LatAm StartUp Challenges: Why startups should raise capital today, not tomorrow

Takeaway: Bootstrapping or Raising capital is an easy decision if you can answer a far more difficult one: Are you building a startup with solid barriers to entry?

As an entrepreneur in Latin America one of the hardest decisions is whether to bootstrap or to seek outside capital. While these decisions are very case specific, our firm’s view is that you should definitely decide to raise outside capital if your business venture is one where you can build significant barriers to entry. There are many forms of barriers to entry, but advanced technology stacks, network effects, economies of scale or scope, and improved business processes are all integral to creating solid barriers to entry.

In a traditional businesses,  there can be few of the above mentioned barriers, and the main defense against competition becomes a strong brand. A brand can be a very powerful barrier to entry (see: Coca Cola), but a strong brand is the result of careful and controlled growth. Startups, by their definition, are not intended to execute slow and controlled growth but, on the contrary, fast growth. Good startups need to execute fast growth because they are solving a pressing problem, one that requires an urgent solution. Startups are not conceived to build a brand over many decades – though some will, and will therefore add brand to their barriers to entry.

In a competitive market, where a pressing problem exists, there are likely to be many more than one competitor trying to solve a problem. Most startups will seek to solve a problem in a manner that leverages trechnology to create barriers to entry to other participants. That is, the succesful startup is likely to start creating barriers to entry as they grow with the objective of setting up a “powerful business moat” (barriers to entry). In doing so, they will likely increase the costs to compete and scale for other startups that intend to solve the same problem.

One of the old adages in Silicon Valley is: “Optimize for the pie size, not the slice”. That thinking applies best to businesses that will be able to create and capture significant value in a form that beat incumbents and other startups if properly executed. If your startup has limited barriers to entry, like a restaurant, the founder should be thinking about maximizing the pie slice. If you are building the next Facebook, with solid network and technology barriers to entry, you should think about maximizing the pie size, as any slice will be awesome.

In this context, the answer to the question of “Bootstrap or Raise capital?” is obvious. The truly difficult question the entrepreneur needs to ask is whether or not the startup will be able to build powerful barriers to entry and create significant long term value. If your startup will create barriers to entry, be the first to start setting them up because the value creation you will accrue will far outweigh additional potential dilution. Even if operating profitably, the entrepreneur that raises capital will be able to accelerate the creation of barriers to entry,  reduce the chance competition will be succesful, and capture a larger share of the opportunity value. Once the decision is to raise capital, the faster you can raise the capital the better. Setting an unrealistic valuation upfront and hoping to grow into it, or eventually find the investors that will pay the appropriate premium is effectively giving your competitors the opportunity to catch up to you and you risk letting them build barriers to entry against you. That is, you may loose 100% of the value of your startup to avoid giving up an extra 3-5% of your Startup. 

This appears self-serving advice, after all I am in the business of funding startups at the lowest reasonable value and expecting an exit at the highest possible value to make my LPs happy, but it is not. Escala.VC couldn’t possibly fund all the great companies that are or will be in Latin America, the market will determine the right valuation levels for each fund raising round. However, we have seen too many startups that lost momentum and competitive advantages while sitting around waiting to complete fund raising rounds at valuations far above market.

Think about what you want to optimize for.

Latin America startup Job openings / Oportunidades de trabajo en startups Latinas

Las startups Latino Americanas de nuestro portafolio estan contratando gente con caracter emprendedor, experiencia en el mundo digital y sin temor al fracaso. Descubre si alguna oportunidad es para ti aqui.

Posiciones disponibles en empresas de Escala.VC via Angel List

Our portfolio of Latin American startups are hiring entrepreneurial people with experience in the digital world and with no fear of failure. Discover if one of these job openings is suited for you.

Angel List Jobs Postings for Escala.VC portfolio

Investment Thesis: Technology adoption and middle class growth

Latin American consumers will evolve over the next 5-10 years, driven by an increase in technology penetration and raise in middle class affluence.  These changes will uncover unmet needs for the at-large population across multiple verticals, and agile start-ups are best positioned to take advantage of these opportunities.

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To date, the amount of seed capital available in Latin America has been constrained, to a large extent due to a very limited amount of previous success stories and the significant cost of scaling up businesses across the regions.

With the advent of low cost infrastructure (cloud computing) and higher penetration of internet media (social networks), growing businesses regionally or expanding to more developed markets has become a viable strategy for startups.

Combined with the advent of venture capital funds like Escala.vc that are focused on providing seed capital for entrepreneurs, we expect to develop a new batch of startups that have successful Latin American or global platforms, and are able to create and capture significantly more value than previous generations of entrepreneurs.

Technology adoption:

  • Mobile Broadband Connections to reach 500mm in 2017 from 100mm in 2012
  • Smartphone penetration to reach 45% in 2017, from 20% in 2012

Middle Class growth

  • Affluent and middle class expected to double to 100mm by 2020 from 2010