Is venture capital in Latin America adventurous enough?

Contxto – Venture capital in Latin America is reaching a tipping point.

Many of the VC deals I have seen lately are predictably bland. At least, from my writing experience.

Perhaps they’re underwhelming since it seems like many of Latin America’s first VC wave are not actually seeking to support innovative, disruptive and home-run startups. Similar to a president seeking reelection, many VCs are mostly looking out for themselves.

Long story short, they’re playing it safe.

Two words – risk aversion

The reality is that Latin Americans are culturally risk-averse. Add that to the fact that most of these are the first or second fund for these local firms and that’s the perfect recipe for investing in, what I like to call, “tech SMEs”. Not startups.

They don’t want to be “too” risky. They just want to survive, and honestly, I don’t blame them. 

We all know the risk-reward tradeoff and how this dynamic works. The riskier an investment, the more potential variation for the initial investment. It could be either a potential up or downside, meaning you either hit a home-run or fall flat on your face. 

Venture capital in Latin America is no different. If these funds back up risky (but potentially rewarding) companies, the probability of failure is exponentially higher.

If these risky portfolio companies turn out to be bad investments, GPs face not only damning publicity but also marginalization and unlikelihood of ever raising another fund. And, who would like to finance a losing investor?

For many, this is a legitimate fear. Nevertheless, it is not supposed to be the nature of venture investing. Meaning, Latin American VCs aren’t really playing the game as US investors did back in the day.

If you don’t agree, let me ask you this: do you think Latin American VCs with their current pro-traction and post-revenue investment thesis would fund companies such as Uber, Spotify, Facebook or Palantir at their early stages? 

I would honestly say no to this question. Now, consider the timing advantage. Back then, there weren’t any indications or comparables to ponder whether Paypal or Netscape would succeed or not. Think about how crazy those companies sound at a Powerpoint level.

Venture Capital in Latin America: A vicious cycle

I understand where they’re coming from, honestly. However, the problem with playing it safe is even worse in my opinion. There are even more downsides but perhaps in a more utilitarian way. If an investor invests in something too risky, well yeah, perhaps it could be detrimental to that person.

However, if an entire ecosystem fails to invest in riskier ventures, the entire ecosystem fails. This is a pretty simple and vicious cycle for both startups and investors.

Now, think about this. If you’re a developer with big dreams of becoming the next Elon Musk, then you’re most likely determined to launch controversial, disruptive, perhaps even naïve products. Once you’re out there pitching to VCs, though, you’re most likely going to scare them off.

First, either the product is too complex to understand, especially considering most VCs come from investment banking, consulting or brick and mortar business backgrounds, instead of tech. Or, the fear to invest in very early-stages or underground industries is too high.

What happens next? Well, despite all of the chit-chat and promoting innovation, in actuality, many investors are just as risk-averse as much as the rest of Latin America. You may feel disappointed and frustrated, and so, your next big idea perhaps is not gonna be as groundbreaking.

All about survival

Perhaps now you’re more familiar with the types of deals these investors support. Naturally, you’re going to become one of those products to increase your chances of tapping into the prevailing VC/startup world.

Less risky, less disruptive but certainly appealing to investors. Mmm, what about a shoe marketplace? Sounds just about right. The perfect amount of low-level coding, huge markets and traditional, copycat business moves. Just remember, there is nothing less fancy yet more stable (predictive) than becoming a “tech SME.”

If everybody were to do this on a large scale, the ecosystem would be doomed. That’s to say, LPs could continue earning the same amount and making reliable returns with safer, more traditional assets.

Any incentive to plunge into unknown industries, like technology, would be thrown out the window. In turn, the ecosystem’s support system would just continue playing it safe. 

VC funds in Latin America and resources would then become even more scarce, making partners pickier when deploying their capital. Even though there may be a lot of demand, supply could end up lacking. An ongoing vicious cycle.

Where to look for inspiration?

What’s different in more mature ecosystems such as Silicon Valley? Well, adventurous VCs (as redundant as it sounds since that’s what VCs should be in the first place) have dared to fund crazy ideas. 

After many failures, these massive exits certainly captured the attention of non-tech investors. This generated a massive effect on the ecosystem. More companies were interested in providing exit alternatives through M&A, as well as a rising interest in engineering talent recognizing the upside of working at startups.

Many from the first successful wave of founders have left their companies to become VCs or founders once again. The only difference is that they have more grit the second time around.

Those who worked at these companies are now more capable, experienced and knowledgeable to start their own companies. Like this, it becomes a multiplying “snowball” effect. More companies mean more wealth to deploy.

The blessings of operational VCs

Ex-founder VCs are well-versed in startup operations, product design, growth hacking, etc. Due to this, many now provide valuable advice to members of their portfolio founders, ultimately increasing the probability of success.

However, many are also more willing to fund disruptive companies since they’re familiar with the industry. This is a virtuous cycle.

We’re at a tipping point. Now is the time that the first new wave of investors will start to exit their positions, only to reveal their returns or losses. If some of these gains are not large enough to justify the losses, then do expect fundraising deceleration from local LPs.

The problem with playing it safe

It all starts with a desire to be adventurous. Find risky endeavors. Look for exponential wins or losses. Look out for the outliers. VC is not supposed to follow a normal distribution or bell curve, it’s supposed to be skewed.

Investment and traditional risk-averse LPs certainly present some barriers but that’s the job of GPs to overcome. For the sake of all participants, go hard or go home. 

To keep it relatively safe, investors are entering companies with low capital needs, low barriers of entry, and low differentiation. Eventually, as it gets easier to compete, these industries are going to start saturating. 

With so much inevitable competition among similar ventures, it will ironically become even riskier to invest in these companies than in capital-intensive, disruptive, unproven business models. 

Comparing numbers

In 2017, the entire venture capital funding in Latin America totaled US$1.141 billion, according to LAVCA. Out of that amount, US$336 million only went to payment startups. Not fintechs but payments received 30 percent of the entire capital deployed.

With this, just imagine how little there was left for all the other industries and subindustries. It might sound like I hate payment companies, I don’t, I just have a problem with the lack of diversification, playing it safe in well-known markets. 

Most VCs only fund post-revenue and post-product market fit companies. In other words, they’re more likely to invest in mature companies to diminish risks while expecting VC-like returns. This is very ironic.

Conclusion

Invest in smaller tickets and stay diversified, yes, but invest earlier, then. You might be reading this with disgust if you’re a VC. You might be thinking, “Well, those startups are no Uber or Facebook!” But listen, this reluctance is your fund’s main limitation.

Consider this. That hyperactive founder you just chatted with, proposing an idea so ambitious that it sounded blasphemous – that might be your golden ticket. At first, Spotify must have sounded ridiculous, especially after Napster crashed and burned. 

Moreover, the taxi industry was a corrupt mafia when Uber launched. Furthermore, who would’ve thought that a platform with no other purpose other than randomly commenting on strangers’ posts would become as popular as Twitter?

This post’s goal is nothing more than playing devil’s advocate, sparking at least some “doubt” on your investment thesis and hopefully getting some crazy founders some capital to keep going.

Happy to discuss what you think! Comment below.

-VC