The Private Equity Review: Argentina
Private equity activity in Argentina flourished in the 1990s when it received a large portion of the investments made in the Latin American region. However, at the beginning of the 2000s, the Argentine economy crashed and has since then dipped in and out of financial crises. In Argentina, politics and economic activity tend to be more intertwined than in other places, and they influence each other significantly. As a result, M&A and private equity tend to slow in times of political or economic change or instability.
Currently, Argentina is, once again, undergoing a deep economic crisis. After a slow recovery in 2016 and 2017, the hardships began in the first quarter of 2018 when the country lost access to the international, voluntary credit markets it had regained in late 2015 and had to ask for support from the International Monetary Fund (IMF), which approved the largest loan it has ever granted (US$57 billion). The crisis translated into two consecutive years of recession, high inflation, steep devaluation, unemployment growth and political uncertainty.
The new economic scenario had an obvious impact on the results of the primary elections of August 2019, which function as a strong indicator of the outcome of the general elections (which took place in late October 2019). In the primary elections, it became clear that Alberto Fernández and two-time former president Cristina Fernández de Kirchner would eventually become president and vice-president, respectively. This meant, in the general view, that the country would step away from an orthodox-leaning economic approach (as a result of the IMF agreement), to return to a heterodox economics-oriented administration. Also, even before the elections took place, international creditors and investors cast doubts on the country's capacity to repay its large sovereign debt, including the IMF loan.
The certainty that the country would be run by a new government after December 2019 created additional volatility, which led the then-incumbent administration to reinstate foreign exchange restrictions in an attempt to control the depreciation of the Argentine peso.
In this sense, on September 2019, the Executive Branch and the Argentine Central Bank (BCRA) issued regulations establishing the obligation on Argentine exporters to transfer and convert foreign currency proceeds to Argentine pesos in the Argentine foreign exchange market. Such regulations also limited the ability of both Argentine and non-Argentine residents to purchase foreign currency with Argentine pesos in the Argentine foreign exchange market and transfer it abroad. Most importantly, these regulations also established the requirement for companies to obtain BCRA's prior approval before purchasing foreign currency to pay dividends outside of Argentina, although these restrictions were partially relaxed at the end of January 2020.
The government also extended, unilaterally, the payment dates of foreign and local currency-denominated debt, giving a clear signal that Argentina was in high financial stress.
On 27 October 2019, the Fernández formula won the general elections and took office in early December 2019. Shortly after the change of government, a bill was passed by the Congress declaring the economic emergency and vesting the president with several extraordinary powers for 180 days. The bill also created a 30 per cent tax on the purchase of foreign currency for savings, tourism and other purposes and repealed an automatic inflation-linked adjustment formula for retirement pensions. All of these measures, according to government officials, were aimed at facilitating the restructuring of the sovereign debt and keeping public spending under control.
At the time of writing, the restructuring of the sovereign debt is probably the biggest challenge the new government faces.
i Deal activity
Private equity investments increased in Argentina during 2018 on a year-on-year basis, although it remained slow in light of its potential.
The Latin American Venture Capital and Private Equity Association (LAVCA) reported 29 deals during 2018 for a total investment of US$567 million. These figures include the US$190 million investment by Riverwood Capital and Blackstone in telecommunications provider Metrotel and the US$150 million investment by Lone Star Funds in oil and gas company San Antonio International. As for venture capital investment, LAVCA reports a total of 19 investments during 2018 for a total of US$84 million, including the raising of US$34 million in Series B for fintech Ualá and a US$31 million Series C for digital security company Onapsis.2
Although full year statistics are not yet available for 2019, the Argentine Association of Private Equity, Venture and Seed Capital's industry report shows that there were no significant variations in private equity activity between the first part of 2018 and the same period of 2019.3 However, although the number of private equity transactions during this period was similar in both years, committed investments doubled from US$445.46 million in the first half of 2018 to US$891.11 million in the first half of 2019. Having said this, the increase in the invested amounts in the first half of 2019 was mainly driven by the closing during this period of the acquisition by Advent International of the payment processing company Prisma Medios de Pago for US$724 million, which divestment from the prior owners (a group of local banks) was mandated by the Argentine Antitrust Commission.
The political uncertainty and the economic crisis affected activity during the second half of 2019. Despite this, we saw some transactions of significance. For example, in November 2019, Ualá, a fintech, raised US$150 million in a round led by SoftBank and Tencent, and in December 2019, commercial earth imaging company Satellogic, headquartered in Buenos Aires, announced it had raised US$50 million to help scale up its satellite constellation. Funding came from Tencent, Brazilian fund Pitanga and new investors, including IDB Lab, the 'innovation laboratory' of the Inter-American Development Bank.4
This deal illustrates that the Argentine tech environment is quite active, with prospects for venture capital deals in this area looking positive for the upcoming years.
