Worldwide: A Deep Dive Into Acquisition Finance In Latin America

Introduction

When structuring an acquisition, one of the paramount decisions confronting the involved parties is the strategy to obtain financing. This financing decision must strike a harmonious balance: the buyer seeks efficient financing that neither inflates the overall acquisition cost nor curtails operational flexibility post-closing; simultaneously, the seller's priority is to ensure closing certainty and timely receipt of the purchase price at closing.

In the ever-evolving landscape of global mergers and acquisitions (M&A), Latin America stands as a region of unique opportunities and challenges. As businesses seek to expand their footprint, the intricacies of acquisition finance in this diverse region come to the forefront. While acquisition finance serves as a powerful tool for funding acquisitions, its structure, parties, documentation and regional specifications in Latin America demand a deep understanding.

This chapter reviews the current M&A trends in Latin America, examining the structure of acquisition financing in the region, the role of various parties, the importance of due diligence and the specific protections and considerations essential for navigating acquisition finance in Latin America.

Current M&A trends

In 2021, the Latin American region witnessed a surge in M&A, with transactions totalling approximately US$168.3 billion.¹ Yet, 2022 unveiled a set of global challenges, which resulted in the region experiencing a 35.9 per cent decline in M&A activity compared to the preceding year, culminating in M&A transactions worth US$106.9 billion.² Factors such as escalating inflation, the energy crisis, falling stock prices and rising interest rates contributed to this slowdown. Given the intrinsic relationship between M&A and acquisition finance, these external challenges also had implications for financing structures and the availability of funds.

Fast forward to the present, and despite the prevailing global uncertainties, Latin America's M&A sector demonstrates resilience, although not quite reaching the levels seen prior to the pandemic. KPMG's 2023 survey on M&A in Latin America underscores this sentiment, highlighting a reinvigorated momentum in the region's M&A activities.³

Traditionally, Brazil has been at the forefront of M&A activity in the region, primarily due to its size, abundance of natural resources and strategic positioning on the global map. In recent times, Mexico has caught the eyes of investors, particularly as 'nearshoring' is unfolding. As global economic dynamics evolve, many investors are recalibrating their strategies. While Asia has traditionally been the manufacturing and services hub for the US, a combination of factors, including proximity to the US market and a skilled young labour force, has propelled Mexico as a preferred alternative. This movement, termed 'nearshoring', is yet to reach its peak in Mexico, indicating further potential growth in transactions in the country.⁴ Investments in infrastructure and public services will be paramount for the exploitation of nearshoring prospects to reach its potential.

Also in Mexico, several traditional sectors have attracted heightened attention in terms of acquisitions. The pharmaceuticals, manufacturing, premium retail, spirits and fintech sectors have witnessed a notable increase in acquisition volumes. However, the strengthening of the Mexican peso may pose constraints on their sustained growth.

Amid the evolving landscape of M&A in Latin America, Costa Rica is rapidly carving a niche for itself, emerging as a sought-after destination for deals. Its reputation as a politically stable and economically robust nation instils confidence in potential investors. Furthermore, its progressive approach to environmental policies is notable; not only is the nation spearheading efforts to reverse deforestation, but it is also championing broader ecological initiatives. This environmentally conscious stance aligns seamlessly with the priorities of investors inclined towards environmental, social and governance criteria. Recognising the potential of foreign direct investment, Costa Rica has also been proactive in rolling out new initiatives designed to attract global investors. These endeavours, ranging from reducing bureaucracy to opening up sectors such as the agriculture, food, tourism, manufacturing and services industries to foreign capital, further accentuate the country's appeal in the M&A domain.⁵

Optimism about the M&A landscape comes with its fair share of caution. A majority of investors and corporations are optimistic that the volume of acquisitions will increase over the next couple of years, both from within the region and externally. This sentiment is supported by the potential for greater regional integration and an influx of foreign investment. Yet, investors are well aware of the geopolitical and economic risks inherent to the region. Concerns range from potential breakdowns in the rule of law to more dramatic shifts such as governments nationalising private entities or diminishing incentives for foreign investment. These factors could easily dissuade potential investors, putting a damper on the otherwise promising M&A forecast for Latin America.

