Mexico City — Venture capital investment in late-stage startups is becoming more cautious in an environment of crisis in the technology sector., and which has prompted Latin American unicorns to resort to contracting debt with multinational banks in order to continue growing.
In Mexico there are eight startups that have become unicorns: Clara, Clip, Kavak, Konfio, Stori, Bitso, Merama and Nowports.
Clara, Clip, Kavak, Konfio and Stori have opted in recent months to contract debt, and Goldman Sachs and HSBC have been the common denominator as financiers, while Bitso, Merama and Nowports, in contrast, have not resorted to debt.
MercadoLibre and Brazilian neobank Nubank have also contracted debt, even after going public, while Chilean startup Xepelin, which is currently in a Series B, has done so twice.
Regardless of the stage they are in, Latin American startups are opting for this investment instrument to obtain liquidity.
In the first half of the year, venture debt represented 13% of total investment, surpassing even 2019 levels, which was at 11%, according to data from the Latin American Private Equity Investment Association (LAVCA).
In times of crisis, startups begin to see an increasingly tight capital scenario, in some cases because they did not plan well their financials, and seek to capital rounds, but in order to do so they have to spend months fundraising, and in that interval many companies’ go broke, says Jerónimo Peralta, managing partner of Maquia Capital.
Peralta points out that in these cases, startups would arrive at the negotiation table in a disadvantaged position, urgently needing cash, and which is why they are opting for the debt route because “debt is much more stable, much safer,” he told Bloomberg Línea.
However, contracting debt also has its downsides because the cost is not cheap, and is rising as central banks raise interest rates in a bid to stem inflation.
One investor familiar with the behavior of credit rates, who preferred not to be named, estimates that in the US last year, interest rates on debt ranged from 15% to 17%.
Denis Yris, managing director of Wortev Capital, is a bit more conservative in his estimate of percentages, and says they are around 10% per year.
Debt avoids down rounds
With the Federal Reserve’s interest rate hike, tech stocks are once again dragging down US stocks and companies’ valuations are plummeting.
“This year there has been a global readjustment of startup valuations for several reasons, including high interest rates and inflation, and somehow the startup bubble in the United States has burst,” says Luis Felipe Treviño, managing director of the private investment firm Beamonte Investments.
In the US, venture debt is very common, although not in Latin America, however.
“Although it has been around for many years, debt is relatively new to the market in Mexico and Latin America,” says Treviño.
Debt funds are often used as growth capital and, if strategically placed, entrepreneurs can plan to achieve certain milestones prior to equity rounds using such funds, which in turn will strengthen their chances of winning an equity round.
This capitalization mechanism prevents startups from losing valuation, in addition to not diluting shareholders.
Looking at what is happening in Latin America with these startups, Treviño recalls the case of WeWork, which was worth $47 billion when it was a unicorn, but suffered a valuation adjustmen of approximately $9 billion after its merger with special acquisition vehicle (SPAC) BowX Acquisition Corp.
“These are the types of adjustments we’re experiencing, that’s the market,” Treviño says. And, “one of the reasons they’re looking for debt rather than equity is because it’s very difficult to price a deal today.”
The valuations of unicorn companies and the way of analyzing them has changed this year. Before, funds focused a lot on user-based metrics; on growth and acquisition, according to Treviño.
Yris, from Wortev Capital, adds that with debt it is about avoiding a down round, because that also hurts venture capitalists and not just the startup.
“In those cases it’s possible for startups to wait for a next investor to come in and buy that debt,” Yris says.
Funds are looking at traditional metrics again, especially in the US. Treviño adds that a company’s ability to generate sales, how to monetize users and margins, which is something that had been neglected, now matters again.
Many of the startups that have raised capital are not yet at the break-even point or generating profits, and although they are growing, they are still in the red, which is why they cannot demonstrate to the market their capacity to generate cash flow and sales, which is what is needed to go public, says Treviño.
However, for the Beamonte Investments executive, the issue is not that startups such as Clip, Clara or Kavak cannot raise capital, but rather that they are having a hard time raising it with their historical valuations.
Kavak, the most-indebted unicorn
Kavak, the used-car sales platform unicorn valued at $8.7 billion, recently raised more debt of $810 million, which is more than the $700 million it raised in its last venture capital round from funds including General Catalyst, SoftBank, Tiger Global and Founders Fund.
With this debt, Latin America’s most valuable unicorn is now the company with the largest amount of financing granted by financial institutions to companies less than 10 years old in the region.
The line of credit, although the terms are unknown, is greater than the total amount of debt acquired by some Latin American startups -mainly Mexican- in the last year, which totaled $733 million.
Goldman Sachs has lent $140 million to Chilean fintech Xepelin, $150 million to Mexican loan and expense management firm Clara, $233 million to Mercado Libre (MELI) and $160 million to Mexican fintech Konfio in February 2021.
In addition, in early September, another unicorn, Mexican payments fintech Clip secured a $50 million three-year unsecured revolving credit facility from Morgan Stanley (MS), J.P.Morgan (JPM) and HSBC.
Debt capital does not always denote a crisis
Acquiring debt is not always done in times of crisis, but rather when there is accelerated growth and liquidity is required to sustain it, according to venture capital experts consulted by Bloomberg Línea.
“This type of debt goes to safe companies that have the capacity to generate cash to repay the debt,” says Peralta of Maquia Capital.
Venture debt for startups in early stages or debt for startups in accelerated growth is a solution for growing companies, but it will cost them more work to create a runway, up to five times more to raise the rounds, explains Peralta.
For Yris, from Wortev Capital, debt is a mechanism widely used in more advanced markets such as the US, where “large companies that used to be startups were raising venture capital and debt”.
In advanced stages, it is a guarantee for banks that other venture funds have already invested in these startups, says Yris.
However, “in Latin America we had not had cases of companies that had been so strongly driven by venture capital, and there was a lack of knowledge of this investment process,” Yris says.
It was only in 2020 that the first unicorns appeared in Mexico, while some had already emerged in Brazil and Argentina.
“Right now the Mexican and Latin American entrepreneurial ecosystem is maturing,” Yris points out.
When corporate expense management solutions unicorn Clara received $150 million in funding from Goldman Sachs, the company’s CEO Gerry Giacomán told Bloomberg Línea that this funding showed the potential that exists in the region.
Giacomán said in August that the loan also represented the confidence that international investors have in the potential of technology startups and in the future of this sector in Latin America, even at a time that presents great challenges for the sector’s development.
Combining debt with venture capital
An example of this back-and-forth between venture capital and debt is Konfío, the $1.3 billion unicorn, as the fintech has been combining both instruments in its most recent capital injections.
In July 2018, David Arana’s fintech raised a Series C for $25 million. In September 2019 it raised a $100 million loan from Goldman Sachs and in December it raised a Series D for another $100 million led by SoftBank.
Later, in early 2021, Konfío received $160 million from Goldman Sachs prior to the $110 million Series E that gave it unicorn status in September last year backed by Tarsadia Capital, and QED Investors.
Another example is personal credit fintech Stori, the most recent Mexican unicorn. In July it reached a value of $1.2 billion, after receiving a $150 million Series C extension, which came on top of the $125 million in venture capital it received in October 2021, in a round co-led by GGV Capital and growth-stage investor GIC.
Stori’s Series C was accompanied by $75 million in debt financing from Community Investment Management, in addition to a $100 million credit line extension from Davidson Kempner.
But, Treviño points out, the debt issue has its downsides, as repayment could affect the startup’s cash flow in times of hyper-growth. Added to this are exchange rate differences when the loans are from US banks.
