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Venture Capital

Vol. 10, No. 2, April 2008, 111–126

Private equity and venture capital in an emerging economy:


evidence from Brazil
Leonardo de Lima Ribeiroa* and Antonio Gledson de Carvalhob
a
Center for PE/VC Research at Fundação Getulio Vargas; bFundação Getulio Vargas School of
Business at Sao Paulo
(Accepted 20 December 2007)

The Private Equity and Venture Capital (PE/VC) financial model was initially
developed in the US and, therefore, designed for the US institutional environment.
The degree to which the US PE/VC model can perform in other institutional
environments is an interesting question. This article is based on data supplied by all of
the 65 PE/VC organizations with offices in Brazil in 2004. Comparing Brazil and the US,
we found that the main similarities are: an industry composed mostly of independent
organizations, managing capital coming mostly from institutional investors; capital is
heavily concentrated regionally and in few organizations; investments are made within a
close geographical distance; and software and IT are preferred sectors. The main
differences are that for Brazil: investments are concentrated in more advanced stages of
corporate development; since credit is scarce, few LBOs take place; low levels of sector
specialization (PE/VC investing in a broad variety of industrial sectors); firm
concentration in Sao Paulo’s financial district suggests a quest for commercial partners
and strategic buyers for portfolio companies; and Brazilian PE/VC regulation
recognizes the inefficiency of the legal system and forces the use of arbitration. We
also discuss possible reasons for these adaptations.
Keywords: private equity; venture capital; emerging market; institutions

Introduction
The Private Equity and Venture Capital (PE/VC) financial model was first developed in
the US where it attained outstanding success in fostering the entrepreneurial sector. This
success encouraged several countries to develop their own PE/VC industry. During the
1970s and 1980s, PE/VC financial technology spread out around the world. However, the
prevailing model for PE/VC was tailored for the US institutional environment. As
Gompers and Lerner (2002) state, a natural question concerns the degree to which the US
venture capital model can be successfully adapted to other countries. We examine this
question by exploring the PE/VC industry in Brazil. As a leading country in Latin America
and part of the BRICs (Brazil, Russia, India, and China) group of rapidly developing
countries, Brazil provides a good setting to examine the evolution of this financial
technology in an emerging economy. Moreover, the Brazilian PE/VC industry has
accumulated more than two decades of experience, making it possible to examine the
industry at the end of a complete PE/VC investment and exit cycle.

*Corresponding author. Email: leonardo.ribeiro@fgv.br; gledson.carvalho@fgv.br

ISSN 1369-1066 print/ISSN 1464-5343 online


Ó 2008 Taylor & Francis
DOI: 10.1080/13691060801946121
http://www.informaworld.com
112 L.L. Ribeiro and A.G. Carvalho

Empirical evidence has shown that the PE/VC industry has evolved very differently
across countries (Jeng and Wells 2000) and within countries (Gompers and Lerner 1998).
The relative size of the industry ultimately depends on the supply of funds from investors
(factors that push investors into the PE/VC asset class) and on the deal flow for PE/VC
(factors that affect the number and quality of ventures seeking capital). Gompers and
Lerner (1998), Jeng and Wells (2000), and Romain and Van Pottelsberghe (2004)
investigated the determinants of the PE/VC industry’s size across countries. These studies
found that the most significant factors that explain the deal flow are: (1) reduction in the
capital gains tax (over time); (2) entrepreneurship activity; (3) innovative efforts (i.e.
overall R&D expenditure, stock of knowledge and patent fillings, especially when the
workforce is mobile and the entrepreneurial activity exceeds a certain level); (4) GDP
growth (in countries with low market rigidity); (5) labour market rigidities (mainly for the
high-skilled workers, with a stronger effect over early stage investment); and (6) interest
rates (with a positive rather than negative effect). With respect to the supply of funds, the
main factors are: (1) allowance for pension funds to invest in the asset class (e.g. ERISA in
the US); (2) growth of the private pension market (explains variability over time but not
across countries); (3) reputation of the established PE/VC firms; (4) quality of accounting
standards; and (5) long-term against short-term interest rates. Other important factors are
the volume of initial public offerings (IPOs) (with stronger effect over later stage
investment); stock market capitalization; and government programmes (with an important
role in both setting the regulatory framework and galvanizing investment during
downturns).
Some other studies investigated the determinants of the PE/VC industry’s structure.
Megginson (2004) found that the differences in the design and the degree of development
of the PE/VC industry are due to institutional factors, with the country’s legal system
being paramount. Cumming and MacIntosh (2002) observe that PE/VC managers
operating in countries where rights are efficiently enforced have a greater tendency to: (1)
invest in high-tech SMEs; (2) exit through IPOs rather than buybacks; and (3) obtain
higher returns. Cumming, Schmidt, and Walz (2004) further examined legal system effects
and found that in better legal systems: (1) the faster the origination and screening of deals;
(2) the higher the probability of syndication; (3) the less PE/VC managers tend to use
capital from different funds to invest in the same company; (4) the easier the board
representation of investors; (5) the lower the probability that investors require periodic
cash flows prior to exit; and (6) the higher the probability of PE/VC investing in high-tech
companies. Lerner and Schoar (2005) found that: (1) in a bad legal environment, PE/VC
managers tend to buy controlling stakes, leaving entrepreneurial teams with weaker
incentives early on; and (2) valuations tend be positively correlated with the quality of the
legal environment. Kaplan, Martel, and Strömberg (2003) found that: (1) rights over cash
flows, liquidation and control, as well as board participation, vary according to the quality
of the legal system, the accounting standards, and investor protection across countries; (2)
more sophisticated PE/VC managers tend to operate in the US style irrespective of local
institutional concerns; (3) managers operating with convertible preferred stocks are less
prone to failure (as measured by survivorship rates). The results in Kaplan, Martel, and
Strömberg (2003) are interesting because they suggest that the US contractual style can be
efficient in different institutional environments. Finally, Bottazzi, Da Rin, and Hellman
(2005) corroborate some of the previous results and obtain further evidence on the home-
country effect (the tendency of PE/VC managers operating abroad to maintain the
investment style used in their home country). This home-country effect is observed in
managers based in both good and bad legal environments.
Venture Capital 113

