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This article was published on April 1, 2018

6 reasons why Latin American valuations are lagging behind Silicon Valley

6 reasons why Latin American valuations are lagging behind Silicon Valley
Nathan Lustig
Story by

Nathan Lustig

Nathan Lustig is a serial entrepreneur and Managing Partner at Magma Partners, a seed stage investment fund with offices in San Francisco an Nathan Lustig is a serial entrepreneur and Managing Partner at Magma Partners, a seed stage investment fund with offices in San Francisco and Santiago, Chile.

Latin American startups haven’t had the same valuations as Silicon Valley startups. This frustrates many Latin American entrepreneurs seeking investment, as they don’t understand why Latin American VCs aren’t doing deals at Silicon Valley valuations.

There are important reasons why Latin American early-stage investment valuations are lower. For one, there are few acquisitions in Latin America, and when acquisitions do happen, they tend to be at lower valuations than their counterparts in other parts of the world. VCs need to make returns, or they’ll be out of business. Therefore, if exits are lower, the initial price that venture capitalists pay must be lower.

But what other reasons are there for this? Why are there still so few Latin American exits and why are they at lower valuations compared to their international peers? Here are just a few of the reasons.

1. Large Latin American companies make very few acquisitions

Most Latin American companies have not been worried about competition, either from technology or other forces in the market. Many large companies in Latin America, even publicly traded ones, are family-run, have been in business for generations, and their goals are much more geared toward maintaining position and profit, rather than growth or remaining competitive in the market.

What’s more, many high-level executives at large Latin American companies never truly believed that global brands such as Amazon, Alibaba, Netflix, or other large technology companies would compete with them. While this mentality is starting to change as these giants move into the market, large companies haven’t felt the need to acquire to compete.

2. When Latin America acquisitions do happen, they’re for lower valuations

Many of the large Latin American business sectors are still controlled by powerful families. Of the $1 billion-plus businesses in Latin America, around 75 percent are family-run.

As many can imagine, these families want to keep cash in their pockets. Family-run businesses tend to focus on cash flows and dividends, rather than continuing to build their businesses for the long term.

As a result, if a private company wants to make an acquisition, it often requires taking cash out of their own pockets, which as we all know, is harder than spending other people’s money, resulting in fewer mergers and acquisitions, and therefore lower valuations for Latin America companies.

3. Foreign startups rarely make Latin American acquisitions

When Uber entered the Latin American market, it didn’t acquire top competitor Easy Taxi; instead, Uber used its billions to compete with Easy Taxi and others for market domination.

This is a typical pattern. Most US startups are not making Latin American acquisitions if and when they move into the market. This trend may be starting to change as 99, Brazil’s version of Uber, was just acquired for a reported $1 billion by Didi, China’s largest ride-hailing platform, but it’s still rare.

4. When acquisitions of Latin American startups do happen, they’re for lower multiples than similar acquisitions in other parts of the world

Latin American companies are currently valued at much lower multiples than companies in other parts of the world. 99 in Brazil was acquired for a reported $1 billion and was the second biggest player in a country of 220 million people. If 99 had similar numbers in the US, Asia, or Europe, it likely would have been valued much higher.

For example:

Compare these numbers to Delivery Hero’s acquisition of Yemeksepeti, Turkey’s food delivery startup for $589 million USD. While Yemeksepeti had a huge number of orders, Turkey has a GDP per capita of $14,071 USD and 80 million people.

If we summed up all of the food delivery startup acquisitions that have taken place over the past few years in Spanish-speaking Latin America, a region of 400 million+ people, the total likely doesn’t exceed $50 million USD, or less than 10 percent of what Delivery Hero paid for Yemeksepti in Turkey.

5. Most Latin American startups don’t IPO

There have been three significant IPOs in Spanish-speaking Latin America: Despegar, MercadoLibre, and Globant. There are a few more in Brazil, but that’s nothing compared to the vast amount of IPOs in the US market. For comparison purposes, US social media company, Snap Inc., raised $3.4 billion during its IPO, which is equivalent to more than half the total of all of Latin America’s IPOs, not just in technology, in 2017.

Fortunately, there are many rumors that several technology companies in Latin America, especially those from Argentina and Brazil, will IPO soon as a result of success stories such as Despegar, Globant, and MercadoLibre. In fact, Latin America just saw its best year for IPOs since 2013, with nearly twice as many IPOs as the last three years combined.

The quantity of IPOs may be on the rise, but as Carmignac, one of Europe’s leading asset managers, points out, the Latin American technology companies that do IPO still tend to be undervalued.

6. Acqui-hires are rare

An acqui-hire is an acquisition of a startup to hire the talented founders and team working on the startup, and not necessarily for the startup’s product or for the business itself. If a Silicon Valley VC invests in a tech team that came out of Stanford or worked at Google, Facebook, Apple, or another hot tech company, many times they will acqui-hire a startup for $500K-$2M per engineer, sometimes more.

In Latin America, large businesses are not yet acqui-hiring startup teams to get talent into their organizations, meaning that if a startup fails, it really fails. Movile, the Brazilian technology giant, is a Latin American pioneer in acqui-hiring, but in the rest of Latin America it’s extremely rare. US companies have started to acqui-hire talent in Latin America to open Latin American development offices, but it is still not very common.

What all of this means for valuations

Approximately 70 percent of early-stage startups will go bankrupt. Therefore, an early-stage startup investor needs to invest in every deal thinking they have the potential to earn at least 10x and hopefully 20x on their investment if everything goes well. In Latin America, outside of Brazil, a few IPOs from Argentina, and some copycat models from the US, the biggest tech acquisitions have been in the $20M-$50M range — far less than their US, European, or Asian counterparts.

If a company asks me to invest $2M at an $8M pre-money valuation, it means that to return 10x, startup might either sell for $100M, or that it will be able to pay out $20M in dividends over the life of our investment so that I return $20M on my $2M investment.

Do the same math at $1M and $4M pre-money valuation, and the company needs to sell for $50M and return $10M on my $1M investment, something that’s rarely happened outside of Brazil. This simple analysis doesn’t account for additional dilution from future rounds, which will likely be at least 30 percent, meaning that valuations for early-stage investments could be even lower.

As venture capitalists in Latin America, we can’t base our investment thesis on hoping for a once per decade exit, or that our investment is the last round a startup takes so we avoid future dilution. We have to base it on what is actually happening on the ground.

While things are changing and VCs are investing at higher valuations, especially as US and Chinese companies are making investments and acquisitions in Latin America, entrepreneurs should consider this math as they pitch investors in Latin America. US, Chinese, and European companies should also strongly consider acquiring Latin American companies, both for their business units and for acqui-hires, because they are massively undervalued.

Lastly, investors should look at alternative investment models not solely based on acquisitions. Models like US-based have the potential to both help entrepreneurs and generate returns, and may be a better fit for the region.