ArpexCapital

Dream, People, Culture

New Technology Won’t Drive Brazil’s Boom

Filed under Brazilian Venture Capital, Entrepreneurship, posts by

My friend Tiago Sommacal wrote a great comment on my last post, in which he asserted that Brazil may not have the technological innovation to support a wave of startup success similar to that in the US from 1994-1999.  As I sat down to write a reply, I decided the importance of the issues merited a full blog post.   
 
It's probably a topic many people have opinions on, so feel free to weigh in.
 
Tiago’s comment:
 
….I would add that you did not directly address Brazil's technological position. Your expectation that huge wins will take place isn't explicitly related to any specific vertical/industry. However, the dot-com bubble was strongly related to a new industry (Internet) formed by ventures bringing technologically groundbreaking products which basically shaped a whole new market [think about AOL's or Amazon's services]. These products' newness largely justify why their usage quickly took off. One can argue that Brazilian startups or entrepreneurs (including geeks) are far behind their American counterparts when it comes to the technological edge of their solutions, especially when we consider that Brazilian online ventures already compete with many US-based players [e.g., Google, myspace or PayPal] – that is, from a certain standpoint, the Internet, here, is a world-class industry.
 
I would definitely like to know your thoughts on Brazilian startups' technological edge in 2010 against their American counterparts in 1994 when you get a chance.
 
Reply:
 
The premise of your question is that, in order to have the huge wins that I predict, Brazil must have a technological edge or at least technological innovation. I don't think this is correct. It's true that the American boom that happened in 1994 was enabled by a technological innovation (Arpanet, which became the Internet) but the innovations that occurred with, e.g., AOL and Amazon, were business innovations, not technology ones. In fact, only one of the companies you listed, Google, succeeded because of technology innovation (search algorithms): AOL, Amazon, MySpace and PayPal (and EBay, YouTube, etc.) did not.
 
There were certainly many technology-based companies that did succeed back then but there were even more companies that were nothing more than imitators or aggregators (auction sites, email services, shopping aggregators, etc.). Many of these grew and were acquired at huge returns for entrepreneurs and investors.
 
In sum, the technology that is required for a boom is present in Brazil: broadband and great software development. What will spark the boom going forward is the confluence of other factors, including but not limited to demographics (emerging middle class, consumers), the economic environment (lower interest rates, fiscal stability) and culture (entrepreneurship, high wireless and internet usage).
 
Regarding US-based competitors, in the broad universe of web-based businesses only a small percentage of US companies have penetrated the Brazilian market in a meaningful way – plenty of space remains open, for now, for Brazilian companies. 
February 26, 2010 at 08:01 Comment (1)

VC in Brazil: Pessimist vs. Optimist

Filed under Brazilian Venture Capital, Entrepreneurship, Macro Environment, posts by

Last week, I suggested that the startup ecosystem in Brazil has reached an inflection point similar to the one reached in the United States in 1994, with the next five years promising huge wins for aggressive startups and disciplined investors. 
 
One can certainly make a strong case against such an outlook and, below, I provide the pessimist’s viewpoint (taken from the last post), followed by its optimistic counterpoint.
 
A.            Pessimist: Entrepreneurialism has shallow roots in Brazil and entrepreneurs are few in number and inexperienced. The startup ecosystem is nascent and scattered.
 
B.            Response: Yes, historically, the most talented Brazilian business people have gone into large corporations or into government but this is changing rapidly: there is a large number of talented entrepreneurs, mostly below the age of 35, involved in startups or interested in making the leap. Some have already had successful exits from companies they founded. Over the next five to ten years, a larger percentage of society will become entrepreneurs, especially as they witness earlier entrepreneurs succeed.
 
 A.            Pessimist: Brazilian startups must cope with much more burdensome tax and labor regulations than their compatriots in the US.
 
B.            Response: Absolutely true and it is one of the reasons I so respect entrepreneurs that have made it in Brazil – they have overcome immense obstacles. 
I have also learned, however, that the tax and labor laws can be dealt with effectively, it just takes more time and effort than in the US.  In other words, these issues are speed bumps, not walls.
 
