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 after the failure of the convertibility plan when the local currency was pegged to the US dollar. Since then, the country dipped in and out of financial and economic crises, defaulted on its sovereign debt, settled with its creditors and by the end of the 2010s, found itself in a similar situation. In Argentina, politics and economic activity tend to be more intertwined than in other places, and they influence each other significantly, thus the economic ups and downs tend to be tied to, and more influenced by, domestic politics rather than by international events or cycles. As a result, M&A and private equity tend to slow in times of political or economic change or instability.
The year 2020 was, for Argentina as well as for the rest of the world, a very difficult one. However, the trailing structural weaknesses made the arrival of the first wave of the covid-19 pandemic particularly difficult. At the beginning of 2020, Argentina was already undergoing a deep economic crisis that had been in the making throughout the 2010s. After a slow recovery in 2016 and 2017, fuelled by a return to the international voluntary markets, the delay of structural reforms weakened the faith of lenders in Argentina's repayment capacity, which in turn led to a debt crisis and steep devaluation in 2018. The incumbent administration asked for support from the International Monetary Fund (IMF), which approved the largest loan it has ever granted (US$57 billion). The need for such a huge rescue worsened the crisis, which translated into two consecutive years of recession, high inflation, steep devaluation, unemployment growth and political uncertainty.
The new economic scenario led, in December 2019, to a change of administration led by Alberto Fernández and two-time former president Cristina Fernández de Kirchner. It was clear by then that Argentina had to restructure its sovereign debt and the terms of the IMF loan.
The new government, inclined to a more interventionist approach, returned to heterodox economics policies, which led to many investors putting on hold their plans for Argentina until at least the sovereign debt was dealt with and the outline of a broad economic plan was unveiled.
While dealing with the problems described above, in early 2020 the covid-19 pandemic outbreak was initially deemed to be a faraway or less urgent problem, However, in March 2020, Argentina documented its first covid-19 cases. With the confirmation that the virus had spread to the country, on 19 March 2020, the government established a strict lockdown that included restrictions on commerce and circulation, closure of borders, etc. and lasted, with some flexibilities, several months. The covid-19 pandemic significantly impacted an already dire Argentine economy, which shrank for the third consecutive year. In the meantime, the Argentine peso continued its slow but continuous depreciation against international currencies.
A combination of high inflation (36 per cent year-on-year), a trailing structural problem because of an endemic lack of confidence in the Argentine currency, and the steep decline in GDP (over 10 per cent) as a result of the covid-19 crisis has also led to a worsening of certain social indicators. As many countries around the world did, the Argentine government increased its spending exponentially to assist the most affected by the pandemic. The fiscal deficit of 2020–21 is expected to be the largest in 45 years.
On the bright side, in August 2020 the government finally managed to restructure the sovereign debt, avoiding an otherwise problematic default. It also began conversations with the IMF to negotiate a new programme for the upcoming maturities of the stand-by loan.
The fact that the prices of commodities are on an upward trend might also help the Argentine economy to enter into a recovery path in the upcoming months.
i Deal activity
The number of investments remained steady during 2019 on a year-on-year basis when considering private equity, entrepreneurship and seed capital transactions. As regards pure private equity deals, the number of transactions fell approximately by 65 per cent, while committed investments almost doubled, while venture capital (VC) remained most active as Argentina continues to be a dynamic tech hub and homeland for several landmark unicorns such as Mercadolibre and Globant.
The Argentine Association of Private Equity, Venture and Seed Capital (ARCAP) reported 92 private equity, entrepreneurship and seed capital deals during 2019 for a total investment of US$1.1283 billion. These figures include 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, and the raising by fintech Ualá of US$150 million in a round led by SoftBank and Tencent, and by the commercial earth imaging company Satellogic of US$50 million to help scale up its satellite constellation.2
While full-year statistics are not yet available, ARCAP's report for the first semester of 2020 shows that there were no significant variations between the first part of 2018 and 2019 and the same period of 2020 in terms of number of private equity, entrepreneurship and seed capital transactions (i.e., 44, 45 and 43 respectively). However, committed capital significantly decreased when compared to the first semester of those years (i.e., US$445.5 million, US$891.1 million and US$41.6 million, respectively). The significant drop would be explained by the fact that during the first semesters of 2018 and 2019 there were extraordinary transactions for over-the-average amounts and because during the first semester of 2020, where the effect of the pandemic was beginning to be evident and the stringency of the lockdown was the highest, there were no proper significant private equity investments (only entrepreneurship and seed capital) which usually involve transactions for higher amounts.
Industry news report at least some significant transactions in the second semester of 2020. These include the raising by the online travel agency Despegar.com of US$200 million in August 2020 through a private placement with L Catterton and an agreement with Waha Capital, an Abu Dhabi-based investment company, to issue and sell Series B preferred shares.3 Other transactions are the raising by Autho, the most recent Argentine unicorn specialised in password authentication solutions, of US$120 million in June 2020, with investors such as Bessemer Venture Partners, Shappire Ventures, Meritech Capital, World Innovation Lab, Trinity Ventures, Telstra Ventures, K9 Ventures and DTCP participating in the rounds,4 and the raising by Nuvemshop (also known as Tiendanube), an Argentina based e-commerce platform, of US$30 million in October 2020 led by KaszeK Ventures and Qualcomm Ventures.5
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. The current political and economic context will likely result in a more active participation of local players in private equity transactions. This trend became apparent in many 2020 M&A transactions, including the purchase by Grupo de Narvaez of the Argentine business of Walmart in Argentina and the potential acquisition of Edenor, the largest electricity distributor in the country to a group of local investors.
