Spotlight: key transactional issues in tech M&A in Mexico

The Technology M&A Review, 2nd Edition

Key transactional issues

Generally speaking, foreign technology companies coming into Mexico are set up as private companies and either as stock companies (SAs) or limited liability companies (SRLs). In practice, however, both types of entities have the same prerequisites for incorporation, which are easily achieved. Further, both vehicles grant investors the same level of protection (shielding investors from liability), are allowed to enter into the same businesses and are not distinguishable for local tax purposes.

SAs have certain practical benefits, as the shares that represent ownership in said entities are freely negotiable subject only to specific restrictions that may exist in the bylaws of a target entity, or any possible shareholders' agreement. SA vehicles also allow for shareholders to enter into shareholder agreements, which are not otherwise regulated for SRL entities. In contrast, a transfer of ownership of equity quotas representing ownership in an SRL requires a majority approval from the existing partners of the target entity.

On the other hand, however, minority holders in SAs have more statutory rights than those in an SRL, which may also result in bottlenecks when engaging in an M&A scenario: among other minority rights, as little as 25 per cent of the shares are allowed to challenge and suspend resolutions adopted by the majority.

Public company M&A transactions are few in the country and are considerably more complicated, as they require public filings and potentially public tender offers depending on the amount of shares being acquired. Given the relatively short period of time during which technology companies have been active in the country to a relevant degree, most technology M&A transactions in Mexico involve private unlisted companies that have no such requirements.

Although each technology M&A transaction has its own specific background affecting what type of transfer structures or mechanisms are ideal, in Mexico M&A transactions (and especially those seeking a complete change of control) are usually structured as share purchases. The evident advantage of this approach is that private market share purchases are generally less complex that structuring mergers, acquiring assets or issuing tender offers.

The standard share purchase of technology companies is supported by investors or buyers betting on the future of the relevant companies and the underlying technology asset (software, applications, services, etc.) as well as in the management group that has steered the company to the place that resulted in it being an interesting investment or acquisition target. Using these basic points, a straightforward majority share transfer would result in an automatic change of control of a company, without involving pre-closing divestments or carve-outs. In other words, technology sector companies are generally built and operated around the technological assets created or owned by said company, and do not tend to require significant pre-transfer carve-outs or divestments, or significant non-technological assets such as, inter alia, real estate, that may result in a different acquisition structure being more convenient.

Generally speaking, technology M&A transactions differ from those in other industries in terms of the protections and indemnities extended to buyers. Given that usually the value of a transaction revolves around just a few technology assets, and that the nature of said assets inherently requires certain specialised considerations, buyers and sellers can generally expect to see transfer agreements placing special emphasis on the following:

1. Consideration: usually consideration is mainly set in cash, which would be disbursed in tranches subject to certain milestones to be met by the acquired company as of closing (such as achieving certain operating income). In addition, a portion of the consideration may be subject to retention or hold-back mechanisms, depending on the complexity of a transactions and sophistication of the parties involved.
2. Representations and warranties: as mentioned above, when negotiating a technology M&A transaction, it is customary to find specific representations and warranties addressing, among other items, full title of the underlying technology assets, the absence of third-party claims either actual or threatened, full compliance with the data privacy laws applicable to both buyer and seller, including proper handling of all required consents from end-users when applicable, title and validity over all IP rights claimed by the seller, compliance with applicable specific tax obligations and compliance with the Fintech Law (if applicable). Of course, these are in addition to customary representations and warranties usually found in traditional M&A transactions.
3. Closing conditions: specific closing conditions for technology M&A transactions are generally negotiated depending on the underlying technology asset. As such, it is usual to encounter closing conditions relating to:
   • the proper filing and renewal of all IP rights for a reasonable period time;
   • updating all data usage consents; and
   • the delivery of certificates certifying that the seller and the target are in full compliance with the representations and warranties negotiated for the transaction at hand.
4. Governmental approval: a part of the closing conditions that requires special attention is the approval of the Federal Competition Commission of the Telecommunications Federal Institute. As mentioned above, the Commission and the Institute have been known to outright prohibit certain M&A transactions when it is thought that a market participant would acquire substantial market power that may either restrict competition or have a negative impact on consumers. This condition is of special interest to outside counsel, as reviews and filings made by them greatly influence the decision-making process of the authorities, and may result in additional closing conditions set by the government that may ultimately affect the value of a transaction as a whole (e.g., divestments or business separations).
5. Indemnification and survival: because of the nature of technology M&A transactions, parties may expect indemnification clauses heavily centred on the technology assets, and also heavily tailored to protect the buyer, and for the seller to indemnify the buyer and target against any and all issues and damage that may arise specifically from any dispute or claim over the IP rights held by the target as well as underlying asset itself. These clauses generally involve indemnification as of a certain pre-closing period that usually goes hand in hand with the applicable legal prescription terms for matters such as data handling, IP rights and registrations.

