Great Expectations: Latin American fintechs’ unfinished business according to VCs

Venture capitalists are always on the hunt for rapid growth and high returns. Especially from fintech, the most promising sector in most regions (and where investments have been focused lately, according to Crunchbase records). Latin America is no different, asserts Ricardo Sangion, partner at TheVentureCity, a venture capital fund in Brazil, the country that gave birth to one of the world’s leading fintech companies: Nubank.

To achieve rapid growth and profitability, fintech companies need scalable business models that address an unresolved problem, which justifies their existence and value proposition. Above all, they must convince investors that they are investing in a business that is useful for users and innovative within the ecosystem.

The term fintech encompasses many solutions, from remittances, crypto, payments, loans, collections, to cybersecurity. All of these grew very quickly because they were the entry point to other digital services, points out Fabrice Serfati, managing director and general partner at Ignia Partners. “In order for you to be able to sign up for Netflix or shop on Amazon and Mercado Libre, there had to be a payment platform, because it is the first step for there to be commercial activity with digital platforms,” he adds.

In recent years, the use of fintech in Latin America has been growing and is expected to exceed 380 million users by 2025, according to forecasts made by Statista.

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This represents a growth opportunity for all fintech companies and an attraction for venture capitalists, who tend to bet more on startups in the financial sector when investing.

The fintech sector is number one in venture capital acquisition. It represented 34.8% of the total investment in 2022. Translated into money, USD$2,700 million were invested in 190 deals.

But, are current business models covering all the needs of users in the region? What are investors looking for when investing in a promising new fintech?

To be attractive, fintech companies must rethink basic issues focused on generating incremental value for the user, who must always be at the center. Similarly, they must consider whether, as fintech, they are better positioned than a traditional financial services company to serve that end user, opines Joaquín Abal, venture capital investor at the Mexican fund, DILA Capital.

They must also have teams with solid technical skills, multidisciplinary, diverse, and with a clear vision for business growth, points out Andrés Gabito Aspe, managing director of Glisco Partners.

“It’s important that they stay very aware of compliance with regulatory and regulatory issues, and pay a lot of attention to security, as it’s very important that they have solid measures to protect the financial and personal information of users,” Gabito adds.

Large financial returns, high margins and efficiency

What venture capitalists are looking for in Latin America is simple. It all starts with the expectation of financial returns; for this to happen, these fintech companies must solve real problems and have large markets.
Today, business models with positive marginal utility are needed. “As money is their raw material, it is very important that their business models are recovering the cost of capital, even more so in a time when interest rates are so high,” says Eric Pérez-Grovas, managing partner of Wollef, a Mexican fund that has in its portfolio the fintech unicorn Konfío, in addition to Kavak, Loft and Nubank.

To receive investment, fintech companies need “margins wide enough to justify access to capital with these double-digit cost rates that we are seeing,” adds Pérez-Grovas.

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Leonardo Arango, principal at One Way Ventures, an early-stage fund that invests in immigrants, also highlights the term capital efficiency. Venture capital funds in Latin America are looking for greater efficiency in a region where fundraising can be more challenging and market share often concentrates among a few dominant players.

Arango exemplifies that “in the case of new lending companies, maintaining strict underwriting standards, demonstrating prudent growth and ensuring low delinquency rates become especially critical in times of economic recession and rising rate environments.”

This leads us to think about what investment funds are demanding to support a startup. That is, what needs are still to be met by fintech?

Pending tasks of Latin fintechs

Sangion, from TheVentureCity, states that the primary unmet need is greater access to credit at lower interest rates. “This is something that is abundant in the US and far from being a reality in Latin America,” he says.
The Brazilian investor says the region faces several challenges in the financial sphere: “It has a relatively low proportion of people who invest, people who trade stocks, and people who buy insurance that is not for their cars (such as life insurance, home insurance, electronic insurance, etc.).

The above, Sangion explains, has a lot to do with two main things: lack of education in personal finance areas and greater poverty compared to regions like North America, which means that a large part of the population does not have spare money to dedicate to insurance and investments.

This makes a lot of sense with what Abal, from DILA Capital, thinks. For him, there are three barriers to the adoption of financial services that fintechs must try to break down:

1. Efficient distribution of these financial products to certain segments of the population.
2. Understanding the user from their specific needs.
3. User’s financial education.

