new legislation is the requirement for compartments to have two or more investors. Each compartment will issue its own participation units.
The possibility of setting up compartments allows PEFs to attract investors that are looking for specific investment conditions, co-investment opportunities and investment alternatives that align with the GP's objectives.
Investments made by the LPs into the PEF are made through capital contributions. The private placement memorandum sets out the minimum conditions and amounts for the capital commitments. To invest in a private equity fund in Colombia, the current minimum commitment must equal 600 monthly legal minimum wages, which in 2019 amounts to 496,869,600 pesos. However, the private placement memorandum may set out a higher amount for the minimum amount of capital commitments.
Usually, in adhering to the private placement memorandum, the LPs undertake to pay the capital commitments within a set period or once the capital commitment is made by the GP in accordance with the private placement memorandum. Decree 2555 allows the possibility of making in-kind contributions, provided that this alternative is explicitly included in the private placement memorandum.
GPs tend to make investments in private equity funds managed by them. This practice is broadly welcomed, given that it ensures the alignment of interests.
Private placement memorandum
The private placement memorandum is the governing document for private equity funds in Colombia, as it sets out the terms and conditions that will govern all the fund's activities and investments. The private placement memorandum must include, inter alia, the following information:
- general features of the fund (such as name of the fund, ID number, term, domicile, minimum number of investors and minimum amount of commitments);
- the fund's investment policy;
- the general terms that will rule the agreement entered with the GP (if appointed);
- functions and composition of the investment committee;
- functions and composition of the supervision committee;
- mechanism for the distribution of profits;
- administration and management fees;
- rules and powers of the limited partnership meeting, and liquidation events; and
- liquidation procedures.
Private placement memoranda are reviewed by the SFC before the private equity fund commences its operations. Any amendment to the limited partnership agreement (LPA) must be submitted to the SFC for its review.
Apart from the limitation on investing at least two-thirds of its funds in assets different to registered securities in the RNVE, PEFs do not have significant limitations regarding their investments.
Fees and distribution mechanisms
Fees charged in Colombia by administrators and GPs are similar to those under international standards. Thus, administration and management fees range between 1.5 and 2 per cent, whereas the carried interest is commonly 20 per cent. The high-water mark usually varies between 6 and 12 per cent.
The distribution of profits of Colombian PEFs tends to follow the traditional waterfall scheme. The model for the distribution of profits is based on the whole-fund model in contrast to the deal-by-deal model. Nonetheless, certain early-stage funds do have deal-by-deal carried interest schemes.
Private placement memoranda usually have a provision regarding the possibility of undertaking co-investments together with the sponsors of the fund. This provision is established in the private placement memorandum, and sets the rules that will govern such co-investment.
Because of the increase in the number of private equity funds and investment alternatives, some of these are specialising in specific sectors. As a result, key-man provisions have become critical to attract investors interested in investing in these sectors. Such provisions usually stipulate that, if a key person leaves the fund, the investment period may be suspended while a substitute previously approved by the investors is appointed. Infrastructure-focused funds provide a recent example, with experienced individuals being appointed in their investment teams to attract investors. Key-man provisions are governed by the contractual terms negotiated between the fund's administrator and the GP.
Participation units correspond to the participation of the LPs in private equity funds. Participation units are issued to the LPs once payment of the agreed capital commitments has been made. Unless stated otherwise in the LPA, capital commitments will not grant voting rights until the capital commitments have been paid in full, in accordance with the terms of the private placement memorandum. Furthermore, participation units of private equity funds are automatically listed in the RNVE and become publicly traded, provided that a decision to this effect has been included in the private placement memorandum. The valuation of the funds' participation units is calculated on a daily basis.
The Colombian regulatory framework allows PEFs to issue different types of participation units based on the LPs that invest in the fund. Each type of participation unit may set out different rights and obligations, such as, inter alia, the management rules for a participation unit's redemption. Nevertheless, the conditions, rights and obligations of each type of participation unit must be clearly described in the private placement memorandum. In practice, it is common that the participation units issued to the GP that invested in the fund confer different rights than those subscribed by the other investors. Said differentiation may be useful at the moment of distributing the profits in a waterfall model.
Decree 2555 and the SFC have determined the key items that have to be disclosed.
In addition to the private placement memorandum, the prospectus of the fund must also be disclosed. The prospectus is the document the administrators use to carry out the promotion of the fund. It must contain at least general information about the fund, the investment policy and its risk profile, and the fund's economic information, and it must identify the GP (if a GP is appointed). Moreover, this document must be written in Spanish, has to be consistent with the information set out in the private placement memorandum and cannot contain any misleading information. The investment policy shall include the investment plans, the type of target companies or investments to be undertaken, the guidelines for selecting such investments, the economic sector and the geographical locations of the investments.
