Venture Capital in Latin America over the next decade

Latin American Venture Capital will remain attractive for investment in the middle of a deceleration of the Emerging Markets in general and of the BRICs in particular. The appeal of its Copycat Ventures continues in place due to its still high growth and large market size; while the appeal of its Innovative Ventures grows because of a maturing ecosystem, backbreaking growth on R&D and Education Investment and active Public Policy to promote Innovation, Entrepreneurship and Venture Capital.

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As we discussed in a previous posts, Venture Capital in Latin America has mostly focused on Copycats that replicate and adapt US business models in their local markets (i.e. Mercado Libre/ Ebay, Despegar/ Expedia). Over the past ten years there has been a surge in the interest for these investments with key GPs (i.e. Redpoint, Burril, Sequoia) and LPs (i.e. Horlsey Bridge, Silicon Valley Bank, Cisco) entering the Region with a focus in Brazil.

VC Investmet Distribution in Latam

Source: Axia Ventures Proprietary Analysis

This growing interest was the consequence of Latin America´s high growth, Brazil´s new role in the world as a key market and a member of the BRICs and the successful Copycat Ventures of the 90s.

Today, the main driver of the growth of the last 10 years in the region is not there anymore: the rise in in commodity prices is slowing down as China rebalances and reduces its growth. Furthermore, the increase in asset prices via reduced risk spreads caused by institutional improvements has evaporated since spreads have compressed to almost zero.

Therefore, the growth of Latin America over the next few years will not come from the rise in commodities; it will come from productivity gains. Productivity gains in Latin America could be achieved by raising the capital and technological intensity of production, specializing through more trade or innovating.

In this context, the decision by the Pacific Alliance (Chile, Colombia, Peru, Mexico) to create a regional free-trade market for their already open economies has been appreciated by the markets that believe such strategy is a cornerstone of future growth and a sign of a willingness to eliminate red-tape that will allow for higher capital efficiency and intensity. Although we agree with this view, we believe that the region as a whole will continue to grow at a higher pace than developing nations because it is still far from the capital and technological frontier and it has stable institutions in a converging world. This is the fundamental secular reason to invest in the region since the rest of the issues will prove cyclical (i.e. politics). Most International Economic Organizations are forecasting Latin America to grow at a 6% CAGR over the next five years, 50% higher growth than the Advanced Ecomies.

Source: IMF World Economics Outlook

Furthermore, the valuations in the region have already adjusted to the slow-down of the past 2 years, paving the way for further gains by riding the growth in multiples and diminishing the downside risk. Low entry multiples have been one of the most important conditions for high PE and VC returns over the decades. Jim O'Neil, the former Goldman Sachs guru that coined the BRIC term in 2001 and predicted the emerging markets rally, says the selloff has made the Emerging Markets "very attractive".

Consequently, we believe that investing in Copycat Ventures in Latin America continues to be a sound investment due to Latam´s big and growing market and its discounted valuations and costs.

Source: Yahoo FInance

But above all, we believe there is a great story to invest in Innovative Ventures in Latin America. The Region has doubled its R&D and Education Investment over the past 6 years, on the back of growing GDP and the increasing relevance of Innovation Policies. However, there is very little capital pursuing these opportunities since there are no key innovation hubs in Latin America when looking at it on a single city or country basis. 

Source: OECD

Innovation Policies in South America

Sources 1) 14/03/2013 – FINEP- Launch of Plan Inova 2) http://www.finep.gov.br/inovaempresa/ 3) Financial Statements 1H 2013 4) Colciencias 5) MINCyT 6) “Fronteras en Biociencia" 7) Cumbre Latinoamericana de Innovación 8) Josh Lerner and Ann Leamon – Harvard Business Review

This is starting to change because R&D and Education are cumulative long-term investments that are starting to show the results of a decade of hard work and Rio de Janeiro, Medellin, Santiago de Chile and Buenos Aires are aggressively trying to position themselves as Innovation Hubs with a global competitive mindset. The Region is already producing some top-notch innovative companies like IndexTank, CVDentus, Amyris, Ciencias para la Vida, Keclon or Bioceres.

These opportunities are coming at very competitive valuations today because of the lack of capital for such investments, the recent steep decline in foreign exchange rates and the competitive pricing of technology experts and scientists. Those investors prescient enough to invest in this embryonic part of the Latin American VC ecosystem will get rewarded in kind. 

To exploit these opportunities consistently as a Venture Capitalist, a Latin American geographic and a generalist industry approach are necessary since only then will the Deal Flow have enough depth to make an Innovative Fund viable. Also, Innovative Ventures need to have Validation from Key Innovation Hubs and Business Development in the Advanced Economies. In the past, this would have been a great difficulty; but in an integrated digital world it is actually an opportunity since it creates a global company from day one.

To sum up, Latin American Copycat Ventures are still a sound investment since the Region has a big market that will continue to grow. But we also believe that there will be a growing success story in the Innovative Ventures of the Region.

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Thank you to Lisandro Bril -Managing Partner of Axia Ventures- for his collaboration on this piece