A.            Pessimist: Angel investor networks have yet to fully coalesce and institutional venture capital is extremely scarce. 
 
B.            Response: Yes and that is why there is still a huge opportunity for venture capital investors, especially those willing to get their hands dirty in helping early-stage entrepreneurs. 
Moreover, a greater amount of angel capital exists than most people think. I have met many, many Brazilian entrepreneurs backed by high net worth angels. Many of these businesspeople also act as willing and able mentors.
 
A.            Pessimist: Interest rates, while falling, remain high enough to compete for investor dollars – why invest in a high-risk startup when you can earn 11% a year buying a low-risk bond?
 
B.            Response: Certainly interest rates must continue to fall or, at least, not rise, in order for the venture capital ecosystem to flourish. 
Indeed, why has most of the venture capital in Brazil come from government sources (FINEP, BNDES, etc.) up to this point? Because private investors have had no incentive to take the huge risks involved in venture capital investing.   They could get great returns from bonds or, if they wanted to dabble in alternative investments, private equity. The mediocre track record of VC funds in Brazil (and the US) in the last ten years has not helped the situation: for the moment, non-governmental institutions (e.g., pension funds) have no interest in putting money toward venture capital. They will only do so if 1) interest rates fall to the point where they have to take more risk in order to get high returns and/or 2) they see proof that the VC asset class can actually succeed in Brazil.
 
A.            Pessimist: The specter of inflation never seems to go away and political risk in Brazil remains: the surprise 2% tax on FDI jarringly reminded investors of the potential for sudden moves by the government.
 
B.            Response: Inflation risk and political risk are real but decreasing. In fact, Brazil is a nation of inflation hawks. I was shocked that, even at the height of the financial crisis, while the US was dropping interest rates to zero, Brazilian policy-makers were worried about inflation. This vigilance reflects Brazil’s painful history with inflation and will serve as a guard against inflation in the future. 
Regarding political risk, only a small minority believes that the government could ever revert back to far-left or far-right policies. A large percentage of the population has seen their lives improve as Brazil has moved toward a free market economy, few will want to return to a heavy-handed, government-centric system.
 
A.            Pessimist: There is too much optimism about venture capital in Brazil. 
 
B.            Response: This worries me but we are a still a long way from an imbalance in which too much venture capital chases too few good businesses (as exists in the US).   In fact, the opposite situation exists and will continue to do so for the foreseeable future. 
Of course, good investment opportunities, whether they be tulip bulbs, railroads, Internet companies or consumer real estate, inevitably become overvalued, sometimes so overvalued that a massive bubble forms and pops, leading to years of woe. Something like that may happen in venture capital in Brazil, maybe five to ten years out, but the point is to get take the ride on the way up and protect yourself on the way down.
I believe that the “ride up” is starting.
February 19, 2010 at 11:55 Comments (9)

Party Like It’s 1994?

Filed under Brazilian Venture Capital, Macro Environment, posts, US Venture Capital by

I just spent two weeks in Brazil and, as has happened on almost every trip to Brazil since 2006 (I have been traveling there since 1999), I came back shaking my head at all the opportunities in that country.   Unless I have misread the last four years of experience or am completely delusional, the venture capital market in Brazil has reached an extraordinary moment. I compare it to the US in 1994 – an inflection point where a critical mass of startups in certain markets will grow exponentially.
 
Like the US in 1994, a healthy balance exists between the number of startups and the market for their products and services. With proper execution and sufficient capital, Brazilian entrepreneurs have the potential to build the next generation of great companies.
 
Before my optimistic investment thesis leads you to you conclude that sun and samba have damaged my brain, however, let’s review and respect the anti-thesis (I'll continue the bullish case for Brazil VC in the next post).
 
Obviously, Brazil in 2010 is not totally analogous to the US in 1994: entrepreneurialism has shallower roots there and entrepreneurs are fewer in number and generally less experienced. The startup ecosystem is more nascent and scattered – Sao Paulo is not Silicon Valley, Rio is not New York and Belo is not Boston.  Brazilian startups must cope with more burdensome tax and labor regulations than their compatriots in the US.
 
