Startups on alert: without capital, they cannot maintain their valuations in Latin America

At a time when pension funds are looking at their private equity assets, equities are facing a bear market, investors are looking for cash returns, and IPOs are drying up due to rising interest rates, funds are beginning to pay more attention to their LPs (Limited Partners).

Private equity (PE) firms usually sell their portfolios through public listings, corporate takeovers, or sales to other private equity firms. And that last case is more common as LPs demand returns, venture capital (VC) managers told Bloomberg Línea.

In August, Brazil Journal reported that venture capital firm Valor Capital sold part of its II fund to US private equity firm StepStone for liquidity.

In an interview with Bloomberg Línea, Humberto Zesati, managing partner of Mexican PE firm LIV (Latin Idea Ventures) Capital, says he believes it will be a different story in Latin America now that valuations “have come back to earth.”

The Mexico-based fund targets growth equity investments with at least $30 million in revenue.

“I don’t think we’re going to see anywhere near the investment numbers that we saw in 2020 and 2021,” Zesati said.

“I don’t see many companies continuing to invest at the same rate they have invested in the region in the last two years.”

Marcos Leite, co-founder and managing partner of Brazilian venture capital fund Canary, is more optimistic.

“There are dozens of global funds very interested in LatAm studying the markets. When the capital markets improve, there will be more funds investing in Latin America,” he recently told Bloomberg Line in an interview.

Leite says that the last ten months were outliers for investing globally. Due to risk aversion, investments have slowed down, but compared to 2019, venture capital in Latin America is still growing.

“There is an activity for early stages. This year we had about 20 investment rounds within our portfolio. These numbers are roughly 30% larger than last year’s amount. What is not happening is Series C onwards,” he said.

While volatility in Latin America still haunts investors, financing for growing companies is more difficult and will push valuations down; venture capital managers told Bloomberg Line.

But dealing with a negative round is not easy and can kill a company, according to Sebastian Miralles, managing partner of Tempest, a private equity firm active in Latin America.

“Many times venture capital funds would rather see a company die than let it raise a bearish round,” Miralles said.

Venture Capital and Private Equity are the same asset class but generally invest in different stages of company development. VC tends to arrive before PE.

“The PE and VC distinction originally came about in the 1980s because New York bankers wanted to do leveraged buyouts, massive inflows from conservative investors like pension funds.

“But now VC and PE are converging, and you can see this conversion in growth-stage PE and late-stage VC,” Miralles told Bloomberg Línea.

In addition to investment vehicles, Tempest advises sovereign wealth funds and family offices. The firm also joined the Series C of the Mexican unicorn Clip and has an investment commitment of US$1.1 billion.

“I don’t know how to invest in a company listed at a 24x valuation; for me, it is something that does not compute. That is not reasonable.

“I run my models on most startups and see that they are overrated by three, sometimes even more.

“So, how do you invest? You are in a dilemma. Either you participate and try to be as conservative as possible, or you choose not to play,” Miralles said.

For him, most startups will not be good, and that’s how the industry works. “Some founders aren’t that great, and even for those that are, the ratings were off.”

“I told the founders that they would have killed their company if they went up with that valuation.

“Not now, but in two years. After expending all that effort, they will find that they can’t grow at that valuation, and the funds won’t allow them to raise another one.”

Even though he sees that the best startups will survive the negative rounds.

“There is a whole generation today that believes VC is just about investing in the early-stage software business that is supposed to lose money. But it is wrong and destructive for society,” says Miralles.

With information from Bloomberg

LatAm Markets: Live Signals → — real-time movers, turnover leaders and FX across Latin America.