Extending runway, making necessary adjustments and fundraising during crisis | Canary

The venture capital scenario in Latin America - The year of 2022 saw a cycle of monetary tightening in the major economies of the world, along with an energy and geopolitical crises and rising worldwide inflation. With no visibility of improvement in the medium term, venture capital and investment in innovation in Latin America are impacted in a very simple way: the crisis increases risk aversion, which results in a global liquidity crisis - meaning investors around the world are less likely to take risks with their capital. What we had been experiencing up until the end of 2021 was the opposite.

There is a current fallacy that venture-backed businesses were growing uncontrollably, chaotically, and without rational business strategies, and that they are now imploding in the midst of a liquidity crisis. My intention here is to try to deconstruct this misconception because it applies to certain types of companies and in certain places. And what do I mean by places? I will explain.?

If you take an ecosystem like Latin America, it is easy to conclude that it is not a region that enjoyed years of abundant liquidity. It's not as if there was a huge amount of capital available and, from there, entrepreneurs arose with the mentality of growing at all costs, instinctively investing in marketing or growth, only to subsequently certify the viability of the business over the long term.

As I have stated, this is true in some parts of the world. Long stretches of liquidity influenced this way of thinking in more developed nations, where people had been accustomed to very low (or negative) real interest rates for many years. On the other hand, we didn't spend a lot of time under these circumstances here in Latin America. In terms of comparison, we are contrasting a phase of 10 months (in 2021) with a liquidity period of 10 years. There was not enough time for a generation of entrepreneurs to be formed who did not place enough emphasis on the long-term viability of their enterprises. This is a fallacy that has to be confronted.

The typical Latin American entrepreneur is a person who is accustomed to operating under difficult circumstances. Nothing around here has ever been simple to do. I can state from our experience in Canary that the businesses founded in recent years have rational business plans. At the very early stage, where we make our investments, we come across entrepreneurs who frequently have nothing more than ideas and are still putting together teams to develop their goods or services while looking to test their theories.?

Since mid-2018, there has been a rising curve in LATAM from the perspective of liquidity and venture capital money. This development is still true even if we remove 2021 data from the math. Even with the year 2022, which is a year of crisis, the growth trend is there.

The key point is that, compared to that year, the decline in investment appears larger than it actually is because throughout 2021, we experienced 6–10 months of exponential growth in capital inflows. My objective is to keep in mind that the excess of capital that existed before the current crisis, not the crisis itself, is what makes it an anomaly.

When the crisis started, we were really impressed with the founders' response. They made judgments and changes in their businesses extremely fast, in my opinion, since they rapidly realized that we were approaching a critical period and that a prolonged cycle of crises was starting.

Canary is one of the most active funds in LatAm. We saw more than 90% of Seed rounds that happened here, 40% of Series As-rounds held in Brazil were from firms we invested in, and Canary companies have been reaching Series B rounds three times more often than the global average. Our portfolio companies have, on average, 20-30 months of runway. So we believe we can use our data as a proxy for the market, for this analysis.

"The venture capital hype is over'' is another thing that no longer shocks us when we hear it. You see, we have met with a significant number of international funds—more than 50 in the past months—who have expressed greater interest in LATAM than ever before. We think that following the current financial crisis, we wil have more foreign funds investing here rather than less.?

The future may not hold good news, but being prepared will be crucial to avoiding being the focus of negative news - There is a chance that this crisis may last longer than it looks and that there won't be any recovery in the next 12 to 18 months, despite the fact that businesses have plenty of cash and the assurance of continuing to operate for the next two years. Companies that are currently doing well will inevitably require cash after this point and may not be able to find it.

In our opinion, the news will continue to get worse before it gets better. In the upcoming months, headlines will be unpleasant. Again, because the majority of businesses are healthy, with cash, and have already made the necessary adjustments, now is the time for them to turn inwards and concentrate on things like efficiency, product construction and margin, and processes development. Cleaning up the houses is the main priority.

Therefore, the majority of what will be revealed and what will make headlines will concern the companies that weren't able to raise capital at the right time, restructure accordingly, or have long-term sustainable operations. These are the firms that are most likely to cease operations in the upcoming months and generate headlines. We anticipate hearing a lot of unfavorable news in the upcoming months involving technological companies. But I believe that these businesses are a small minority in the market.

What advice do we have for founders right now? - Try to raise capital now. Even with a runway for 18-24 months, try to raise money today. There is a non-zero likelihood that the situation won't get better and, by the end of 2023, there might be more demand for capital than supply. Any amount of cash is welcome! It is crucial that they make an effort to raise funds, even if the terms are not optimal.?