Angel investor networks have yet to fully coalesce and institutional venture capital is extremely scarce. Interest rates, while falling, remain high enough to compete for investor dollars – why invest in a high-risk startup when I can earn 11% a year buying a low-risk bond?
 
The specter of inflation never seems to go away and political risk in Brazil remains: the surprise 2% tax on FDI jarringly reminded investors of the potential for sudden moves by the government.
 
Perhaps most negatively, for the first time I feel a twinge of concern that there is too much optimism about venture capital in Brazil. I know that sounds crazy coming from a guy who hypes the market for VC in Brazil but I live by Warren Buffet’s dictum: “Be fearful when others are greedy and greedy when others are fearful.”  I now know of at least four parties thinking of or actively trying to raise early/growth stage VC funds in Brazil. Those are the only the ones I know of, so there are surely more.
 
The people interested in raising funds have a high level of talent and sophistication — that's not the issue.  The issue is whether too much early/growth stage capital would exist if all the new funds get raised:  when combined with Ideiasnet, Monashees, Criatec, FIR, Confrapar and other, smaller funds, I begin to get worried about an imbalance. 
 
Think of it as an equation, with good potential VC investments on the left side, investment funds on the right. There are only a limited number of good entrepreneurs and businesses on the left side; when too much capital pours into the right side of the equation, valuations get driven too high, more startups get funded than can succeed in the market and the venture capital asset class then fails to deliver sufficient returns on investment. 
 
Unfortunately, a problem like this cannot correct itself quickly. Venture funds have a ten-year life and their investments are in private companies (and therefore very illiquid). So, unlike the public markets, which can adjust relatively quickly to imbalances, once the venture market is oversaturated, it takes a very long time to correct itself. 
 
For a real world example, just look at the US. Since 2000, US venture capital asset class has had a negative return. Negative! VC is the riskiest asset class—LPs need a 25% IRR to justify investing in VC funds – and ten-year returns have been negative! So, of course, the US venture market is a disaster. Most LPs don't want to touch it and it will take another 3-5 years for enough tier two and tier three VC firms to disappear before a balanced equation re-forms: a sufficient number of good entrepreneurs and businesses on the left side, an appropriate amount of venture capital on the right.
 
Next post will make the bullish case for venture capital in Brazil and specifically address the concerns above.
February 11, 2010 at 08:12 Comments (4)

Campus Party

Filed under Brazilian Venture Capital, posts, Random Posts by


Recently I attended Campus Party in Sao Paulo and had a great experience.  As I tweeted at the time, Campus Party is a rave meets Grateful Dead show meets Star Trek convention meets Dave and Busters.  It seemed like the physical manifestation of the entire Web in one place: art, music, technology, games, advertising, pornography, etc.  (As an aside, the distinction between the physical and the virtual world, based on the amount of immersive gaming there, is rapidly blurring.)

 

Many attendees actually camped inside the convention center.  The camping area was analogous to one giant techie bedroom, except that instead of rolling out of bed and onto the Net, the techies walked into the exhibition center and interacted in person.   Meetings, games, panel discussions and general hanging out took place 16+ hours a day.

 

 As on the web, some of the content Campus Party was fascinating, some of it was useless and some of it was fascinating and useless. Regardless, the event had a festival atmosphere of unbridled creativity.  As someone who constantly focuses on Web-based business, I felt rejuvenated – Campus Party reminded me that the Web is a whole more than a new business platform.

 

Check out the pictures…

 

 

Last week I was also supposed to attend SocialMediaWeek in Sao Paulo.  In fact, it was a primary reason for my trip to Brazil.  Unfortunately, a wicked headcold/sore throat laid me out one night and a massive thunderstorm stopped traffic in Sao Paulo the next night (“stopped traffic" in Sao Paulo means three hours to go three miles ).  As an aside, the rain in Sao Paulo has been biblical – at one point they had over 40 straight days with rain.

 

Apparently SocialMediaWeek, which was sponsored in part by Startupi, went very well.  I look forward to catching up on some of the presentations if and when they are posted online. 

February 8, 2010 at 09:00 Comments (2)