By Ian Paul Otero and Alejandro González*
The economy of Mexico, like that of many other countries, is going through a complicated and key moment. Not only due to the crisis unleashed by the COVID-19 pandemic, but also because of the latent possibility that Mexico loses its investment-grade and faces one of the deepest recessions in decades. Some prominent investors believe this could soon happen following the state-owned oil company (Pemex) seeing its credit rating cut to junk status.
As an emerging economy however, Mexico is positioned as a strategic region for receiving investments. The country’s demographic characteristics, the strength of its middle class, its trade agreements with the world’s largest economies, its culture of innovation. These and other reasons give a huge economic potential to Mexico and make it a massive market for technology-based companies.
On the other hand, Latin America has recently seen great growth in venture capital investments. Last year, SoftBank announced the creation of a US $ 5 billion fund that was described as “the largest technology fund, focused exclusively on the Latin American market for fast-growing companies”. This validates the great interest of sophisticated global investors in the region.
We know that Silicon Valley is a well-known and recognized worldwide as an innovation ecosystem and an entrepreneurial hub. California receives more than US $77 billion in venture capital investment every year. This amount is 40 times more than total investment in Latin America and about 80 times more than what Mexico receives. However, this speaks to the great potential that Latin America has as a region. Latin America is a virgin market where hundreds and hundreds of innovative, profitable, scalable startups have a high growth potential to emerge. However, they still cannot find enough fertile ground due to the lack of available capital for this asset class.
Since 2017, investment in venture capital in Latin America has had a significant rebound, more than doubling the amount invested in 2016. Later, 2018 saw another historical record with more than US $800 million investment compared to the immediately preceding year.
In 2019, more than US $2 billion were invested in Latin American startups, achieving another record year. Growth continues with the entry of great players to the region -such as SoftBank, QED, Sequoia, Andreessen Horowitz and other flagship funds- that until a few years ago had not turned to see Latin American startups.
This situation is forcing private investors in Mexico to find new investment vehicles that add value to their portfolios. Consequently, Mexican startups are increasingly open to receive investment from international funds even changing their corporate structures to legal figures that appeal to investors from the US and around the world. Little by little we are seeing how the Mexico’s domestic entrepreneurship ecosystem is becoming more sophisticated and adapting to global practices.
But why invest in Mexican and Latin American startups?
1 New problems. In Mexico and Latin America there are problems to be addressed that are unimaginable in developed countries. For example, in Mexico more than 60% of the population is unbanked. This has been a huge opportunity for Fintech startups in the country. While only 7% of the population in Latin America has a computer at home 73% have internet access through a smartphone. This has led to huge adoption of mobile digital services and the birth of unicorns like Rappi, NuBank, and GymPass.
2 Market size. Latin America’s Gross Domestic Product (GDP) amounts to US $ 5.61 trillion as a whole. This would rank the region as the third largest economy in the world. Latin America is a region made up of 20 countries that has a shared culture and more than 640 million inhabitants.
3 Startups in Latin America are born global. Unlike in developed countries, in Latin America local markets are not consolidated enough to be able to grow a startup locally. Entrepreneurs in Latin America conceive their company ideas as being global. Migrating is part of their culture and this generates that from a very early stage that we see validation of replicable and highly scalable business models. This in addition to corporate structures in the US, Canada that allow them to help mitigate the risk that an international investor may perceive.
4 Entrepreneurial spirit. According to Development Bank of Latin America (CAF), small and medium-sized enterprises (SMEs) represent 99.5% of companies in the region and generate more than 60% of jobs. Latin America has the highest indicator of Total Early-Stage Entrepreneurial Activity (TEA), with 18.5% of the adult population having started or continuing to operate a business that is less than 3.5 years old.
5 Low consolidation of markets. The low consolidation and professionalization of small companies in the region creates an enormous opportunity for digital companies to quickly take large market share through technological solutions and innovative business models.
6 Down-to-earth valuations. All around the world the price of anything stems from supply and demand. In Latin America however, there is a very low supply of capital and financing. According to figures published by the Organization for Economic Cooperation and Development (OECD), SMEs in Latin America receive only 12% of total credit, less than half that of the rest of the countries belonging to the group (25%). The Inter American Development Bank (IDB) estimates that the financing gap in the region is US $1.2 trillion. This causes the valuations of most startups in Latin America to be more a result of the actual performance and potential of the company than of a simple “industry standard”. They are down-to-earth valuations that increase the chance of good returns for investors.
7 Real smart money. Implementing a value generation strategy using non-monetary resources is really possible in Latin America. Commercial links, strategic alliances, access to financing, support in the internationalization of companies, etc. All this is possible thanks to the fact that entrepreneurs are more humble, more coachable and easier to help.
8 Fast profitability. Startups in Latin America just cannot afford losing money. We have resilient entrepreneurs with great common sense who seek to validate their business models with the market and not with investment funds.
Hopefully these facts can provide a general overview of why it is attractive to invest in Mexican and Latin American startups to those who are doubtful of daring to bet on a region that best represents the word “opportunity”.
* Ian Paul Otero and Alejandro González are part of the leadership team of Redwood Ventures, an industry-agnostic venture capital fund based in Guadalajara, Mexico and are close collaborators of The US-Mexico Foundation. The U.S.-Mexico Foundation is a binational non-profit organization dedicated to fostering bilateral cooperation and improving the understanding between the United States and Mexico by activating key people in the relationship that once were dormant. Twitter: @usmexicofound