How Entrepreneurs Are Transforming Latin America
Entrepreneurial Momentum
Access to Capital
VC offers unique opportunities for entrepreneurs, particularly those looking to innovate and grow quickly. VC grew from around $2.0 billion in 2018 to $15.9 billion in 2021—an unprecedented increase—before dropping again to 7.8 billion in 2022 and even further to under $3.0 billion in 2023. Beyond financial backing, VC firms provide invaluable mentorship, strategic and operational support, access to networks and experts across the globe, and business visibility. VC leadership has provided the basic structure for new and innovative ways of financing entrepreneurs, including impact investing and tools such as blended finance. The international nature of VC investments has also fostered cross-border collaboration, particularly as firms that receive VC funding are increasingly expanding regionally.
Successful entrepreneurs have been known to produce multiplier effects—virtuous cycles of entrepreneurial investment and risk-taking—that can disrupt traditional industries with novel products and services that take advantage of dynamics created by the work of other entrepreneurs. For instance, e-commerce platform Linio, based in Mexico City, pioneered the country’s rapidly growing e-commerce industry in the early 2010s as the populace quickly adopted digital technology. Many of the company’s founders and former executives—like Carlos García Ottati, founder of Kavak, Mexico’s first unicorn—went on to form 66 additional companies, mostly in the e-commerce space. In Colombia, Rappi shares a similar story: more than 110 companies have been formed by company alumni across a wide range of industries. These companies have collectively raised more than $2.1 billion in VC funding and employ more than 14,000 people.
Levels of VC investment in Colombia have skyrocketed; Colombian technology start-ups received over 1.7 billion in VC funding in 2021, compared to less than $100 million in 2017. Several governments in the region have played a key role incentivizing entrepreneurship by creating agencies to support entrepreneurs technically and financially. Start-Up-Chile is an example of such efforts. Launched in 2010, it stands as a regional and global example of how government initiatives can catapult the entrepreneurial ecosystem. In part, looking at Chile’s example, in 2012 the government of Colombia launched INNpulsa Colombia, its version of a national entrepreneurship and innovation agency. In addition, these two countries, along with Argentina, Brazil, Chile, Mexico, Panama, Peru, and Uruguay have adopted laws to promote their digital development strategies, which include “developing broadband infrastructure, promoting digital companies, and encouraging large and small companies to adopt digital technologies, as well as promoting general IT skills and competencies.”
Raising Capital in an Uncertain Economy
Access to VC capital has been on a downward trend since its peak in 2021. Late-stage investment deals led much of the earlier unprecedented growth, reaching over $9.4 billion. This compares starkly to Q1 and Q2 of 2023, which only reached $0.3 billion for late-stage investment. When comparing 2021, 2022, and 2023, investment has generally shifted away from late-stage fundraising and toward early-stage start-ups. While in 2021, late-stage investment accounted for most of the venture capital directed at LAC, 2023 marked a notable shift in the investment landscape: early-stage investment is now ranked first, followed by seed, venture debt, and lastly, late-stage. This shift is certainly a reflection of capital drying up across the globe and investors being more conservative considering the current economy. However, the sustained investment in seed, early-stage, and VC shows that investors are still interested in seeing the region grow and see potential—but also that their investment behavior reflects the current socio-economic reality in LAC.
Consequently, 39 percent of respondent companies reported not fundraising in 2023, according to the 2023 LAVCA Startup Founders Survey, instead focusing on “internal company restructurings and building leaner teams.” Start-ups have also worked toward building more geographically distributed teams in 2023 compared to 2018, with more financially mature companies 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 applicable to the entirety of the start-up ecosystem.
Foreign Direct Investment
Following the commodity boom of the late 2000s and early 2010s, major private equity firms like Carlyle, GA, TPG Capital, KKR, and Ajax Partners opened offices in LAC. However, a combination of political instability, protectionist policies, and slower growth levels had made foreign investment in LAC riskier, significantly worsened by the impact of the Covid-19 pandemic. FDI levels dropped from their 2013 peak of over $200 billion to about $100 billion in 2020.