The data technical sheet includes the basic information about the fund, which has to be updated on a daily basis pursuant to the instructions of the SFC. Colombian regulations require the fund's administrator to publish on the fund's website the private placement memorandum, the prospectus and the technical data sheet, among other documents.
Decree 2555 sets out a disclaimer that must be included in the fund's documents, stating that the obligations of the fund's administrator are undertakings that do not guarantee any outcome or result, the funds provided by the investors are not considered deposits and hence are not covered by the general fund of financial guarantees of financial institutions, and the investment commitments are subject to the investment risks related to the funds' investments.
In connection with solicitation of investors, Colombian regulations do not establish specific limitations for the promotion of PEFs located in Colombia, apart from the obligation to provide truthful and clear information regarding the fund and the entities related to it (i.e., mainly the administrator and the GP). Decree 2555 and the Legal Basic Circular set out the disclosure data that has to be publicly available.
As a result of the reduced number of potential Colombian investors who invest in the asset class, GPs initiate the promotion of a PEF before the fund is set up. This is to identify the requirements and profile sought by potential investors, so that the GP and the administrator can include these conditions in the private placement memorandum and the prospectus. This practice is more evident in the case of pension fund administrators, which, because of their importance as potential investors and their strict investment criteria, have to verify whether the PEF will comply with all the requirements applicable to them, and with the investment profile sought by the pension fund's assets; likewise, the GP seeks to attract the pension fund administrator, and therefore will try to design the private placement memorandum to suit these requirements as long as they are in line with their own objectives.
As to fiduciary obligations, pursuant to Colombian regulations, the fund's administrator, the GP and the members of the investment committee owe fiduciary duties to the LPs and are considered administrators in accordance with the definition of administrator under Law 222 of 1995.15 Decree 2555 states that administrators and managers will be held liable for slight negligence (the lowest threshold), and that they shall act as prudent experts in the performance of their management duties as managers of private equity funds.16 Because of the fiduciary responsibilities of the fund's administrators and the GP towards the LPs, administrators, GPs and members of the investment committee must adhere to principles and obligations such as observing a duty of care towards the investors, acting in good faith, and looking after the best interests of the LPs and of the fund. In addition, administrators and GPs are obligated to act in accordance with the applicable regulations, the LPA and the principles governing private equity funds.17
iii REGULATORY DEVELOPMENTS
Because of the structure of PEFs, the entity that serves as fund administrator is supervised by the SFC. Hence, the administrator will have to comply with both the specific obligations applicable to PEFs and the obligations imposed on supervised financial entities.
Private equity funds must be registered before the SFC. Although Decree 2555 states that PEFs do not require prior authorisation for registration, a procedure must be undertaken by the administrator to register with the SFC. The administrator files the private placement memorandum and other ancillary documents with the SFC and, as of this filing, the private equity fund is entitled to start operations. However, the SFC may provide observations and modifications to be included in the private placement memorandum. Once any such modifications have been made, the SFC will issue a communication stating that it has no further objections or comments. GPs do not have to register to undertake their managing activities in Colombia. However, pursuant to Decree 2555, GPs must comply with specific disclosure obligations resulting from the performance of their management activities.
For tax purposes, PEFs are considered pass-through entities, as they are subject to the tax-transparency principle, therefore any income received by the PEF in connection with its economic activities will be transferred directly to the LPs, preserving its initial nature. All income will be considered earnings of the LPs as if the PEF did not exist and as if the economic activity had been carried out directly by the LPs. Bearing in mind the above, the applicable tax provisions will depend on several factors inherent to the LPs and the type of income (i.e., if the LP is considered resident for tax purposes or the source of income).
To date, most of the divestiture of portfolio companies by PEFs has been through sales to strategic investors or other private equity funds. Any asset that has been held for over two years will be taxed at a rate of 10 per cent; otherwise, it will be taxed at a rate of 33 per cent for transactions occurring in 2019, 32 per cent for transactions occurring in 2020, 31 per cent for transactions occurring in 2021 and 30 per cent for transaction occurring in 2022.
