I OVERVIEW

The private equity industry has continued to develop in Chile but at rates lower than in previous years. Growth rates of 2.1 per cent for the year ended 31 December 2015 and an expected rate of 1.6 per cent for the year ended 31 December 2016 have certainly affected the investment activity generally. Chile continues to offer, however, an attractive business environment and a stable legal framework. Notwithstanding the important legal reforms pursued by the current government in critical areas such as constitutional amendments, taxation, employment, education, Chile still holds the first position in the LAVCA Scorecard ranking, which reflects regulatory, policy and market conditions for the private equity industry.²There are three areas where Chile obtains high scores compared to other Latin American economies: protection of intellectual property rights, perceived levels of public corruption and strength of the judiciary. Confirming this, the 2016–2017 Global Competitiveness Report prepared by the World Economic Forum awarded Chile the first place in the competitiveness ranking for Latin America, and improvement of two tiers in the global ranking.³

By the end of 2015 (most recent available data) there were 80 investment funds with estimated aggregate investments of US$2.797 billion, plus 24 management firms. Those funds were divided as follows: 35 venture capital funds with investments of US$415 million, eight private equity funds totalling investments of US$100 million (considering only local funds) and 37 feeder funds holding aggregate investments of US$2.282 billion. Feeder funds experienced the highest growth rate with 12 new funds with investments reaching US$990 million. The number of private equity and venture capital funds also increased during 2015, with three new PE funds and three new VC funds.⁴

i Deal activity

Chile’s main appeal to the PE and VC industries is that, unlike other countries of the region (such as Brazil or Mexico) the number of sponsors in the market is still limited; new players are attracted by the opportunity for better value. Depreciation of the Chilean peso during 2016 has made the country especially interesting for foreign investors, although this effect has been offset by the uncertainty created by recent structural legal reforms.

The larger players in Chile from the fundraising perspective are international sponsors such as KKR, The Carlyle Group, Apollo, Blackstone, EQT (i.e., funds with assets over US$50 million, and with a regional and not purely national focus) that use local feeder funds to raise capital mainly from institutional investors. In terms of PE investments, main players are also regional and international sponsors doing deals in Chile, such as Advent, CVC, Linzor Capital Partners or Southern Cross Group. Finally, some of the most relevant local sponsors are Aurus, EPG Partners, Sembrador Capital de Riesgo, Equitas Management Partners, BTG Pactual, Activa Private Equity, NXTP Partners Chile and Moneda Asset Management.

The average size for PE/VC funds (not including feeder funds) is US$12 million.⁵This is consistent with the nature of the investors participating in the industry (i.e., low participation of institutional investors) and with the profile of the deals that are seen in the region, which are generally within the small and lower-middle market.

Typically, foreign sponsors enter the country associated with local firms that have a better understanding of the local market. Generally, that same local firm is the one that creates local feeder funds if the foreign sponsor is interested in raising funds from local institutional investors.

During 2015, while the aggregate amount of private equity investments in the Latin American region decreased by 18 per cent, the number of deals increased only by 1 per cent. The final figures for 2015 indicated 310 deals for US$6.47 billion within Latin America.⁶

Chile, in line with the rest of the region (other than Mexico and Peru), experienced a slow year compared to the previous period in terms of deal activity. There were a total of 14 reported deals in Chile during 2015, compared to 27 deals reported in 2014, for an aggregate amount of US$178 million, a 79.5 per cent decrease compared with 2014 when the aggregate amount of investments reached US$867 million. As measured by deal count, the period showed a 48.1 per cent decrease according to publicly reported deals. No exits were reported during 2015. During the first half of 2016, six deals were reported amounting for US$64 million of investments and one exit for non-disclosed amount was also reported.

