Value Investing In Startups May Be An Oxymoron, But Not In Latin America

Jan. 24, 2018 7:47 AM ET
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Contributor Since 2018

Serial entrepreneur and Managing Partner at Magma Partners, a seed stage investment fund with offices in the U.S., Latin America, and China.

Summary

  • Latin America is still overlooked by startup investors. Here’s a look at some of the current investment opportunities Latin America presents, and why it’s worth paying attention to the region.

For anyone interested in looking beyond the US for value investment opportunities in startups, I’m here to tell you why Latin America might just be the best place. As many later stage “unicorn” startup valuations plummet in the US and seed-stage investments rise, most people would laugh if you mentioned value investing and startups in the same sentence. And while value investing in startups may sound like an oxymoron, this old school way of investing actually makes a lot of sense in emerging markets.

Latin America is filled with resilient entrepreneurs starting and growing innovative ventures for both the Latin American and US markets – and they’re spending a lot less cash to do it.

Many startups in Latin America unknowingly fall in line with many of the value investing principles. These principles center around keeping within the boundaries of one’s area of expertise, having real sales backing you up to secure investments, and accomplishing more by focusing on the long-term, rather than focusing on where you’re going to find your next round of funding.

Latin America: A region still overlooked by investors

Industry statistics show that out of every 10 startups, seven will most likely fail, one will provide a return on investment, one will make 2-4X, and the last one must return the fund or more for traditional funds to be successful. Or the statistic that says 33% of startups will fail, 33% will return some capital, and 33% will be very successful.

Statistics like these are why venture capital funds need to invest in 10 to 20+ startups at seed or series A per year in order to discover the one or two companies that will provide a real return on investment.

For example, a “micro vc” in Silicon Valley fund will invest US$25-$50M over a 3-5 year period investing in pre-seed and seed stage companies. However, with average seed rounds in Silicon Valley approaching US$2M or higher at US$6M-10M valuations, a fund that specializes in seed rounds now needs to invest US$1-2M per company in order to produce any significant value.

I believe you can invest up to 90% less capital capital and produce similar or better outcomes for investors and founders alike by investing in US incorporated startups with Latin American founders and tech teams.

My seed-stage investment firm has invested US$2M into 32 startups across Latin America to date, getting the same equity stakes as a Silicon Valley fund would get for US$20M for similar companies. In total, our companies are doing eight figures in revenue per year.

Many of the companies my firm has invested in are also incorporated in the US and are not only profitable but also competing on a global scale – whether they’ve built products for Latin America or the US market.

Here’s a look at some of the current investment opportunities Latin America presents, and why it’s worth paying close attention to the region.

Generating revenue comes first

Regardless of location, the number one reason for startup failure is, overwhelmingly, running out of capital. A key rule of value investing is to get to profitability as quickly as possible. Value investing giants like Warren Buffett do not advocate the “high risk = high return” principle, as many investing in US startups follow.

Startups in Latin America are well-aware of this risk of failure due to lack of capital because accessing capital is extremely challenging for them. 500 Startups reports there are approximately 25 VC funds in Latin America, compared to approximately 800 in the US, 700 in China, and 100 in the UK/EU.

So you can see why Latin American startups are often much more focused on generating revenue first, rather than fundraising. This also means they are often valued significantly lower than in more developed markets due to lower operating costs, such as salaries, for their teams.

To illustrate this point, the salary of one Silicon Valley developer today may be the same as the salaries of three or four developers in Latin America. A recent study by Cisco revealed the average annual salary for an IT professional in the US has reached US$84,400 per year.

Compare that with the average salaries for IT professionals in Latin America, and you’ll see why Latin American startups are able to operate much more efficiently than their US counterparts, also making them more competitive in a lower valuation environment.

The average annual salary for IT professionals ranges from US$10,000 in Central America and up to US$45,000 across Latin America. Furthermore, IT professionals in Latin America tend to stay at the same company for a number of years, unlike in Silicon Valley, and that predictability is very valuable and can be factored in when evaluating a company.

It’s never been easy for Latin American founders to raise money at home, and it’s even harder for them to raise US funding, mostly based on ignorance about Latin America. Therefore, many Latin American companies are well-accustomed to operating without large rounds.

Startups in Latin America tend to focus on ideas that pass the common sense test and can reach profitability without endless rounds of financing. Because of the lower operating, infrastructure, and distribution costs, there are plenty of startups in the region scaling via customer and revenue growth, rather than venture capital. However, there is a way to help the ambitious companies which still need some financial support to scale.

Our vision is very similar to Bryce Roberts’ Indie.vc, in that we’re looking for companies that can “bleed black” after getting off the ground. Companies that have real business models.

I believe there are additional advantages for capital-efficient, US-incorporated Latin American startups that are targeting the US market. We help these companies combine the lower costs of operating in Latin America with the scalability and vast consumer base that can only be found in the US. Secondly, we help Latin American companies targeting the Latin American market only. It’s important to help these startups focus on cash flow and profitability from an early stage.

This model differs from nearly every other traditional business model and funding source startups are able to access in Latin America today – and it works.

Recently, when one of our US portfolio companies with offices in Latin America told a US investor that their burn rate was US$125K, the investor immediately assumed that he meant monthly, not yearly. When corrected, he was incredulous and ended the meeting. And when Latin American founders are able to raise money, they often act as if it’s the last investment they’ll be able to secure.

For investors, this means that they are much more likely to encounter startups that have a real business or revenue model and working capital in the bank, promising a better chance for a return in the near future.

Lower valuation environment

The valuations of startups in Latin America are usually far below what most investors are used to seeing in the United States. However, this doesn’t discourage entrepreneurs in the region from churning out some incredible companies anyway.

PedidosYa is a great example. The online food ordering and delivery service successfully dominated its domestic market of Uruguay before expanding operations across nine Latin American countries in just four years.

By the time of its acquisition, PedidosYa had raised US$2M in a “Latam” Series C round of funding. A Series C round of funding of this size wouldn’t even be considered a pre-seed or seed-stage round in the US! In fact, the average Series C round that same year was a whopping US$26M, according to Mattermark’s 2014 Startup Traction Report.

And yet, despite raising just shy of US$8M total before its acquisition, PedidosYa had established a network of over 7,000 partner restaurants and was generating over one million website visits every month.

There are examples like this all over Latin America.

Argentine startup Eventoiz, an event registration software, raised only US$1.5M in two rounds before its acquisition by Eventbrite in 2013. Mexican ride-sharing company, Aventones, raised less than US$4M before its acquisition by the world’s largest ride-sharing company, BlaBlaCar, in 2015.

Peruvian mobile movie ticket platform, Cinepapaya raised US$2M series A round before it was acquired by California-based Fandango in 2016. Brazilian job platform, Love Mondays, only raised a seed round of funding before it too was acquired by Glassdoor in 2016.

Launching pad to enter global markets

Startups that think globally from day one often provide much greater returns for investors when successful. More often than not, Latin American founded startups focus on building sustainable companies and plan for global expansion in the long-term.

Today, venture capital and funding opportunities are still relatively scarce in Latin America, and entrepreneurs rely heavily on friends and family, paired with government grants, to grow their ventures. We believe that talent is more or less evenly distributed, but opportunity isn’t. These talented entrepreneurs and engineers leading high quality companies provide key opportunities for people looking to apply value investment principals to startups.

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