However, its diverse economies and vast potential ensures that Latin America remains an exciting prospect for M&A activity. The interplay between the region's traditional strengths, emerging trends such as nearshoring and the various strategies being employed in countries such as Costa Rica, and the ever-present risks, makes it a dynamic and intriguing region for investors and corporations alike.

Acquisition finance structure

Acquisition finance, in essence, refers to the use of debt to fund the acquisition of a business. The finance dynamics for acquisitions require a delicate equilibrium; not only should the financing be cost-effective, but it should also provide the purchaser with ample latitude for effectively governing and further growing the newly acquired entity.

There are several primary considerations to take into account when structuring an acquisition finance:

• the nature of the buyer, which could be either a strategic entity or a financial investor;
• the type of M&A transaction, whether it is a result of direct negotiations or it emerges from a competitive bid; and
• the availability of financing sources; the accessibility to financing options plays a pivotal role in dictating the financing structure for both buyers and sellers.

Nature of buyer

A strategic buyer's motivation often revolves around the potential for expansion, whether that is horizontal or vertical. Their pursuit is primarily for the acquisition of businesses that can be seamlessly integrated into their prevailing operations. Hence, their financing preferences usually lean towards affordable options that would not hinder their operational or expansionary agility. Financial buyers – for example, private equity firms – are concerned with future return on their investment. They identify businesses with growth potential or that can operate more efficiently, hoping to achieve lucrative returns on their investment within a typical period of five to seven years.⁶

Taking this into consideration, strategic buyers commonly lean towards unsecured short-term or bridge loans, which have full recourse to their financial statements. In contrast, financial buyers usually opt for financing extended to a special purpose vehicle, which is formed specifically for the acquisition. This loan is usually secured by the vehicle's assets, which normally include the shares of the target entity, as discussed further below.

Type of M&A transaction

An M&A transaction can be the result of direct negotiations between the seller and the buyer or an auction process in which prospective acquirers place bids to compete against each other.

Therefore, a direct negotiation offers a more conducive environment for the buyer, allowing for negotiations that can yield favourable acquisition agreement terms, translating into more advantageous financing. In a competitive bid, sellers meticulously assess buyers' financing prospects and the associated risks of unavailability of funding at closing. Sellers typically favour bids accompanied by financing assurances. Hence, commitment letters frequently feature 'SunGard' provisions, which essentially tie funding conditions at the closing phase to, inter alia, fundamental representations and warranties being true and correct, there being no material adverse change (MAC) in the target company and the successful execution of collateral documentation (funding typically occurs before the perfection of these documents (such as registration in public registries), which will be included as a post-funding covenant).⁷

Availability of financing

Marked by their low debt rates, 2020 and 2021 presented buyers with the option to wholly or partly fund their acquisitions via debt. Despite the shift in the economic conditions in 2022 and 2023, buyers in Latin America persistently explored bank, private placement and debt capital markets. Historically, the most prevalent acquisition financing mode in the region has been the bridging loan route.

Unlike the US, where acquisitions are frequently directly funded through capital markets, Latin America displays a strong preference for bridging loans. Several factors contribute to this preference: there is restricted access to capital markets, the region's markets are generally smaller and less liquid than those in the US, and the process of listing with stock exchanges can be cumbersome and expensive.⁸ The bridging loan mechanism elevates the reliability of funding availability at the acquisition's closing date, safeguarding the seller's price. Beyond its immediate benefits, a bridging loan also furnishes the buyer with post-acquisition flexibility, granting it the discretion to replace the loan with a term loan or bond.

In recent times, there has been a notable trend towards innovative financing mechanisms, such as equity kickers and seller financing. Seller financing allows the seller to facilitate transactions by providing part of the finance for the acquisition. Equity kickers give the lender an ownership position in the buyer's entity, often in return for a reduced interest rate. They serve as an enticing incentive for lenders, offering the potential for equity participation in a company in addition to interest payments. These two methods are typically employed to finance a portion of the acquisition and become particularly appealing in scenarios where traditional financing sources are not available or are less favourable.

