The 4 reasons why it is difficult for entrepreneurs from Central America to have access to Venture Capitalists

18 2017 September
Authors: Felipe Symmes, Carlos Martínez, Urs P. Jäger, Ryan Schill

If you ask an entrepreneur, What is the most urgent need you have to grow your business?In 90% of the cases, the answer would be: “financial resources”. Central America has plenty of entrepreneurs with the desire and potential to grow. What they lack is access to financial resources to implement their ideas on the scale they dream of.

Most of the economic resources invested in ventures do not come from the region. One might hastily conclude that the reason would be that there is not enough money in Central American countries to invest in risky initiatives. However, this is not so. In the region there are a large amount of resources, especially in families with a business tradition, but for some reason, they are not investing in ventures with higher degrees of risk.

For the sake of the development of the region we need to change this situation and help entrepreneurs to have access to investors. But how to do it?

Venture Capitalists (VC) as a good investment instrument in startups

A fundamental component of entrepreneurship ecosystems are venture capital investors or English Venture Capitalists (VCs). This type of investor provides financing for new ventures in the growth phase in exchange for a percentage of the company's equity and, in general, a position with voting rights on the Board of Directors. Given the high risk of bankruptcy during the growth stage, VCs require high rates of return for their investment portfolio to be competitive with stock market indices.

VCs are expert risk managers. For this reason, they are capable of raising financial resources from people who trust their expertise. With these resources they build their portfolio made up of different investment funds, each with specific focuses and criteria.

Central America has a low position in the global VC ranking

Since 2006, IESE Business School academics have prepared a VC attraction index.[1] This index is calculated from those factors of the countries that affect the attraction of VCs, such as: the level of economic activity, size and liquidity of capital markets, tax level, investor protection through good practices of corporate governance, social and human capital, and level of entrepreneurial culture. Given the variables of the aforementioned index, it is not surprising that the first positions are occupied by developed economies and with dynamic entrepreneurial ecosystems such as the United States, United Kingdom, Canada and Singapore. In Latin America, Chile (position 27 out of 125), Colombia (36) and Mexico (39) stand out. Further back are the Central American countries evaluated: Panama (78), El Salvador (91), Guatemala (103) and Nicaragua (111).

Reasons why it is difficult for Central American entrepreneurs to have access to investors

The Latin American Center for Entrepreneur of INCAE Business School has carried out a study on the VC industry in Central America. This study provides some clues that explain the lagging positions occupied by the majority of Central American countries[2].

1. VCs in Central America face greater complexity in their work, since they must not only seek the ventures to finance but also assume an active role in creating the legal and regulatory framework that allows their operation.

2. VCs are often forced to invest in companies of the powerful families that finance their investment portfolios. In other words, families use the expertise of VCs to increase their family wealth. It is very likely that when deciding on investments for their VCs, these families use their family relationships to invest in people they know and less the risk logic of VCs.

3. There is a culture that VCs should not interfere with entrepreneurship. This culture is even more pronounced when the venture is run by a powerful family.

4. There are very few exit opportunities given the region's nascent capital markets.

Need to create more knowledge about the VC market in Central America

The aforementioned study provides some clues at a general level to explain the lag of most Latin American countries in the ranking prepared by IESE. However, we need much more information before we can offer recommendations that help not only bring more VCs to the region but also develop entrepreneurship ecosystems in Central American countries.

This is one of the objectives of the recently formed Latin American Center for Entrepreneurs from INCAE Business School. In addition to influencing public policies through research focused on the region, the center seeks to have a more direct role in the training of entrepreneurs and the promotion of the entrepreneurial ecosystem through INCAE graduates.

[2] See also Bruton, GD, Ahlstrom, D., & Puky, T. (2009). Institutional differences and the development of entrepreneurial ventures: A comparison of the venture capital industries in Latin America and Asia. Journal of International Business Studies40