Stronger Private Equity Culture Needed to Unleash Latin America’s IT Services Industry

Whether it’s through leveraged buyouts, growth capital or venture capital, private equity groups are zeroing in on Latin America. According to the Latin America Venture Capital Association, 2010 …

Whether it’s through leveraged buyouts, growth capital or venture capital, private equity groups are zeroing in on Latin America. According to the Latin America Venture Capital Association, 2010 was a record year for fundraising in the region with $8.1 billion. At least some of that money is reaching technology services companies directly through funds like Riverwood Capital, a major player behind Argentinean IT services provider Globant.

Furthermore, and perhaps more importantly to LatAm’s tech sector, private equity investments are supplying brick-and-mortar companies with the working capital needed to upgrade their IT infrastructure. This means greater domestic demand and more business for the multinationals, but also for those domestic IT vendors looking to grow internationally.

To get a better read on how the region is working to improve the flow of domestic and foreign investment, we took a closer look at the recently released 2011 LAVCA Private Equity and Venture Capital Scorecard report.

Developed in partnership with the Economist Intelligence Unit, the annual report analyzes different aspects of twelve major PE/VC markets in Latin America. It gauges things like entrepreneurship, tax friendliness, perceived corruption, protection of intellectual property rights, minority stakeholder rights, among others.

Here is what LAVCA had to say about some of the major markets, particularly with respect to scoring criteria most relevant to fund managers interested in technologies firms:

Argentina continues to underperform…

Despite its size, Argentina continues to be unfavorable to PE/VC investors relative to other markets in the region. The Office of the US Trade representative put Argentina on its Priority Watch List in 2012 for poor protection of intellectual property rights. When assessing company risk and exit strategies, investors should also be mindful of bankruptcy procedures that vastly “favor employees and tax authorities over creditors”. Turning a profit via IPOs may also be a challenge, given Argentina’s stock exchange which is small and mostly dominated by foreign listings. Despite a challenging operational environment, Argentina does win on its human capital and a strong entrepreneurial community that continues to create interesting investment opportunities.

Brazil is open to new investors but somewhat less friendly once established…

Brazil remains a strong private equity option in the region, second only to Chile. The ground rules for opening and operating a fund in Brazil are well established and are strong from a legal and accounting framework perspective. Brazil’s active stock market also provides investors exit opportunities not available in other markets in the region. Reforms in 2005 have also improved bankruptcy proceedings, but the country scored low in the categories of perceived corruption, intellectual property protection and corruption in the judicial system.

Chile continues to lead the pack, but could be friendlier to local investors…

Chile heads up the regional rankings and scores well across all categories. Some accolades include a proactive government policy around innovation and entrepreneurship, favorable laws around fund formation, and intellectual property protection and judicial transparency. The development of a common stock exchange between Chile, Colombia, and Peru also have fund managers excited about local capital market reforms that could make it easier for SMEs to go public. Chile lost one point from the previous year’s score because the process of opening a fund is slow (albeit well organized) and a lack of “pass-through provisions” makes it difficult for funds based out of Chile to invest in other countries.

Mexico is good for minority stakeholders, but don’t rely on the courts for quick resolutions…

Investors with 25% or more control in a company have leverage to appoint directors and board members. This should be particularly favorable for private equity groups interested in tech services companies ripe for acquisition and changes in management. Mexico’s capital market is also strong in light of recent legislation that eased restrictions on entry of small and medium-sized companies. But when it comes to settling disputes, courts are undependable and slow and international arbitration (settlement by a non-court third party) has become common practice.

Colombia ranked fourth, but it is still stigmatized by negative image over drug trafficking…

Software along with apparel was cited as prime targets for intellectual property rights violations in light of limited budgets for enforcement agencies. Likewise, perceived corruption continues to be a problem with the illegal drug trade and limited accountability of local officials. Colombia scored well in the “Protection of minority shareholder rights” and the “laws on PE/VC fund formation and operation” categories.

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By all accounts, the private equity landscape in Latin America has matured and is becoming friendlier to foreign investors – as evidenced by the LAVCA report. However, the region certainly isn’t out of the woods when it comes to ease of new fund formation and operation. So, while we continue to hear about tech-hungry venture fund managers sniffing out start-ups in Brazil, poorly developed regulatory environments and capital markets are also holding back local investors, as well as much -needed growth capital for local companies. Directly or indirectly, private equity market health will have a huge impact on Latin America’s economy, as well as the IT services industry.

 

 

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