NB Financial Innovation
Exploring the Role of Venture Capital in Latin American Economic Development: Dalberg, IDB study assesses VC’s social impact
In advanced economies, it is easy to point to the positive impact of venture capital (VC): investment in early-stage, high-risk startups. The evidence is everywhere; Facebook profiles, iPhones, Skype calls, Google maps, FedEx packages, and Intel processors are all products of companies that were once venture-backed.
Venture capital may be an effective tool for commercializing technological advances by savvy investors in Silicon Valley, but can it help fight poverty or spur social and environmental well-being in the developing world and emerging markets?
Dalberg explored this question in a study commissioned by the Inter-American Development Bank (IADB) on the impact of venture capital in Latin America. The Multilateral Investment Fund (MIF) at the IADB has been a major multilateral investor in VC funds in Latin America for over a decade. As of January 2012, the MIF had invested over $160 million dollars in more than 350 small and medium-sized enterprises (SMEs) via 50 VC funds.
The MIF asked Dalberg to investigate whether – and if so, how – VC affects business performance and broader economic, social, and environmental well-being throughout Latin America.
In Latin America, as in many parts of the developing world, SMEs lack access to finance. They are too small for domestic commercial banks and too big for microfinance institutions. They fall into an enormous financing “missing middle.” We expected that venture capital would alleviate this well-known problem, and our analysis suggested that VCs do help close the financing gap. Moreover, SME CEOs reported that venture capital support gave their companies a credibility boost among potential customers, suppliers, employees, lenders, and investors. In several cases, CEOs said that VC backing enabled them to secure commercial loans previously unavailable to them—a considerable benefit.
But the CEOs we interviewed made clear that the benefits of VC backing extend much further than funding. They spoke of the non-financial benefits of venture capital, including four in particular: (i) strategic and operational support, (ii) sector expertise and access to networks, (iii) improvements in governance and professionalization, and (iv) reduction of informal employment agreements. This non-financial support affected SMEs’ performance, as well as their economic, social, and environmental impact on their communities.
One way VC support enhanced companies’ social and environmental performance is by ensuring that companies met local and international environmental, labor, and safety standards. These considerations are not necessarily top-of-mind for leaders running a start-up in a developing country, but venture capitalists need to think about them; to attract the best buyers for portfolio companies, they must ensure the companies do not carry environmental or social liability risks.
Our quantitative analysis of the performance of companies within the MIF’s VC portfolio corroborated these findings: on average, MIF VC-backed companies outperformed comparable companies’ national employment and GDP growth rates, while conducting business in a socially and environmentally responsible way. Collectively, MIF portfolio companies averaged annual revenue growth rates of 23%. On average, they had 55 employees and the number of employees grew by 13% annually. Overall, portfolio companies doubled their number of employees in a four to five-year period.
In this study, we were not able to definitively distinguish whether the companies in the MIF portfolio enjoy outsized success due to receiving VC support, or were intrinsically primed for outsized success and, as a result, received VC support (a common problem in assessing results arising from a competitive selection process). Most likely, the answer is a combination of the two. In either case, our results suggest that VC can play an important role in a developing country through the selection and support of companies with high growth potential.
Because VCs are, by definition, interested in backing “winners” with superior growth prospects, only a select few companies will receive VC investments. As a result, VC is not a “silver bullet” for development. Nonetheless, our findings suggest that VC can serve as an important tool for furthering inclusive economic development, particularly if, as has been the case in other regions, these select few mature into pioneering companies with the potential to spur enormous innovation and growth.
Editor’s note: this post was originally published on the Dalberg blog. It is republished with permission.
Rocio Funes is a Senior Consultant in the Dalberg Washington, DC office and brings experience spanning a broad range of development topics, including access to finance, inclusive growth and private sector development.
Lorenzo Bernasconi recently joined the Rockefeller Foundation, but formerly served as a Senior Consultant in Dalberg’s New York office, where his work has focused on emerging markets private equity and venture capital, access to finance, inclusive growth and technology for development.