However, in 2022, a post-Covid-19 recovery surge marked the first time since 2013 that FDI levels surpassed $200 billion; Brazil received 41 percent of total FDI, followed by Mexico with 17 percent. FDI flows grew by 55.2 percent between 2021 and 2022, as investors’ interest—especially in the region’s oil and gas, mining, and renewable energy sectors—grew substantially. Fourteen megaprojects in these sectors with total FDI surpassing $1 billion represented 41 percent of total investment in 2022. Moreover, 80 percent of the total investment in LAC toward announced energy projects was directed toward the top 170 largest projects.
In terms of FDI investment by sector, services had the lowest relative rate of growth (35 percent), while manufacturing experienced 47 percent more growth compared to 2021 but remained 50 percent lower compared to its peak in 2013. Within services, the subsectors with the largest share of investments were financial services, electricity, natural gas and water, information and communications, and transportation-related services. Natural resource FDI grew by 79 percent in LAC in 2022, with considerable growth in Brazil’s oil and gas sector. Colombia’s FDI in natural resource extraction grew by 228 percent in 2022, while Mexico’s FDI in the same sector declined after more than doubling in 2021.
Venture Capital Investment
VC investment in LAC has had a remarkably different trajectory compared to traditional FDI capital flows. While FDI levels stagnated and declined between 2016 and 2021, VC deal volume between those same years surged from 197 to 1,095, according to LAVCA. Furthermore, international investment in LAC start-ups has more than doubled since 2015 from a diverse range of international firms. Moreover, about 75 percent of VC investment in LAC went toward the information technology and financial services sector, indicative of the large, untapped potential of the region’s high levels of digital connectivity. VC investment in fintech services in LAC represented 43 percent of all tech VC investment in 2022.
Tax Systems
In LAC, where informal employment is a significant problem, businesses require clear tax regulations and incentives to legally hire personnel and incorporate workers in social security systems. This is especially important during the initial stages of growth when certainty for both entrepreneurs and workers is crucial. A predictable tax policy is essential for businesses to plan and budget effectively. Without a predictable taxation system and tax courts, businesses are forced to allocate resources to deal with unexpected changes, which can lead to reduced productivity and profitability, along with greater uncertainty. Additionally, having predictable tax regulations is essential in attracting foreign investment, which plays a crucial role in the growth and development of new businesses. Tax systems in some LAC countries have become especially complicated due to poor planning of federal systems and their interactions with provinces and states. A useful tax policy regulation needs to address and incorporate both local and federal taxes. Businesses can find it overwhelming to calculate, report, and pay taxes when dealing with provincial and municipal regulations. This is further compounded by the added responsibility of managing and administering complex social security contributions for workers.
Navigating the Way Forward
Entrepreneurship is on the rise in LAC. In the last five years, start-ups from across the region have attracted record-breaking investment from abroad, disrupting traditional industries with innovative products and services that create more efficient markets and support the growth of high-value industries. Entrepreneurs have also confronted long-standing challenges of the region, such as its large informal economy, its overbearing bureaucracy, and the dominance of industries traditionally resistant to change. Governments that have worked to support the growth of their entrepreneurial sectors have benefitted from virtuous cycles of investment and innovation, creating resilient economies that are less vulnerable to commodity-driven shocks. To achieve this, public and private sectors would be well-suited 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 change. As a result, more and more individuals are showing interest in starting their own businesses. The accessibility of this possibility has increased, leading to a surge in motivation to become self-employed and enjoy greater flexibility. The Covid-19 pandemic has also hastened the adoption of technology by businesses. However, there are still several challenges that must be overcome to fully benefit from the opportunities presented by technology, such as retaining talent and obtaining funding. Covid-19 has highlighted the need for the digitalization of processes, while insufficient information about financing and a lack of education about basic corporate finances remain problematic.
Clear, transparent, and simpler tax systems. Recognizing the role of predictable tax regulations in attracting foreign investment is vital for the growth and development of countries. Simplifying the calculation, reporting, and payment of taxes is essential to alleviate the administrative burden on small enterprises. Streamlining and coordination need to occur at all levels of government, particularly in countries with federal structures like Brazil and Mexico. Lastly, providing support and guidance for managing complex social security contributions for workers will contribute to a more favorable business environment.
Rethink the actors. The VC industry and its start-ups need to be developed in the region, and industry-led initiatives are uniquely suited to do this. VC funds are in a win-win position if they develop business that can grow or train the next unicorn. Initiatives that focus on acceleration, seed and early investment, growth investment, and social and environmental factors have an immense potential to grow their footprint in the region, while at the same time creating positive social, economic, and environmental effects.