A non-exhaustive list of both recent regulatory developments and draft regulations currently under discussion includes the following:
- Law 1819 of 2016 introduced a structural tax reform that includes:
- income tax on dividends, levied at a rate of 35 per cent;
- tax on dividends distributed to non-Colombian residents levied at a rate of 5 per cent;
- a tax on the import, sale and consumption of oil and gas derivatives used for energy purposes;
- a tax on passive income resulting from investments made by Colombian residents in foreign companies, including but not limited to dividends; and
- the unification of income tax and equity tax (CREE) (including its surplus), which will be levied at a rate of 40 per cent for 2017, a rate of 37 per cent for 2018 and a rate of 33 per cent from 2019 onwards.
- reorganise admissible assets in accordance with a risk-based approach, allowing segregation of traditional assets and alternative assets;
- introduce a new category of assets – 'restricted assets' – aimed at contributing towards the diversification of risks associated to pension funds; and
- modify investment caps and requirements for currently admissible assets, especially for investment vehicles incorporated by foreign issuers.
- to include the local and foreign real estate PEFs as eligible assets in which those entities may invest;
- to replicate the constrains and restrictions applicable to pension funds with respect to investments in PEFs the main assets of which are infrastructure projects; and
- to modify the maximum percentage of the insurance companies that can be allocated in PEFs.
- PEFs are now authorised to carry out certain operations such as issuing bonds in the stock exchange and granting financing; and
- valuation of the PEF's portfolio (formerly a duty of the PEF's administrator) must be assigned to the GP under the new regime.
During the past few years, the amounts of capital commitments denominated in dollars have exceeded those denominated in pesos. As at June 2017, 68.7 per cent of the capital commitments of active funds were denominated in dollars, and in the same month in 2018, 66 per cent of PEFs' capital commitments were denominated in dollars.18 This could be the result of the strong devaluation of the peso against the dollar, making denomination of capital commitments in dollars more attractive, to mitigate the risk of devaluation. Other possible factors behind this trend include the increased stake held by foreign investors in the Colombian PEF market and the number of foreign PEFs investing in Colombia.
Following recent trends in fundraising activity in Colombia, the industry expects that real estate and infrastructure PEFs to have the major stake of the capital commitments raised in Colombian market. In fact, of the US$1.06 billion that the PEFs aimed to raise as of June 2018, US$735.2 million (69.1 per cent) was expected to be raised through real estate and infrastructure PEFs.
Finally, number of venture capital funds is expected to increase over the next few years. In fact, of the PEFs at the structuring stage in June 2018, 33.2 per cent were venture capital funds; these were followed by buyout and growth financing PEFs with a 27.8 per cent share of the total, and by real estate and infrastructure PEFs, each of which had a 16.7 per cent share.19
1 Hernando A Padilla is a partner and Pedro Arango is an associate at Philippi Prietocarrizosa Ferrero DU & Uría.
2 Ernst & Young and ColCapital (2018), 'Potenciando la economía colombiana: Evolución y análisis de la industria de Fondos de Capital Privado. Reporte 2018', p. 21; Latin American Private Equity & Venture Capital Association (LAVCA) (2018), 'LAVCA Industry Data & Analysis: Update on Latin America Private Equity & Venture Capital', p. iv.
3 LAVCA, footnote 2, p. 3.
4 Bancoldex, Foreign Trade Bank of Colombia, the country's entrepreneurial development and export-import bank, (2015), 'Catálogo Fondos de Capital Privado y Emprendedor 2015–2016'.
5 EY, footnote 2, p. 59.
6 Ibid., p. 58.
7 Ibid., pp. 47–49.
8 Ibid., p. 49.
9 According to LAVCA, Colombia currently ranks fourth, with the best regulatory landscape for private equity and venture capital investment in Latin America after Chile, Brazil and Mexico; see LAVCA, '2017/2018 Scorecard: The Private Equity and Venture Capital Environment in Latin America', pp. 2–5.
10 EY, footnote 2, p. 61.
11 Ibid., p. 58.
12 EY, footnote 2, p. 46.
13 Ibid., p. 44.
14 The current proposal to amend PEFs' regulation eliminates the faculty of the limited partnership meeting to request the GP's removal.
15 Law 222 of 1995 sets out the obligations and duties required of officers and directors (considered administrators within the scope of Law 222).
16 Insurance companies have introduced insurance policies for GPs.
17 On 20 July 2017, a bill of law was filed before the Colombian Congress under which managers' fiduciary duties regime would be amended. One of the main changes would be the introduction of the business judgement rule in Colombian law. At the time writing, the bill of law had not been approved by the Colombian Congress.
18 EY, footnote 2, p. 59.
19 Ibid., pp. 47–49.