Private equity in Argentina is mainly driven by foreign (mostly regional) private equity firms and a relatively small number of local players. Local private equity firms are smaller in size than foreign private equity firms. Major international players such as TPG, KKR and Blackstone do not have significant direct presence. Riverwood Capital, Victoria Capital Partners and other major regional funds do have investments in local companies, although mostly with regional reach.
Given the lack of specific regulations regarding the creation of private equity funds, in general funds are raised outside the country and invested through foreign special purpose vehicles (SPVs).
ii Operation of the market
Management equity incentive arrangements in the local market follow international standards, in general. These include the payment of bonuses and the granting of stock option plans, restricted stock units or similar. Normally, these incentives are a linked to a foreign issuer, which acts as a holder of the local company.
Sale processes in Argentina generally follow international practices. However, since Argentina's capital market is relatively underdeveloped, most of the transactions relate to the acquisition of unlisted companies or assets.
After identifying the target, a due diligence process is normally conducted. The parties may or may not sign a letter of intent, memorandum of understanding or similar.
Once the due diligence is finalised, the transaction documents are negotiated. Transactions may be structured as share deals or asset deals. In the case of share deals, it has become increasingly common for purchasers to acquire at least part of the equity interests by making contributions in the target company for newly issued shares, rather than acquiring existing shares. This is usually because certain funds need to stay at the target entity level. The preferred structure will mainly depend on the parties' goals and a detailed case-by-case analysis of the efficiencies and inefficiencies of the different structures.
Transactions may also be envisioned with simultaneous or deferred signing and closing. This will usually depend on the conditions to closing that the parties may establish and any required prior consents to which the transaction could be subject either by law or contractually.
Having said this, depending on the industry in which the target operates, prior approval or post-closing filings may be required to implement the transaction.
Also, provided it entails a change of control, the transaction could be subject to merger control. There is currently a post-closing merger control system in Argentina. Therefore, if required, obtaining antitrust clearance is usually reflected as a post-closing obligation. Pursuant to a relatively recent amendment in applicable law, however, Argentina's merger control system should switch to a pre-closing system in the near future.
In the case of listed target companies, the Capital Markets Law and the rules of the Argentine Securities Exchange Commission (CNV) will apply. Should the transaction entail a change of control in terms of the CNV rules, the purchaser will be required to issue a mandatory tender offer in favour of the remaining shareholders of the company, as provided in the CNV rules. In terms of mechanics, the tender offer needs to be launched immediately after a binding agreement is reached.
Asset transfers, if considered as the total or partial transfer of a business unit, will make the acquiring company jointly and severally liable with the seller for all pre-closing liabilities of the business. Likewise, asset deals are not different from share deals in terms of exposure to pre-closing liabilities. The Bulk Transfer Law, and other regulations, establish proceedings that, if fully followed, limit the successor company's liability for pre-closing periods (commercial liabilities and certain liabilities regarding federal taxes only). The Bulk Transfer Law proceeding entails publishing notices in favour of creditors and, if fully followed, notifying the Argentine tax authorities of the transfer. The fact that the publicity of the process may increase the seller's exposure and does not limit all pre-closing liabilities usually acts as a disincentive to follow the Bulk Transfer Law proceeding when solvency of the seller is not at stake or adequate guarantees are provided to the buyer.
i Acquisition of control and minority interests
Private equity funds are not subject to a specific legal framework in Argentina. Neither are the acquisitions of control or minority interests, which are subject to the same rules applicable to any M&A transaction.
In general, for the reasons cited above, private equity firms, even when formed by Argentine residents, create foreign vehicles for investment outside Argentina (SPVs) in which they remain as general partners in charge of the administration, while incorporating limited partners. Investment and shareholders' agreements ruling the relationship between both types of partners are usually also subject to foreign law and jurisdiction.
Should the SPV be set up in Argentina, the relationship between the partners will be subject to the rules applicable to the investment vehicle form chosen by the parties and the terms of any shareholders' agreement in place. Since there are certain mandatory rules in Argentina for the different forms of vehicle, it is generally advisable that shareholders' agreements in these cases be governed by Argentine law.
The most frequently used corporate vehicles in Argentina are as follows:
- corporations (SA);
- sole shareholder corporations (SAU), which are very similar to SAs but can be set up by one shareholder only and are, therefore, subject to certain stricter rules;
- limited liability companies (SRL), which are sometimes preferred by US clients since they consider them as check-the-box entities; and
- in the past couple of years, simplified corporations (SAS), a new corporate type created in 2017 by the Entrepreneurship Law. SASs can be set up by one shareholder only, similar to SAUs, but are subject to less scrutiny from the registry, give shareholders a greater degree of flexibility to set rules and have lower maintenance costs.
