3 New Challenges for Private Equity in Latam

Private equity has had an extremely complex 2022. This year, unlike in 2021, has seen a considerable drop in terms of risk bets in Latin America, despite the apparent strength of venture capital in the first six months of the year – with $5.4 billion deployed in 541 deals–.

The early years of the pandemic, counterintuitively, presented a golden opportunity for both investors and startups in Latin America. As the process of global digitization accelerated, venture capital gradually came into play to support industries with clear medium-term growth. Along with this, private equity lent itself as a suggestive strategy for hedge funds, companies and institutions to take control of booming businesses with a view to recovering the investment in considerably short times.

However, these trends have been reversed in 2022, which presents complex economic contexts. Besides the liquid investments affected by volatility, companies and investors must consider the time factor. For example, according to CrunchBase data, the first two quarters of this year represented a drop in venture capital in Latin America of almost 70 percent compared to the same period last year. 

These are scenarios that present new challenges for investment capital for the end of the next quarter and the beginning of 2023. What, then, are the aspects that we need to consider? How can general partners anticipate market developments, regulatory changes, interest rates or forex variations?

The first step in making the right decision is searching for information and looking at the big picture. Now, although the international context is important and we can learn a lot from European or even American strategies, it is also necessary to ground our actions according to the local context. In Latin America, it is not enough for companies to be resilient.  

In this context, for Maquia Capital, these are the three major challenges facing private equity in the region for the remainder of the year:

Inflation That Won't Let Up

The main challenge for private equity in Latin America today is inflation. We are seeing inflationary pressures that we have not seen in decades. For example, what we are seeing in the US is quickly beginning to affect other countries, such as Mexico, Colombia and Brazil, particularly in an ecosystem (such as the case of startups dedicated to technology and innovation) that depends on the strength and accelerated growth projections of companies.

Inflation at an annual rate in the US is currently at 8.26 percent (the lowest in four months, but 3 percent above the levels observed in 2021); while in Mexico, according to the National Consumer Price Index of the National Institute of Statistics and Geography (INEGI), it is at 8.6 percent, showing an upward trend that does not seem to be receding yet. 

Considering the above, we must be attentive to the services that have the highest increases and identify the inflation rate to establish a minimum rate of return. From this, you can start looking for some alternatives.

The Specter of a Recession 

The problem behind too high inflation, sustained over a long period of time, is that it presents contractions in the growth of an economy. As prices rise, circulating capital becomes wary, particularly for fear that everything will become more expensive at the same time that money loses its value. This logic and the accompanying dynamics are not foreign to private equity, whose acquisition and investment models depend on low interest rates to be attractive.

The current challenge for private equity, faced with the specter of a possible recession that will last until 2023, is to balance high interest rates with markets at volatile breakeven points. In the face of such a scenario, private equity's priority will have to be to find interesting and innovative projects on which to bet. The key is to reassess the costs and then analyze the profit margins that could occur in the current economic environment.

Brakes in Disruptive Sectors

In line with the previous point, it should be taken into consideration that in times of crisis, industries that bet on development and innovation can be stunned. Whether due to lack of market interest or low investment, startups can see their operations and, in that sense, their future compromised. 

It is at such times that investment capital can serve to catapult entire industries, even during complicated scenarios. We cannot forget that, as the classic saying goes, necessity is the mother of invention. Market sectors that previously seemed unreachable can become accessible if your company finds the right opportunity. For this reason, it is important to be open to innovation and also to the adaptation that this implies.

The Startups’ Competitive Advantage

To reiterate, the current context has changed the rules of the game. Inflationary pressure in North and Latin America and a probable recession on the horizon have made VC funds look for particular characteristics of the startups they will invest their money in. Some of these elements go far beyond profitability.

Maquia Capital Group has GC Capital Fund, a venture capital fund that invests in high-impact ventures that have the potential to transform lives and change the world. Its portfolio companies include Tu Cantón (now Tu Habi), the most recognized and efficient proptech in Latin America; Rocket.la, the financial partner platform for the Mexican market; SkyAlert, a seismic alarm system that allows the user to be prepared up to 120 seconds in advance of an earthquake; and Pinion Education, which is transforming education through design thinking.

All these companies have a common factor: they are projects that generate tangible benefits for their users. Maquia looks for projects that are truly innovative and have a real impact. The company operates under a unique methodology called Programa Vela. This program is aligned with the main codes of best practices at a national and international level and with the requirements of the leading rating companies, the Mexican Stock Exchange and the New York Stock Exchange, which allow for outstanding results compared to the average investment fund.

According to a report by the Capgemini Research Institute, 79 percent of consumers have been modifying their purchasing preferences based on a company's social responsibility, inclusiveness, or environmental impact for some years. These trends have also become part of the search criteria for VC funds to invest in a startup today.