Monterrey: Ground Zero for Mexico's Emerging Venture Capital

UNCLAS SECTION 01 OF 04 MONTERREY 000032

SENSITIVE
SIPDIS
STATE PASS EX-IM, OPIC, USTDA
WHA FOR MEX AND EPSC

E.O. 12958: N/A
TAGS: EFIN ECON MX
SUBJECT: Monterrey: Ground Zero for Mexico's Emerging Venture Capital
Industry


1. (U) Summary: To provide greater space for small and
medium-sized companies, Monterrey Tec, Mexico's most prestigious
private university, has established a private enterprise program
which provides seed capital for start-ups. Teaming with Monterrey
Tec and private industry, ConGen Monterrey is sponsoring the
first-ever Mexico venture capital conference April 20-22 in
Monterrey. With the planned conference, organizers seek to open up
the next segment of the market: venture capital. The conference
will bring together Mexico's leading entrepreneurs, innovators,
captains of industry, investors, policymakers and economists to
identify barriers, find solutions, and build an ecosystem that
generates new technology and competitive high-growth companies. In
business-oriented Monterrey, family-owned firms have traditionally
dominated the landscape, with private equity playing a much smaller
role. The April 20-22 event will provide participants with an idea
of how venture capital can promote greater entrepreneurship and
innovation, as well as the obstacles stunting its growth.
Organizers welcome participation from USG agencies. End Summary.

Whither Mexico's Venture Capital?

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2. (U) On December 16, 2009 the Americas Society/Council of the
Americas hosted a panel discussion on the state of venture capital
in Latin America. According to panelists, although sources of
private equity (PE) and venture capital (VC) have dried up in
developed country credit markets in the past year, the credit
crisis has not affected the Latin American VC industry. Key
countries in Latin America have well-regulated banking systems and
minimal leverage and debt. Panelists commented that sound
macroeconomic policies have allowed for organic small and medium
sized enterprise (SME) development throughout much of the region.
This, in turn, helps foster venture capital investment. That said,
panelists concurred that the reason venture capital has held up in
Latin America is that it starts from such a low base. Latin
America represented just 1 percent of global Private Equity
(PE)/Venture Capital (VC) fund-raising in 2008, and in 2007 PE
represented just 0.23 percent of its GDP.




3. (U) Seminar speakers noted that, according to statistics from
the Latin American Venture Capital Association (LAVCA),Mexico
comes in second after Brazil in Latin America as a destination for
VC investment. After discounting for the relatively large size of
its economy, Mexico is underserved in terms of VC compared to other
key countries in Latin America; in 2008 it accounted for a mere 15
percent of investments in the region as compared to 55 percent for
Brazil.



VC Growth in Mexico Stymied

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4. (SBU) Alonso Bustamante Guerra, Senior Analyst of Ignia, a
Monterrey-based social venture capital firm, recently told EconOff
that Mexico has a robust social VC climate, but regulatory
restrictions have stunted the industry as a whole. He estimated
that there are currently less than 10 formal VC funds operating in
Mexico. Not all VC funds have achieved success and many shut down
in the past year. However, interest from investors remains high.
Ignia has received significant investments from the Inter-American
Development Bank, Fondos de Fondos, Soros Economic Development
Fund, OMIDYAR, and, most recently, and as yet unannounced, the
IFC/World Bank. (Note: Social venture capital is a form of

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venture capital investing that provides capital to businesses
deemed socially and environmentally responsible. End note.)


5. (SBU) The Fondos de Fondos (Fund of Funds),Mexico's sole
provider of seed capital to SMEs, was established in 2006 by
GoM-affiliated development banks across Mexico - NAFINSA,
BANCOMEXT, BANOBRAS, and FOCIR - to serve as an economic policy
instrument specializing in the PE and VC markets to promote SME
development. According to Bustamante, the fund currently lacks the
direction or experience to guide development of a viable VC
industry.


6. (SBU) Rogelio de los Santos, venture partner of Monterrey-based
AltaVentures Investment, noted that as venture capital is a
high-risk endeavor, it is a very new concept in Mexico and there is
not a lot of capital available for this type of investment.
However, he added that Mexico does have certain advantages,
including its well-developed consumer market, its geographic
proximity to the U.S., and it's relatively low cost of labor,
goods, and services. Moreover, Mexico has an advanced university
system, numerous R&D initiatives, and regional technological
clusters. (Note: AltaVentures, formed in 2009, is a member of the
Monterrey Venture Capital Conference organizing committee. End
note.)



Obstacles -- Capital Formation

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7. (U) While there appear to be significant opportunities and
growth potential in Mexico for VC markets, there are several
obstacles. Most entrepreneurs and SMEs obtain capital from family
and friends. Larger more established and less risky enterprises
receive capital from investors seeking lower risk investments.
However, local entrepreneurs have limited access to local capital
markets because of the high-risk nature inherent in start-up
financing. Moreover, only since 2005 has the GOM allowed pension
funds such as AFORES to invest in the Mexican Stock Exchange (BMV)
and the GOM did not allow them to invest in VC/PE until mid-2009.
In addition, private pension funds lack the size and experience to
invest in these markets. Many foreign-owned insurance companies
operating in Mexico are unfamiliar with Mexican insurance
investment regulations and have forgone local investment
opportunities.

