Brazilian Venture Capital

the venture capital market in the Brazil; Brazilian venture capitalists; venture capital investment practices in Brazil; venture capital trends in the Brazil

After AngelList: What’s the Next Step in VC Innovation?

AngelList is the most important company in venture capital – more so than the various Unicorns and Thunder Lizards roaming the landscape – because it solves the discovery and transparency problems in early-stage investing.

AngelList provides the marketplace for startups that early-stage VC has lacked for so long. Think auctions/classifieds before eBay.    It won’t be the only place startups find investors but it will become an essential reference for almost all angel transactions.

The VC ecosystem, however, has many pain points that beg for innovation, especially in the area of secondary liquidity.

People focus on the gross return aspect of investing but time is a critical aspect of Internal Rate of Return (IRR), as well.  A lot of angels would rather have a 5x return after 2 years than a 10x return after 5 years but right now they have little ability to sell their shares.  They must wait for a big liquidity event, probably many years into the future and hope they don’t get too diluted in the meantime.

For whatever reason, Second Market and others like it just haven’t solved the liquidity problem.  My hunch is that it results from their (logical) founding focus on large, mature opportunities like Facebook, etc.  rather than on transactions involving companies at the late Seed, Series A and Series B stage.   Deal terms and government regulations play a big role as well.

But I have more confidence in AngelList or someone with DNA in the angel ecosystem, rather than a Second Market, to solve this problem, which demands an approach closer to eBay than to Sothebys.

Until recently, no one believed in an online marketplace for early-stage investment; angels will rejoice again when we find a secondary market for such investments.

Investors Need to Take Their Own Advice

 

Mark Suster recently wrote another good post, “Shiny New Objects”, reiterating the need for entrepreneurs to focus.

 

Mark directed his post at entrepreneurs but the same principles apply to investors – to me.  Lack of investor focus results not just in “slow no’s” to frustrated entrepreneurs but ultimately in stupid investments and long-term failure.

 

Every investor, like every entrepreneur, has ample opportunity to lose focus.  New businesses – new shiny objects – in “billion-dollar markets” come in all the time.  Some are in clean tech, most are internet-based, some are medical devices, agro-tech, etc.  It’s easy to begin dreaming that, yes, this will be “the next Google”, the next Pfizer, the next  _____ [fill in the blank with an .001% company that becomes worth US$100B+].

 

Investors also get fearful about “missing out”: no investor wants to be the record producer that passed on the Beatles.

 

So we rationalize our lack of discipline: “Well, if there is a 1% chance that it could be worth billions, shouldn’t I spend some time learning about it?  Isn’t that the responsible thing to do?”

 

Actually, no, it’s the irresponsible thing to do.

 

It takes months of work to become deeply knowledgeable about most industries; when dealing with more complex, tech-heavy businesses, it may be impossible, unless you came from that industry.

 

Of course, you can and should seek outside experts that can help but, at the end of the day, do you want to rely on outsiders to drive investment decisions?  And why take time and energy away from investment areas in which you can leverage your existing expertise?

 

I have difficulty managing my time as it is; when I chase investments into new areas, the diligence process becomes even longer and choppier, resulting in amateur behavior and (understandably) pissed-off entrepreneurs.    If I do eventually invest, if I am not an expert in their business, how much can I really help the company?  I can offer generic advice but not deep strategic feedback.

 

Investment focus can expand over time but it should happen in a methodical, incremental way: moving from ERP software into accounting software makes sense: moving from ERP software into cleantech probably doesn’t.

 

The only exceptions to all this might be superangel funds: in that case, the investment method relies on diversification and multiple small bets, none of which divert too much time and resources.  For investors with more concentrated portfolios, however, a decision to expand into new areas has a huge impact on firm resources and really, can make or break an investment business.

 

VCs repeat the mantra of “focus” to entrepreneurs all the time but I need to remember that what’s good for entrepreneurs is also good for me.

Don’t Copy Silicon Valley

The Next Web recently published an important article by angel investor Juan Pablo Cappello.

Juan convincingly states what many have learned the hard way:  Brazil is not Silicon Valley, its startups should not emulate Silicon Valley and we should not look to foreign investors for validation of businesses.  Instead, focus on real problems in Brazil and building solutions to those problems.

(Daniel Isenberg, a professor at Babson College, made similar comments in the most recent Exame.)

My own two cents:

    • Cloning businesses from foreign markets can work if those businesses address a real pain point in Brazil BUT…
      • There are so many unique obstacles in executing a business in Brazil that it changes the entire analysis of whether a cloned idea is a good one.  Most people only see the good idea and not the true obstacles to execution in the Brazilian market.
      • Good ideas are always cloned by more than one company and therefore have multiple competitors from day one.   There is no lead time for a cloned business.  This reduces the chances of success.

