A Latin America Perspective of the Venture Capital (VC) Industry
The success of the VC industry depends largely on the ability of General Partners (GPs) to invest in start–ups and exit years later at great multiples (buy low/sell high). This is a long process, often spanning many years, of selecting companies in which to invest, nurturing them to increase their valuations, and harvesting value by selling stakes. Each VC firm claims to have a unique investment thesis to deliver “unfair” returns (or gains) to its Limited Partners (LPs or investors) and to themselves (via carried interest). Most VC firms claim to have their own ‘secret sauces’ based on objective and subjective claims:
- Past Fund(S) Performance.
- Geographical Focus: USA, EU, Latin America (LatAm), Israel, India, China, et al––as well as bridges among two or more geographies.
- Industry Focus: Bio–Tech, Fin–Tech, Ed–Tech, Legal–Tech, Clean–Tech (Renewables/Green Technologies), Consumer Audiences, B–2–B services, et al.
- Time Frame: Incubation/Acceleration Phase, Early Stage (Pre–Seed and Seed), Growth Stage (Series A and Beyond), etc.
- Track records/careers of partners.
- “Private” or “privileged” deal flows.
- Networks of relationships or relationship capital.
- University degrees and alumni networks.
The on–going COVID–19 crisis and the ensuing global recession, or likely economic depression will create the impetus to disrupt industries untouched during prior crises. The coronavirus pandemic will have long–lasting human and economic effects and will cause a massive global reset, during which most societal behaviors will be forced to change by replacing old habits and customs with new ones. The purpose of this brief is to look beyond the on–going global reset caused by the ongoing pandemic, by analyzing the impact in the VC industry, and in particular the Latin American VC industry.
The current pandemic is impacting VC firms in 4 areas:
- Portfolio Companies: Depending on the industry or economic sector of operations their revenues are extraordinarily negatively impacted (tourism and hospitality) while in the other extreme positively impacted (virtualization of most services), affecting their valuations and runway (slide). A special case is the decision of making follow–up investments in current portfolio companies. This is a hard one as it may lead to down–rounds or even to accelerate their death in the event the investment committee decides to pass.
- Limited Partners: Their ability to timely respond to the request of wiring the committed capital. If capital contributions are not made, due to the impact of the current crisis on specific LP’s finances, it may lead to the reduction of the VC fund size.
- Quality of Deal Flow: VC funds will need to work harder to find solid, reasonably priced deals. While many companies will likely face down rounds, attractive companies benefiting from the current crisis will likely be deluged with both old and new money, enjoying well priced valuations.
- Exits: The current crisis will delay market activity for possible exits, deflating valuations. There could be exceptions, but, at large, the “irrational exuberance” for Unicorn–type valuations have been diminished.
LatAm VCs will need to re-evaluate their portfolio vis-a-vis to two essential realities:
- The economic recession/depression is likely to have a more pronounced impact on LatAm countries. LatAm economies are more vulnerable. This will affect the valuation of those portfolio companies which heavily depend for their revenues on domestic and regional markets.
- A depressed LatAm economic climate will impact portfolio company exits: Likely these exits will happen outside LatAm (this was true before, and even truer in the post pandemic times). LatAm startups that have strong customer base outside LatAm, particularly in sectors that have suffered limited COVID–19 impacts, will be in privileged positions. In short, truly global start–ups whose stakeholders––including founders, customers, technology, investors, and partners––are globally–minded will likely be the winners in in the post-Coronavirus times.
In addition, most funds today, in two to five years, will inevitably seek to form new funds to compensate for decreased levels of activities (and fees) in present funds. To attract old and new LPs as investors in these new funds, the performance of present funds is critical, placing additional pressure on VC firms. The current health crisis and the economic recession that will follow decreases the odds of a stellar performances. A possible positive outcome resulting from the on-going crisis, is the renewed impetus by established corporations to expand their Open Innovation initiatives, to mitigate the increased obsolescence risk, by adding to their innovation arsenal Corporate Venture Capital (CVC).
Potential attractive areas for investment are the opportunities that have emerged from the on–going pandemic. My proposed focus would be on the economic sectors that have not yet been disrupted––the oldest industries known to mankind that have remained prevailingly untouched: health care, education, law, government, and organized religion. My invitation would be to focus on the first three industries, as the last two cut through core beliefs about how society should be organized, making disruption less likely and more uncertain in the imminent future; moreover, they often depend on intangible parameters not easily quantifiable.
If there were ever a time necessitating strong leadership, this is it! Society is accelerating exponentially. In this environment, paralysis is not an option. Action is demanded. The unprecedented speed and magnitude of COVID–19 demands that VC firms focus on three things simultaneously:
- Nurture and support portfolio companies: Each company (startup) must survive and re–invent itself to maximize its potential by reimagining the future.
- Increase transparent communications: Clear, fruitful exchanges among LPs, founders, and VC’s personnel will be more important than ever to minimize uncertainty and anxiety due to the on–going crisis.
- Empathetically manage difficult choices demanded by these challenging times: Salary reductions, personnel reductions, and renegotiations of every possible expenditure must all be on the table. Everything and anything. Why? Because there are NO SACRED COWS, during these unprecedented times. As more Startups impose salary reductions to their staff, it opens again the opportunity to potentially offset these reductions with stock options, which is still and “incomplete assignment” in the Latin entrepreneurial ecosystem.
COVID–19 offers every company a once in a lifetime great global reset opportunity. Difficult as it is to survive and rise above the gathering global storm, re–inventing one’s firm is a must to come out a vibrant and dynamic winner and thrive in a reimagined future! This will play to Latin entrepreneurs’ strengths as their DNA includes disproportionate levels of resilience and adaptability making them able to prosper in the presence of extraordinary uncertainty and socio-economic instability.
Until our paths cross again amigo — Carlos B