Entrepreneurial Finance in Latin America: The Rise of a Region
Latin America has long been viewed as a source of crime, commodities, and cocaine. The idea that the region could be technologically sophisticated enough to attract significant interest from venture capitalists has seemed unlikely.
Indeed, generally, investors view Latin America with its great geopolitical risks and frequent sovereign debt crises as high risk and unworthy of consideration by VCs whose business is already inherently risky.
However, in recent years, this perspective has been changing radically. Latin America is currently experiencing a major tech boom catalyzed by massive venture capital investment that is redefining the conservative, risk-averse approach to investing in the region and disrupting many sclerotic industries.
According to data from Crunchbase, Latin America was the fastest-growing region for venture capital in 2021 with investors devoting $19.5 billion to investments, a figure that is triple that made in 2020:
These massive investments, particularly in late-stage and technology growth companies, are more than the total capital invested in the previous 6 years. Why?
SoftBank’s establishment of the $5 billion SoftBank Latin America Fund in 2018 to make growth investments in the region gave much-needed credibility to VC investing in Latin America. But, ironically, it is the Covid 19 pandemic that has had an even greater impact. The pandemic forced many staid, traditional businesses to “go digital” in order to survive and also opened up entire industries to disruption by new technologically savvy entrants.
Overnight, unprecedented opportunities were created for entrepreneurs to either assist the establishment in using technology to adapt to radical changes in the business environment or build new businesses with new business models unencumbered by the legacies of the past.
Banking was profoundly affected by the pandemic. In just 5 months in 2020 at the beginning of the pandemic, over 40 million people were added to Latin America’s banking ecosystem. Venture capitalists noticed and increased investment:
Latin America also has appealing demographics. Although not quite as young as Africa, the population in Latin America is much younger than that of Europe and North America with a median age of 31 versus 43 in Europe, 39 in North America, and only 20 in Africa, which makes it the second youngest region in the world.
Only 13% of the population is over the age of 60 so as a consumer market it is much more attractive than those of North America and Europe. Approximately a quarter of the population will soon be entering adulthood which is the prime spending period on many goods and services including clothing, education, entertainment, housing and such. In a world in which the established consumer markets of the West and East Asia are aging rapidly, these demographics are very attractive as they indicate the existence of populations that will purchase the innovations of entrepreneurs.
Likewise, there is untapped demand amongst the bottom 90% of Latin American households who consume just 64% of the total which is the lowest share in the world. These are the consumers who are eager to adopt innovative banking and e-commerce solutions that leverage technology and novel business models to facilitate their inclusion in the formal economy.
It is by targeting both the growing middle class and the latent potential of the under-consuming bottom 90% that entrepreneurs and the venture capitalists that finance them can thrive.
The region’s longstanding problems of poor housing and inadequate infrastructure are also challenges that yearn for the out-of-the-box thinking and innovation that great entrepreneurs can provide.
Globalization is another important factor in the growth of venture capital interest in Latin America. There are many startup entrepreneurs with experience in Silicon Valley who are returning to their home countries to start companies.
Many have been educated at elite American educational institutions and have excellent skills and important social contacts. Often, they have ties to venture capital firms in the US that they can leverage to obtain seed or growth capital.
Latinos are the fastest-growing segment of the population in the United States and their impact is being felt both within America and throughout Latin America. These social networks are an underestimated part of the story of why venture capital is thriving in the region.
Characteristics of VC investment in Latin America
Much of the growth in venture capital dollar volume in Latin America through 2021 was driven by a dramatic increase in late-stage and technology growth investing in the region. This indicates that just as in the US, late-stage investment by venture capitalists is dominating entrepreneurial finance in Latin America. This should not be surprising as a large portion of the region’s investment comes from firms that are headquartered abroad, especially in the US so the biases of those firms remain:
The consequences of this are profound as the 2021 surge in funding was largely driven by late-stage funding with over $13.3 billion going to late-stage deals, a figure that amounts to more than 2/3s of total funding. As is shown here, there were actually more angel-seed and early-stage deals but most of the capital flowed to the minority of late-stage and technology growth deals:
Due to this trend, Latin America has been experiencing many mega rounds of $100 million or more in funding to approximately 27 unicorn companies in the region that have over $1 billion in market valuation.
These 2021 investments include many of the kinds of companies that took off in the United States during the pandemic such as Rappi, a Colombian provider of fast delivery services (a la DoorDash) that raised $500 million; Nuvemshop, a Brazilian company that helps Latin American businesses to go online, which raised $590 million; and Nubank, a Brazilian digital bank that raised $750 million.