       

    • At some point, the goal of many startups (in the US and Brazil) switched from building a successful business to successfully raising capital.
      • This is backwards: raising capital is a means to an end (building a great business), not an end in itself.
      • Accelerators are hugely important and hugely helpful to the startup ecosystem but they are partially to blame for this switch: an incredible amount of time in acceleration programs is spent on how to pitch VCs; in some programs, the pitch, not the business itself, is THE focus.
      • Pitching is important but it is a “sugar high”.  Even with the best pitches, the sugar high – the excitement – wears off quickly and the reality of the business becomes obvious.  If the business is weak you have wasted your (and the VC’s) time.

       

    •  As ever, focus on solving a painful problem for which people will pay for a solution.  The bigger the problem and the more money people will pay for the solution, the better the business.

 

Angel Investing and the Series A Crunch

Much ink has been spilled on the question of whether we have a “Series A crunch” — a lack of investment capital for companies at the Series A stage — in the US and Brazil.

In my opinion, there is plenty of Series A capital available… for companies that are actually at the Series A stage.

 
Angel investment is essentially money for research and development — R&D capital — used while teams search for a scalable, repeatable business model.  If they don’t find that model, if the R&D doesn’t lead to a viable business, the startup gets “crunched” at the Series A stage.

For companies that have proven a scalable, repeatable model and are ready to move to the “execution” phase, plenty of Series A capital exists.  In fact, in Brazil and the US, investors fall all over themselves to fund the next proven Series A-stage company — valuations are high and terms are relatively easy.

Since the cost of starting a business has dropped, however, many more startups exist and, therefore, a smaller percentage of companies are actually reaching the execution phase.

The disconnect occurs because, from the startup’s perspective, since they have already raised Angel and/or Seed money, they naturally approach Series A investors for the next round of capital.  Just because the funding rounds have evolved, however, doesn’t mean the company has.  If the company is still in search phase, they need angel capital.   The entrepreneur is asking the Series A investor to act as an Angel; most of the time, the Series A investor won’t do that.

Thus the “Series A Crunch”.

This critical point — where expectant entrepreneur and angel investor meets skeptical Series A — doesn’t often have happy ending.  If the company is still in search mode, then the company should go back and find more funding from additional Angel or Seed investors.   This is very tough to do — you need to convince the new investor that more money will lead to success, despite previous investment not having done so.   You also need to convince current investors to accept high dilution from new investors.

 

Optimism and the Brazilian Online Market

I attended a get together organized by BayBrazil last night.  Lots of members of the Brazilian startup community are in town for TechCrunch Disrupt and the atmosphere was great.   I expect the same at the StartupiCon event on Thursday night.

It’s fun to see hard-working Brazilian entrepreneurs (and investors and mentors etc.) in the Valley/San Fran environment – there is something energizing about it, it provides a morale boost.  Anything seems possible here and entrepreneurialism is king.

The amount of quality Brazilian startups here proves how dramatically the startup ecosystem has improved in the last few years.  Several of the pitches I saw last night would fit seamlessly into the Y Combinator Demo Day I saw last month.

One big cloud hangs over my optimism, however, and there is insufficient discussion about it: the customer market for Brazilian startups remains small.

I am not talking about the size of the Brazilian economy, which is huge.  I am talking about the number of people who use and PAY FOR new online products and services.  We hear a ton in the news about the large size of the Brazilian market, the growth of the middle class, improving infrastructure, etc. — all true, all important — but the real size of the paying online community in Brazil is still extremely small.

Yes, people buy shoes and clothes online but, outside of that, we still don’t know when and where other parts of the online market will grow, nor how big it will actually be.

For the moment, the market for new online product and services is thin.

It’s true that startups face less competition in Brazil – in any given niche, there may be two or three competitors versus six or seven in the US – but the true market for those three competitors is proportionally much smaller than the market for the seven competitors in the US.

It is better to have seven competitors in an addressable market of 50 million users than three competitors in a market of 10 million users.

I don’t think anyone, including me, truly knows how large the online market will be in Brazil, what will people pay for (outside of normal retail goods), nor when they will start paying for it.

I am an optimist (come to think of it, maybe that what is in the air this week: optimism) but a lot of positive assumptions about the Brazilian online market remain unproven.

Vamos ver…

A War of Tweets Breaks Out

A war of  tweets broke out between Dave McClure, Fred Wilson, Mark Suster and some other high-profile VCs this week.

The subject involved Convertible Notes and whether different investors in the same convertible note should have different valuations.

In sum, Dave thinks they should, depending on when they invested in the note and how much value they bring to the company.

His point is that 1) an investor that comes in first deserves a discount for “leading” the round and 2) later investors in the same round often enter when the risk of the investment has lessened.

Regarding #1, I can see how an investor that has the courage to jump in first and “lead” a round should get a discount; only, however, if the company is having trouble getting others to commit.

