October 5, 2012
Interviewed by: David Snow
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Partnering With Latin American Entrepreneurs

Private equity is increasingly seen as an “accelerator of institutionalization” and avenue for wealth creation among entrepreneurs in Latin America. This and other observations are shared in an expert conversation with Philip Bass of EY, Arturo Saval of Nexxus Capital, and Scott Voss of HarbourVest Partners. This thought-leadership series is sponsored by EY.

Private equity is increasingly seen as an “accelerator of institutionalization” and avenue for wealth creation among entrepreneurs in Latin America. This and other observations are shared in an expert conversation with Philip Bass of EY, Arturo Saval of Nexxus Capital, and Scott Voss of HarbourVest Partners. This thought-leadership series is sponsored by EY.

David Snow, Privcap: Today we’re joined by Philip Bass of EY, Arturo Saval of Nexxus Capital, and Scott Voss of HarbourVest Partners. Today we’re talking all about entrepreneurs in Latin America. And specifically, how entrepreneurs, especially in later-stage businesses, established businesses, connect with private equity to grow. This is a topic that all of you have a lot of experience with.

I’ll throw the first question over to Arturo. You are established in Mexico and have been doing deals there for a long time. From a private equity prospective, what are you seeing by way of the business owners, who when they come to a private equity firm, they need capital, but what else do they often need in order to make it to the next level?

Arturo Saval, Nexxus Capital: Very clearly, in the case of Mexico, what is very obvious is the fact that, in most of the cases, entrepreneurs, as you all know, are kind or wild people, very good salesman ideally, and what they lack mostly is organization, is management skills, is often the circumstance. What we believe and we have failed to live through is that what they do lack the most is two things. First and I send a general counsel to cope with governance. Because, in essence, in most of the cases, the leader, either the older brother or the main entrepreneur, would make all decisions from the color of the walls to the price of sales of giving you the service. That would be the first one, entering into a kind of joined decision process.

Second thing is, of course, transparency in accounting, transparency in reporting. Most of these guys are usually not accustomed to reporting anybody. So the main thing that you provoke in them is this need to report and share the decisions.

The third, obviously, most important thing is, again, reflecting the right numbers. Mexico’s recently force for public incident is the IFRS accounting standards that you are more familiar with than I with. Obviously, that’s a huge step in most of the cases. Because up to that level, these companies are mostly driven by tax efficiency strategies and not necessarily by accounting transparency rules.

So we do add up these three concepts that I would generally spoke as a basis for a   good corporate governance. You start making what we call a market-friendly company. You are able to join that drive of the entrepreneur with this corporate governance accountability, then you have a market-ready company. That’s where we believe that we add most of the value.

Snow: So I’d like to ask a follow up question for Philip. Is that your experience? I know that you look across the emerging markets as head of emerging markets for EY. Does the experiences and the observations of Arturo jive with what happens across emerging markets?

Philip Bass, EY: Yeah, I think. We’ve recently released a study earlier in the year with MPO, joint study around exits, and taking a look at how private equity really worked with entrepreneurs to create value. And what came out of study was interviews with about 30 GPs taking a look at 60 exits. Really, all the things that Arturo identified really came through, really around governance, transparency, getting the right accounting.

But I think we came out was even more than that. It was really around expanding their networks. So making sure they’ve got the right financing, the capital structure in place. Many of the entrepreneurs, for example, really didn’t have bank financing. It really came through that private equity was really teaming with the entrepreneurs and was much more than just an investment of capital. It was really around an active investment, really working hand-in-hand with the entrepreneur, and really bringing the additional expertise that they’ve had working with other companies in their portfolio. 

Scott Voss, HarbourVest Partners: I think that’s an important point to pick up on. Arturo talked about how the entrepreneur can be promotional in selling his company. But private equity has evolved over the last two decades in Latin America. But it’s still the job of the private equity investor to sell the entrepreneur on the value that private equity can bring to their company, and educate the entrepreneur on the role that private equity plays during a stage of the company’s life.

Snow: Let me ask about family businesses. Because when you’re talking about later-stage, existing successful businesses across Latin America and Mexico, many of them are family-owned. Is it harder or easier to work with families, or does it depend on the family? As someone who backs GPs across Latin America, you must hear a lot of stories.

Voss: Yes, from our experience, in the 1990s, I think it was a little bit more challenging to partner with a family because the company was their identity. It’s what people associated the entrepreneur with. And therefore, when it was time to exit the company, it was difficult because you were taking a piece of the identity of the individual away.

But what we’ve seen is entrepreneurs see their friends exit companies, they make a lot of money, and they go on to start another company. So I think it’s been easier for private equity to partner with families more recently.

Saval: As Scott just pointed out, the examples are the best lesson for most of the families. We have had that case of joining with the families for what I would believe are good reasons. You have this generation who, I think also, where an old family has an established business wants to simply transfer the business to the following generation. And obviously, you have been privately join in order to institutionalize, get corporate governance, real corporate governance, again, transparency, accountability. It brings a whole new scenario into the picture where some members of the family will maintain its role at the company and some family members will simply laugh.

