Latin American Startups Turn to Venture Debt With Equity Deals Drying Up

Latin American startups are increasingly taking on high-interest loans as venture capitalists pull back on equity investments in the region.

(Bloomberg) — Latin American startups are increasingly taking on high-interest loans as venture capitalists pull back on equity investments in the region. 

Debt represented about one-third of all venture capital raised in the first half, the highest proportion on record, according to data from Lavca, a nonprofit association for private capital investment in Latin America. 

Startups are “rolling out the red carpet” for lenders, said Gabriel Carbonelli, a money manager for venture debt at Riza Asset Management in Sao Paulo, which loaned 70 million reais (about $14 million) in the past year. “In the prior years, we had to actively go out and explain all the details to companies. Now, they are coming to us.”

The increase in borrowing reflects how desperate founders have become for cash and how reticent they are to accept equity deals that would drastically reduce valuations their companies received when money flowed freely and interest rates were low. It marks a dramatic shift for an industry that had just started to flourish, producing dozens of billion dollar companies — known in the startup world as unicorns — and catching the attention of global investors, such as SoftBank Group Corp, that built dedicated funds for the region. 

Venture spending has declined globally as policymakers raised interest rates, but the impact has been acute in Latin America’s relatively young startup scene.

While venture debt has been widely used in other markets, it was largely unseen in Latin America until equity investors started to shy from writing big checks. In the 12 months ending June 30, startups borrowed about $1 billion, often at interest rates in the low teens. Equity investments in the region fell to around $3 billion in that same period, after dropping steadily since a late 2021 peak, according to Lavca’s data.  

“Startups need cash,” said Freddie Goudie, a Miami-based partner and business lawyer at Foley Lardner, which has worked on debt deals. “The sources of funding are drying up.” 

The alternative, he said, is not to get the capital and closing their doors within 12 months.

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Due to a lack of options, companies are being forced to accept terms and conditions such as minimum return guarantees, make-wholes and equity kickers — on top of high interest payments, Goudie said. 

“We are talking about companies that have good ideas, but don’t have proved business models,” said Felipe Barreto, a Sao Paulo-based private equity lawyer at Candido Martins. “So investors ask for collateral that is quite elevated. You can bankrupt your own company if your accounts are not balanced.”

Such an environment heightens the difference between startups that are struggling to gain foothold and those that have established a thriving business model, according to Marcos Kantt, chief financial officer at Habi, a Colombian online residential real estate platform that gained unicorn status in 2022. 

Habi raised about $300 million in debt lines over the last 12 months at very low rates, allowing it to grow without diluting shareholders further, Kantt said.

“Not everybody’s going to debt because that’s their last chance at surviving” he added. “A lot of us are going to debt because it’s the best thing to do for the business and our stakeholders.”

Miami-based HCS Capital CEO Alex Horvitz said his tech fund has completed $10 million of venture debt deals in the last nine months and zero new equity investment in Latin America. In the nine months prior, the fund had deployed around $20 million in equity and no venture debt.

HCS, which invests in health care, insurance and financial startup companies globally, is charging between 12% and 16% in interest, roughly in line with benchmark rates in the region.

“It was very rare, you would not come across any debt opportunities,” Horvitz said. “We started doing venture debt just two years ago and now 25% to 30% of our capital is venture debt.”

–With assistance from Michael O’Boyle.

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