Entrepreneurial momentum
Access to capital
VCs offer unique opportunities, especially for entrepreneurs looking to innovate and grow fast. VCs showed an unprecedented increase, growing from about $2 billion in 2018 to $15.9 billion in 2021, but then dropped again to $7.8 billion in 2022 and further to less than $3 billion in 2023. Beyond financial assistance, VC firms provide valuable mentorship, strategic and operational support, access to networks and experts around the world, and visibility into businesses. VC leadership has provided the foundational structure for new and innovative funding methods for entrepreneurs, including tools such as impact investing and blended finance. The international nature of VC investments has also fostered cross-border collaboration, especially as companies receiving VC funding expand regionally.
Successful entrepreneurs are known for creating a multiplier effect, a virtuous cycle of entrepreneurial investment and risk-taking that can disrupt traditional industries with novel products and services that leverage the dynamics created by the work of other entrepreneurs. For example, Linio, a Mexico City-based e-commerce platform, spearheaded the country’s burgeoning e-commerce industry in the early 2010s as the public rapidly embraced digital technology. Many of the company’s founders and former executives, such as Carlos Garcia Ottati, founder of Mexico’s first unicorn, Kavak, have founded 66 more companies, mostly in the e-commerce space. In Colombia, Lappi tells a similar story: More than 110 companies have been founded by alumni from the company across a wide range of industries. These companies have collectively raised more than $2.1 billion in venture capital and employ more than 14,000 people.
The level of venture capital investment in Colombia has soared, with Colombian tech startups receiving more than $1.7 billion in venture capital funding in 2021, compared to less than $100 million in 2017. Several governments in the region have played a key role in encouraging entrepreneurship by establishing institutions to provide technical and financial support to entrepreneurs. Start-Up-Chile is one such initiative. Launched in 2010, it has become a regional and global example of how government initiatives can jumpstart an entrepreneurial ecosystem. Taking the example of Chile, the Colombian government launched INNpulsa Colombia in 2012, the Colombian version of the national entrepreneurship and innovation agency. Additionally, these two countries, along with Argentina, Brazil, Chile, Mexico, Panama, Peru and Uruguay, have enacted laws to promote digital development strategies, including “developing broadband infrastructure, promoting digital enterprises, encouraging the adoption of digital technologies by large and small companies, and promoting general IT skills and competencies.”
Financing in an Uncertain Economy
Access to VC capital has been on the decline since its peak in 2021. Late-stage investment deals drove much of the previous unprecedented growth, exceeding $9.4 billion. This is markedly different from the first and second quarters of 2023, when late-stage investments only reached $300 million. Comparing 2021, 2022, and 2023, investments have generally shifted from late-stage funding to early-stage startups. While late-stage investments made up the majority of venture capital directed towards LAC in 2021, 2023 has seen a notable shift in the investment landscape. Early-stage investments now rank first, followed by seed, venture debt, and finally late-stage investments. This shift reflects capital drying up around the world and investors becoming more conservative given the current economy. However, continued investments in seed, early stage, and VC indicate that investors are still interested in and see potential in the region’s growth, but at the same time, their investment behavior reflects LAC’s current socio-economic realities.
As a result, the 2023 LAVCA Startup Founders Survey reports that 39% of responding companies will not raise funds in 2023 and will instead focus on “restructuring internally and building leaner teams.” Startups are also working to build more geographically distributed teams in 2023 compared to 2018, and financially mature companies are more likely to hire full-time employees outside of LAC. However, given the rapidly changing venture capital landscape, it is difficult to make broad assumptions that apply to the entire startup ecosystem.
Foreign Direct Investment
Following the resource boom of the late 2000s and early 2010s, major private equity firms such as Carlyle, GA, TPG Capital, KKR and Ajax Partners opened offices in LAC. However, a combination of political instability, protectionist policies and slowing growth rates made foreign investment in LAC riskier, a situation that was significantly exacerbated by the impact of the COVID-19 pandemic. FDI levels have fallen from a peak of over $200 billion in 2013 to around $100 billion in 2020.
However, in 2022, a surge in the post-COVID recovery will see FDI levels exceed $200 billion for the first time since 2013, with Brazil receiving 41% of total FDI, followed by Mexico with 17%. FDI flows increased by 55.2% between 2021 and 2022, due to a significant increase in investor interest, especially in the oil and gas, mining and renewable energy sectors in the region. 14 megaprojects with total FDI of over $1 billion in these sectors accounted for 41% of total investments in 2022. Moreover, 80% of total investments in energy projects announced in LAC went to the top 170 large projects.
