How Brazil’s Newly Elected Government Will Affect Its Bustling Startup Ecosystem

On October 30th, in a close run-off, Brazilian voters decided to push the country towards a new direction: President Luiz Inacio Lula da Silva (Lula) of the Workers' Party (PT, Partido dos Trabalhadores) was elected to lead the executive power for the next four years.

After years of economic turmoil, rising energy prices, and the pandemic that cost hundreds of thousands of lives, Brazil is facing a set of challenges that have prompted many Brazilians to head to the ballot box and demand change.

But an old dispute between market liberalism and state intervention divides the country—especially now that Brazil has been experiencing massive innovation growth.

In fact, throughout the past few years, Brazil’s young founder generation has made a name for itself with record amounts of investments (in 2021, there were a total of $10 billion) in more than 12,000 active startups.

Driven by hope and flaring entrepreneurial spirit, many of these minds want to overcome grievances and social inequalities through technological innovation.

Now, with a new political wind blowing through Brazil, we need to ask: What impact might Lula's election have on the buzzing startup ecosystem?

Let's look at what changes we can expect in terms of economics, financial regulations, diversity, and research and development for the emerging class of young entrepreneurs.

Time to Resolve the Ancient Market Dispute?

There’s no doubt: Brazil is an economic giant with massive growth potential. The South American nation comprises the world's seventh-largest economy and is intertwined in international economic relations with most parts of the world, especially the United States, Europe, and Asia.

For that matter, Brazil is the primary destination of foreign direct investments in South America and attracts most companies looking to expand in the region.

But despite the tremendous market opportunities, Brazil, much like the rest of the world, has been feeling the effects of a stagnant economy.

Even more so, the current slowdown in funding activity makes it difficult for today's young entrepreneurs even to gain a foothold in the $2.4 trillion economy.

As the economy has been fluctuating between periods of growth and recession for ten years now, the country's gross domestic product only grew by an average of only 0.15% per year in the ten years to the end of 2021.

Given the unfriendly economic climate, predicting the new government's financial targets and policies is vital. Luis Felipe Pinto Valfre, Lawyer for Startups and Venture Capital, and Ambassador of the Startups Association Abstartups, has been observing the entrepreneurship and startup ecosystem over the past 15 years.

“Lula is in favor of state intervention. And that, of course, can hinder Brazilian entrepreneurship,” he explained.

“It is important to recognize that Lula does oppose innovation because otherwise, the government would lose overall social support. However, what we saw during the last few years, these great turnouts for startups and investors could slow down,” Luis Felipe added.

So far, the composition of Lula's economic ministry, which will be massively influencing the new term, has yet to be decided.

Favored candidates, including former São Paulo Governor Geraldo Alckmin, all argue for free markets, economic growth, and international trade, even though to a lesser extent than previous economic minister Paulo Guedes.

In addition, on several occasions, Lula has shown signs of following a more liberal policy than the last time he was in office. For example, in September 2022, he met with more than 100 Brazilian business people, discussing the country's future of entrepreneurship.

During his campaign, Lula also received support from the liberal Henrique Meirelles, former president of the central bank and minister of economy, in 2016 and 2017.

“Lula should also be credited with paying enormous attention to supporting Brazil's middle class, with a particular focus on boosting the population's purchasing power,” explained Lucio Cordero in an interview.

He’s the Director of FGV Ventures, a leading accelerator of Brazil’s number one Business School, FGV.

"According to Lula, the economy needs consumption. And this is the market the startup ecosystem needs to grow," Lúcio highlighted.

Generally, consumption is related to external and macroeconomic conditions and restricted to the current recession and high-interest rates.

Still, Lula's well-known redistributive policies and social programs (such as Bolsa Familia) aim to create a resilient middle class, which will fuel consumer spending.

During his recent political campaign, Lula announced that in addition to maintaining the current social program that pays low-income Brazilian families 600 reais ($112) in cash, he would increase the amount by 150 reais per child under six years.

Boosting the internal market and growing the middle class seem to be positive signs for Brazil’s startup entrepreneurs. On top, however, startups need a running ground to build a thriving business model. That’s why fiscal and tax policy is another disputed area to examine.

It’s the Economy, Lula!

Despite the current economic slowdown and rising inflation, Brazil remains attractive to local and international investors.

According to Finance Yahoo, Brazil's Ibovespa index has been up 7.1% over the past year, compared to the U.S. S&P 500 index, which fell 23%.

On top, Brazil's central bank has been arguably the most restrictive in the world over the past 18 months, with 12 rate hikes (currently at 13.75%) since March 2021.

However, there’s a problem with the current interest rate spike, as it negatively impacts borrowers. Many entrepreneurs desperately need funding to scale their startups, but state bonds are currently more attractive to risk-averse investors.

This starkly contrasts last year’s investment climate of 760 rounds of financing and $10 billion in investments in Brazil in 2021. In Q2 and Q3 of 2022, the investment amounts and quantity of deals have decreased massively.

"What startups need more than anything right now is funding. Brazil is idea-rich, technologically-savvy, and has the necessary infrastructure and the market potential to be extremely attractive to investors and founders," explained Lúcio Cordero.

According to Léonardo Jianoti, General Partner of Honey Island, Lula’s “expansionist policies are driven by increasing money supply, mainly through credit enablement. This is a trademark of Lula's management, which may return in case of his comeback. The higher liquidity in this possible scenario tends to ease startup fundraising and create a favorable environment – an essential strategy for startup models underpinned by intensive capital and a fast growth pace.”