And that, of course, has happened to us for both not as wealthy families and very wealthy families. And it has worked pretty well. And I have to agree with Scott in the fact that the thing has changed in the last, I would say, decade mostly, where but we have been successful in taking some companies public where the main guy or the main families are still running, controlling the company with less than 50%, which is another Latin phenomenon, that you need 50% control. And once you gain that, the size of the company simply booms. And that’s a wonderful example.

Today is easier, yes. Now you have to still be very careful to find out before you actually do the deal, what the company, what the family wants. If they are just selling you installments, that’s a very different business.

Snow: I want to pick up on something that Philip mentioned, which is that access to bank financing is just not as expansive as perhaps in the United States, what you find in Latin America. But what other types of capital, what other resources are private equity GPs competing with in Latin America recently? So a successful entrepreneur who wants to partner with someone, what are his options other than private equity, or her options?

Voss: We often find the other option is just no transaction at all. It’s not a sale. And the family or the seller just decides to finance the company with free cash flow.

You do see hedge funds and other alternative sources of capital come in and out of the region. But entrepreneurs need to be careful there because that’s not always long-term capital, and private equity, I think, definitely has that longer term perspective.

Saval: Again, I have to agree with you Scott, because in the case Mexico, previously to the private development in the country, what did happened was that very rich family offices that would simply buyout these entrepreneurial businesses. And there was no association with them always controlling stakes, always calls on the remainder of the equity. So there was actually no development of this entrepreneurial culture.

Now, private equity has become an alternative. In the case of Mexico, you also have some hedge funds, as Scott pointed out. We also have some government programs that are tailor-made for very small entrepreneurial efforts that after that are taken out by the VC and entrepreneurial seed capital funds.

Bass: And what we found is that what private equity does very well, it’s really that alignment of interests with the entrepreneur, with the family business owner. It’s around making sure they’re aligned right from day one or they won’t like the investment and there won’t be a transaction. But getting that alignment, and while many times it is contractual, the private equity firms will say, it’s really not about the contract, it’s about the relationship, and ultimately making sure that the entrepreneur, they have the same vision and they agree upon execution, and ultimately what the exit strategy is. And I think private equity does that well.

What we found is many of the transactions in the market are minority transactions. So again, when we looked at those 60 transactions and the exits, many of those, the CEO, the family owner was a big part of the business on a go-forward basis.

Voss: We still have a very strong bias for control investing. Not that we don’t like our managers to do any minority investing. But we really want to be certain that the manager can control management changes as well as exits. And the only way to be sure of that is to actually control the company.

Saval: That’s a fact.

Snow: I would love to hear some stories if you have them. You don’t necessarily have to name names. But examples of investments that either you’ve done or you’re aware of through clients that indicate that there really is a change and a progress in Latin America in the awareness among entrepreneurs for the private equity option. And certainly, Arturo, I’m sure you have a lot of stories, but I wonder if one comes to mind as a very good example.

Saval: There’s an example talking about family-owned business. We have this that actually I’m no going to say the name because we plan to place that one in the markets within the following weeks or so. And it’s owned by very wealthy families, that they have this kind of side business where the same members or the same families were involved in this kind of smaller business. So they asked us to go there, join with them, put some money with them, so their interests were clearly aligned. And institutionalize the company, again, corporate governance decisions, transparency, accountability, and accounting, according to IFRS.

And this has been a very good example because we as a fund have been able to deliver to the families what we wanted to, which is gain on that, gain an independent status for this particular company, and also provoke to those members of the family that are either not interested or involved, the necessary liquidity, while the remainder of the families that still want to move this business forward go on. That’s a wonderful example.

I might say, on behalf of balance, that we have also had bad experiences. Not everything is pink in our world, as you well know. And that has provoked a certain volatility that we were commenting in other meetings. The fact that you believe that your alliance sometimes, the alignment isn’t there because there were some hidden reasons for somebody to not behave very clearly.

But in general terms, I believe that the perception of private equity today as an accelerator of institutionalization and, in the end, growth of net worth, but for both your partners and the private equity fund, has been shown and is gaining a lot of popularity. At least in Mexico, which is, in my view, still beyond Brazil in that sense.

Snow: Are you bullish, Scott, generally about what lies ahead for Latin American private equity?

Voss: Yeah, I think there’s a phenomenal macro tailwind in Latin America. The thing that we all need to focus on is the amount of capital that’s flowed into the region over the last two years. Private equity as a percentage of GDP is still very much under-penetrated in Latin America relative to the developed world markets. But the region’s been asked to basically absorb a lot more private equity capital than it has in the past.

Snow: Closing thoughts, Philip, are you bullish about Latin American private equity?

Bass: Yes, very bullish on Latin America. I think even with some decelerating GDP in Brazil, for example, we think the long-term fundamentals are strong. We think the rising middle class will continue, increase consumerism. We’ve talked about GDP growth throughout the region, I think, will be strong. And again, continued opportunities for private equity really fill that capital gap and help transform the landscape.

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