Argentine law also includes partnerships limited by shares (SCA) within the corporate vehicles available. The SCA is the vehicle that better reflects the structure of private equity vehicles, since it distinguishes between partners in charge of the management of the vehicle (general partners) and mere equity partners (limited partners). However, in practice, this type of company is rarely used.
While in the case of SAs, SAUs, SRL and SASs, the general rule is that all partners limit their liability to the contributions made to the company, with limited exceptions (e.g., cases in which a judge may consider that there are reasons to pierce the corporate veil), in the case of the SCA, limited partners limit their liability to their contributions to the SCA, but general partners have unlimited liability for the company's operations.
To become a shareholder of a local corporate vehicle a foreign entity would need to have previously appointed a representative in Argentina and registered with the public registry of the relevant Argentine jurisdiction (in the city of Buenos Aires, the IGJ) and with the Argentine federal tax authorities.
If the SPV is set up outside Argentina and subsequently acquires shares of an Argentine company, the SPV itself should have previously obtained those registrations.
For many years, registering a foreign entity in the city of Buenos Aires entailed a lengthy process because the IGJ requested foreign entities to provide evidence that their main corporate activities were conducted outside Argentina. The former administration relaxed these requirements and the documentation to be filed by foreign companies is now very straightforward. The new administration has announced tighter control on legal foreign entities with focus on offshore companies.
Argentine law does not generally restrict the acquisition of equity interests in Argentine companies by non-Argentine residents.
Despite this, as mentioned above, certain limitations, prior approvals or post-closing filings may exist in connection with certain industries. Also, restrictions may exist in connection with the acquisition by foreigners of rural or border lands, which would be analysed on a case-by-case basis depending on, among other things, the jurisdiction of the land within Argentina and the particularities of that jurisdiction.
In addition, while there is no prohibition to invest in Argentina from certain jurisdictions, foreign entities incorporated in jurisdictions considered as non-cooperative on fiscal transparency or in the fight against money laundering and terrorism financing will be subject to further scrutiny when submitting an application to register before the IGJ.
There are also some negative tax impacts associated with channelling investments in Argentine companies through a vehicle incorporated in any jurisdiction considered as non-cooperative on fiscal transparency or in a nil or low tax jurisdiction, as defined by the Income Tax Law. In principle, equity contributions in Argentine companies are tax neutral for the shareholder and the Argentine entity receiving the funds. However, the Argentine Tax Procedure Law sets forth a legal presumption by which incoming funds from those jurisdictions will be deemed to be an 'unjustified equity increase' on the Argentine entity, no matter the nature of the operation involved. Unjustified equity increases on the Argentine entity are subject to income tax and value added tax, and in both cases, the tax rates would be assessed on 110 per cent of the amount of funds transferred. Although Argentine residents may rebut such legal presumption, the standards required by the Argentine tax authority are difficult to meet.
In contrast, Argentina has entered into several double taxation treaties that could be beneficial for certain investors and should be taken into consideration when structuring a potential transaction.
Most of the private equity transactions in Argentina consist of the acquisition of non-listed entities, and transactions are implemented as per usual international terms. In terms of the transaction documents, the higher the interest acquired, the more bargaining power the purchaser will have. If acquiring control, the purchaser will be interested in reducing as much as possible the minority shareholders' rights after closing. If seeking a minority investment, the purchaser will seek to obtain as much control of the investment as possible, fixing aggravated majorities for certain sensitive matters, securing the appointment of a certain number of board members, etc.
In terms of governmental approval, transactions involving changes of control could be subject to merger control in Argentina, unless the transaction falls within any of the exemptions set forth under the Antitrust Law.
Also, the acquisition of control of public companies in terms of the Capital Markets Law and the CNV rules could make it necessary to follow a mandatory tender offer process, as mentioned in Section I.ii.
Whatever the percentage of shares of a local company acquired by the SPV, private equity firms usually pay special attention to exit provisions so as to ensure that the investment can be divested at a given time.
The most typical form of exit in Argentina is through a sale to an investor. In the case of the investment in Prisma discussed in Section I.i, some local media conveyed that Advent International may be interested in exiting through an initial public offering, but this is not the most common practice.
ii Fiduciary duties and liabilities
In general, pursuant to the Companies Law, directors are subject to a duty to act loyally towards the company and its shareholders and to carry out their functions with the diligence of a good business person. Should the SPV be set up in Argentina or if the SPV is set up abroad but appoints a director in an Argentine target entity, these standards will apply. The concept of loyalty embraces the obligation to meet the standard of an 'honest person' and to defend the interests of the company. In this sense, a director cannot compete with the company in furtherance of his or her own interest where such interest conflicts with the interest of the corporation. The good business person standard is applied to the particular circumstances of each activity undertaken by a director and is an objective standard. This standard requires, among other things, that directors possess certain qualifications (e.g., technical knowledge, expertise) and that they perform their responsibilities in accordance with such qualifications. Failure to meet the foregoing standards will make the directors unlimitedly and severally liable for any damage caused.
