Foreign venture capital funds want to invest in Brazil even with high interest rates

RIO DE JANEIRO, BRAZIL – Despite having the fourth highest interest rate globally, 11.75% per year, Brazil continues to attract investments from foreign venture capital funds. According to firms consulted by Forbes, the demand for innovative solutions and the large market size are the main factors that explain the country’s attractiveness.

Data from the Distrito platform show that the total volume of investments received by Brazilian startups in 2021 was R$44.1 billion (US$9.4 billion), 165% higher than that recorded in 2020 and 208% higher than in 2019. In the first quarter of 2022, there were R$9.5 billion in investments, up 4% year-on-year.

However, the expectations that investments will continue to grow contradict one of the basic assumptions of the financial market: that the increase in interest rates causes the depreciation of risky assets.

Amure Pinho, former president of Abstartups (Brazilian Startups Association) and founder of Investidores.Vc says that changes in the macroeconomic scenario usually hinder venture capital investments because this is a model based on uncertainties. Safer assets with certain returns take the preference.

“However, we cannot forget that not all assets are equal,” says André Iaconelli, head of Flash Ventures in Brazil. “There is a fundamental difference between applying this concept in shares traded on the stock exchange and in shares of startups, which will still take time to have cash flow and reach the public markets.”

WHAT THE FUNDS SAY

Flash Ventures is one of the global funds that have plans to invest in Brazil. Headquartered in Berlin, Germany, the fund intends to invest in up to 15 Brazilian companies over the next two years and projects initial investments starting at US$500,000 per business. What motivates the firm to bet in Brazil is precisely a long-term vision.

Flash Ventures focuses on early-stage companies in any sector. Iaconelli admits that financial services, SaaS (software as a service), and web 3.0 are some of the most “well seen” universes for offering a better risk-return ratio than capital-intensive industries such as manufacturing or advanced research.

Currently, the fund has about 30 companies in its portfolio. Among them, five are Brazilian: Barte and Blipay, which are already in operation, Compensa and Lunix, which will launch their products soon, and a fifth that has not yet been revealed.

“There is still a lot of inefficiency and wealth to be built by solving Brazil’s problems,” explains Iaconelli. “The combination of market size, more favorable regulatory environment, and advancement in the training of technical professionals allows us to see an increasing wave of disruption and creation in the country in the coming years.”

A similar view is shared by US fund Flourish Ventures, led by eBay founder Pierre Omidyar. The fund has invested in Brazilian startups such as Neon, Dinie, Mercê do Bairro, and Kamino and intends to expand its presence in the country further.

According to Diana Narvaez, partner and responsible for investments in Latin America, the fund seeks startups that help promote the financial inclusion of individuals and small businesses, stating that the fintechs that exist today still take little advantage of the “huge market opportunity” present in Brazil.

She points out that Brazilian fintechs hold only 1% of total deposits and 2% of the consumer credit market in the country. The five main traditional banks hold 90% of the Brazilian retail banking market and manage 80% of the assets.

Among the factors contributing to the region’s potential, she cites the growing demand for digital services, the limited penetration in lower socioeconomic segments, and the scalability of new financial products.

In this context, she says that rising interest rates are just a detail.

“Flourish, as a perennial fund with a permanent capital reserve, is not subject to the same market dynamics and pressures,” Narvaez explains. “The change in interest rates primarily affects funds that raise money from institutional investors, which have to compete with other asset classes that offer higher returns.”

According to her, higher interest rates may even increase the demand for venture capital funding by making debt financing a less attractive source of capital for entrepreneurs.

IMPACT OF HIGH INTEREST RATES

The main impact of high interest rates turns out to be an indirect one. According to Iaconelli, this impact has to do with companies that planned to go public but gave up because of the lack of appetite in the public market, which is inversely proportional to the interest rate.

When these companies don’t come to market or have their values depreciated, the funds that use them as a reference to price investments need to reduce prices, reducing the appetite for funding rounds.

“This creates a chain effect that impacts the more mature companies more and gets diluted down to the younger ones,” he explains.

Still, the advantages are more significant. “Brazil is cheap for those who invest because there is still a lot of room for growth, and these funds manage to be very relevant when they come here,” says Pinho.

He also adds that the high interest rates and inflation are problems for most nations, not just Brazil, mainly because of the war between Russia and Ukraine. Although insecurity and instability increase investors’ risk aversion, Brazil is not significantly damaged.

“On the contrary,” he says. “As we are seeing a commodities boom because of this crisis in Ukraine, which mainly affects the energy and supplies segments, Brazil even has some advantages,” he says.

With information from Forbes