In essence, the landscape of acquisition finance in Latin America is characterised by its distinct regional preferences, strategies and challenges, which prospective buyers must navigate to make successful transactions.

Acquisition finance parties, processes and documentation

Acquisition finance involves various parties and crucial documents. This intricate web defines the terms, conditions and mechanisms that facilitate the financing aspect of any acquisition. This section delves into the primary players in the acquisition finance process, the primary documents that form its foundation and the indispensable role of due diligence.

Parties

Acquisition finance involves three primary parties: the buyer (or borrower), the lenders and the sellers.

As highlighted above, borrowers and buyers in an acquisition financing can be categorised primarily as strategic or financial. Their distinct objectives and acquisition strategies play a defining role in shaping the financing structure.

The lenders or financing sources are the entities providing the required financing for the acquisition. Lenders in Latin America often consist of local banks or non-bank lenders as well as international banks. Taking into account the region's preference for the bridging loan mechanism, the lenders might opt for various financing structures such as bilateral, syndicated or club deals, depending on the deal's complexity and the parties involved.

Sellers are focused on receiving the agreed-upon value of their assets or enterprise, which is why they endeavour to ensure that buyers have the necessary financing at closing to meet the purchase price. This is a crucial concern, especially given the nature of M&A transactions, whether it is a private sale or a competitive bid.

The triad of main players in acquisition finance often seek insights from financial consultants and legal counsel. Financial advisers shed light on the financial facets of the transaction, ensuring the terms struck are both favourable and sustainable. Their expertise is invaluable in assessing the viability of the proposed acquisition financing structure. Also, given the legal intricacies of acquisition finance, both borrowers and lenders engage legal counsel. These experts ensure the terms and conditions are compliant with prevailing laws.

In the context of Latin America, acquisition finance deals frequently involve a blend of local and international legal expertise. For example, a cross-border transaction involves both local and foreign law, which typically governs the principal loan agreement (which normally falls under New York law) while observing the required components to consummate the acquisition under the local jurisdiction.

The players in acquisition finance are not limited to these parties. Other pivotal players, such as stakeholders, auditors and regulatory authorities, may have a vested interest in the acquisition finance process.

Due diligence

Prior to the execution of any documentation for an acquisition finance transaction, the debt provider finalises its due diligence. Due diligence serves as the linchpin in the acquisition finance process. Before the green light is given to any financing, it is imperative to comprehensively vet the buyer's and the target company's financial, operational and legal status. This scrutiny helps lenders evaluate the risks and ascertain the deal's viability. It aids in uncovering potential pitfalls or liabilities, ensuring that lenders, buyers and other stakeholders make informed decisions. In essence, due diligence acts as the gatekeeper, ensuring that the financing structure is robust, sustainable and in the best interests of all parties.

Documentation

The terms and conditions of an acquisition finance transaction are laid out in two separate sets of documents, which are executed at different stages of the M&A transaction.

The first set of documents is referred to as the commitment documents. At the outset, buyers and potential financing sources negotiate the core economic, commercial and legal terms. These discussions crystallise into the 'commitment documents'. The first set includes:

• commitment or mandate letters, which delineate the terms under which lenders are obligated to fulfil their commitments;
• fee letters, which outline the fees that will be paid to the lenders, arrangers and agents; and
• SunGard and market flex provisions, both of which frequently find their way into commitment or mandate letters. The SunGard provision outlines specific, limited conditions for funding, ensuring that the necessary funds are available at the close of the M&A transaction. This feature distinguishes acquisition financing from non-acquisition financing. On the other hand, market flex provisions grant arrangers the flexibility to tweak financing terms, which aims to guarantee successful syndications.

