In the wake of Softbank’s enormous fund launch, startups and investors across Latin America are wondering how this news will affect startup fundraising in the region. In 2017, Latin America attracted just over US$1B in startup funding. The new US$5 billion fund outstrips any previous investors by several orders of magnitude.
However, for Latin American startups raising early-stage rounds across the region, the rules have not yet changed. Capital in most countries is still relatively scarce and raising a round is a time- and labor-intensive process. Even startups in Silicon Valley usually expect to spend months fundraising; in Latin America, it can sometimes take up to a year.
For entrepreneurs looking to raise capital soon, do not despair. There has never been a better time to found a startup in Latin America. Venture capital is available in almost every country across the region, if you know how to find it. Here are five tips to make sure your first investor meeting goes your way.
1. Plan ahead for future rounds
Most entrepreneurs need much longer than they think to build a successful business. What seemed possible with a single investment round might take two or three (or more!) to build. An extended timeline is not a bad thing. Startups take time to mature.
However, the founders should consider this possibility starting during their first formal capital raise. The valuation (or valuation cap in the case of a convertible note), round size, liquidation preference, and dilution terms will affect how a company and its founders fare in future rounds. It is worth spending the time to fully understand and negotiate the terms of the first institutional investment to avoid kickback from pesky legal issues five years down the road.
Even when a startup badly needs capital, it is wise to be picky on who gets added to the Cap Table. During early rounds, the founders should own at least 50% of the company and other stakeholders, like employees and angels, should be clearly adding value to the company. A Cap Table with dozens of stakeholders during an early round can be a red flag for investors. If the investment is for equity, every person on the Cap Table could have a legal impact on the deal, which could hurt the startup and the investors in the long-term.
2. Consider an international strategy
Most Latin American markets are too small to support exponential growth in a startup. Ignoring this fact could lead investors to believe your company is more of a traditional business than a startup. While small companies can still be great businesses, they do not follow the same growth pattern as a startup, so they are not a good fit for VC funding.
The founders of Cornershop, one of Latin America’s largest exits of 2018, attribute their rapid success to their international launch strategy. The delivery app began to provide services in Chile and Mexico at the same time, from the start. While this strategy can be hectic, it also proves to investors that the idea is scalable. When working in a fragmented region with many small markets, like Latin America, international reach is a must for most VCs.
3. Be valuation-sensitive
It is incredibly common for startups to shoot themselves in the foot by insisting on an inflated valuation in an early round. Unfortunately, Latin American still has few large exit cases, so many investors are unwilling to commit to Silicon Valley-level rounds, especially in early stage companies outside of Brazil.
Overly large valuations in early rounds in Latin America can also make it challenging to raise future rounds without accepting significant dilution or negative terms. It is often better for the startup and the investor to aim low and raise a smaller amount of capital in an early institutional round than to overshoot. There will likely be an opportunity for follow-on if the relationship proves to be a positive one. If it is not a fit, the startup avoids getting stuck with a powerful, but counter-productive, investor on their Cap Table.
4. Evaluate alternative funding sources
Entrepreneur-friendly venture capital firms are still relatively scarce in Latin America. While the investment ecosystem has improved significantly in the past decade, traditional VC is not always the best fit for every startup or every funding round.
Luckily, Latin America is rife with alternatives to venture capital ranging from crowdfunding to government grants, accelerators, and corporate partners. Each of these institutions provide slightly different services with a similar goal: providing entrepreneurs with the capital they need to grow. A startup might use several of these resources throughout its life-cycle, so it is wise to keep alternatives present when one is looking for growth capital.
5. Understand the exit strategy
When raising capital in an emerging market like Latin America, it is not enough to simply understand one’s industry and value proposition. At the point of seeking capital, founders should also know who could eventually buy their company, and at what price. For startups, acquisition prices will depend not only on the company’s assets, but also on the technology and team they can provide to the acquirer. While the startup might be years away from an exit, many investors will be impressed to see this level of prescience.
It is wise for entrepreneurs to maintain relationships with companies that could eventually acquire the startup, as well as to understand the exit ranges for businesses in that industry. Not only can this knowledge help drive company strategy, but it will also show investors the potential monetary value and impact of their investment. These industry actors can also serve as valuable mentors, supporters, and even investors in startups that serve their niche.
Although international investors have a growing interest in Latin American startups, raising capital can still be a major challenge for entrepreneurs. It is worth evaluating any capital raise within a long-term strategy for the benefit of both the startup and the investor.