So, beyond listing the services that Latin fintechs have yet to offer, one must first think about how to overcome these barriers.
“The big issue pending in Latin America is how to achieve a mass option of financial services that is fair, that all segments can access and that all elements can grow in their financial life”, Abal deepens.

Eric Pérez-Grovas adds that there are still many services that are not reaching the base of the pyramid, “there is a very important opportunity there”. The Wolf investor says that people need help to have a higher return on their capital and to facilitate people to pay without the need for a credit card, but through mobile platforms.

“We believe there is great potential with alternative payment systems, like ‘buy now, pay later’, which gives users a great possibility to acquire products and services in a more comfortable way,” adds Gabito.

“Payments in the digital economy is a pending issue, so that people can access certain services, like e-commerce and reach the levels of China, which is at 50% penetration, much has to do with the ease of electronic payments; mobile wallets still need to grow,” says Pérez-Grovas.

In addition to this, for the Wolf investor, there is a lack of a credit offer to make large transactions, like a house or a car. “As fintech can provide more positive information about people and in turn can lower the cost of capital, they will have access to larger credits,” he emphasizes.

B2B and Other Urgencies to be Covered by Fintechs

“Helping businesses grant credits to their customers is also another market opportunity,” adds Pérez-Grovas, who, like other risk investors, sees in B2B a great opportunity to undertake and to invest.
There is a very clear trend of fintech companies that are pivoting from a B2C model to B2B, which Abal interprets as a maturity of the fintech ecosystem.

Daniel Lloreda, co-founder and general partner at H20 Capital Innovation, an early-stage VC with operations in the U.S. and Latin America, expects fintechs to foster profitable B2B business models and products, with lower capital requirements, that can leverage fintech sandboxes to build and test with users in less time, with the aim of scaling as soon as possible.

In Latin America, Lloreda says, entrepreneurs initially focused on solving B2C problems and now we are witnessing trends in the field of B2B fintech, especially in verticals such as B2B payments, cross-border payments, currencies, and solutions for the CFO suite, such as accounts receivable, accounts payable, massive payment automation, recurring payments, and business intelligence (BI) for treasury teams.

“Thanks to advances in open banking, driven by favorable regulatory sandboxes (more favorable in some countries of the region than in others) and open banking companies like Belvo, we are seeing entrepreneurs building solutions for SMEs and business clients that a few years ago were not viable or took a long time to implement,” adds Lloreda.

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“Fintech stops being a specific business model to get into other platforms and models. Everyone wants to have some component of fintech, for example GoTrendier, a circular economy company, is exploring how to have a wallet so that transactions are simpler,” says Serfati, who from the portfolio of Ignia Partners has invested in the Israeli fintech Rapyp, in Konfío by selling Mr. Pago and in Tiendanube.

In the Bridge LatAm fund, mainly composed of Mexican entrepreneurs who have become angel investors, they believe that there is currently a huge opportunity in the field of money transfer, both internationally and nationally.

“If we stop to analyze the current landscape, it’s evident that the process of sending money from one account to another is characterized by being slow and costly, which poses various problems for both individuals and businesses. There are many businesses and/or people who have this need and there are not enough solutions (even vertical solutions) that solve the problem,” they emphasize.

At Bridge, they believe there is enormous space to continue building suitable infrastructure. The infrastructure for electronic payments and other fintech services is not as developed as in other parts of the world. This makes it difficult for fintechs to reach customers and offer their services to the majority of the population.

Abal also sees that moving forward. There will be greater and better collaboration between fintech and traditional providers to generate more value for the end user, in his opinion.

However, although fintechs have introduced disruptive innovations, integration with the traditional financial system remains a challenge in some cases, opines Gabito Aspe, from Glisco Partners. “Cooperation and collaboration between fintechs and traditional banks and regulators, could promote greater integration and facilitate the widespread adoption of fintech solutions,” he affirms.

The investor refers to all kinds of synergy not only with traditional banking but also with non-financial companies: “With Toyota, FEMSA, Walmart, although to optimize that collaboration there are cultural issues, bureaucratic issues, administrative issues and there are technological and connectivity barriers,” concludes Abal.