Obstacles -- Regulatory Environment, Lack of Effective Corporate
Governance

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8. (SBU) Mexico's inflexible regulatory environment has hobbled
the growth of the VC industry. Potential investors view the
Mexican legal system as slow, unreliable, and volatile. A sizeable
number of Mexican entrepreneurs and companies, many family-owned,
lack the corporate governance capacity or training to gauge
performance levels, assess risk, gauge global competitiveness, or
provide for a going concern. Many lack formal boards that include
external/independent members, do not have audit committees, board
approved succession plans, and are unfamiliar with measures to
protect minority investor rights.




9. (SBU) The overwhelming majority of companies are still in

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noncompliance with the Mexican Stock Exchange Law (NLMV),approved
in December 2005 to address investor concerns over corporate
governance, and the GOM lacks the means to enforce the law. For
example, prior to the NLMV, Mexican companies were legally
obligated to confer pre-emptive rights to all stockholders,
requiring them the right to purchase a a proportion equivalent to
their current holdings of any new stock issued. This requirement,
and its subsequent financial implications to shareholders,
effectively kept Mexican companies from issuing future stock
options, warrants, anti-dilution rights, and registration rights as
equity.


10. (SBU) Another hindrance to investment relates to voting
rights. Prior to passage of the NLMV stockholders could not
legally agree to vote in a predetermined fashion, blocking minority
members from voting as blocs to protect themselves from the
majority stakeholders. Furthermore, Mexican law did not allow
private companies to trade in their own stock unless legally
required to do so to meet credit debts. Stockholders were also
subject to retroactive liability and thus were legally responsible
for the company's preexisting commitments. While the terms of the
NLMV rectified these problems, its provisions are not being
uniformly enforced.



Obstacles -- Lack of Fiscal Transparency

--------------




11. (U) Another obstacle to VC growth is Mexico's lack of a
domestic investment conduit for the VC industry. As it is now, if
an investment corporation conducts business in Mexico, it is taxed
twice: both the fund and the individual investors. Mexican law
does not allow the companies to act as a tax pass-through whereby
taxes are only assessed to the fund owners. This lack of fiscal
transparency is extremely costly to investors. To bypass this
regulation, investors use offshore funds as investment vehicles.
As U.S. Limited Liability Companies (LLC) are not accepted as
fiscally transparent by Mexican law, investors have resorted to
Canadian Limited Partnerships (LP) for investment purposes because
Canada is considered fiscally transparent. (Additionally, Canada
is not considered a tax haven and thus is not subject to a 40% tax
on gross capital gains payable on share transfers.) However, this
method of circumvention is still expensive as investors cannot have
offices or a tax presence in Mexico unless they are willing to face
steep tax liabilities, including an income tax on their worldwide
earnings.

Steps Toward Reform -- Seed Capital and Angel Investors

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12. (U) Despite the obstacles, the culture of investment has been
changing over the past decade. Angel investment clubs have gained
a greater presence. These clubs join private investors who seek to
diversify their portfolios, invest in entrepreneurs, and help
support SMEs. Angel Ventures Mexico (AVM) and Investors Club
Mexico (CIM) are among the growing crop of angel investment groups
that have not only experienced success, but have been gaining
worldwide attention as well. They are changing and supporting the
entrepreneurial culture, even going so far as to hold angel
investment 'classes' at local colleges.

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13. (U) Universities such as Monterrey Tec have taken a more
comprehensive approach in providing seed capital to entrepreneurs.
Tec has established a private enterprise program which provides
seed capital for start-ups. Meanwhile, Tec received funding from
the Nuevo Leon State Secretary of the Economy to create a
technological center for research and development. These
facilities host start-ups in their endeavors. Approximately 30
percent of those supported are Tec students, while the remaining 70
percent are alumni or members of the community.




14. (SBU) Cesar Godinez Rodriguez, Director of Capital Funds and
Vice-Rector of Investment and Technological Development at Tec
estimated that of the start-ups since 2002 that have received seed
capital, 80% remain in operation. Additionally, Tec helped develop
10 angel investment clubs throughout its campuses to connect
private investors with start-ups. Each investor commits to a
minimum investment of US$23.4 million, with no ceiling for the
amount they can invest. Every entrepreneur submits a project idea.
Tec then chooses the best technology and innovation projects and
the start-ups are connected with the angel investment clubs. While
Tec cannot monetarily benefit from the transactions, it benefits
via promotion of its students and recognition of its leadership.




15. (U) As stated earlier, Monterrey Tec, private industry, and
Post have collaborated to organize Mexico's first-ever venture
capital conference to be held April 20-22 in Monterrey. For further
information regarding the agenda and schedule for the 2010
Monterrey Venture Capital Conference, contact Monterrey Consul
General Bruce Williamson (WilliamsonB@state.gov
) or Econ/Pol Chief Tim Hall at (
HallTO@state.gov).




16. (U) Embassy Mexico City has cleared this cable.
WILLIAMSON