VC in Brazil: Pessimist vs. Optimist
Posted: February 19th, 2010 | Author: Ted Rogers | Filed under: Brazilian Venture Capital, Entrepreneurship, Macro Environment, posts | 9 Comments »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.