Financing for Mexican M&A transactions in the technology sector varies depending on the size of the target company and the assigned value of the underlying asset. However, because of the general and relative size of Mexican technology companies and the average 'young age' of the involved companies, parties involved may generally expect to be self-financed rather than relying on third-party financing. Special attention must be considered from a tax perspective, as there are important limitations and requirements. For example, debt pushdown is not commonly accepted by tax authorities.

However, because of the constantly changing technology sector landscape, the types of financing and proportions thereof vary significantly from target to target and also depend on the economic cycle. By way of example, the covid-19 pandemic and ensuing economic crisis has lowered banking interest rates significantly, so buyers may be more prone to finance their M&A transactions through bank debt.

Mexico taxes residents following a worldwide income rule. The corporate tax rate is 30 per cent that is applicable to the result of the income obtained minus authorised deductions. To apply deductions, formal requirements and specific limitations should be considered.

The federal Income Tax Law sets capital gain tax for all holders of shares or equity in a Mexican entity, which tax is triggered upon the transfer of said shares or equity. The general income tax payable by foreign tax residents upon any transfer of shares or equity is 25 per cent over the gross transaction price, or choose to pay using a 35 per cent rate over capital gains (i.e., the spread between the acquisition cost and sale cost). The choice of which rate to apply rests on the seller, who may need to meet certain formal requirements to be able to obtain the 35 per cent capital gains rate.

Having said that, Mexico has approximately 60 tax treaties with several jurisdictions around the world, including the US and the EU. Although not all tax treaties are equal, a significant amount contain provisions allowing foreign participants to either decrease the tax payable as a capital gain in Mexico or, in some cases, altogether eliminate said tax. Among other things, for example, the US–Mexico tax treaty allows US residents to trigger an exemption participation clause with which a US-based seller of Mexican equity (to exemplify) would not be required to pay income tax as long as its position in the target entity was below 25 per cent and certain additional formal requirements are met.

In most if not all cases, benefits stemming from a tax treaty are subject to local formal requirements that, if not fully met, will render the requested benefit inapplicable.

In addition to the aforementioned exemptions, Mexican law allows for some corporate reorganisations to be achieved on a tax-free basis when certain formal requirements are met. This is relevant for the M&A industry as a whole, as it permits companies to rearrange themselves prior to a potential transfer or sale of a particular line of business that may have previously been working together with another separate business.

Tax treaties include important relief on the applicable taxes according to local regulations, to avoid the double taxation on payments that are considered income from source of wealth in the country. Mexican accounting standards (its Financial Information Rules) are published by the Mexican Counsel of Financial Information Rules and are largely based on international accounting standards rather than the US counterpart, the US generally accepted accounting principles.

As mentioned in the initial sections of this chapter, Mexico is generally considered to be an open country for receiving foreign investments. Market participants may expect little to no restrictions when doing business in the country.

Foreign market participants should be wary, however, of the changing political landscape, populist governmental policy, a relatively high degree of bureaucracy and foreign currency exchange rates that may swing significantly during a short period of time.

Mexican entities with foreign investments are required to include what is known as a 'Calvo' clause in their articles of incorporation. The purpose of a Calvo clause is to clearly state that foreign investors agree to consider themselves as nationals with regard to the property owned by their local entity and waive their right to seek assistance from their own government as regards assets held by the Mexican entity. This is more a historic legacy of foreign invasions in the nineteenth century than anything else, but foreign investors should be made aware of its existence.