Startups

Softbank investment conditions cause discomfort in Latin America

People related to the venture capital sector expressed some practices considered abusive.

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In Latin America, venture capital funds are developing. Last year they accounted for only two billion dollars, a small portion compared to the 50 billion dollars that move worldwide. 

The contribution of risk capital to the Gross Domestic Product (GDP) is also minimal in the region. In Latin American countries, it makes up only 0.04% of GDP, ten times less than in the United States, where it is 0.43%, and eight times less than in China, where it represents 0.33%, according to a report by McKinsey & Company.

The creation of a Softbank’s fund with five billion dollars exclusive to Latin America in 2019 represented a revolution for startups in the region. However, more than six months after the entry of the Japanese conglomerate, not everyone is pleased with how this investment fund operated by Marcelo Claure works. And in Latin America, Softbank has imposed different rules for the region.

Softbank’s investments have risen doubts

In recent months, financial analysts have questioned the talent of the Japanese conglomerate for risk investments. The WeWork case has been the cause of this crisis of confidence within the company.

From the beginning, several investors questioned that WeWork’s business model was innovative and suspected that the company was only one company plus real estate. Despite these doubts, WeWork was preparing to go out to the public until a scandal halted the company’s ambitious plans. Besides being just another real estate company, WeWork lacked a long-term sustainable model and was running out of funds.

Adam Neumann caused the insolvency of his own company. The WeWork founder rented buildings that were in his name to the startup while placing family and friends in key positions. This behavior did not go unnoticed, especially since it was an eccentric entrepreneur who did not pity showing off his excesses.

Neumann’s mishandling caused many to consider that Softbank gave too much freedom to the managers of the startups that it helped finance. Also, plans to create a more ambitious risk fund than the scandal now pauses its Vision Fund.

In Latin America, Softbank tells a different story.

Softbank announced its investment fund for Latin America since the beginning of years. In the beginning, it seemed that the Japanese conglomerate would do the same thing it did with other startups: inject large amounts of money so that in a short time, they monopolize most of the market.

At first, the strategy seemed hugely successful. Softbank was one of Uber’s first investors and one of the majority partners, as well as its Chinese competitor Didi. 

In the region, Softbank has done the same with companies such as the Rappi home delivery service, to which it allocated one billion dollars, which represented more than a third of the region’s venture capital investments in the first half of 2019. 

In smaller proportions, the Japanese fund has directed resources to different companies in Brazil, Colombia, and Mexico, such as AyendaClip, or Creditas. However, analysts have questioned this same strategy with the discouraging exit to the market of Uber and the great collapse of WeWork.

Perhaps motivated by a change in strategy, or perhaps by the characteristics of risk funds in Latin America, Softbank has changed the way it invests in the region.

Venture capital is a very young sector in Latin America. Softbank investments are an opportunity to boost innovation for technological ventures that are already in the late stage of development. So far, these have been the main objective of the Japanese fund. 

However, the Japanese conglomerate has also decided to invest in risk investment funds in the region, which has caused some discomfort for some investors due to the conditions Softbank imposes at the time of financing, anonymous sources related to the industry told Reuters.

One of the main disagreements is that Softbank requests the right of first refusal – to have priority in the investment round – if one of the companies of a specific investment fund decides to invest extra money or be put up for sale.

This condition would give Softbank a decisive advantage as a potential investor in future rounds, in addition to offering the conglomerate an advantage over investors in the same fund.

Reuter’s sources point out that Softbank’s desire to take this position in a fund bothers other investors in the fund who wish to co-invest.

Two Brazilian venture capital funds have rejected Softbank’s proposal due to the condition of the terms, according to two sources that knew the subject.

Softbank also asks venture capital firms to invest in accepting a clause that gives priority to the Japanese conglomerate when interested in investments in startups in the early stages. 

Softbank mentioned that it would direct about 500 million dollars in third-party risk investment funds; however, it has not been said how much has been invested so far. In September, the Reuters news agency mentioned that Softbank had closed deals with at least two venture capital firms: Brazil’s Valor Capital and Argentina’s Kaszek Ventures, who recently announced that they had obtained 600 million in new capital.

Valuation matters

Part of the conflict with Softbank’s conditions for investment funds is related to the valuation a company receives after successive rounds of investment in startups. Investors within a venture capital firm are the ones who usually lead the investment rounds. One of the sources indicated that this was considered the best practice for both venture capital funds and other investors to allow different actors to have a higher weight in the valuation of their efforts.

The failure of WeWork in its attempt to go out to the public shows why investors disagreed with the valuation of 47 billion dollars established after their last private round. 

Columbia University professor Donna Hitscherich sees the demand to lead successive investment rounds as a fundamental requirement of an investor or venture capital fund that bet on a company from the beginning. 

Softbank has not yet participated in successive rounds of investment in any Latin American company, as its fund directed to the region began barely this year. 

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