The second set is referred to as the definitive documents. During the period between signing the initial agreement and closing the M&A transaction, the involved parties finalise the acquisition's definitive documentation, based on the previously agreed commitment documents. Essential among these are:

• the loan agreement, which is the pivotal document detailing the terms of the loan. In a Latin American scenario, the governing law of this document could be either the local law of the country where the borrower, buyer or target is based, or foreign law – typically New York law; and
• collateral documents, which outline the specifics of the collateral, when applicable. Typically, collateral in an acquisition finance deal comprises the shares or assets being financed, future revenue streams stemming from the acquired assets or entities, or a corporate guarantee, particularly when a strategic player is involved. Although the loan agreement can be governed by foreign law, any collateral documents related to assets located in a Latin American country must comply with that nation's legal framework and stipulations. For example, when the collateral involves shares of the target being acquired, the document should adhere to the local laws and registration requisites needed to formalise the security interest.

Acquisition finance is not merely about pooling funds for an acquisition. It is a meticulous orchestration of parties, documents and processes, each serving as a cog in the M&A process. As Latin America continues its dynamic M&A journey, understanding these components becomes pivotal for investors, corporations and professionals navigating this landscape.

Protections and considerations specific to Latin America

Acquisition financing in Latin America is characterised by its distinct dynamics, shaped by the region's diverse economic, political and regulatory landscape. This section explores key protections and specific considerations for lenders and borrowers involved in these transactions in the region.

As mentioned above, a cornerstone of acquisition financing is the due diligence process. In their quest to minimise risk, lenders review the acquisition agreement, diving into the terms of the acquisition, as well as the profile and assets of the target. This review allows lenders to gain insights into the dynamics between the involved entities. A vital component often embedded within the acquisition agreement is the financing cooperation covenant, which mandates the buyer's collaboration, also ensuring the active participation of the seller and the target.

Providing a primary protective shield for lenders are the commonly named 'Xerox' provisions. Incorporated within the commitment documents, these provisions act as a buffer, shielding debt providers from becoming entangled in transactional disputes that may emerge if an M&A deal falls apart. In essence, they establish a clear demarcation, stipulating that both the buyer and seller refrain from dragging the lenders into litigation. Nevertheless, the buyer retains the right to exercise its rights under the commitment documents. Additionally, acquisition agreements often limit the buyer's liability through mechanisms such as reverse break-up fees, a factor lenders should observe or maybe even require to be included in the agreement. To reinforce these protections, debt providers position themselves as third-party beneficiaries within acquisition agreements, exclusively to secure the right to enforce the Xerox provisions and to ensure that these provisions remain unaltered without their explicit consent.

Within acquisition agreements, specific clauses require thorough attention and examination by financing providers. Definitions concerning MACs and their associated exceptions can profoundly affect the financing framework. To protect their stakes, lenders often advocate for qualifiers that reinforce clarity, especially when the exceptions encompass wide-ranging economic or political circumstances. For instance, if a MAC definition incorporates broad exceptions, a lender would typically expect the buyer to specify that these exceptions are relevant only when 'they solely impact the target and the said impact is notably more severe than on comparable businesses'.⁹ Furthermore, lenders must meticulously review and analyse the disclosure schedules, ensuring they identify any exclusions, assess their materiality to the business and determine the presence of substantial liabilities.

Each Latin American country brings to the table its distinct legal regulations and its unique considerations. Some of the most important items to bear in mind when structuring an acquisition financing in Latin America are as follows.

• Collateral documents. In several Latin American jurisdictions, the perfection of collateral demands strict formalities such as mandatory notarisation and registration in public registries. These processes, while ensuring legal robustness, can amplify costs and introduce potential delays, which lenders must factor into their calculations.
• Foreclosure procedures. The region's varied foreclosure procedures, shaped by each nation's judiciary and collateral structures, can be cumbersome and resource-intensive. Lenders should anticipate both the costs and duration of these processes.
• Insolvency laws. Insolvency and bankruptcy laws in Latin America can be difficult to navigate, with each country introducing unique layers of complexity.
• Tax. Withholding tax rates on interest payments can vary considerably across the Latin American nations. While some countries impose rates as steep as 35 per cent, others offer preferential rates, contingent on multiple parameters relating to the nature of the borrower or lender's jurisdiction.
• Foreign exchange controls. The region's fluctuating foreign exchange landscape, with countries such as Argentina imposing stringent controls,¹⁰ requires meticulous evaluation. These controls, often influenced by the broader political and economic context, play a pivotal role when structuring a transaction in the region.

