Brazil has been generating a significant amount of buzz in the venture capital and startup community recently, fueled in part by media coverage of several high profile firms “planting their flags” in the country with dedicated funds or investments. A growing awareness of the burgeoning Brazilian startup scene, and Brazil’s role as host in the upcoming World Cup and Olympics, has further elevated the country’s profile.
Is this hype justified? When discussing Brazil, comparisons to the evolution of China’s VC industry are commonplace. But what do the VCs investing in Brazilian startups really think? And how might Brazil’s VC ecosystem evolve over the next five to 10 years?
Our MBA team from the MIT Sloan School of Management recently concluded an in-depth study* of these topics sponsored by Sloan’s Global Entrepreneurship Lab program and Ideiasnet, a leading Brazilian venture capital firm. We conducted extensive research via industry publications, online sources, and academic papers, interviewed over 20 VCs and ecosystem participants, and spent one month on-site exploring Brazil’s VC ecosystem first-hand. Here is what we learned:
Long-term demographic & tech trends underpin investments
Brazil has a rapidly growing consumption-oriented middle class that now represents over half of the population. Approximately ~88 million users are currently online, and by 2016 broadband and 3G penetration are projected to increase by 32% and 103% respectively. Brazil’s internet users are also highly engaged: despite having only 46% of its’ population online, Brazil ranks number two worldwide in numbers of users of both Facebook and Twitter.
Put all these trends together and you get a very attractive addressable market for internet-enabled companies, with many categories yet to be claimed. While economic growth in Brazil has recently slowed, many of the VCs we spoke with believe these secular trends are sufficiently de-coupled from short-term, macro-economic cycles and that they will continue to drive the market growth necessary for startups to successfully scale.
Investors are changing & domestic GPs are sought after
While a handful of funds have been making technology investments since the 1990s, the emergence of a Brazilian VC ecosystem began in earnest only in the past several years with a significant increased activity in the last 18 to 24 months.
According to the Brazil Startup Dealbook, at least 50 firms made approximately 80 investments in startups in 2012, which marks a sharp increase over previous years. Additionally, at least two Brazil-focused funds were formed representing ~$250M of assets under management. (The list of firms active in Brazil is rapidly evolving, but for a good sense of the major players, we recommend checking out Joshua Kemp’s blog.)
While participants include both global-scale VCs opportunistically making investments out of global funds as well as a handful of U.S. and European VCs who have committed resources and/or dedicated funds on the ground, recent trends reveal the formation of a small but growing group of Brazilian VCs and super angels. These local investors are often sought out as “river guides” by foreign VCs to navigate the local investment landscape and manage day-to-day contact with portfolio companies in syndicated deals. They are seen as irreplaceable complements to the sector experience and potential acquirer relationships of many global players, particularly in early-stage deals.
Focusing on fast-follow and proven business models — for now
Many of the high profile venture-backed startups in Brazil over the past few years have been consumer-oriented “fast follow” companies (e.g., Rocket Internet) capitalizing on proven business models customized for the Brazilian context, particularly e-commerce and marketplaces.
This focus made sense given the avidity of the market for these unclaimed categories and allowed the vanguard of investors to mitigate business model risk while taking on perceived “geographic risk”. However, as competitive intensity has increased many of these fast-follow sectors have become increasingly crowded and unattractive, with margins eroding and returns diminishing for investors.
As more investors become comfortable controlling for Brazil-specific risks by cutting their teeth in well-established categories, we predict a shift in focus towards uniquely Brazilian business models that may not have comparable analogs in developed markets and that will offer more defensible and lucrative investment opportunities.
The implication for aspiring entrepreneurs: Think about solving uniquely Brazilian pain points, or global pain points that have not yet been addressed. If you are working on the “tropicalization” of a proven model, be aware the bar for funding viability is rising and that competitive intensity is making it more and more likely that only definitive category leaders will achieve exits in popular sectors.
A unique exit path
The main question on the minds of many VCs investing in Brazil is the exit path. There is limited precedent of successful exits in the country and, unlike China and India where deep(er) capital markets have provided reliable liquidity, the Brazilian BOVESPA market is seen as largely unattainable for small-cap tech startups.
This means current investors are placing their exit bets on strategic M&A, primarily driven by multi-national trade sales. Most believe in a coming wave of such acquisition activity, and there is a lot riding on this belief. A string of successful exits would serve as liquid fuel for the ecosystem – bolstering the gradual cultural embrace of entrepreneurship by top Brazilian talent, demonstrating returns and liquidity, and prompting more capital to enter the ecosystem. On the other hand, a lack thereof would call the valuations of the current generation of portfolio companies into question, and the ecosystem would likely stagnate as capital stayed on the sidelines.
Tech in Brazil is tough, especially for outsiders
Before you quit your job or drop out of your prestigious university and pack your bags for Brazil, you should understand that conducting business here is not easy, especially for those unfamiliar with navigating the local context.
While the Brazilian government is a large and vocal supporter of venture capital, the traction gained by the current cohort of Brazilian tech companies and their investors has been achieved not because of the surrounding institutions and environment factors, but in spite of them.
Startups and VCs in Brazil face restrictive labor market rigidity, regulatory complexity, high taxes, and pervasive bureaucracy. Many of the VCs we spoke with felt that these structural frictions, combined with a potential “talent gap” due to a historical cultural aversion to entrepreneurship amongst top graduates (who tend to migrate towards consulting, banking, and oil and gas), make it difficult to rapidly scale businesses and manage the transition to growth-stage.
If these business environment frictions, including access to deep domestic capital markets, are not addressed, the likelihood of Brazil joining the ranks of global VC hotbeds is low.
So where does this put the future of the Brazil VC ecosystem in the next five to ten years?
Most investors we spoke with believe Brazil is in a state of fragile growth where a select group of strong businesses will emerge from the current ecosystem, capitalize on the secular technology and demographic trends to scale, and achieve exits via strategic mergers and acquisitions (or possibly international public offerings for outliers). While this will demonstrate the exit potential of the Brazilian VC market, local friction points and relatively shallow capital markets will hold Brazil back from achieving the VC industry growth profiles of China and India, and may ultimately cause investors to follow a more conservative approach towards committing capital to Brazil.
As for the authors of this study, we haven’t thrown out our Havaianas just yet — far from it. Despite the long-term uncertainty regarding the Brazilian VC ecosystem, we believe that there are big opportunities for both investors and entrepreneurs, especially beyond “fast-follow” business models. Those who can bring both relevant sector expertise as well as deep understanding of the local environment to bear will be positioned for some big wins.
* A copy of the final detailed report can be downloaded here.
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