• VC firms shied away due to overpriced valuations
• PE firms struggled to raise new funds
• Lower inflation and interest rates may boost investment activity

The combination of high interest rates, overpriced valuations in venture capital and difficulties for private equity firms to raise new funds made 2023 a challenging year for Latin American companies and financial investors, a pool of entrepreneurs, and legal and financial advisors told this new service.

Amid the hype in risky investments like cryptocurrencies, non-fungible tokens (NFTs) and the metaverse, many start-ups were hypervaluing their businesses. Most VC and PE funds, however, hit the breaks in 2Q22. Since then, valuations between investors and companies have rarely met.

“I think 2023 was a particularly interesting year because it was kind of a reality shock for a lot of VCs when it came to investing, not only in Brazil but throughout the world,” said Renato Gomes, co-founder and president of Pix Force, a Rio Grande do Sul, Brazil-based deep tech company serving the oil and gas and other industries. “The available capital has not changed; there continues to be a lot of capital, but there was a certain caution and a sudden realization that people were perhaps overdoing it with risk,” the entrepreneur said.

In the first three quarters of 2023, the volume of venture capital deals in Latin America fell to USD 2.9bn from USD 6.9bn in the same period of 2002, and USD 11.9bn in the same period of 2021, according to data compiled by non-profit Association for Private Capital Investment in Latin America (LAVCA). Brazil received 62% of the venture capital invested in 3Q23, and Mexico, 33%, according to LAVCA.

“Venture capital investments continued, but at a much lower level than in 2022,” said Alejandro Ibarra, Deloitte partner in Mexico City. Instead of investing directly in equity, the sector focused mainly on “bridge capital” to finance companies that were between early-stage and Series A and B rounds, with an average ticket in Mexico of USD 10m, Ibarra said. Investments in Mexico were made mainly by US funds, with a smaller participation of local funds, which focused on companies already in their portfolios, Ibarra said.

According to the Deloitte partner, the early-stage sector is also active, but with tickets between USD 50,000 and USD 100,000, mainly through acceleration programs such as the one that has San Francisco, California-based venture capital firm 500 Global through its Luchadores II and III funds, as well as other funds such as DILA Capital, a Mexico City-based a multi-stage venture capital firm, and IGNIA Partners, a cross border early-stage venture capital firm based in San Francisco and focused on Mexico and Latin America.

“The rest of the companies focused on reducing operations and on cash generation to get much closer to profitability,” Ibarra said. Most companies that had a relevant scale were able to raise debt from USD 40m to USD 100m with a senior and mezzanine structure, with assets and a portion of capital as collateral, he explained.

After being unable to secure an investment because they were asking for a valuation that was too high in 2023, companies are expected to make more realistic valuations in 2024 and the investments will happen again, said Patricia Grabowsky, executive manager for innovation and digital transformation at Rio de Janeiro-based oil services company Ocyan.

Growth was also complemented by consolidating companies within the same sector and purchasing artificial intelligence platforms, Ibarra said. With lower interest rates, in 2024 institutional investors will be able to provide more capital to VC funds at a global level, he added.

Private Equity 

The outlook for Latin American PE is not so clear, as the interviewed advisors differed in their hopes for improvement.

“I don’t see the PE market recovering in the coming years,” said Ricardo Perez Vas, partner at Mexico City-based M&A advisory firm RioN. “The number of active funds has been decreasing because they have not been able to raise new funds due to the low returns they have given to their investors,” Perez Vas said.

“There was a significant decrease in PE activity because managers participating in the sector have not received additional capital from their institutional investors and have very little capital available to invest,” Deloitte’s Ibarra said. In Mexico in general, there has been no capital raising for a couple of years, mainly because the managers have been focused on having exits mainly through sales to the families that were the original owners or to competitors.

The exit through a placement on the stock market has not been viable in Latin America and there is a significant reduction of institutional investors who prefer to be in markets with greater liquidity, Ibarra said. Mexico’s stock market is 80% controlled by investors who seek to replicate the index, he said, adding that the listed companies that are not in the index have suffered a significant drop in liquidity and therefore in valuation despite having positive results in profits and business growth. Given this, it is expected that there will be additional struggles in 2024, Ibarra said. For example, the Mexican pension funds Afores have concentrated their capital in investment trust certificates (CERPIs), which allows them to invest in international stock markets with asset managers outside of Mexico, the consultant added.

In Brazil, PE firms also exaggerated when markets were favorable, conducting IPOs of companies that did not deserve it, said Salvatore Milanese, founding partner of Pantalica Partners, a Sao Paulo-based advisory firm specializing in turnaround and restructuring. “PE is essential to build governance in companies in the pre-IPO phase,” Milanese said. “However, some companies that listed in the last IPO hype lost up to 90% of their market cap,” the advisor said. “Hopefully they come back more mature.”

Financial sponsor deals in Latin America dropped to USD 10bn in 2023 from USD 24bn in 2022, according to Mergermarket data. The number of deals fell to 120 in 2023 from 183 in 2022. Financial sponsors entities include PE, pension funds, sovereign wealth funds, family offices and loan-to-own hedge funds.

In recent years, PE funds have focused on raising capital to make investments in debt instruments, a sector that has shown more dynamism on the part of PEs in Mexico, Ibarra said. However, it has been difficult to find investments given the low appetite for risk, he added.

Other advisors were more optimistic about the future. “PE funds that are more productive, as are some of our clients, have no problem raising funds,” said Pantalica’s Milanese. Those that have low productivity or made questionable deals are having trouble, he said. “There is money for PE funds that have experience and have delivered good results,” Milanese said.

“In the PE space in Mexico there is now a more positive movement and there is already renewed interest on the part of the funds,” said Sergio Garcia del Bosque, managing director at investment bank Seale & Associates. The decrease in activity was due to high interest rates and valuations, which were recently at historic highs, Garcia del Bosque said. “The reduction of interest rates and pressure from investors to make investments in PE and VC are likely to lead to a recovery of the sector and many transactions are expected,” the investment banker said.

Among Latin America’s creative venture capital and private equity deals in 2023 was a Series B that was smaller than the company’s Series A round, a transaction led by Valor Capital Group for Mexico City’s Nexu, an alternative lender for motor vehicle financing. The company raised USD 20m in its Series B round in October, after raising USD 50m in a Series A round in January 2022.

Gympass, a company created in Brazil and headquartered in New York, New York, in August raised USD 85m in a Series F round led by EQT Growth, a Stockholm, Sweden-based investment group.

Sao Paulo-based proptech Loft raised USD 100m in convertible debt in August from ADQ, a United Arab Emirates sovereign wealth fund.