Why 2014 will be the year of the “Acqui-entry” in Latin America

Juan Pablo Cappello is an investor in more than twenty early stage companies, among them he is a co-founder of Idea.me, Urbita and the LAB Miami. Juan Pablo was a partner in Patagon.com and was named in December 2013 by Poder Magazine one of the most influential Hispanics in Science and Technology. His blog can be found at jpc.vc

The Chinese Zodiac, known as Sheng Xiao, is based on a twelve-year cycle, with each year in that cycle linked to an animal sign. The Latin America venture space seems to have also followed a twelve-year cycle. 2014 is the year of the horse in the Chinese Zodiac, which seems appropriate since beginning with the current twelve-year cycle in 2009, the TechoLatino (Latin America’s tech ecosystem) has been growing steadily from a trot to a gallop.

TechoLatino’s past four years, and what is in store for 2014

2010 was TechoLatino’s year of the “Venture Fund” in Latin America, with the likes of Tiger Global, Accel, Redpoint, Sequoia and other international funds beginning to make investments in the region (albeit initially focused on Brazil), and Argentina/Uruguay based Kaszek Ventures raising over $80mm to make local investments. These investments generated attention for TechoLatino from the very cliquish venture world inside Silicon Valley.

2011 was TechoLatino’s year of the “Accelerator/Incubator”, with local early-stage accelerators like NXTP and 21212 coming into their own, 500 Startups setting up shop in Brazil and Startup Chile scaling the concept of “venture tourism” by offering $50,000 for startups to go to Chile.  This flow of early stage capital enabled a generation of Latin millennial to think of “entrepreneurship” as a career path.

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2012 was TechoLatino’s year of the “Angel Investor” in Latin America.  Prior to 2012, angel investors in Latin America usually required draconian terms in favor of the angel, with the angel gaining virtual control of the company.  2012 was the year that local and United States based angel investors began investing in earnest in Latin America, permitting startups to raise $250,000-$750,000 under convertible notes or at valuations of between $1 million and $3 million, using Silicon Valley entrepreneur friendly “series seed” terms.

2013 was TechoLatino’s year of “Scale” in Latin America, whereby certain local companies showed that the high-end Latin American companies could compete on the world stage.  Companies like Argentina’s Globant filed its $86 million IPO on the NASDAQ, Venezuela/Miami’s OpenEnglish raised over $100 million in a one year period, traffic to Argentina’s Despegar grew to over 38 million visitors a year, and Brazil’s NetShoes continued to exceed expectations in advance of the World Cup.

2014: The year of the Acqui-entry

2014 will be remembered as the best time in a generation to have bought a venture-backed company in Latin America as an efficient way to gain entry to the quickly growing Latin America market (known as the “Acqui-entry”). The opportunity in Latin America is extraordinary and valuations generally remain very low compared to similarly situated U.S. based startups.

Acqui-entry is not to be confused with “acqui-hire”, which is very popular in Silicon Valley, given that hiring a capable engineer can cost upwards of $500,000. The term acqui-hire sometimes has a negative connotation as it suggests the company being acquired was bought mainly for its human talent rather than for its product.

Acqui-entries into Latin America are a bit more complex. They involve the acquisition of talent and of a product, but the “secret sauce” is that provide a low-cost vehicle for entering the Latin America market and growing an international presence. The Latin market for acqui-entries is particularly attractive at the moment for three main reasons:

LatAm’s compelling demographics:  Latin America today has over 280 million Internet users, which is more than the whole of the United States. With over 600 million consumers in Latin America, the Latin American Internet consumer market likely will mature with somewhere near 450million consumers online in the coming years. To put these figures in context, in the year 2000 there were only about 18 million Internet users in the whole of Latin America, and at such time, the US had at least seven times more Internet users than Latin America.