In addition, directors are personally and unlimitedly liable to the company, the shareholders and third parties for non-performance of their duties, violation of the law, by-laws or regulations, or for fraud, abuse of power or gross negligence.
Year in review
Recent deal activity
During 2018 and 2019, the hottest areas for private equity investment in Argentina were telecommunications, fintech and other areas of technology.
The biggest private equity transaction of the first part of 2019 was the acquisition of 51 per cent of Prisma Medios de Pago by the Boston-based private equity firm Advent International for US$724 million. Prisma is the leading payment company in Argentina and one of the largest in Latin America, operating in 15 countries, processing more than 7 billion transactions per year and hiring more than 1,300 individuals.5
The transaction was part of a divestment commitment undertaken by the shareholders of Prisma (14 banks and Visa Inc) in the context of an investigation initiated against them for monopolising the credit cards and electronic payment market.6
At the beginning of the process, bidders showed high interest in the company. However, the economic instability made some bidders lose interest. Certain local analysts have conveyed that the Prisma shareholders considered the valuation at which shares were sold as 'lacklustre' and that they would probably have waited for a better offer had they not had a deadline to divest by January 2019. In spite of this, Prisma's chief executive officer himself said that the deal was probably one of the largest equity transactions in Argentina in the past 30 years.7
As regards the economic terms of the transaction, according to public information, it was agreed that 60 per cent of the price would be paid at closing, while the balance will be paid within a five-year term, and that 70 per cent of the payment would be made in US dollars with the balance to be paid in Argentine pesos.8 The deal included the granting of certain guarantees to secure payment of the deferred portion of the price.
It is worth mentioning that, during the previous administration, the Argentine Congress created the Knowledge Economy Promotional Regime aiming at promoting economic activity that applies the use of knowledge and the digitalisation of information (supported by progress in science and technology) to obtain goods, provide services or improve processes. The regime grants certain tax and social security advantages to its beneficiaries.
To qualify as part of the Knowledge Economy Promotional Regime, companies must register before the National Registry of Beneficiaries and meet at least two of the requirements set forth in the applicable regulations. The requirements include that the company performs continuous improvements in the quality of services, products or processes, invests in research and development activities for a certain period of time, or a certain minimum percentage (which will vary depending of the kind of activity and the beneficiary) of its exports of goods or services derive from the performance of any of the promoted activities.
Companies meeting at least two of these requirements will obtain certain tax benefits, including:
- fiscal stability (the Argentine total tax burden at a federal level will be determined at the moment the beneficiary requests its registration and will not be modified thereafter);
- 15 per cent reduction of income tax;
- reduction in social security contributions;
- exemption from value added tax withholdings or collection; and
- tax credit bonus equivalent to 1.6 times the amount payable as social security contributions that the beneficiary does not pay due to the benefit mentioned in point (c).
Each beneficiary must, however, pay an annual amount of up to 1.5 per cent of the total tax benefits granted under the Trust Fund for the Development of Entrepreneurial Capital regime.
The new administration would, in principle, maintain the Knowledge Economy Promotional Regime.
No specific regulators have oversight of private equity transactions or firms in Argentina.
If the SPV or the target entity are incorporated in the city of Buenos Aires, the IGJ will, in principle, be the regulatory body with oversight of their operations. The role of the IGJ in potential transactions carried out by, or in connection with, registered local entities will depend on the type of vehicle involved. In the case of SA, SAU and SAS entities, for example, transfers of shares need not be filed with the IGJ. On the contrary, transfers of quotas of an SRL must be registered with the IGJ to become enforceable with regard to third parties. Periodical filings to be made with the IGJ will also vary depending on the corporate type.
Listed companies' activities are subject to the supervision of the CNV.
Depending on the industry in which the target entity operates, it may also be subject to supervision of other governmental bodies (e.g., insurance companies are subject to the supervision of the National Superintendence of Insurance). This may include the request of prior authorisation to close a transaction.
In all cases, the approval of the Antitrust Commission may be required if the transaction involves a change of control.
The economic situation and the fact that there has been a change in the government will very likely slow down private equity activity during the first part of 2020 and at least until there is more clarity on whether Argentina will be in a position to climb out of the recession and restructure its debt.
However, times of crises have proven to be times of opportunity, particularly for private equity funds.
1 Diego S Krischcautzky is a partner and María Laura Bolatti Cristofaro is an associate at Marval O'Farrell & Mairal.
2 2019 LAVCA Industry Data & Analysis Update on Latin American PE & VC.