In terms of FDI investment by sector, the services sector had the lowest relative growth rate (35%), while manufacturing recorded a 47% growth compared to 2021, but remained 50% lower compared to its peak in 2013. Within the services sector, the subsectors with the largest investments were financial services, electricity, natural gas and water, and information and communications, transport-related services. Natural resource FDI increased by 79% in LAC in 2022, with a large increase in Brazil’s oil and gas sector. Colombia’s FDI in natural resource extraction increased by 228% in 2022, while Mexico’s FDI in the same sector declined after more than doubling in 2021.
Venture Capital Investments
VC investments in LAC have followed a markedly different trajectory compared to traditional FDI capital flows. According to LAVCA, FDI levels stagnated and declined between 2016 and 2021, while VC deal volume surged from 197 to 1,095 during the same years. Additionally, international investments in LAC startups have more than doubled since 2015 from a range of international companies. Additionally, approximately 75% of VC investments in LAC are directed towards the information technology and financial services sectors, suggesting significant untapped potential in the region’s high degree of digital connectivity. VC investments in fintech services in LAC accounted for 43% of all technology VC investments in 2022.
Taxation
In LAC, where informal employment is a major issue, businesses need clear tax regulations and incentives to hire employees legally and incorporate workers into the social security system. This is especially important in the early stages of growth, when certainty is crucial for both entrepreneurs and workers. A predictable tax system is essential for businesses to plan and budget effectively. Without a predictable tax system and tax courts, businesses are forced to allocate resources to deal with unexpected changes, which can lead to lower productivity and profitability, and increased uncertainty. In addition, predictable tax regulations are essential to attract foreign investment, which plays a key role in the growth and development of new businesses. The tax systems of some LAC countries are particularly complex due to the lack of planning in the federal system and its interaction with the states. Useful tax regulations must address and incorporate both local and federal taxes. Businesses can feel overwhelmed calculating, reporting, and paying taxes when dealing with state and city regulations. This is further complicated by the added responsibility of managing and administering complex social security contributions for workers.
Paving the way forward
Entrepreneurship is on the rise in LAC. Over the past five years, start-ups in the region have attracted record investment from abroad, disrupting traditional industries with innovative products and services, and creating more efficient markets to support the growth of high-value-added industries. Entrepreneurs also face the region’s long-standing challenges, including a large informal economy, heavy-handed bureaucracy, and the dominance of industries traditionally resistant to change. Governments that have committed to supporting the growth of the entrepreneurial sector have benefited from a virtuous cycle of investment and innovation, creating resilient economies that are less susceptible to commodity-driven shocks. To achieve this, the public and private sectors would do well to learn from the following recommendations:
Foster a culture of innovation and entrepreneurship. The job market continues to undergo significant changes due to ongoing technological innovations. As a result, more and more individuals are showing interest in starting their own businesses. With easier access to this possibility, there is an increased desire to become self-employed and have more flexible working arrangements. The COVID-19 pandemic has also accelerated the adoption of technology by businesses. However, there are still some challenges to overcome to make the most of the opportunities that technology brings, such as talent acquisition and fundraising. COVID-19 has highlighted the need to digitize processes, but a lack of information on fundraising and a lack of education on basic corporate finance remain issues.
A clearer, more transparent and simpler tax system. Recognizing the role that a predictable tax system plays in attracting foreign investment is essential for a country’s growth and development. Simplifying the calculation, reporting, and payment of taxes is essential to reduce the administrative burden for small and medium-sized enterprises. Streamlining and harmonization must occur at all levels of government, especially in federalist countries like Brazil and Mexico. Finally, providing support and guidance in managing the complexities of workers’ social security payments contributes to a more favorable business environment.
Rethink your actors. The VC industry and its startups need to develop in the region, and industry-led initiatives are a great way to make this happen. VC funds can develop businesses that can nurture or develop the next unicorn, which is a win-win. Initiatives focused on acceleration, seed and early stage investments, growth investments, and social and environmental factors have great potential to expand their footprint in the region, while at the same time creating positive social, economic and environmental impact.
