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The Search for Liquidity in LATAM

On a recent podcast I hosted with Cristobal Perdomo of Jaguar Ventures, we got on the topic of exit opportunities for startups in LATAM (you can listen to the episode here). It became something I couldn’t get my mind off of, so today, I’m going to cover some of the trends around exits in the region and why they’re essential.

First, the basics, why are exits so important anyway? Set aside for a second that VCs are liable to return cash to their LPs when a fund’s lifecycle is complete. What does liquidity do for an emerging startup ecosystem? It legitimizes it, leading to further development. When investors prove they can generate returns in a new ecosystem, others see opportunity and pile in. This trend happens at both a global and a local level. Developed nations look to invest at lower valuations in emerging markets with favorable currency conversions, and local investors become more comfortable with the VC asset class. Beyond comfort, generating returns allows VCs to raise more (and typically larger) funds, helping them finance more startups and continue funding them in future rounds. For founders and others with equity stakes in the company, a liquidity event allows them to eventually go on to their next project, whether it be starting a new company or contributing to the ecosystem by becoming mentors, starting accelerators or becoming investors themselves.

So how does this translate to LATAM? Over the last decade, specifically the second half of it, the region has been on an upswing of private capital investment. The idea of launching a startup and working at one has become less scrutinized compared to traditional career paths, leading to more individuals forming companies. The education around the venture asset class has also improved, leading to more LPs investing in newly created funds. The market opportunity has attracted foreign capital, with firms such as A16Z and Softbank, among others, helping develop startup ecosystems across the region. 

Despite the pandemic, 2020 was a record-breaking year for LATAM venture capital, seeing 488 deals between VCs and startups (Source: LAVCA). Dollar figures were down -10% at $4.1B, but that didn’t stop some countries from producing their first unicorns, such as Mexico’s Kavak and Uruguay’s dLocal. Another thing those two companies have in common? They’re both still private, sitting comfortably at a high valuation with other cohort members such as Colombia’s Rappi and Brazil’s Nubank. Something seen consistently with these unicorns in LATAM is that they grow large enough to a point where M&A is not a viable exit for them, but they may also be too small to IPO on the U.S. public exchanges, which is where many of them choose to trade.

IPOs are not common in LATAM. In general, this process is time-consuming and expensive everywhere, but there is a lot of red tape involved in the region. Besides the fact that there aren’t many retail investors, there is also quite a bit of regulation. For example, Mexico’s BMV mandates that a company is profitable before being eligible to be traded on the exchange, something that is rare for high-growth tech companies these days. This overregulation is not necessarily the case in every country, as Brazil’s B3 exchange has seen an uptick in IPO filings over the last year. Still, this increase is the exception and doesn’t support the growing number of companies in the ecosystem. Brazil currently has a little over 300 companies currently listed on its exchange. They’re leading the pack in the region, with Chile in second at around 200 companies compared to the U.S.’s 3,500 and China’s 3,700. There is an opportunity to provide more avenues to local exchanges and increase the number of retail investors in each country. Until that happens, startups will opt to go another direction.

M&A is the typical exit strategy for most startups globally; as the saying goes, “great companies are bought, not sold.” There is undoubtedly activity happening in this space; as many companies competing in a similar vertical look to expand across borders, they have the opportunity to merge or acquire a competitor rather than launch into a new market. An example of this is the above-mentioned Kavak expanding into Argentina by merging with Buenos Aires-based Checkars. Great for both companies, but once again, Kavak is still private and highly valued.

Companies staying private longer and at higher valuations has been the norm recently, but things began to change last year. The most significant trend is SPACs (special purpose acquisition companies), which have been in existence since the 1980s but have reemerged as a strategy to take startups public. These public holding companies raise capital in an IPO for the sole purpose of acquiring a private company and taking it public, basically sidestepping an IPO which is both expensive and time-consuming. Currently, over 400 SPACs exist, and due to the competition for deals, they’re looking to acquire companies outside of developed markets. Many, such as the ones formed by Softbank, Alpha Capital, and LIV Capital, have their sights on LATAM. Proponents of this method argue that it helps surpass many of the regulations and costs in the IPO process and makes it easier for LATAM companies to list in the U.S., as many of them are already registered as Delaware C-Corps anyways.

There are some dangers, however, with the new SPAC craze. Critics of the method cite the lack of a strict due diligence process, where some companies that shouldn’t go public end up on the exchanges (i.e., Nikola’s potential fraud). Also, with the number of SPACs created in such a short amount of time, it certainly looks a little bit like a bubble. With financial markets the way they are these days, it seems like just about everything looks like a bubble. But, if we can keep the good times rolling, this new path to liquidity for both founders and institutional investors could bring a new wave of development to LATAM’s startup ecosystem.

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