By Luis Enriquez
This Building Bridges is a fraction of an article that was published in The Realistic Optimist.
Biography
Luis Enriquez is the co-founder and operating partner at Bridge LATAM, a VC fund spun out from an angel syndicate. Bridge LATAM has the particularity of being led by former founders.
Prior to Bridge, Luis co-founded Cultura Collectiva, one of the largest native content platforms in Latin America.
You claim that LATAM VCs shouldn’t replicate the US way of doing things. Why?
The conventional US VC approach is to invest in Series A rounds and continue with follow-on investments in Series B and C. This model is predicated on a large market size, lots of available VC funding ($248B in 2022) and proven exit opportunities. You can invest in Series A and have a decent chance, or at least many proxies of success, to exit that investment later on.
In 2022, LATAM as a whole raised $8B in VC funding. Mechanically, exit opportunities are both rarer and smaller. Let’s do some math.
Let’s say you run a $50M Series A VC fund in LATAM, and you are aiming to return 3 times the fund. Your average investment is a $3M check on a $30M valuation. For a deal to be one of your “homeruns”, you should aim to exit that investment for $100M. To do so, the company’s valuation would have to rise to 34x, surpassing $1B. You’ll also need a liquidity event to exit your position.
The statistics don’t play in your favor. Today, LATAM only has around 36 unicorns, so the chance of your deal generating an exciting internal rate of return (IRR) is low. And your LPs want money, not a sexy dashboard. Out of these 36 LATAM unicorns, only a fraction have undergone liquidity events. Your deal’s odds of distributing outstanding distribution to paid-in (DPI) aren’t stellar.
What’s a better approach, in your opinion?
In LATAM, VC math makes more sense if you invest very early. Let’s say you run a $10M fund and write average checks of $1M, on a $10M valuation. To get your homerun, you’d need one of those deals to return $20M. That implies the company would need to reach a $200M valuation.
It’s safe to assume LATAM has way more companies in those waters, and you can sell your stake to a later stage investor rather than waiting for a liquidity event. Ideally, you would exit 2/3rds of your investment at the $200M valuation round, and keep 1/3rd of it in case of an extraordinary IPO, à la Nubank.
This strategy boils down to adapting VC math to the ecosystem’s youth. That being said, it implies bigger risks: you are investing earlier and thus in very immature companies. Increased risk means you will have to invest in twice as many deals, to make sure to optimize the chances of fund returners.
In that scenario, who could you sell your stake to?
A few actors might be interested.
Private equity (PE) might be keen. Ben & Frank, a Mexican eyewear brand, raised their first rounds with VC money before switching over to PE funding later on.
Growth funds such as General Atlantic are another option. Berkshire Hathaway, Warren Buffet’s fund, famously made a $500M investment in Nubank. Larger VCs such as Softbank or Kaszek might also want a stake. Same for US banks such as JPMorgan or Morgan Stanley.
Does this change the type of companies you invest in?
This approach makes it hard to specialize. There are only so many early-stage deals in a specific sector, especially in a young ecosystem such as LATAM’s. This calls for sector-agnosticism. It doesn’t change the fact that we are looking for the best founders with the best potential.
You spoke about getting your stake bought out by another investor. What about an M&A scenario?
Tech startups being acquired in LATAM is still a new phenomenon. Especially later-stage companies with larger exit sizes. Remember you are playing the power law game, so one of your portfolio companies exiting for $15M isn’t of much use.
There are a few outlier examples. In 2021, Okhta acquired Argentina’s Auth0 for $6.5B. In 2019, Uber acquired Chile-based Cornershop for $1.4B. But apart from that, large LATAM tech M&As are still few and far between.
The ecosystem’s youth plays a role in this but there is also a lack of buyers. LATAM has a reservoir of large, family-owned businesses. They rarely go public, preferring to keep family control. It seems that LATAM business culture prioritizes control over wealth, contrary to the US. This doesn’t facilitate M&As. That being said, these businesses’ younger, tech-savvy inheritors might have a larger appetite for buying tech startups.
There isn’t really a world in which LATAM’s tech value creation doesn’t increase significantly. As of 2022, tech companies’ market cap in the US made up 52% of its GDP. In LATAM, that figure was 1.5%. I’m not saying LATAM’s share will surpass the US tomorrow, but the catch-up potential is undeniable.
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