The table below shows reported deals in Chile during 2015 compared with deals in other countries in the region:

Source: LAVCA Industry Data & Analysis 2016

The table below shows exits in Chile during 2015 compared with those in the other countries of the region:

Source: LAVCA Industry Data & Analysis 2016

ii Operation of the market

The terms of private equity deals are fairly consistent with US industry standards. Frequently, transaction documents are based on US forms (including contracts drafted in English). Usual terms include representations and warranties, purchase price adjustments, anti-dilution provisions (including full ratchets), affirmative and negative covenants, events of default, indemnities and non-compete clauses. Shareholders’ agreements are generally used for the corporate governance of the target company and to restrict the transfer of shares for the benefit of the private equity sponsor.

In some cases, the private equity seller may agree to escrow arrangements to secure buyer claims until the lapse of the statute of limitations (generally five years) or the shorter period set forth in the purchase agreement. Representations and warranties insurance has not been used in a Chilean deal yet. Arbitration is the preferred dispute resolution mechanism for these transactions in almost all instances.

A typical sale process starts with the negotiation by the parties of the basic terms and conditions of the transaction, typically in the form of a term sheet. Term sheets may include indicative offers subject to due diligence conditionality. Often, the buyer will conduct the due diligence before the announcement of the transaction to the market, but a fair number of deals are announced without any due diligence having been carried out. Diligence ‘outs’ remain the norm, but it is standard practice for sellers to impose minimum thresholds and objective tests. Definitive purchase agreements will still be subject to conditionality, especially as they are relevant to governmental consents. For instance, in concentrated markets the approval of the antitrust authority will be a likely requirement, and transactions in the utilities sector will also require approval by the relevant authority (the sanitary authority in the water industry, the energy authority in the electric industry, etc.). If the sale process involves an initial public offering (IPO), prior approval by the Securities and Insurance Commission (SVS) will be required.

Unless there is an IPO, a deal will typically take between three and six months to close (of course, depending on the negotiations of the parties and the complexities of the deal, a particular transaction may take longer or shorter to close).

The management of portfolio companies usually have a significant portion of their compensation tied to stock options and other rewards linked to the performance of the company. Alignment of incentives and favourable tax treatment make this type of compensation very desirable in Chile.

II LEGAL FRAMEWORK

Chile allows for a number of corporate entities with different results in terms of control.

A Chilean corporation is managed by a board of directors, with certain specified decisions reserved to the shareholders.

A corporation can be publicly traded, or ‘open’, private or ‘closed’. An open corporation is one that has issued equity shares registered with the SVS. Registration is voluntary, except where the corporation has 500 or more shareholders, or if at least 10 per cent of its capital stock is held by at least 100 shareholders. Open corporations are supervised by the SVS. All other corporations are closed. Closed corporations are not subject to the supervision of the SVS unless they are issuers of publicly traded securities (whether equity or debt) or if otherwise required by a special regulatory frame (e.g., insurance companies).

Corporations are managed and controlled by a board of directors appointed by the shareholders. The board has the broadest authority over the corporation and its affairs. Closed corporations must have at least three board members, open corporations at least five.⁷

There are statutory withdrawal rights for shareholders pursuant to which a shareholder can put its shares to the corporation upon certain actions being approved.⁸

Corporations in Chile require at least two shareholders.

Chilean law also provides for a corporate type similar to Delaware’s limited liability company, with two critical distinctions: Chilean limited liability companies (LLCs) require a minimum of two members, and Chilean LLCs require unanimous consent to amend their charter in any respect, to accept new members or to allow existing members to assign their interest.

Share companies (SpAs) combine the best attributes of a corporation (free assignability of the equity interests) with the contractual flexibility of an LLC (the SpA does not require unanimous consent for amendments of its charter). An SpA can be formed by one or more persons (individuals or legal entities), and allows for any type of corporate agreement save for a few mandatory rules.

SpAs allow for a single equity holder and can have as many equity holders as desired. If an SpA, however, reaches the number of equity holders that would render a corporation an open corporation, then it will automatically become an open corporation.