Even more exciting than just the number of traditional online consumers, in the five-year window between 2012 and 2016, we’ll see over 150 million new Internet users in Latin America thanks to the spread of basic Internet enabled smart phones.  This mass influx of new consumers represents a once in a generation opportunity for international companies to access the Latin America market on the precipice of an explosion of new middle and lower middle class online consumers.  The needs of those new online consumers remain desperately unmet.

Latin America’s regionality: Entrepreneurs in the Latin America in the past five years have done many things the wrong way (i.e., too many “copy cats” of international counterparts, raising too much money before determining the needs and desires of their consumers, and charging into Brazil without understanding the local culture).  However, entrepreneurs in Latin America got one very important thing right – they understood that for almost any company to be successful in Latin America, it needs to be a regional play.

Thus, almost every venture-backed company in Latin America was built from day one to be a regional company, and as such, the management teams of such companies have experience in operating in multiple markets. The ability to acquire a management team that has experience with operating in multiple markets is of huge value, as increasingly more US-based companies realize that the next great stories are going to be written by the 3 billion plus non-US-based consumers that will be connecting to the Internet in mainly emerging economies in the next five to seven years, many of which are in Latin America.

Compelling low valuations:  The overwhelming majority of Latin American based start-ups are facing the “valley of death”.  In Latin America there is still plenty of early stage capital available.  There are also plenty of investors looking to invest $5mm or more in high growth companies. The so-called “valley of death” remains the “Series-A” $1-3 million raise that so many start-ups in Latin America have unsuccessfully tried to accomplish the past two years. Two years of “bootstrapping” (stringing together small financing amounts to make ends meet) has made many entrepreneurs in Latin America open to deal terms that would have been unthinkably low just a short time ago.

Many Latin America based start-ups have failed to raise Series-A capital because they have been measured against their peers in the United States, which is an unfair comparison. The lesson of the past 13 years of technology enabled businesses in Latin America is that building a great, sustainable, regional tech business in Latin America takes time—a lot more time than it would take to build a similar business in the United States.  For instance, both MercadoLibre and Globant took more than eight years from inception to go public.  Despegar has spent the past 14 years consolidating its position in the region. Latin America is not the region of the “overnight” success.

The fact that building a business in Latin America takes more time and effort than building a similar business in a developed region should not be surprising given the complexity of the myriad of exchange rate, inflation, tax, labor and political issues that every company in Latin America must address country by country.

A prospective acquirer, whether a well-capitalized, venture-backed company or a strategic investor, should not care why Latin American companies are facing a financing squeeze.  Prospective acquirers in the region have the luxury of being offered  great values.

Deal terms

How great are the deals? Actually, the terms are at present potentially staggeringly favorable for the acquirer.  I would wager that least 50% of Latin American tech-enabled companies launched in the past several years would be open to being acquired for a combination of cash and equity worth between $3 million and $8 million — a paltry amount to a acquire a company like hundreds of technology companies in Latin America, with a real product, real customers, operations in several countries, revenues of $10,000 – $50,000 a month and a management team that has spent several years learning how to run a regional business.

To be attractive, these types of acquisitions generally need to have a cash component, which permits the existing investors in the company being acquired a 1x-3x return on their investment.  So if a typical startup raised $250,000-500,000, think that a buyer to be competitive often only has to come to the table with $750,000-$1,500,000 in cash, which is a remarkably modest investment given the opportunity.

The rest of that $3-million-to-$8-million consideration may come in the form of equity in the acquirer. For the acquirer, offering its stock aligns interests and “stings” a lot less than writing a check for the full amount of the purchase price to acquire a business in a region the investor does not particularly understand.  Also, that sizeable equity component provides a nice cushion if there are unexpected contingencies with the Latin company that is being acquired.

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In short, 2014 offers a once in a generation opportunity for prospective acquirers of technology-enabled businesses in Latin America.  The demographic trend indicates over 150mm consumers coming online in the region in a five-year period and valuations of local technology enabled business remain incredibility low…. for now.

So 2014 is TechoLatino’s year of the Acqui-Entry so its time to “Let’s make a deal” and get these “acqui-entries” closed.

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