Brazil’s startup ecosystem: set for growth but throttled by interest rates

The fundamentals of a strong innovation ecosystem are in place in Brazil — a young, tech-savvy and entrepreneurial workforce, domestic and international capital waiting on the sidelines, and an increasingly professionalised investment sector. However, the country’s investors say they are being held back by the persistently and somewhat inexplicably high interest rate, which currently hovers at around 15%.

This was a key theme for investors attending the 10^th annual Corporate Venture in Brasil conference in São Paulo, the largest corporate VC gathering in Latin America, bringing together domestic and international investors.

Brazil’s 15% interest rate is far above other countries in the region – Mexico’s rate stands at just under 4%, Chile’s at just over 4%, Colombia’s at around 5% and Argentina being a historic exception with 31% but decreasing.

It has meant that investment appetite in Brazil is lagging, even as venture capital activity is gently ticking up again around the world, with deal count and exits increasing.

“It’s hard for corporates to take risks when you can get a good return for no risk,” says Gustavo Cavenaghi, managing partner at Kortex Ventures.

Many Brazilian companies have been focusing on investment efforts closer to their core business during the downcycle, away from more “blue sky projects”. A number of corporate venture units have also been shuttered recently. Some of these were units set up during the startup hype of the pandemic, when many companies jumped on the bandwagon for investing in startups without a clear sense of the objective.

The closure of units, such as Gerdau Next Ventures and Braskem’s Oxygea have spooked the sector, but beneath the caution, there is real bullishness on the core fundamentals of the country’s innovation space.

Many see Brazil’s market as a coiled spring waiting to be let loose once the interest rates go down. On the one hand, the main impediment felt by investors was something out of their control, but on the other everything else is already in place for dynamism once it does.

Deeptech and mindset

Latin America has a deep bench of knowledge and an increasingly entrepreneurial culture at universities, but needs to do a lot of work to have that translate into a vibrant deeptech ecosystem.

Deeptech startups are by and large still too young, too immature, and can often not even know how to sit at a table with larger players who know better – a lot of work is needed to professionalise the tech founder pool. Too many are looking at solutions in search of a problem, without an understanding of how it applies to industry, and are dealing with a range of issues from everything from intellectual property to cap table problems, was the feeling in a roundtable discussion of deeptech in the region.

What is lacking in LatAm, investors say, is a matchmaking nexus – a common platform that can bring together the capital, the business savvy, and the academia-derived knowhow.

A mindset shift is also needed for the Latin American startup ecosystem to become competitive with that of the US or Europe in deeptech.

“Deeptech founders don’t want to be rich, they want to be right,” was a phrase bandied around a group discussion on challenges in deeptech in the region. In other words, their mindset is more geared towards having the tech work and have impact than actually creating a business.

In academia especially, there has been the sense that too many potential founders in LatAm – in contrast to their counterparts in the US – would be satisfied writing a paper about a technology rather than making a business out of it. But that is slowly changing, and more researchers are jumping straight to wanting to make a business. While this has already been a growing trend in Brazil, it is now increasingly the case in neighbouring markets like Argentina and others.

Finance and AI

Latin America has seen fewer AI startups emerging than the US and Europe, but there is some innovation happening in this space.

Financial services companies are some of Latin America’s most active CVC investors, last year making up 25% of all investments into fintech companies. These investors are doing considerable work to integrate AI technology into financial institutions, especially at a time when banks’ margins are low and there is a push to drive up revenue and reduce costs, according to participants in a panel discussion on financial CVCs in Brazil.

One challenge financial institutions are dealing with is having workable data for AI to operate. Philippe Schlumpf, head of banking group Itaú’s CVC, Itaú Ventures, described how its parent company has been working hard to have the structured data needed for AI integration, such that it can effectively bring on the over 100 AI products being worked on throughout the organisation.

Sebastian Spena, the head of Argentinian financial group Grupo Galicia’s VC arm Galicia Ventures, said there is an ongoing internal back and forth over the extent to which AI initiatives should be carried out centrally, covering the whole group, or if it should be left to different parts of the business to do their own thing.

Aldo Alvarez, an investor at Citi Strategic Investments, said that it is difficult to find startups in the region doing anything revolutionary or disruptive with AI in the sense of building something new from the infrastructure or the model level.

SoftBank investment director Maria Tereza said that the Japanese investment group, which invests at the later stage in the region, was finding it hard to find AI-native startups that justifed a $35m investment ticket, especially as its investment committee was looking for businesses that could provide returns in US dollars despite an unfavourable BRL-USD exchange rate.

However, a lot of companies are using existing AI to improve their own processes and making them more efficient, increasingly integrating AI into their culture. Humberto Matsuda, venture partner at Kamay Ventures, said there was a huge opportunity for LatAm to jump the tech cycle straight into AI, in the same way that much of the consumer base in Africa jumped the telecom cycle and went straight to mobile.

SoftBank’s Tereza added Brazil had an opportunity to use innovative regulatory policies for AI development in the same way the country did for fintech, wherein its central bank is widely praised to have been extremely proactive in seeking and developing new financial technologies.

Areas like cryptocurrencies are a big opportunity in LatAm, though, given the high uptake in the region due to economic turbulence, according to Ziheng Li, vice president at Saison Capital.

The importance of celebrating victories

Despite the downcycle, many of the investors at the GCV Brazil event were keen to celebrate the wins for corporate venturing. The upcoming launch of Petrobras’ $90m+ investment fund, the manager award for which was announced a day before the conference, for example, was taken as a hopeful sign.

In the long term, many are optimistic about the appetite in Brazil to build initiatives and invest.

“When you see the numbers, you see current CVC activity, but many more companies are thinking about how to open one. They just don’t know how, there’s a lot of missing knowledge about what kind of professionals can help do it well,” said Sebastian Gonzalez, head of corporate venturing LatAm at Wayra, adding that if just the 10 biggest companies in the region decide to create VC units, that would be a massive wave of money into the ecosystem.