If provided for in their charter, SpAs are allowed to make capital calls and issue equity interests if resolved by management (i.e., without the consent of the equity holders). Unlike corporations, there are no statutory pre-emptive rights (again, except as contemplated by the organisational documents). The organisational documents may indicate minimum or maximum percentages or amounts of capital that are to be directly or indirectly controlled by one or more shareholders. The repurchase of their own equity interests is allowed for SpAs. Contrast this with corporations, which can make capital calls only if agreed by the shareholders. Statutory pre-emptive rights apply to equity issuances by a corporation. Corporations are also generally prohibited from acquiring their own shares and must distribute minimum statutory dividends (at an amount of 30 per cent of net earnings).

Most notably, however, an SpA may issue preferred shares accruing fixed or variable dividends. Features like preferred dividends accruing from specific businesses or assets are permitted (i.e., tracking stocks).

Chile also has investment funds. These can be structured as public funds (which are subject to substantive regulations by the SVS restricting the type and amount of assets in their portfolios, transactions with affiliates and periodic reporting to the market) or private funds (which are not subject to such regulations). Only public funds can publicly offer their securities.

i Sponsors’ controlling investment of an entity

A sponsor seeking control of an investment in Chile will have to consider the specific features of each type of corporation.

Where the sponsor wishes to acquire control of a corporation, it will require at least the control of the number of shares required to control the board of directors and corporate decisions in shareholders’ meetings – typically a majority of the outstanding shares. A number of material corporate actions require approval by at least two-thirds of the outstanding shares.⁹Some of those actions (such as the sale of more than 50 per cent of the assets and the creation of preferred shares) are material to private equity or venture capital sponsors. No corporate actions require unanimous consent of the shareholders.

Chilean law explicitly recognises shareholders’ agreements and provides that they need to be ‘deposited’ with the corporation as a condition of the parties to it making claims against third parties based on such agreements. Chilean law, however, provides that shareholders’ agreements are not enforceable against open corporations insofar as they create restrictions on the transfer of shares.¹⁰As a result, frequently liquidated damages clauses are agreed to by the parties in amounts large enough to create the appropriate incentives.¹¹

SpAs provide the broadest flexibility in terms of contractual structuring provisions. The express recognition by the statute of contractual requirements in terms of maximum (or minimum) levels of equity interests held by its members, the fairly broad flexibility to trigger increases or reductions in equity capital and the ability to repurchase their shares,inter alia, make SpAs highly desirable vehicles for private equity investors.

Uniquely, SpAs’ charters can provide for ‘squeeze-outs’, whereby a minority holder can be forced to sell its interest upon another holder acquiring a certain threshold percentage. SpAs also allow for preferences consisting of multiple vote shares (and shares without voting rights).

In summary, a private equity sponsor will benefit significantly from the flexibility provided by an SpA when setting up a holding vehicle for its investment. By the same token, a sponsor investing in an existing SpA will need to conduct thorough due diligence and understand the implications of the SpA’s organisational documents.

ii Structuring considerations for sponsors not domiciled in Chile

The key structuring considerations will be driven by control issues (as previously discussed), tax issues and the regulatory framework relevant to the industry in which the investment is made. For example, a number of activities in Chile have to be – at least directly – performed by corporations (banking, insurance, retirement funds administrators, utilities, infrastructure concessionaires, etc.). In addition, corporations are the only corporate entity that allow for an IPO.

Similar to US tax law, Chilean law creates incentives for the use of leverage in a private equity transaction. Subject to certain conditions, Chilean tax law allows for tax deductions on account of interest payments. The same deduction does not exist for dividend payments.

Ordinarily, dividends remitted to non-Chilean sponsors are subject to a 35 per cent withholding tax rate. Interest payments are taxed at the same 35 per cent rate, but a 4 per cent reduced withholding rate applies,inter alia, to interest payments on loans made by foreign banks and financial institutions. In some cases, however, such as when the debt is guaranteed with cash or cash equivalents provided by third parties, or when the lender is an affiliate of the borrower, in order to qualify for the reduced 4 per cent rate a 3:1 debt-to-equity ratio will have to be satisfied every year when an interest payment is made.

