Risk Reduction For Private Equity Firms With Nearshoring
Companies are constantly seeking ways to optimize their operations and reduce costs, and one strategy for this is nearshoring. According to Product Distribution, 33% of U.S. businesses are considering relocating their operations to nearby countries, such as Mexico, which has seen its economy grow by 3.5%, highlighting its growing position in global trade.
This strategy allows private equity firms to optimize their investment approaches and capitalize on lucrative opportunities, reducing risks by investing in companies relocating their operations closer to primary markets. This post will explore the risk reduction benefits of nearshoring and how to optimize this strategy for private equity firms.
Global Trade Fluctuations and Their Impact on Private Equity Investment
As the business environment changes, geopolitical risks that were years ago on the sidelines have risen to the top of strategic considerations. These risks influence investment decisions and resource allocation.
For private equity firms with extensive global and sector-specific investments, adapting to this new geopolitical situation is necessary for effective investment management and planning. During this change, it’s important to perform due diligence on all the risks and make sure investments are safe and good for the future.
Impact on Private Equity Firms
The shifting global trade environment opens up private equity portfolios to new risks and opportunities, motivating a need for strategic adjustments. These portfolios face increased vulnerabilities as a result of geopolitical and trade disruptions, requiring a proactive approach to investment management. Some impacts include:
- Cross-Border Value Chains: Global events like pandemics and trade risks have amplified the vulnerability of international supply chains. These challenges lead companies to explore more resilient and adaptive supply chain strategies, which call for more detailed analysis by private equity firms.
- Strategic Sectors Growth: There is high growth in sectors such as renewable energy, semiconductors, and biotechnology. This expansion is driven by both public and private investment initiatives, offering new opportunities for investment.
- Climate Regulations: As global carbon neutrality ambitions grow, companies are adopting environmental sustainability practices to take advantage of tax credits and other benefits offered by countries like the U.S. This drives private equity firms to adapt to the regulatory environment to make better investments.
What are the Risk Reduction Benefits of Nearshoring
Nearshoring offers a strategy to reduce business and operational risks by taking advantage of closer geography, stronger economic ties, and faster market response. This aligns with how private equity firms seek to maximize profits through innovative and risk-conscious investment strategies. The risk reduction benefits of nearshoring include:
1. Supply Chain Security
Nearshoring helps lower risks by speeding up and simplifying supply chains. By moving operations to Mexico, companies reduce their dependency on distant regions, such as Asia, making them more resilient and avoiding problems related to geopolitical tensions or supply chain disruptions.
2. Economic Stability
By relocating to regions like Mexico, firms benefit from the economic stability provided by strong bilateral trade agreements, such as the United States-Mexico-Canada Agreement (USMCA). This stability lowers risks linked to economic fluctuations in other global markets, offering a more predictable business environment.
3. Rapid Market Access
By moving manufacturing facilities closer to the U.S. market, companies can respond more quickly to changes in consumer demand and market dynamics. This reduces the risk of inventory becoming obsolete and allows companies to seize market opportunities quickly.
4. Cost Reduction
Relocating operations to countries with lower labor and production costs through nearshoring cuts expenses. These cost savings can be wide-ranging, including direct production costs, logistics, and tariffs, contributing to improved long-term financial performance.
5. Investment Attraction
Nearshoring boosts the investment potential of regions by offering operational efficiencies, regulatory incentives, and access to expanding markets. These factors make investments in nearshore operations more appealing to private equity firms, promising higher returns and lower risks.
Why Nearshoring is Good for Private Equity Firms
For private equity firms, nearshoring offers strategic benefits by providing attractive opportunities to finance businesses that are moving their operations closer to their main markets. This approach is especially appealing for several reasons, including:
1. Developing Opportunities in Real Estate and Infrastructure
Private equity firms can find profitable opportunities in the real estate and infrastructure investment sectors of warehouses due to nearshoring. According to Forbes, the arrival of new companies has led to a 9.1% annual growth in Mexico’s industrial real estate segment.
This sector reduces logistical challenges and increases capital management efficiency. The proximity allows:
- Better control over projects for developing industrial hubs, distribution centers, and residential properties.
- Accelerated returns on investment in infrastructure or facilities.
- Contributing to regional economic growth.
2. Companies Improving Supply Chain and Operational Efficiency
Private equity firms can invest in companies improving supply chain resiliency and efficiency by moving operations closer to the U.S. market. This strategy offers benefits, as shown by the 42% increase in nearshoring reported by supply chain leaders in 2023, according to Product Distribution.
This strategy optimizes operational efficiency, offering benefits such as:
- Minimizing transit times and reducing transportation costs.
- Leading to cost advantages and savings on logistics due to shorter transit times.
- Maintaining higher quality and faster adaptability to market changes.
3. Expanding Financial Options
Private equity firms can benefit from greater financial flexibility through nearshoring by investing in innovative financing options, such as infrastructure and energy projects, as well as supporting the supply chain through direct financing, factoring, or confirming. The benefits include:
- Local investment incentives, including an accelerated investment deduction ranging from 56% to 89% for the rest of 2024, as reported by Mexico Business.
- Lower operational costs.
- Access to new funding sources according to regional market conditions.
How to Optimize Nearshoring Strategy with Shelter Services
When private equity firms consider investing in companies nearshoring to Mexico, they should evaluate the shelter model. This model acts as a legal intermediary, enabling foreign businesses to set up manufacturing in Mexico without incorporating a subsidiary, simplifying market entry.
Functions of the Shelter Model:
- Regulatory Compliance: Ensures adherence to environmental and workplace safety standards.
- Sales and Supplier Management: Handles purchasing negotiations and supplier relationships.
- Real Estate Management: Manages facility acquisition and maintenance.
- Human Resources & Payroll: Oversees recruitment, payroll, and employee benefits.
- Customs & Fiscal Compliance: Manages customs, import/export, and tax compliance.
Benefits of the Shelter Model:
- Quick Start-Up: Expedites operations by handling IMMEX and IVA certifications.
- Cost Efficiency: Achieves cost savings through economies of scale and tax incentives, including reduced corporate tax rates.
- Expertise & Compliance: Provides expert knowledge in local labor, regulatory compliance, and business practices.
- Entry Models: Offers flexible market entry options, such as single-company setups, contracts, and partnerships.
Key Things Private Equity Needs to Know About Nearshoring
Private equity firms must properly understand the markets they wish to enter and establish local partnerships for insight into each country’s unique segment. Key factors to consider include:
- Geopolitical and Economic Risks: Foreign investments carry risks like political instability and economic fluctuations. Rigorous evaluation of geopolitical and macroeconomic conditions is crucial.
- Quality Infrastructure: Investing in regions with strong or improving infrastructure, especially in transportation and public services, enhances operational efficiency and reduces costs.
- Technology & Sustainability: Focus on projects with innovative technology and sustainable practices, which meet regulatory demands and add long-term value.
- Local Partnerships: Aligning with local governments, businesses, and communities ensures smooth operations and compliance with local laws and norms.
- Exchange Rates: Understand currency fluctuations in key markets to manage financial risks.
Reduce Risks in Private Equity with The Nearshore Company
Nearshoring presents private equity firms with a key opportunity to optimize investment strategies and improve financial returns by supporting companies that lower operational costs and accelerate market access. This close market proximity enables these companies to remain competitive in volatile economic conditions.
At The Nearshore Company, we help private equity firms minimize investment risk by empowering their portfolio companies to cut costs, boost efficiency, and gain a competitive edge through nearshoring. Let’s work together to drive smooth operations and long-term success!
