The Scoop

“¡Mexicanos!, ¡Vivan los héroes que nos dieron patria!, ¡Viva Hidalgo!, ¡Viva Morelos!, ¡Viva Josefa Ortiz de Domínguez!, ¡Viva Allende!, ¡Viva Aldama! ¡Viva Matamoros!, ¡Viva la independencia nacional!, ¡Viva México! ¡Viva México! ¡Viva México!”

In less than a month from today, on the evening of September 15^th, just before the clock strikes twelve, millions of Mexicans near and far will gather with their loved ones to celebrate their country’s independence from colonial rule. Just as Miguel Hidalgo y Costilla marched on the streets of Dolores Hidalgo, Guanajuato some 212 years ago, Mexicans will march through their communities (both figuratively and literally), celebrating their right to determine their own fate as a sovereign nation. As they do so, many will internalize the above words of the Father of Independence which is now famously known as “el Grito”.

What very few people know about Mexican Independence Day, is that it doesn’t commemorate the end of the war for independence, but rather Miguel Hidalgo y Costilla’s cry for his fellow citizens to join him in the fight to set their country free. In other words, it represents the beginning of a nation’s struggle to achieve prosperity not for a few but for all that call her home.

The venture ecosystem in Mexico is in a similar moment in time. In 2021, VC investments increased fourfold to $5.5 billion across 228 deals while minting four new Mexican unicorns. While the pace of investing has decreased in H1 2022 due to a global slowdown in venture spending, the expectation is for mid-term and long-term trendlines to continue upward. By this point, we all know what’s driving this growth: increased emphasis on technical talent, 1^st generation founders and startup employees breaking off to start their own ventures, downstream capital inflows from the US market, local LPs allocating capital to an increasing number of new fund managers, foreign investors looking for new frontier markets to achieve outsized returns, early signs of an exit market, and the list goes on and on. However, what we often fail to talk about, is what’s missing to make the Mexican VC market even more prosperous, not for a select few but for the majority of those that are participants.

During the 2016 – 2020 time frame, many of us observed funding gaps at the pre-seed / seed stage as well as growth equity stages. Because of increased competition for Series A deals, we subsequently saw later stage funds going much earlier as well as the creation of new funds who wanted to capitalize on the lack of institutional money to fund companies to reach product-market-fit. At the same time, seasoned LATAM entrepreneurs with newly found liquidity started to support 2^nd generation of founders through angel investments. This influx of capital to the earlier stage of the market helped institutionalize investing and was more equipped to provide the hands-on support that these companies needed. Fast forward some six years later, many would argue that the supply-demand equation at the pre-seed / seed stage has reached closer to equilibrium while the gap at growth equity has potentially expanded given the wider funnel that has been created. Given the very limited availability of Mexican growth equity investors, startups typically have to look to the north for expansion capital. As we are seeing in today’s climate, and have observed in other downcycles, while important and should be encouraged, foreign direct investment is often the first capital to dry up as they flee to “safer” or rather more familiar territories. When we look at other emerging markets such as India, Southeast Asia, or even to a certain extent Brazil, one thing that these regions have in common is the ability to fund a significant number of their startups with local capital from ideation to exit. Mexico is in dire need of increased local growth equity investment capital to not only create a level of stability which keeps investors excited about the potential of this market, but to also encourage competition in the startup ecosystem.

Access to venture debt is another opportunity that needs to be further unlocked. B2B marketplaces, and e-logistics companies are just two examples of models that still struggle to raise debt financing to finance working capital. In the US, venture debt represents roughly 8% of the amount allocated to venture equity investments. In LATAM, that number is closer to 1%. Venture debt could have many advantages in the Mexican ecosystem, it would allow companies to quickly fill funding gaps, build out their thesis to better position them to raise subsequent equity financing, and could maximize future equity valuations by helping companies to raise non-dilutive capital to achieve new milestones.

We at H20 believe that we are at the stage where startups are creating businesses to solve the low-hanging fruit problems. This is expected of any nascent venture ecosystem. As the market continues to evolve, we will hopefully see a diversity of new business models being funded and an increase in SaaS companies as founders gravitate towards solving problems encountered by the 1^st and 2^nd generation of tech companies. To propel this advancement, we will need to see more specialized funds with expertise in bespoke themes and models. On the founder side, we will need increased incentives for them to focus on new problems and not flock towards already crowded sectors.

Finally, we hope to see increased exit opportunities. As of today, we have all bought into the promise of monetizing on venture capital, but very few investors’ capital has actually been returned. Part of this is given the gestation period of venture, part of it is because of limited local M&A activity and a closed local IPO market. If we look once again to Brazil as inspiration, we have observed that local stock exchanges present a real opportunity for companies to seek liquidity at $50-200 million valuations (a strong return threshold for pre-seed investors). We also see that Brazilian companies are beginning to become acquisitive as they look to technology M&A as a way to acquire innovation. While it’s harder to tell whether regulation will change to open the Mexican IPO market, we are beginning to see signs of hope regarding the M&A opportunity (e.g. Cornershop’s sale to Uber, Urbvan’s acquisition by Swvl, and TrueHome’s sale to Loft). The increasing number of corporate venture firms of leading Mexican conglomerates is also a step in the right direction as it shows that incumbents are beginning to seek strong partnerships with technology companies.

As the Mexican venture ecosystem continues to evolve, there will undoubtedly be new challenges for us to conquer in order to reach the next level of the sector’s development. It’s our hope that at some point, the necessity to increase local growth capital and venture debt, a push to diversify themes being funded, and a more vibrant exit environment, will be needs of the past. However, we hope that the spirit of Miguel Hidalgo will never die and that we all will remain hungry to achieve prosperity throughout the Mexican venture ecosystem.

THE SCOOP