When structuring a transaction as a leveraged buyout, sponsors will have to ensure that thepro formaamount of debt of the target company (including the debt raised to finance the LBO) allows the surviving company to remain solvent. Chilean bankruptcy courts have jurisdiction to void transactions resulting in insolvent entities.

It is common to bridge a leveraged deal using short-term debt and then to refinance with long-term securities in the bond market or with a long-term secured loan.

Another reason for leveraging up a deal is that remittances of equity contributions to a foreign sponsor are first allocated to taxable retained earnings and profits (assuming the Chilean company is taxed under the ‘partially integrated system’). Accordingly, outflows of capital contributions can only be tax free if the Chilean business does not have accumulated earnings and profits that are taxable (starting on 1 January 2017, if the Chilean company is taxed under the ‘attributed income system’, the investor will pay taxes for 100 per cent of the taxable income every year, regardless of its distribution, and therefore repatriation of capital contributions will always be tax free under this regime). There is no such requirement affecting principal payments on debt transactions.

iii Fiduciary duties and liabilities

The main source of fiduciary duties in the Chilean corporate context is the Corporations Act and its regulations.¹²Directors of a corporation have an obligation to act with the degree of care and diligence that they would apply in their own affairs. They are jointly and severally liable for damages caused to the corporation or its shareholders for their fraudulent or negligent actions. The same principles apply to an SpA, unless it is not managed by a board of directors or unless provided otherwise in the SpA by-laws.¹³As a result, a private equity sponsor will not be directly exposed to liability with regard to other shareholders. The shareholders of a corporation (or an SpA) do not generally owe fiduciary duties to each other, and are permitted to act in their own self-interest. They might be liable to the corporation (or SpA) for losses arising from breaches to the Corporations Act, the company’s by-laws or the rules issued by the SVS.

Areas of concern for a sponsor arise in the insolvency context. While the Chilean courts do not apply the ‘zone of insolvency’ test to the same extent that a court in the United States might,¹⁴the Chilean Bankruptcy Act¹⁵does provide for liability on account of actions that are fraudulent to creditors. For example, Chilean courts may void a sale of assets consummated within two years of the insolvency of a company. They are, however, very unlikely to find liability for a sponsor other than in the very narrow circumstances of a fraudulent voidable transaction expressly provided for in the Bankruptcy Act or under criminal fraud statutes.

During the last four years the SVS has focused on compliance with the legal and regulatory requirements in connection with related party transactions (OPRs). The criterion applied by the SVS to qualify a transaction as an OPR has been determined largely by specific facts and circumstances. For instance, in 2012, a capital increase in the energy company Enersis, was qualified as an OPR because the controller was paying for the equity shares issued to it, pursuant to the capital increase, in kind, while the minority shareholders had to pay for their shares in cash. On the other hand, a broad reorganisation of that same company in 2015, including several mergers and splits among Enersis and its subsidiaries, was not deemed an OPR by the SVS, even though the latter required to satisfy procedures and formalities applicable to an OPR. In the first case, assessing the fair market value of the assets that are being contributed by the controller as payment of the purchase price for its equity shares, and in the second case, assessing the fair market value of the company that is being merged into another company, were one of the main concerns for the minority shareholders, and characterising the transactions as an OPR could make a big difference in connection with that valuation process. In a private equity context, special attention should be paid to agreements between the holding company, the sponsor and the managers, on the one side, and the target or operating company on the other side, when the latter is a public corporation subject to the supervision of the SVS. This discussion might also be relevant in an acquisition involving a public company, were part of the purchase price is paid with shares of the purchaser or of another company, or in general, with any assets different from cash.

III YEAR IN REVIEW

i Recent deal activity

An interesting deal from a fundraising standpoint was the recent closing by Greystar Real Estate Partners, LLC and Credicorp Capital of their multifamily development fund, which will focus on residential real estate development in Santiago. This deal continues with the trend across the region of international sponsors partnering with local players to leverage their experience and knowledge of the local housing market. Until this point no major corporate players had entered the rental housing business in Chile.