Downrounds receive media attention and are perceived as unfavorable information, but it actually indicates that the company is successfully raising money and will survive - Marcos Toledo

What do we believe in spite of this pessimistic outlook? After the crisis is resolved - and all crises come to an end - we believe that there will actually be an increase in the amount of money invested in Latin America. We are really thrilled about the fact that more funds are moving to the region, opening offices here, hiring dedicated partners and keeping a close watch on LATAM.?

Why do international investors have interest in LATAM now? - The response we got was that they believe Latin America is approaching a second stage of market development for innovation, entrepreneurship and venture capital. More capital is available, more people are starting businesses (we must not forget that becoming an entrepreneur is now a viable career path), and most crucially, Latin America is concentrating talent geared toward technology firms.

The executives we have right now received their training while the first wave of tech firms and the first unicorns in this area were emerging. Prior to this initial wave, typical businesses did not have positions for data scientists, product managers or UX designers. The first wave saw this workforce leaving traditional corporations to join businesses like NuBank, Loft, 99, and Creditas, receiving in-depth training. Now, this second wave is witnessing those executives, now trained to work in high growth and tech environments, joining new businesses with their new skills.

This is crucial information for individuals starting a business, since it shows that the workforce is highly skilled, well-trained, and has practical expertise in fields like innovation and technology that are rapidly expanding.

LATAM is now compared to places like India by the VC funds that we are constantly in touch with. There, the first wave consisted of the first unicorns, which inspired and energized Indians to take on new challenges, brought additional money to the region, and established India as a vast talent pool of exceptionally qualified individuals. Many of them are interested in placing their bets here because Latin America might be heading in the same direction.

Early in 2018, 99 became the first Brazilian startup to surpass the first billion and become a unicorn. We've only been at this for 4-5 years, so we're just getting started! There were no unicorns in LatAm five years ago. There are currently over 30. More people are being motivated to work for and start their own technological enterprises. Crises always end. It won't be any different with this one. And when it does, we have no doubt that this region, which is still rife with massive challenges that need to be tackled, will witness the creation of fantastic businesses - Marcos Toledo

Speaking from personal experience, the one thing I would say is: it’s really hard to kind of take aside the ego and take the tough decisions that are necessary to be taken. Extend runway or raise funding (in terms that might be perceived as bad terms), anything that gets you additional capital - whether it’s layoffs, whether it’s cost cuts, whether it is raising money…

These are the things that all of us, as fund and CEOs, have the responsibility to do. We have the responsibility to pull the levers. We have the responsibility to act decisively. And that’s being smart.

As Marcos said, there is kind of a massive risk of things falling off the cliff all of a sudden. 2022 is definitely the beginning of that. It may take or it may not take long, but it certainly builds up gradually - doesn’t build up suddenly.?

Knowing that structurally things will take time to get better means that it is necessary to make decisions now. Reducing costs deeper than you would’ve perhaps wished to will be better because you’re gonna build a leaner reputation and you will have less decision making-paralysis.?

For many companies it might mean a combination of raising some capital, cutting costs and getting to 2025 from a runway perspective. But even if you don’t get to the breakeven in your plan, try to at least have 24 months of runway with the capital you have today and the plan that you have - not a wishful thinking plan, but a plan that is truly conservative.?

These next one to three years will be challenging fundraising times but the good times will be coming back. So kind of look at it as a multi-round game, don’t look at it as an on-off game - Mate Pencz

Don’t look at it as “my company is worth 50 million today and I wanna get 50 million because I’ve grown 2-3x; that shouldn’t matter. The paradigma has changed, everything has changed. So, if somebody is willing to give you money on a 20 million dollar valuation even though you raised at 50 million last time, you should be immediately focused on what you have to do to be able to get money on those terms.?

As long as it gets you where you’re trying to get to, which is survival, you should really have these negotiations with your insiders, with the people on your board and focusing on accelerating those conversations.?

Ask your investors how much they think the company is worth, what kind of structure you could do -? whether it’s a price equity round, convertible note, whether it’s a convertible note combined with some incentive structure like ones that incentivize your investors to put more money.

You basically have to ask your investors what they are willing to do and then structure a round that maximizes the amount of participation from your existing cap table. That’s the most likely source capital in these times. Now, once you get an inside round, it’s also much more likely that you may get an outsider to invest. I don’t think it’s a waste of time to look at new investors, especially this year in LatAm.

In summary, have very open and frequent conversations with your board not only about layoffs and operational adjustments but also what it would take to raise money from them. That doesn’t mean you're not gonna raise another round in 2023 or 2024, but it will just make sure that you have options. And you’ll be surprised at how much more operationally efficient and agile you’ll be after doing all of these internal adjustments.

Don’t be afraid to kind of pull the handbrake deeper even if that generates some negative PR and some difficult discussions with your team. At the end of the day, even if they are not going to be sympathetic to the changes, everyone does understand that you need to make these adjustments to survive - Mate Pencz