Conclusion

Acquisition finance in Latin America is enriched by the region's distinctive economic, legal and political dynamism. As both local and international businesses continue to harness the potential of M&A in the region, a profound understanding of its acquisition finance dynamics becomes indispensable. Through meticulous planning, thorough due diligence and leveraging specific protections, lenders, buyers and sellers can craft robust financing structures that cater to their strategic aspirations while mitigating potential risks.

Latin America, with Costa Rica's stable economic and political stance, Brazil's niche M&A market and Mexico's new nearshoring trend among other traditional industries, is poised at an intriguing juncture of growth and global integration. Yet, as with any dynamic region, investors and professionals must remain vigilant. Imminent and upcoming political events, such as the presidential elections in El Salvador, Panama, Mexico, Uruguay and Venezuela and Chile's constitutional plebiscite, coupled with new leadership in Argentina, Colombia, Chile and Brazil, could pivot the landscape. These shifts may either unlock unprecedented opportunities or give way to unforeseen challenges. In this evolving panorama, strategic foresight and adaptability remain key to leveraging Latin America's acquisition finance potential to its fullest.

Footnotes

1. See Sebastián Osorio Idárraga, 'Mergers and Acquisitions dropped by 30% in LatAm in 2022', Bloomberg, 27 December 2022, www.bloomberglinea.com/english/mergers-and-aqcuisitions-dropped-by-30-in-latam-in-2022/ (last visited 26 September 2023).

2. ibid.

3. See 'In an uncertain world, Latam M&A is on the rise: KPMG 2023 M&A in Latam Survey', https://kpmg.com/xx/en/home/insights/2023/06/kpmg-2023-m-and-a-in-latam-survey.html (last visited 18 September 2023).

4. See 'Nearshoring in Mexico', www.mayerbrown.com/-/media/files/perspectives-events/publications/2023/05/whitepaper_nearshoring_fnl.pdf?rev=0383024119224587a4a922b0 7f9632bd (last visited 26 September 2023).

5. See 'Costa Rica Takes Another Step to Bring Foreign Investment to the Country's Rising Cities', CINDE, 24 February 2023, www.cinde.org/en/essential-news/costa-rica-takes-another-step-to-bring-foreign-investment-to-the-countrys-rising-cities (last visited 18 September 2023).

6. See 'Strategic vs Financial Buyer', Corporate Finance Institute, https://corporatefinanceinstitute.com/resources/valuation/strategic-buyer-vs-financial-buyer/ (last visited 20 September 2023).

7. See Jennifer T Wisinski, 'Negotiating Financing Provisions in Mergers', Reuters, May 2023, www.reuters.com/practical-law-the-journal/transactional/negotiating-financing-provisions-mergers-2023-05-01/ (last visited 20 September 2023).

8. See Michelle del Campo and Estephanie Suárez, 'Por qué las startups en México y Latam no debutan en bolsa', Bloomberg, 28 September 2021, www.bloomberglinea.com/2021/09/28/por-que-las-que-las-startups-en-mexico-y-latam-no-debutan-en-bolsa/ (last visited 18 September 2023).

9. See 'Lender Concerns in Acquisition Agreements Checklist: Acquisition Finance', https://uk.practicallaw.thomsonreuters.com/8-381-0300?transitionType= Default&contextData=(sc.Default)&firstPage=true (last visited 25 September 2023).

10. See 'Argentina – Foreign Exchange Controls', www.privacyshield.gov/ps/article?id=Argentina-foreign-exchange-controls (last visited 25 September 2023).

Originally published by Latin Lawyer.