One of the largest investments of the year was the acquisition by Southern Cross of 100 per cent of Petrobras’ distribution assets in Chile for US$464 million. The sale is part of a wider divestment plan of the Brazilian state-owned company. Another important investment was in the banking and finance sector, where IFC made a US$140 million equity investment in Consorcio Financiero. The investment gives the IFC an 8.3 per cent stake in the Chilean company. The lack of liquidity of Chilean capital markets and the property structure of most of Chilean companies (i.e., property concentrated in a few owners generally part of the same family or economic group) makes this kind of minority deals common in Chile.

The energy industry, which was very active during 2014–2015, also experienced certain movement during 2015–2016. An interesting deal in this space was the acquisition by a consortium comprised of the Chilean generation company Colbún, the Abu Dhabi Investment Authority and Sigma SAFI’s Infrastructure Fund of 100 per cent of the thermoelectric generation company Fenix Power Perú. Another relevant deal was the sale of Duke Energy’s assets in Peru, Chile, Argentina, Guatemala, El Salvador and Ecuador.

Finally, in the telecom space the main deal of the year was the acquisition by UK private equity fund Novator Partners of 92 per cent of Chilean telecom company Nextel Chile.

ii Financing

From a regulatory standpoint, it is worth noting that Chilean institutional investors, especially pension funds, are a key source of liquidity for private equity in Chile. Banks are also authorised to participate in private equity deals through their affiliates. Restrictions on the amounts invested (determined as a percentage of their assets) apply. International private equity firms generally use local feeder funds to raise capital from institutional investors.

The recently enacted Law 20,956 allows pension funds to invest in securities, operations and contracts representing real estate assets, private equity investments, private debt, infrastructure and other types of assets (alternative assets) to be determined in related regulations called the Investment Regime for Pension Funds. This Investment Regime must specify the securities, operations and contracts authorised for pension funds’ investments and the conditions that such investments must meet. The law also allows for investments in bonds issued by investment funds regulated by Law No. 20,712 (the Unified Funds Law). The investment regime shall also forth the conditions that these instruments must meet and a maximum limit for investments in alternative assets that shall range between 5 per cent and 15 per cent of the value of the pension fund, and may be different for each type of pension fund (currently pension funds may invest up to 2 per cent of their assets in quotas of investment funds). Finally, the new law also increases the maximum participation threshold applicable for investments in a single investment fund by pension funds managed by a single pension fund manager (AFP) from 35 to 49 per cent. All these amendments will be effective from 1 November 2017.

The Chilean Economic Development Agency (CORFO), the state development agency, is a significant source of financing for private equity and venture capital. CORFO encourages entrepreneurship and innovation by providing resources to start-ups or in key sectors of the economy. CORFO can provide direct financing (up to 40 per cent of the equity of a company) or financing through lines of credit available to private equity or venture capital investors. CORFO’s financing can be unsecured, thereby allowing for additional third-party leverage on a secured basis. By the end of 2015, CORFO had committed equity contributions to 39 out of the existing 43 private equity or venture capital funds (excluding feeder funds), for a total amount of US$560.33 million committed funds, of which US$355.92 millions were effectively disbursed. Those investments were made primarily in venture capital funds (85 per cent) and only five private equity funds received financing from CORFO.¹⁶

IV REGULATORY DEVELOPMENTS

i Regulatory bodies of the industry

Except for specific instances in the context of regulated industries, private equity transactions are generally not subject to special regulations restricting them. If a transaction involves public investment funds or public companies, a private equity sponsor is likely to have to deal with the SVS, which may exercise its overseeing powers. Private investment funds and private companies (including SpAs), on the other hand, are not supervised by the SVS.

For an IPO, both the issuer and its securities to be offered to the public need to be registered with the SVS. An application describing in detail the terms and conditions of the offer is required, and must include extensive information regarding the company (ownership structure, legal information, accounting, business and activities, risk factors, etc.) and its securities. The SVS has ample discretion to approve an application, and usually it will exercise it by asking for further information and for changes to the way information is presented. Once the observations are resolved, the issuer and the shares will be registered in the Securities Registry of the SVS. The SVS making observations is very common; however, an application not ending in an approved registration is extremely unusual.

ii Regulatory developments

One of the main regulatory developments was the enactment of Law 20,956 (explained in more detail in Section III.ii,supra).

