Op-Eds

La Escuela del Sur #3: The Valley of Death

Having spent 20 years and having flown more than 3 million miles to explore the tech ecosystem in Latin America, I have witnessed the highs and lows, the promises and the broken dreams of our TecnoLatino.  The first quarter of 2019 has ushered in an optimism that hasn’t been seen in the Latin American tech scene since 1999.

The reason behind the wave of positive articles announcing the rise of the TecnoLatino is simple.  SoftBank recently announced it will launch a $5 billion fund focused on LatAm, and will seed this fund with $2 billion of its own capital.  

Masayoshi Son, chairman and chief executive officer of SoftBank Group said: “Latin America is on the cusp of becoming one of the most important economic regions in the world, and we anticipate significant growth in the decades ahead.” This fund appears to be the brainchild of a local: Marcelo Claure—Bolivia’s incredible visionary and entrepreneur.

SoftBank’s $100B Vision arguably makes it the largest venture fund manager in the world. However, while SoftBank is a major tech investor, the vehicle is technically defined as a private equity fund.  For perspective, in 2016, the entire U.S. venture capital industry invested $75.3B, according to the National Venture Capital Association.

SoftBank’s Latin America-focused fund would be twenty  times larger than the next largest venture fund operating in Latin America, making it a game-changer in LatAm. Before getting too excited, it’s worth considering how SoftBank will strategically deploy those $5B.  

If Softbank focused on $1M investments on average, it would have to make 5000 investments to allocate $5B.  If the check size is $10M, Softbank would have to make 500 investments to allocate $5B. The only way to make 500 investments within three years would be to “spray and pray,” i.e. make lots of investments with little due diligence and hope for the best.  No fund manager is going to “spray and pray” with $10M checks.

From a bandwidth perspective, Softbank will need to focus on companies where it can invest at least $50M and more likely $100M+ per investment.  Checks of this size will really only add value to the largest tech companies active in the market right now.

In Latin America, capital has never been short for the market leaders who can justify huge valuations.  Successful companies like MercadoLibre, Open English, Globant, and 99 Taxis had no problem raising tens of millions of dollars from international funds.  

SoftBank’s arrival in Latin America may make the next generation of the leading Latin tech companies even more valuable, but I believe it won’t change the harsh reality facing 99.9% of entrepreneurs in Latin America.  

Mistake #3: The Valley of Death

Besides the Atacama Desert in Chile, Latin America does not have many deserts.  But as any entrepreneur trying to build and scale a business in Latin America can tell you, the biggest challenge she or he faces is the Series A funding gap (aka “The Valley of Death”).  

To Latin American entrepreneurs who are trying to raise $1-3M in growth capital, it can feel like trying to find water in the driest place on earth.  There are very few funds or capital sources available to those entrepreneurs in the region outside of Brazil and Mexico.

Since 2010, raising an initial seed round of $250-$750K in Latin America has been made simpler given the number of small venture capital funds that have sprung up in almost every country in the region.  These funds generally have $5M-$20M million to invest and tend to make investments of between $150-$500K.

There are also tens of millions of dollars in Series B financing available to any Latin entrepreneur whose company can justify a $30M+ valuation.  As the world’s largest venture funds have grown, those mega funds are all chasing a few deals that offer tickets above $10M.

In sum, raising the initial seed capital is attainable and raising a Series B round is also achievable. But how can entrepreneurs get from the Seed round to the Series B round?  This process requires passing through the “Valley of Death.”

To startup, all founders should understand what kinds of metrics her company will be expected to show to be credible to Series A investors.

Five years ago, companies generally needed to show $100K MRR to get funded.  Series A VCs are not going to be convinced by how many likes your company gets or how cool your pitch-deck is—expect the conversation will be all about your top line, your metrics, your traction and what have you learned about your customer.

Currently, venture capitalists looking at companies in Latin America expect to see around $200K MRR before they are willing to provide Series A funding.  Why? Many tech-enabled companies in Latin America get stuck earning $30-$80K a month and cannot scale.

A big fear for VCs is to invest in a decent company which stagnates and becomes a “zombie.” A zombie is a startup that got off to a good start and raised a decent amount of money but never really took off and 5 years later is still in business but not going anywhere.

The few investors who are willing to step into the Series A rounds are overwhelmed with dealflow. Those investors can afford to be more selective, and their expectations have inflated upwards.

The typical entrepreneur in Latin America ignores the reality of the market.  After raising a seed round, they run out of runway after 9 months and get trapped in the “Valley of Death” with no prospects of raising a Series A round of financing.  To avoid this trap, Latin entrepreneurs need to be realistic and embrace the market realities.

Every Latin entrepreneur should ask themselves:  “Do I have a realistic plan with this Seed money I am raising now to either i) get to over $100K MRR so I can raise a Series A or ii) get the company to break-even so I do not have to raise any more money?”  

If you do not see a clear path toward one of these options, don’t raise the money.  The odds of finding yourself in the “Valley of Death” are simply too high.

Until SoftBank or some other fund manager can solve the Series A funding gap, most of our companies will have to face the “Valley of Death”.  We should not forget that the Atacama Desert in Chile is not just dry; it is the driest desert in world.

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In his next column Juan Pablo will explain why most tech enabled companies in Latin America have assured themselves failure before they even launch.  Juan Pablo can be reached at jp@pag.law.

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