Léonardo also highlighted that regardless of the government’s plans, there has been a gradual fall in the policy interest rate since the last decision made by the Central Bank to keep it at 13.75%.

This will likely indicate that the peak of the monetary policy has been reached and might heat up the winter in the venture capital environment.

Will Investor-Friendly Regulations Face a Showdown?

Brazil’s bureaucratic and complex financial regulations have been immense difficulties for innovation and investment in the past.

To simplify investments, the Brazilian Securities and Exchange Commission (Comissão de Valores Mobiliários or CVM) has recently made several updates and changes to equity crowdfunding and investor tax regulations.

For example, it is easier today for smaller companies to reach higher total caps, which allows startups to attract more investors and move from pre-seed and seed funding rounds to Series A funding rounds.

The regulation tripled the funding cap from $1 million to $3 million per offer. In addition, CVM raised the annual gross revenue limit for startups from $12 million to $16 million.

“Throughout the past three to four years, we’ve seen continuous improvement for the innovation ecosystem, such as tax liberations impacting investors and setting new incentives,” investment lawyer Luiz highlighted.

“In addition, the insurances and security commissions (CVM) have been working on enhancing investment security and liability. However, the world is changing at a pace, and we still need to do more to be able to create new goods, new solutions, and new business models.”

“Startups' founders focus on projects that unlock value creation in their value proposition, focusing mainly on cash optimization. At the same time, it allows the development of the country’s innovation ecosystem as a whole. Creation of technological parks, tax incentives to entrepreneurs, and minimization of bureaucracy for setting up new businesses are certainly major concerns of their group and will signalize the upcoming government's favorable or unfavorable position to the rise of technology companies,” explained Leónardo.

In addition, Lula is ready to ramp up the tax system in Brazil and make more affluent people pay more.

However, according to Luis Felipe, low corporate tax will help fuel growth, so Lula’s intention to a socially just tributary system focused on welfare distribution could negatively affect this positive climate for business-making. The ancient market dispute, it seems, will remain.

A Positive Sign For Diversity and Inclusion

An essential component of an innovative and successful ecosystem is diversity and the participation of women. And it is precisely here that the country still has a lot of hurdles to overcome.

For example, only 4.7% of Brazilian startups were founded exclusively by women, almost 20 times less than those with exclusively male founders. And while 56% of Brazilians are black, only 19.1% of Brazilian startup founders belong to this demographic.

It’s clear that in a country with such a high level of distorted representation of minorities in business, policy change is needed to promote diversity.

Lula is known among the Brazilian population for advocating for women's employment and education. He has also improved access to education, employment, and equality for black and indigenous people.

During his tenure in 2003, two critical organizations were created in the federal government: the Special Secretariat for Women's Policies and the Special Secretariat for the Promotion of Racial Equality. In addition, several other initiatives, like social welfare policies, helped drive inclusion.

Although this sounds like a positive outlook, private investors, founders, entrepreneurs, and politicians must not lose sight of the efforts that have already begun.

After all, in a multi-ethnic and multicultural country like Brazil, indigenous people’s and Afrobrazilians’ participation in entrepreneurship is a societal effort and will require all hands on deck.

Startups Will Depend on Transforming Research and Development Efforts

"One of the biggest burdens startup founders have been complaining about the past years is a lack of skilled workers. Brazil needs enormous investment in science and giving people access to education," Lúcio argued.

Education, however, is not an easy problem to solve within a single term. In addition, not only is there a shortage of workers in the technology sector, but training opportunities are also outdated—and, often, limited.

This is where Lúcio has seen a positive development with the upcoming government. The number of public and private universities supported during Lula's last candidacy has led to a paradigm shift in Brazil's education landscape.

Now, during his political campaign for the presidency, Lula officially promised the digitization of the sector and new app-employee legislation. He also announced plans to strengthen the state-owned education program Fies by granting new loans to students.

While universities need programs to attract more students, startups need to offer an environment with competitive conditions and employment opportunities. And talent training must become a priority.

In this context, Luis Felipe highlighted that investing state funds into education and universities is not merely enough to spur innovation.

“We need higher integration between universities and the market. The research should explore solutions from universities to be then applied in the market. The universities need to transform with the time and spirit: Not just researchers to create new theories but applicability to be useful to the market to improve the whole ecosystem through this combination,” he highlighted.

This, in turn, creates the need for private and public authorities to reflect on the Brazilian ecosystem and build internal growth initiatives, for example, in the form of scholarships, technical professional and continuing education, or a stronger link between public and private education.

After All, Is Lula a Good or a Bad Sign For Brazil’s Startup Culture?

There’s no doubt: the new political wind brought by Lula's government will influence Brazil's startup ecosystem. Although many precise policy decisions are yet to be made, we can predict both positive and negative signs regarding innovation and investment.

Whereas slower regulations might hinder the growth of private investments, a focus on diversity and education will help meet the skills and inclusion gap the country has been suffering.

But it's also important to recognize that politics is merely a reflection of Brazilian society.

"Brazil is already on the path of giving a central role to business and young entrepreneurship. We see in technology and innovation an opportunity to drive growth, and this social movement will remain strong regardless of the government," said Luis Felipe, ending our interview on an optimistic note.