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, and because of certain rigidities in the foreign exchange market, 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. Exits via IPOs or similar transactions are extremely rare.
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 fact, a new bill has been submitted to the National Congress pursuant to which, if approved, the pre-closing system would become operative within 90 days.
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.
II Legal framework
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. Because 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 because 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 were conceived as entities subject to less scrutiny from the registry, giving shareholders a greater degree of flexibility to set rules and lower maintenance costs. Recent regulations issued by the new authorities of the public registry of the city of Buenos Aires (IGJ) have, however, heavily increased control over SASs. In practice, these made SAS entities lose their distinctive comparative advantage.
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, as 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.
Registering a foreign entity in the city of Buenos Aires may take some time because the IGJ requires foreign entities, among others, to provide evidence that their main corporate activities are conducted outside Argentina. While the former administration relaxed these requirements for a while, the new administration has reinstated prior regulations on this regard.
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 under the Income Tax Law as non-cooperative (i.e., any jurisdiction that has not entered into an information exchange agreement or a double taxation treaty (DTT) with Argentina or entered into any of the foregoing but does not comply with its obligation to share information) or in a nil or low tax jurisdiction (i.e., any country, jurisdiction dominium, territory, associated state or special tax regime in which the maximum corporate income tax rate is lower than 15 per cent). 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 non-cooperative or nil or low tax 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 entities receiving the funds 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 (i.e., Australia, Belgium, Bolivia, Brazil, Canada, Chile, Denmark, Finland, France, Germany, Italy, Mexico, Norway, Russia, Spain, Sweden, Switzerland, The Netherlands, United Arab Emirates and the United Kingdom). Moreover, recently, the Argentine Executive Power has signed double taxation treaties with Austria, China, Japan, Luxembourg, Qatar and Turkey, but they are pending of approval by the Argentine Congress. In general, these treaties are based on the Organisation for Economic Co-operation and Development model. There is no DTT signed between Argentina and the United States.
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 a strategic 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. Reports show that private equity funds making investments in Argentina maintain their investments for an average term of 7.6 years.6
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 businessperson. 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 businessperson 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.
Directors may also incur in liability under certain special regimes, such as under tax, labour, social security, customs, antitrust, banking, money laundering, bankruptcy, environmental and other laws and regulations.
III Year in review
Recent deal activity
During 2018, 2019 and 2020, the hottest areas for private equity investment in Argentina were telecommunications, fintech and other areas of technology (i.e., Saas, E-Commerce, HealthTech, BioTech, AgTech, EdTech, Smartcity).
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.7
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.8
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.9
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.10 The deal included the granting of certain guarantees to secure payment of the deferred portion of the price.
In 2020, the most relevant private equity transaction would be Despegar.com.'s US$200 million raisings announced in tandem with the report of its financial results, which took a big hit from the covid-19 pandemic. As explained by CEO of the company, the capital raise shows the company's commitment to strengthen its balance sheet while allowing the company to grow through M&A transactions.
Because technology is one of the most attractive areas of investment for private equity, it is worth mentioning that the Argentine Congress created a Knowledge Economy Promotional Regime aiming at promoting economic activity that applies the use of knowledge and the digitalisation of information to obtain goods, provide services or improve processes. The regime granted certain tax and social security advantages to its beneficiaries.
While the initial regime was implemented during the former administration, this regime was abrogated by the current administration and a replaced by a new Knowledge Economy Promotional Regime. Although the new regime has undercut some of the benefits of the previous regime, it still provides interesting benefits for those qualifying under its terms.
As in the past regime, to qualify as part of the new Knowledge Economy Promotional Regime, companies must perform any of the promoted activities under the regime, 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 on 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 in respect to the benefits granted under the regime;
- reduction of the general income tax rate, depending on the size of the company (60 per cent for micro and mini companies, 40 per cent for medium companies and 20 per cent for large companies) applicable on the gains derived from the performance of the promoted activities, and possibility of deducting for income tax purposes any amount paid abroad in concept of foreign taxes on the gains derived from the performance of the promoted activities;
- exemption from value added tax withholdings or collection; and
- tax credit bonus equivalent to 70 per cent of the social security contributions paid by the company in relation to employees affected to the promoted activities.
Each beneficiary must, however, pay an annual amount of up to 4 per cent per cent of the total tax benefits granted under the Trust Fund for the Development of Entrepreneurial Capital regime.
IV Regulatory developments
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 unless certain set exceptions apply.
The uncertainties as regards the development of the covid-19 pandemic worldwide, and in Argentina in particular, and the country's economic situation will very likely slow down private equity activity during the first part of 2021.
However, times of crises have proven to be times of opportunity, particularly for private equity funds. Considering the economic and political context, we would expect more involvement of local players and investors than in previous years, as already evidenced by the latest M&A transactions.
In terms of transaction structures, the expectation would be that transactions in cash will include big discounts when compared with pre-crisis asset valuations. It is also expected that more transactions will include earnout schemes that permit the parties to share risks and align interests in light of the future development of the business. As regards the areas of investment, there will probably be a preference for industries with revenues in foreign currency with less exposure to currency devaluations, as well as in sectors where Argentina has shown sustainable competitive advantages. Upon consultation by ARCAP, investment funds reported that their main focus during the following 12 months would be in the technology and digital services, pharma and health, telecommunications and agrobusiness industries.
1 Diego S Krischcautzky is a partner and María Laura Bolatti Cristofaro is an associate at Marval O'Farrell & Mairal.
6 KPMG and ARCAP's report 'El Private Equity en Argentina 2010-2020'.