Regarding #2, can a company reduce its risk so quickly that, during the funding process, the valuation changes measurably?  I guess so: notes are held open for a long time nowadays and, logically, if the risk profile changes, the valuation should as well.  But this approach can make things very complicated (imagine eight investors in the same round with eight different valuations).

There is also the argument that certain VCs deserve a discount because of their brand, i.e., a ” big name” investor has a positive effect on a company’s value and that VC should therefore get a discounted valuation.

Again, this feels awkward but makes logical sense.  Using the public markets as an analogy, if Warren Buffet buys a stock at $10 per share, the perceived value of the stock will immediately rise and subsequent investors, even ones that invest ten seconds later, will pay a higher price.

The bigger message of the debate is that, although we VCs like to think of ourselves as edgy financiers of creative destruction, it is now our industry that is being disrupted.   At the moment, it is Paul Graham, Dave McClure, AngelList, etc. but soon it will be…  who knows?  I do know that all of venture capital’s established practices will be thrown on the table, spotlighted and battered with the mallet of innovation.  Best practices will endure, all others will die.

Regardless, there is no need to worry about missing the action: in the venture world, “the revolution will be televised tweeted.”

 

 

Is Your Company a Feature, a Product or a Business?

In these days of multiplying startups, it’s useful to divide companies into three categories: features, products and businesses.

A feature is less than a product and nothing close to a business. Using LinkedIn as a very rough example, the “advanced search” that you get with an upgraded account is a feature.

A product is more robust than a feature but not enough to be independent business.  An example of this would be LinkedIn’s “Talent Finder” product for Recruiters. Good stuff but, on it’s own, not terribly differentiated; it would not make an interesting investment.

A business is LinkedIn. It’s a huge platform of information on top of which the company builds products (with cool features) for which many people pay.

A lot of features can evolve into products and eventually into businesses — the problem is that it takes time and a lot of other people are doing the same thing.

I had an “uh-oh” moment (kind if like an “ah-ha!” moment but bad) a year ago when I looked at the “Share This” button and saw at least fifty “sharing” products (read: features), all with cool names, probably all with hardworking entrepreneurs, tech talent and many with investments from angels.  How could there be enough users, I thought, for even half of them?  How could there be enough acquirers for more than a few of them?

Two years later, other than the Tweet, Like, LinkedIn and (now) the Google + buttons, most are gone or somewhere out there “pivoting”.  The same fate awaits most of the features and products that are currently masquerading as businesses.

Weak features/products die from lack of usage; strong ones get extinguished by stronger competitors.   If a competitor has more resources (money, developers, users, etc.) and they can build the feature, they probably will.  And they probably will before you scale enough to beat them and before they need to buy you at an interesting price.

Of course, there is an alternative to win it all or die.  Look at the offline world for analogies.  Below the Fortune 5000, there are tens of thousands of good business that generate cash for their owners but will never “win” their markets, scale or have an exit.  The same will exist in the online world: below the Internet 5000, there will be thousands of decent businesses — the online version of restaurants and dry cleaners.

Below those businesses, however, there will be tens of thousands more that die, just like in the offline world.  The business pyramid is narrow at the top and wide on the bottom.

Despite some recent posts (like this one) that might seem negative, I’m not.  Evolution (of species, economies, businesses, etc.) works in cycles, often with periods of explosive growth followed by periods of large-scale extinction.  In the Information Age, these cycles tend to happen quickly, one after the other (think fruit-flies, not mammals).  The Internet ecosystem is in a period of explosive growth; at some point there will be an overpopulation problem, a shortage of resources (customers, users, money) and we will have large-scale extinction.  The strongest businesses will survive and, hopefully, the entrepreneurs and investors that didn’t make it will start over and try again.

Regardless, despite the ebbs and flows of the startup ecosystem, there is ALWAYS a place for good businesses, offline or online and there are lots of those being built everyday, in Brazil and elsewhere.  Many of those online businesses address large markets, are capital efficient, can scale quickly and have quality teams.   If you fit that description, I’d appreciate the chance to talk to you.

Silicon Valley – Brazil Accelerator

There is a new accelerator for startups that want to enter the Brazilian market.  The first part of the program would take place in Silicon Valley/San Fran, the second part in Sao Paulo.

The accelerator is for internet-based businesses from, well, anywhere: Brazil, America, doesn’t matter.   It seems like companies would receive fairly intense assistance, which I think is a good idea, given the challenges of doing business in Brazil.

Even if you are not accepted into the accelerator program, there may be co-working space available in the Valley/San Fran and perhaps in Sao Paulo.  This would be good for learning, networking, etc.

If you have an interest, they have a signup page here.

 

 

Old School Venture Capital

LAVCA recently hosted an event at Monashees for venture capital fund managers, limited partners and service providers.

