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A prescription for building a venture capital industry in Brazil

Brazil has slowly been opening its doors to venture capital since the mid 1990s. In the intervening years, the industry has become increasingly professional. Robert Binder of the Brazilian Venture Capital Association charts the rise of the industry in Brazil but argues that more must be done to ensure its future success.

The cornerstone for a venture capital industry in any country is that it provides a minimal degree of economic and political stability. Accordingly, the Real Plan, launched in 1994, gave Brazil such a framework. In 1995, following the initial success of the Real, the Cardoso government launched its privatisation programme and, as a result, many private equity funds were attracted into participating in the privatisation of the telecommunications and electric power segments of the economy. Brazil's investment bankers - very active, powerful and profitable during the hyper inflationary period - rose to the occasion and became leaders in most of the consortiums that were formed during this period. As a result, the level of Brazil's investment banking and private equity resources had attained an international calibre by 1997/1998. It was not until the internet explosion in 1998 and 1999, however, that professional venture capitalists began to seriously consider investments in Brazil. The ‘country risk' associated with Brazil, because of its huge national debt, could only warrant investments with enormously profitable expectations, which is exactly what occurred during the internet boom. The initial wave of opportunistic venture capitalists started coming to Brazil in late 1998 and continued, roughly, until early 2000. Just as quickly as they began coming in, however, they stopped.

Before 1994 the only real players in venture capital were the BNDES, Brazil's national development bank, and a fund administrator by the name of CRP, which operates in Brazil's better developed south. This fund constitutes a remarkable success story in itself because it somehow managed to survive and prosper in a practically impossible environment, with inflation reaching almost three per cent per day in 1990. CRP was founded in 1982 and in these last 20 years has made some 50 to 60 investments in start-ups and very early-stage companies. Today, this company is the leading promoter of regional funds and has become a steady partner for BNDES in its effort to foster a venture capital industry. The private equity component, on the other hand, has stalled with the discontinuation of the privatisation program.

In 1996 a group of Rio brokers founded an electronic exchange called SOMA, with the purpose of bringing Brazil's over the counter trading to a transparent market place. This market gained some importance during the previously mentioned privatisation process because it provided a vehicle for pricing and allowing fund participation in electric power and, principally, telecommunications spin-offs. With the curtailment of the privatisation program, however, it also stalled because it was unable to attract new listings and new investors. SOMA remains a good potential secondary market for venture capital and private equity IPO´s. It was recently bought out by Brazil's main exchange, the Bovespa, and the new owners have a professed intention to use it to attract new, early stage, smaller value listings. Bovespa intends SOMA to become a stepping-stone to the Novo Mercado, a Neur Market/AIM clone. In all of Latin America, SOMA has the distinction of being the single potential alternative for market-based exits.

In late 1999, just before the last venture capitalists arrived, a diverse group of investors began holding meetings to form an association, ostensibly to support SOMA in its effort to develop listings. This group was the embryo of the Brazilian Venture Capital Association, which was officially founded on June 26, 2000 with 26 members. Today the association has 64 members and in this short period of existence has become the recognised spokesman for the private equity and venture capital industry. The association is deeply involved in promoting changes in the regulatory framework and is today an active forum for discussing the major issues confronting the industry. It is also supplying services to its members such as implementing an industry library, an interactive home page, a technical bulletin and, most important, an industry survey, which is due in July, 2002. It is interesting to note that the association which was initially internet and foreign driven has become local and venture capital driven. The slack created by the curtailment of foreign investors has been entirely compensated by Brazilian government initiatives and active local, private support for these initiatives.   

In May of 2000, FINEP, an agency of the Ministry of Science and Technology, launched a program called INOVAR. This program is comprised of five different initiatives and the overall effect has been to revolutionise the venture capital industry in Brazil in these last two years. FINEP has created an excellent home page to provide essential information to all segments of the industry, has executed a venture forum programme throughout Brazil in seven different editions and which has brought to market more than 200 companies, has created a fund of funds for venture capitalists with important partners and a rigorous due diligence procedure, has established a network to generate deal flow, especially for technology companies and has started an educational program, which is the least visible and successful component  of INOVAR. The Ministry of Science and Technology, on its own, is proposing a new innovation law for Brazil's scientists and is trying to put to use fiscal incentives through the already existing informatics law. SEBRAE, a sort of Small Business Administration, has also become active in venture capital and is presently partnering effectively with FINEP and BNDES. SEBRAE has also been instrumental in providing funds for the establishment of a university linked incubator program. As a result, today Brazil has some 170 different incubators covering the country from north to south. From these examples, to name a few because there are more, we can see that the Brazilian government has become very active in promoting the venture capital component of the industry.