Venture capital interest in Latin America could be deemed to be shallow and transitory if not for substantial numbers of seed-stage and early-stage deals as well. According to Crunchbase, between 2020 and 2021, early-stage investments more than tripled from $1.6 billion to $5.5 billion; and seed funding almost doubled from approximately $500 million to $900 million.
As is evident from recent economic trends both in the United States and abroad, the incredible growth rate of venture capital investment in Latin America is unlikely to continue throughout 2022. In the first quarter of 2022, late-stage and technology growth investment has declined dramatically in both deal volume and the amount of capital invested:
Overall, the $3.4 billion invested in the first quarter of 2022 represents a 30% decline from the fourth quarter of 2022 but this is still 28% higher than that invested in the first quarter of 2021:
Even in the midst of what appears to be a global economic recession, venture capital interest in Latin America appears strong which demonstrates the fundamental strengths of the region as a destination for entrepreneurial investment.
Industries of Interest to VCs in Latin America
What specific industries are attracting the most venture capital investment? An important factor in Latin America is that financial digitization is quite low as more than 90% of payments are in paper money and in the largest market Brazil it is only 70%. Consequently, fintech is by far the sector that is receiving the most investment as it attracted over 40% of venture capital investment in Latin America in 2020 but ecommerce and proptech aka technology-enabled real estate also garnered great interest:
Source: LAVCA’s 2021 Review of Tech Investment in Latin America Report
What those industries have in common is that they can leverage mobile telephony as a platform to provide new services to underserved populations in both the middle and lower classes in Latin America. It is important to note that in emerging economies across Latin America, Africa and Asia, it is the ubiquitous mobile phone that is the dominant information appliance.
These are mobile first countries wherein the mobile phone is the best mechanism to plug consumers into the Information Economy. Mobile telephony enables consumers to overcome the bottlenecks created by the generally poor infrastructure in these countries.
This has allowed technologically savvy entrepreneurs to blossom across the region and attract massive amounts of venture capital. According to PitchBook data, in 2015, fintech startups in Latin America received $236 million in venture capital investment but in 2019 this had increased by over 700% to $1.7 billion.
In many respects, these startups have been taking advantage of the lack of competition in the region’s banking sector which allowed incumbents to maintain high returns and remain viable while only serving the more affluent ends of the market and not innovating with the products, services, and business models demanded by the underserved middle and lower classes.
The well-staffed IT departments that are common in the US have been alien to the Latin American banking sector and this made them vulnerable to attack by technologically sophisticated startups with venture capital support. Consequently, a slew of new well-financed fintech competitors have recently emerged to challenge the incumbents in the Latin American banking industry.
These firms are succeeding by either generating new products and services for the vast numbers of unbanked consumers in the region that have been ignored; directly competing against sclerotic incumbents who are not technologically sophisticated due to years of being protected from the competition; or offering services that can help the incumbents to modernize their operations so that they can compete at a time when consumers demand robust, user-friendly, digital experiences.
This demand for digital enablement is true across many industries in Latin America. Any service that can be delivered online is being redesigned to adapt to the digital imperative of consumers.
Venture capital is an inherently risky asset class, especially in emerging markets. The recent flood of capital into Latin American startups has created an additional problem: overvaluation. According to Mathias Schilling of Brazilian VC Redpoint e.ventures: “At the seed and Series A stage, valuations are still a little bit reasonable…But as soon as a company reaches critical mass, prices rise to perfection because it is then transparent to the global VC market.”
Ironically, it is this overvaluation phenomenon that is a driving factor in sustained interest in seed and early-stage investment in the region as it makes it more likely to obtain the value and solid return on investment that venture capitalists are seeking.
SoftBank, which started out by focusing on growth investment in the region, has made the pivot to early-stage investments by launching a second $3 billion fund that is oriented towards that stage of the entrepreneurial life cycle. According to Shu Nyatta: “We’ve moved to early-stage because it’s getting competitive on all fronts, and it’s the only way to avoid competing only on the deals that get visibility in the US.”
Latin American Venture Capital Firms
One of the most exciting developments in Latin America has been the emergence of a burgeoning ecosystem of venture capital firms to support entrepreneurship in the region. For example, Kaszek and Monashees, which were respectively established in 2005 and 2011, are of particular importance as they are leaders in making investments at all stages of the venture capital life cycle:
Overall, these firms are regionally distributed as follows:
There is change afoot in the venture capital ecosystem in Latin America. However, headwinds are on the horizon. The recent turmoil in tech markets and the increasing likelihood of a global economic slowdown is leading to a flight to financial safety and away from risky investments such as venture capital in emerging markets that are already inherently problematic.
The region also has a cautionary history of boom-and-bust economic cycles. The argument herein is that sound underlying investment fundamentals along with a growing coterie of strong, local venture capital partners will enable Latin America to overcome these challenges and remain viable as a long-term destination for venture capital.