As the Hype Ends, Brazil's Tech Startup Investment Landscape is Changing for the Better

Brazil's startups are praised and celebrated: its young entrepreneurial class has eclipsed many countries in the region, producing one unicorn after another.

But despite the hype around the country's emerging startup heaven, the current forecast for its future seems cloudy. Onlyfive startups went for IPO in the technology sector in local markets. And if this wasn’t enough bad news, Brazil's most popular star, Nubank, recently left the Brazilian IPO field to focus entirely on the American market. As markets increasingly prefer profitability over growth, Nubank decided to cut the unnecessary costs that the Brazilian market tends to incur.

In addition, technology companies are still not very popular with domestic investors, which is reflected in low share prices after IPO. These investors prioritizetraditional sectors such as energy, pharmaceuticals, and banking, making the Brazilian entrepreneurial ecosystem highly dependent on foreign investment.

All of this seems to be part of a more significant clash between the business lessons taught to startups in universities and accelerator programs and the interests of the most active venture capitalists in the region: growth vs. profitability. So far, many local companies have focused on profitability, but foreign capital is still poised for growth.

Luckily, there is also another side to the coin. In Brazil, there is a growing incentive for angel investors and value-based capital funds to look for startups built on solid economic units and that have the chance to become profitable sooner or later. I spoke to__Lúcio Cordeiro__, Director of FGV Ventures and Startup Growth Strategist, and Léonardo Jianoti, General Partner of the capital fund Honey Island, and Carlos Klein, Angel Investor and Board Member of Ventiur, to find out more.

The hype is over, and that’s not a bad sign

There's no hiding the truth: Funding is increasingly challenging to come by, especially in emerging markets like Brazil. As capital markets have been hit by the downturn, domestic and international investors are much more risk-averse than they used to be. On top of that, the high interest rates in Brazil (13.25%) are not exactly conducive to entrepreneurial investment and also prevent startups from choosing debt to grow their business.

“What we notice, mainly, is that, as there is a market adjustment in the quotation of companies. Startups are companies that will deliver a lot of return in the long term. When we evaluate them in the present time, we will asses their present value. If the interest rate is too high, we have to increase the risk rate, and this decreases the present value of the startup companies. So, every time the interest rate goes up, we have a problem managing the startups because their valuation will go down. This is the current problem of the market,” explains Carlos Klein.

It seems that the previous unicorn wonderland in Brazil, where plenty of startups received massive investments and catapulted themselves straight into the world’s capital markets within a few funding rounds, seems much like a myth these days.

The poor performance of Brazilian companies on the local and international markets that went public last year didn't exactly boost demand. According to data compiled by Bloomberg, share prices of 2021 IPOs fell an average of 38% through June 22 of this year. As a result, companies such as Mobly SA, Brisanet Participacoes SA, and GetNinjas SA are trading more than 80% below their issue price.

"The high valuations that drove the unicorns and are now unable to get IPO are taking their toll on now emerging startups,” explained Lúcio Cordeiro, Director of FGV Ventures, the accelerator arm of the country’s most famous private business university Fundação Getulio Vargas.

"Up until recently, startups have been funded in markets that aren't actually big, with no product-market fit or clear structure to achieve profitability. Right now, we don't have a VC market capable of supporting companies like Uber, or We Work with billions of dollars without a clear path to profitability, let alone revenue," he added.

What’s next for the Brazilian venture market?

Despite the current investment fatigue, however, there are still plenty of motivations for investors to fund innovative companies.

According to Léonardo Jianoti, General Partner of Honey Island, a Venture Capital Fund in Brazil, many locally and regionally active investment funds believe in helping boost the local economy by supporting profitable and solution-oriented startups.

"Between 2020 and 2021, many companies could be valued at astronomical amounts (that will never achieve profitability). But, today, we're actually seeing a positive trend: investment is shifting to sustainable growth with real market fundamentals," Léonardo explained.

Lucio also highlights that "early-stage deals are a good market right now. Especially when it comes to those businesses that have market validation and are already generating revenue but may not be profitable just yet. They convince investors if they have broken even, show a revenue growth pattern, and can demonstrate predictable revenue streams."

How innovators can keep the momentum

According to the experts surveyed, recessions like the current one cast a harsh light on the product-market fit of startups. In fact, a downturn doesn't have to be a disadvantage at all if production matches demand. It's a good time to test, attract small amounts of investment from local funds, and work on developing technology. And it also seems to be a great time to prepare for future scaling.

“Startup owners are waiting right now. They don't want valuations to go down. If they wait a little longer, they'll probably have investments at the level they expect,” according to Léonardo.

For growth-oriented startups, freemium models and test programs can attract and retain customers. Those considering profitability as the core of their business needs to learn how to invest their revenue wisely so that it leads to more growth. This helps to practice efficiency and frugality, which in turn will make an interesting argument for future funding rounds.

“In moments like we're living today, it's more common to see investments in solutions that improve existing processes. There’s always the right timing for a solution. If the idea is too far ahead, law, regulations, and society are simply not ready to make beneficial use of it,” Léonardo added.

It seems that Brazilian startups are prepared for what is to come. After all, the current slowdown in funding is not a bad sign for those companies that are striving for a sustainable business model and whose solution is not just a search for quick cash. However, it is a crossroads. Because a large part of the Brazilian startup community will reorient itself and take a path where going public with a profitable startup is not just a possibility but a shared vision among key stakeholders.