Another relevant development was the issuance by the SVS of general rule No. 410, which supplements the list of entities that qualify as ‘institutional investors’ pursuant to the Securities Market Act (Law No. 18,045). The importance of who qualifies as an ‘institutional investor’ pertains, among others, to the rules applicable to funds and portfolio management. The Unified Law on Funds (Law No. 20,712) grants certain flexibility to those funds that have an institutional investor as a shareholder. For example, a publicly traded fund may have fewer than 50 shareholders if at least one of them is an institutional investor. Likewise, private investment funds may have fewer than four non-related shareholders (each of them holding at least 10 per cent of the shares) if they have one shareholder that is an institutional investor and that holds at least 50 per cent of the shares of the fund. This is very relevant to private investment funds, because if they don’t comply with these structural restrictions they would be treated for tax purposes as closed corporations, losing all the tax benefits of a private investment fund.

Starting on 1 January 2017, the new tax regime enacted during 2015 will be fully effective. A key aspect of the new tax law is the increase on the corporate tax burden for Chilean companies from the current 24 per cent rate to 25 or 27 per cent, depending on the regime companies adopt. For this purpose, the amended income tax law provides for two new tax regimes: (1) an attribution regime that levies a 25 per cent tax rate on incomes obtained by companies in each tax year, which will be immediately allocated to their shareholders; and (2) a partially integrated regime that levies with 27 per cent tax rate incomes obtained by companies. Under the second regime, shareholders are allowed to defer personal and withholding taxes until such profits are effectively distributed, but it only allows the use of a 65 per cent credit of the taxes paid by the company, unless the shareholder is resident in a tax-treaty country. The taxable basis of the corporate tax is broadened by way of new controlled foreign entities (CFC) rules; modified thin capitalisation rules; disallowance and limitation of deductions; limitation on the use of tax losses, and limitation of preferential capital gains regimes and tax-free investment fund vehicles, among others. Goodwill in excess of the market value of assets ceases to be subject to amortisation for tax purposes.

Finally, new merger control and antitrust regulations have also been enacted. A mandatory merger control regime will become effective in June 2017. As a result, deals closed after 1 June 2017 will be subject to the new clearance regime. The new merger control regime requires ‘concentration transactions’ exceeding certain thresholds to be filed with the Antitrust Agency (FNE) prior to their consummation. The FNE shall have 30 days to approve the operation (unconditionally or subject to conditions). The 30-day term may be extended up to 90 days. A concentration transaction is subject to filing only if: the aggregate sales in Chile, during the immediately preceding year, by all the parties intending to merge or consolidate are equal to or higher than, approximately US$70 million; or the sales in Chile during the immediately preceding year by at least two of the parties intending to merge or consolidate, are equal to or higher than approximately US$11.3 million.

V OUTLOOK

The Chilean PE market has grown significantly during the last years but compared to other economies in the region (such as Brazil and Mexico), and other emerging markets in the world (such as Ireland), the PE activity in Chile remains relatively underdeveloped and represents a small percentage of the country’s GDP (0.35 per cent by the end of 2014). Even though Chile has a competitive economy and a stable business environment, it still presents issues that impact its attractiveness for the PE industry. Relative lack of liquidity of its capital markets, including a limited banking market for raising local debt for leveraged buyouts. Nevertheless, Chile has a strong entrepreneurship environment and there is a long-standing commitment from the Chilean government to support and finance new businesses, as it is shown by the significant role that CORFO has in the financing of new business ventures.

Some of the new policies being implemented to improve the regulatory framework for investors in Chile and for Chilean pension funds, the continued growth of Chile’s economy, the current deficit of infrastructure together with lower interest rates and the relatively early stage of the private equity industry in Chile suggest the private equity activity in the country will continue to grow within the next few years.¹⁷