Andrew Endicott
Co-Founder and GP
Gilgamesh Ventures
Expert Contributor

An Ecosystem in the Making

By Andrew Endicott | Thu, 06/30/2022 - 10:00

Equity markets are in turmoil today – and Mexico is no exception. Today’s contagion is spanning sectors and international borders, and the coming months will test the resilience of the Mexican tech ecosystem, both small and large. In some ways, this simply represents the typical trend – that “when the US sneezes, Mexico catches a cold.”  But there’s more going on than that – beyond the obvious run-up in equity valuations globally in the last 24 months – and there’s a good chance that things could be meaningfully different today than in prior business cycles for technology and other fast-growing industries in Mexico and adjacent markets.

The technology ecosystem in Mexico is young. Building on earlier decades of development (with firms such as Softtek and Kio Networks in the 1990s and 2000s), today’s technology companies are better capitalized, faster growing and more global in reach than previous vintages. The last five years has delivered an explosion of companies spanning from e-commerce to fintech to healthtech, driven by several meaningful forces. There has been an emergence of permanent, sophisticated capital, ranging from Nazca, Angel Ventures, ALLVP and Wollef in Mexico to Kaszek, QED, and Monashees beyond. This has been accompanied by cohorts of strong companies reaching increasing levels of scale, such as Clip, Kavak, Konfio, Flink, Xepelin, and Credijusto – these businesses are generating meaningful revenue and truly reshaping their markets with disruptive technology. In addition to strong businesses, deep pools of talent have emerged, particularly in Mexico City, and growing communities of early-stage founders and angel investors are coalescing to support the next batch of startups in Mexico that promise bold visions for revolutionizing big markets.

This steady progression over time follows the pattern that established the bedrock that now underlies Silicon Valley. But it also remains the case that not everything in Mexico’s startup ecosystem has reached full maturity. The bulk of growth and development above has occurred within early- and mid-stage companies. Despite meaningful growth and progress, the bulk of companies (with some notable exceptions) are still a number of years away from plausible public-listing or successful exit, which require that certain lofty milestones are met – milestones which become even harder to meet in difficult economic conditions like the ones emerging today. Furthermore, most venture capital funds active in Mexico focus on early-stage investment. The universe of later-stage investors and executives is still relatively small. In this way, Mexico’s tech ecosystem still has mileage to cover in terms of maturity, and economic cycles will test the resilience of the system while it’s under development. 

But there are positive signs on the horizon regarding the next steps of development, notwithstanding and despite current economic turmoil globally. The largest late-stage investors that have been historically active in Mexico, including General Atlantic, SoftBank, Accel and Prosus, appear to be doubling down on their focus on the region, although such resolve will be meaningfully tested in bearish conditions. They have been, furthermore, supplemented by a new cadre of large, serious foreign funds, including a16z, TCV, Bond, Bain Capital, and Avenir.  Indeed, the resilience of Mexico’s technology ecosystem through uncertain times like today will depend on the strategic commitment of these domestic and foreign investors, which are necessary to fuel growth, in addition to the continued emergence of profitable, scaled businesses and seasoned executives to run them. Each is required for success but none happens automatically. But it should also be noted that challenging circumstances themselves are indeed often what supercharges development of great companies and great executives – one need look no farther than the tribulations of Loudcloud or PayPal in the US in the 2000s to find the emergence of some of the defining collections of future founders, investors and executives who would drive innovation and company-building there for the next two decades. Adversity is perhaps required for excellence. 

But what do these later-stage investors (plus executives and founders) need in order to remain committed to the region? Of course, they need returns eventually, and returns depend on quality exits on a reasonable timetable. And how can companies create those here? Exits in Latin America have historically come via acquisition, and acquisitions come in two types: disappointing and successful, the former of which is more common. Disappointing acquisitions happen in various ways (ranging from acquihires to bankruptcy-sales to low valuations on mediocre companies). But a well-capitalized buyer with a strong motivation to pay up is always required for a successful acquisition – there’s no substitute. It usually requires a public company, a very large private company, or a uniquely aggressive private equity company, the latter of which is relatively uncommon in the venture-backed space. And of course, tough financial markets make outstanding exits via acquisition harder to achieve.  Reaching an IPO is even rarer; indeed, the Mexican tech community has yet to chart a reliable path to a public offering in the last few decades, which for most practical purposes requires listing on one of the well-known global exchanges, such as NYSE or NASDAQ, which have relatively rigorous listing standards. All of this is hard to do.

So what is required to reach these positive outcomes, all of which must occur in the coming years to maintain the health of the ecosystem and lay the groundwork for future entrepreneurship in Mexico? The instability in local and global equity markets underscores the necessity of building sustainable businesses, specifically those that can survive independently whether capital is available or not. Of course, this is easier said than done, and reaching cash flow positive is unrealistic for most enterprises prior to reaching a certain level of scale and maturity. But today’s best entrepreneurs absolutely can and hopefully will use tougher conditions today to seize opportunities and build teams that are resilient and enterprises that can stand the test of time. 

There are silver linings to the turmoil today. Despite dips in valuations, the bumper crop of public IPOs from Latin America – particularly in fintech with NuBank and dLocal leading the way – have blazed an incredible trail for all companies in the broader region.  Early investors in those companies – both institutions and individuals – have been amply rewarded and are plowing their earnings back into new ventures and investment funds in the region, with Mexico being a major beneficiary. These same successful firms also stand to become the major acquirers that a healthy startup ecosystem must have to generate exits and attract major investor interest. Although the IPO window today is effectively closed for the coming 12-18 months or longer – Ebanx and Hotmart have reportedly shelved their plans indefinitely – valuations will eventually recover and multiples will improve. It is only a matter of time. And the maturing technology companies today that are building sustainable businesses will be prepared to capitalize when it reopens, along with future crops of companies that are just being forged in challenging yet galvanizing conditions today. As we see it, investors and entrepreneurs that focus on the fundamentals and seize the opportunity to build great businesses in the current moment indeed stand to generate huge outcomes when markets recover in the not-to-distant future, in Mexico and beyond. 

Photo by:   Andrew Endicott