Given this overview, what could be next? Our prescription begins with the need for better coordination of all the activities that are taking place. If the overall effort is not better coordinated this could lead to enormous frustration at each level of the process and, ultimately, to the demise of the overall program. It is very clear that if, on one hand, we are enthused with all the activity, we are also very concerned with the lack of adequate results. At this point in time, nobody is yet profitable and a virtuous cycle is a long way from occurring. It would seem to us that the coordination effort should be assumed by a senior government agency, with enough substance and power to draw immediate respect from all the players. This agency should be shielded from political influence and be able to survive the government transition that is scheduled to occur in October of this year, even if the opposition party comes into office.

Secondly, we are proposing to BNDES the staging of a National Venture Capital Forum, where we could attempt to present an unbiased picture of the present state of our industry. At this forum we would try to produce as much material as possible on venture capital and private equity for distribution, to serve as a stimulus to knowledge improvement. The survey, which we previously mentioned, would be unveiled at this forum and from this point on all players would be advised that quarterly results will be disclosed, thus providing the necessary benchmarks for the industry. After the national forum, we believe that regional forums should be staged in Brazil's main cities, on a bimonthly basis, so as to spread the information throughout the country's vast expanse and potential. It is important to mention that a recent survey conducted by Babson College and the London School of Economics, the Global Entrepreneurship Monitor, places Brazil as one of the most entrepreneurial countries in their 29-country sample. Presently, 14 out of every 100 Brazilians are entrepreneurs of some sort, indicating that there is a lot of untapped potential in the hinterland. There is, however, a major problem to be faced in changing the country's cultural and business paradigm. The educational process, kicked off by these forums, will have to focus particularly on partnership structuring and governance, accounting procedures and transparency and tax education and reform. In this manner, start-ups will come into the market prepared for venture capital investment, which is not the case presently.

Thirdly, something has to be done quickly to develop seed capital financing. Angel investing, as known in the USA and Great Britain, is practically non-existent in Brazil. It will probably take some time before this starts to occur naturally. Consequently, we have to be able to develop schemes such as the ones existing in Germany and France, where guarantee funds and outright small business grants do the job. Our belief is that a study should be commissioned to define the most appropriate mechanism for bringing together private initiative and effective government support. The truth of the matter is that the incubator programme is beginning to churn out young companies with great expectations and  a negligible chance of receiving venture capital investments. The distance between the stage of development of these companies and normal venture capitalist prerequisites is too great.

Fourthly, since the amount of funds invested in private equity and venture capital by the pension funds is negligible, we need to develop a program to convince them of the necessity of doing so and provide them with a road map. The amount of funds available in this segment, more than $180bn, could fulfil the requirements for the entire industry, if a normal three to four per cent were invested in private equity. The barriers begin with the exorbitant interest rate to which they have access, but this should not deter us because they will have to progress to a natural asset/liability allocation model.

Fifthly, it is common knowledge that an efficient private equity and venture capital industry cannot exist without an active secondary market for securities. Despite representing only a small percentage of exits, it is clearly the market that drives this industry. Today, Bovespa is very conscious of the necessity of attracting wide popular support for the stock market and it has invested in a very ambitious program to curry that favour. Recently the various associations in the capital markets prepared an integrated restructuring plan. This is very encouraging for us but, like all plans, it does not focus on practical results. We have to work hard to produce, with our own resources, market exits to serve as commercials for the industry.

Last but not least, we have to continue to promote change in the regulatory framework and emphasize that if we are unable to develop a competitive environment in Brazil, we could eventually fail. The present fiscal structure taxes venture capital and private equity investments in the same bracket as investments in government securities. There are not as yet any specific laws dealing with private equity and the courts do not recognise this practice as any different from other commercial transactions. In order to obtain better results and provide incentives for private equity investments we have to be able to greatly improve the regulatory framework, from the beginning of the business cycle up to the end. The Association is working hard on all the issues, but is constrained by the lack of resources. It is presently lobbying for a new law to promote the establishment of risk capital firms, with the required fiscal incentives and regulatory freedom to attract all kinds of potential investors.

In sum, the weak chains in the link are the lack of seed capital, the absence of the pension funds in the process, the inability of the secondary markets to drive results and the lack of better knowledge regarding venture capital and private equity. Strong points are the enormous potential in the Brazilian economy, the innate entrepreneurial capacity of the people, a strong financial sector and the existence of all the building blocks required to develop the industry.

Copyright © 2002 Brazilian Venture Capital Association

Robert E Binder is the executive director of the Brazilian Venture Capital Association.

The Brazilian Venture Capital Association was founded on 26 March 2000, by 26 institutions, with the objective of implementing the venture capital and private equity industry in Brazil for the benefit of investors, entrepreneurs, professionals and the economy as a whole. Presently it has 64 members, among which 39 are private equity and venture capital funds. For more information please visit www.abcr-venture.com.br