Latin American Innovation And Entrepreneurial Ecosystems Will Be Incomplete Until Exits Become Ordinary Occurrences

Introduction: Incomplete Latin American Ecosystem

From Chile to Mexico over the last decade, the Latin American Region (LatAm) has joined the Global Entrepreneurial Revolution in full force. Inspired by entrepreneurial developments in Chile––including the now notorious Start–Up Chile seed/acceleration program launched almost a decade ago––comparable government–sponsored innovation programs have sprouted across the LatAm region. Enlightened public/private partnerships have included different actors in the ecosystems, namely two: (a) a myriad of new government regulations strengthening the emerging ecosystems and facilitating the formation of young ventures in the formal economy, and (b) the availability of venture capital from emerging funds and individual angel investors or groups thereof.

Over the past two decades, I have had the privilege to observe these developments due to my multiple connections with many actors in the public, private, and academic sectors across the region. Furthermore, the formation of Alaya Capital Partners [1] (Alaya CP or ACP for short) in 2012 and its sister US–based company, Sausalito Ventures, has enabled conversations with hundreds of potential Limited Partners, and probably thousands of founders of young companies, which consist of ventures still in their ideation stages to firms that are fully established. Furthermore, my location advantage of being based in the San Francisco Bay Area/Silicon Valley enables me to compare, contrast, and connect disparate trends and opportunities, bridging the ecosystems and exploring new opportunities across the Americas.

Alongside Alaya CP, there are approximately 50 VC funds in the LatAm region (45 of which are LAVCA [2] members), mostly in Mexico and Brazil. The emergence of VC funds in Latin America began in the early 2000s, and accelerated in the mid–2000s, particularly in Chile. Over the last 10 years, the pace has continued to grow and expand to all geographies, in particular Argentina, Chile, Mexico, and Brazil, and other parts of Latin America.

For all this progress, a critical element is missing in the LatAm ecosystem development: the exits.

The exit market continues to be immature for two reasons: reluctant international buyers and ill–prepared local/regional buyers. In this blogpost and the blogpost that follows, I will (i) identify the problem statement of the “missing exits,” which puts the sustainable growth of LatAm ecosystems in jeopardy, and (ii) refine the problem statement illuminating some potential solutions.

Problem Statement

Over the next 3–5 years, dozens of VC funds will have an approximate total of 100+ Latin startups that are “exit ready” and seeking potential buyers. If successful exits do not materialize significantly in quantity and quality over the next decade, this will represent a lethal blow to the embryonic LatAm VC industry. Its future development would be uncertain, as VC fund administrators will face increasing challenges raising future funds and persuading LPs of the attractiveness potential of their investment theses.

Problem Analysis

The diagram below illustrates the developmental steps of a venture, beginning with the venture’s idea phase and proceeding to its transformation into a fully–fledged business.

Stages (New)

The mortality rate diminishes monotonically as we move from the ideation phase (–2––mortality close to 100%) into each successive transformational phase, reaching a fully–fledged ongoing concern in the growth phase (3– with amortality probability greatly reduced). During the early formative phases (–2 and –1), the founding team borrows, begs, and “steals” resources and invests their sweat, with the hope that its effort will eventually translate into actual economic value. By Phase 0, family, friends, and angels (FFF & Angels) become the first investors of the emerging venture. Somewhere in between the validation and the growth phases (1 & 2) is the time when funds like Alaya CP and other VCs invest. Typical valuations of Latin Startups, require VC investments (or group of VCs) somewhere between $150K to $500+K dollars for anywhere between 5 and 20 percent equity in the emerging venture [3]. Once the product or service is validated in a specific market (after Phrase 2 and Phase 3), the venture may require additional funding to support its market expansion and possible global scaling (Series A and beyond). By the time the venture reaches Phase 3, the venture transformation is complete from an idea (phase –2) to an attractive business, and is now hopefully an attractive acquisition target [4]. This constitutes the exitor liquidity event, enabling all those who have invested sweat or money to cash out and hopefully multiply their initial investments by large multiples [5] for the FFF, Angels, and VCs. Of course, the founding team and the employees who received part of their compensation in equity, are rewarded handsomely here as well.

Refining The Problem Statement

The need to identify buyers (local, regional or global) and successfully complete transactions for dozens (possibly over one hundred) Latin American startups which will be “exit ready” over the next 3 to 5 years, with valuations somewhere in the range between $10MM to $30MM US dollars.

The next question is how such a high volume of transactions will materialize. It is important to recognize that their sizes ($10MM to $30MM US dollars) are out of the range of transactions usually processed by established/traditional investment bankers, whose processes are optimized for transactions which are at least one order of magnitude bigger (or more). Transactions over $100MM dollars can support fees in the range of millions of dollars to compensate the sell and/or buy sides investment bankers, lawyers, accountants, tax specialists, and other players supporting these transactions. Clearly, Latin American startup exits cannot support these fees as they would represent transaction costs in excess of 10%.

LatAm VCs are compelled to identify creative out–of–the–box solutions to support the quantity of transactions efficiently, with a new breed of investment bankers and all the supporting functions leveraging technology and innovative business models.

Finally, LatAm VCs need to work closely with their portfolio companies starting at the moment of investment to have them “exit ready” at all stages of their development. Their accounting and governance need to be in full compliance of the local rules and the USA (particularly Delaware) to be ready to global suitors. Latin American startup founding teams need to persevere in their journeys to develop their ventures to sell them, balancing the goal of monetizing their product/services (and generating greater revenue returns) with the goal of selling ownership of their ventures. The latter goal could be particularly traumatic for many Latin entrepreneurs, since they have a propensity to personalize their ventures (as their babies).

I am confident this challenge will be solved. The progress made so far in the development of entrepreneurial ecosystems across the LatAm region is without a doubt impressive. However, it is now clear that there is a need to identify efficient solutions enabling the completion of the key missing element of LatAm entrepreneurial ecosystems: the development of a market of companies leading to successful exits.

My next blogpost will identify solutions (and their sub–elements) to the challenge identified in this post––in particular the process of Completing The Latin American Entrepreneurial Ecosystem.

Until my next posting – Carlos B.

Deal Volume

[1] Alaya CP was the first venture capital fund formed in the interior of Argentina (outside Buenos Aires).

[2] The Latin American Venture Capital (and PE) Association, of which Alaya CP is a member. LAVCA publishes a valuable index, the 2017/2018 LAVCA Scorecard, ranking the state of development of the Latin American Private Equity/Venture Capital markets. A more comprehensive list of indices and rankings (updated this for 2018) can be found at the Sausalito Ventures web site.

[3] Establishing a range of pre–money valuations between $750K and $10MM US dollars. The sweet spot are companies with products and/or services (v 1.0) starting to gain traction with paying customers. These startups command a typical pre–money valuations in the range of $1MM and $3MM. Convertible notes are vehicles increasingly used to postpone the need to establish the value of young startups in early developmental phases.

[4] Acquisitions are more likely for Latin American startups over the next 5 years. IPOs are not ruled out, but they are not addressed as they are considered unlikely, and if it happens it would be a singular event.

[5] These are the expected returns of Latin Startups. Obviously, funds like Alaya CP aim for the highest possible return, aligning the interests of the founding team, FFF, Angels, and other co–investing VCs.

About Carlos S. Baradello

Investor, thought leader, university professor, and advisor in areas of corporate innovation, born global entrepreneurship and venture capital investing.
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