Most of all the VCs currently active in Brazil were in the room, which was cool, and it made for an interesting discussion.

One of the things we discussed was the size of a typical venture fund’s investment portfolio in Brazil, to whit: it’s smaller than in the US. That matters, because small portfolios increase risk (it concentrates the fund in a smaller number of companies, so if one fails it disproportionately impacts the fund.)

Portfolios are smaller in Brazil not just because funds are smaller here, nor because there are less companies per investor. It’s because, on average, an early stage company requires more time invested by the VC. One fact everyone learns in Brazil, the distance from business conception to market penetration is greater here than in the US. It takes more time, more resources, more perseverance.

Add to that the fact that many entrepreneurs are building a company for the first time and you will see that VCs need to spend more time per company than a VC in the US does.

In the US, the VC can make portfolio construction decisions assuming that, for most of his companies, a board seat plus a phone call every couple of weeks provides sufficient support. This allows them to put together a portfolio of investments numbering 30+ companies relatively easily.

In Brazil, if a VC puts together a 30-company portfolio in a short period of time, he will spend his days and nights putting out fires, fielding panicked phones calls and wishing he had gotten a job at Petrobras like his parents advised.

What’s the solution? Time and experience, both for entrepreneurs and investors. Aside from that, for early-stage investors, some form of shared space, incubation, acceleration, etc. is more than an interesting strategy, it’s essential. In the majority of cases, an early-stage investor in Brazil needs to be proximate to his companies until those companies achieve stability. Of course there are exceptions, and thank goodness for them. In general, however, I think early-stage funds will find that some form of shared space with most of their startup portfolio companies is a must.

In a way, that’s cool. At the LAVCA event, an attorney from K&L Gates, who has been in the business for many years, made the point that what is happening in Brazil is “old school” venture capital. In the early days in Silicon Valley, the pioneering entrepreneurs and investors did not have experience or examples to follow. They were joined at the hip in a new, risky, experiment. By necessity, the VC often took quasi-management roles – business development, operations, HR, etc. – to help his companies survive. Things are like that now in Brazil. It’s tough but it’s fun and, in some ways, it’s how early-stage VC should be.

What about New York?

In the last post I discussed whether a Brazilian startup should have a presence in the US.

Even if a Brazilian company decides it should have a presence in the US, however, it has an additional choice to make: Silicon Valley or New York?

In the last few years, New York has gone from an interesting but secondary market for startups to a viable and, in some cases, preferable alternative to the Bay Area.

Lots of factors have led to this but, when you think about it, New York is a logical place for a center of entrepreneurship.  It might be the most vibrant city on the planet.  In the US – think Ellis Island/the Statue of Liberty – NY symbolizes our immigrant roots and the promise of America: come here and make your life.  It won’t be easy but, in NY especially, anything is possible.

NY says, “This country, this city, is an opportunity. The rest is up to you.”  That is the primary message great entrepreneurs want to hear.

In addition, and this may surprise some people: people from the east coast of the US very often want to stay there.  A great entrepreneur coming out of school in Boston, NY, Philadelphia and DC would often – most often – prefer to stay on the east coast.  Before, that wasn’t a choice, now it is and many will take it.

You can extrapolate the future of the New York ecosystem by considering the concentration of great universities in the northeast of the US: the entire Ivy League, seven of the top ten universities and 19 of the top 25 colleges. NY has wide, deep and permanent source of talent and technology.

What about customers?  It is a world center of advertising, financial services, fashion, retail, media and publishing (and other industries that I will remember about two seconds after I post this blog…).

What about technology?  See this excerpt from a March 17 Wall Street Journal article:

… in the most prominent example of a technology company shifting its focus toward New York [emphasis added]… Google now has about 2,750 employees in New York City, a 38% increase from 2010, the company told The Wall Street Journal. That's faster growth than for the company overall, which expanded 33% from 2010 to 2011.
 
"Many of the most talented and creative engineers and scientists in our field of computer science want to be here…there's a critical mass in the city," says Alfred Spector, the vice president of research and special initiatives based in Google's New York office.
 
Google's expansion in New York—once seen as too expensive for tech start-ups—has helped fuel a perception that the city is in the midst of a technology industry boom. It comes as Facebook, Hewlett-Packard and other companies expand their New York presences, and Cornell University moves forward with an engineering campus on Roosevelt Island.

Look, New York will never be Silicon Valley.  Only Silicon Valley will be Silicon Valley – an exquisite center of sharing, innovation, mentorship, and technology.
But NY may be the only city that can honestly say it doesn’t want to be: NY doesn’t follow anyone or anything – the world follows it.  

When it comes to an entrepreneurial ecosystem, what will NY be?  I’m not sure.  I only know it will be unique, vibrant, wildly successful… and place that Brazilian startups must consider if moving to the US.