While cross-country studies shed light on some important issues, they usually have the
caveat of treating each sample country superficially (i.e. only few available variables are
considered, samples are generally incomplete, and so on). To fully observe the richness of a
country’s PE/VC model, one must understand the local institutional environment
thoroughly and gather a dataset rich in terms of variables and coverage. This focused
but comprehensive approach has gained attention. For instance, Kuemmerle (2001) shows
that Japan and Germany share similar institutional traits that really set their model of PE/
VC apart from the US one. Bruton, Ahlstrom, and Yeh (2004) show how PE/VC has
adapted to the Asian culture, regulations, and institutions. Dossani and Kenney (2002)
discuss policies for the development of PE/VC in India.
While there is considerable evidence about PE/VC in the US, Europe and Asia, very
little is known on its development in Latin America. To our knowledge, Pereiro (2001) did
the first systematic data collection in Latin America. The author surveyed 23, and did an
in-depth interview with seven, of the 39 PE/VC firms that were acting in Argentina by
August 1999. The main finding is that operational parameters of formal PE/VC funds in
Argentina are in line with international standards: (1) the expected return was around 25%
to 35% yearly; (2) in spite of the relatively thin stock market in Argentina, the preferred
exit route was either the IPO (69.6%) or the trade sale (60.9%), after a holding period of
three to seven years; (3) similar to what happens in the US, only 1% to 2% of proposals
analysed would turn into investment; (4) only 30.4% of firms surveyed preferred to invest
in majority positions (i.e. 51% or more of voting shares); (5) virtually all firms (95.7%)
were said to have strategic and operational involvement with their portfolio companies.
The peculiarities of the Argentinean PE/VC industry were that most investments were
directed to companies in late stage. Just a few firms were aiming at early stage financing,
but only after an angel investor provided the initial financing. Also, given the lack of
protection of minority investors under the local business law, several PE/VC firms avoided
investing in a minority position. While this study gives a good overview of the Argentinean
PE/VC industry in August 1999, it does not properly show how the PE/VC model was
adjusted to operate in the local institutional environment. This is so because formal PE/
VC started in Argentina only after 1998 and a great part of the firms surveyed by the
author were actually headquartered in the US and rather than focusing in Argentina, they
were operating in Latin America as a whole.
With respect to the Brazilian PE/VC industry, we are not aware of any other
systematic data collection. Using secondary information, Checa, Leme, and Schreier
(2001) provide a history of a nascent PE/VC industry in Brazil and draw a Porter’s five-
force analysis to foresee how the industry would develop. Mariz and Savoia (2005) also
focus on the prospects for the industry’s growth. Ribeiro and Almeida (2005) find evidence
that the exit strategy has an influence on the whole investment cycle and that trade sale is
the preferred exit strategy in Brazil (but in a period in which the IPO market was closed).
Pavani (2003), based on interviews conducted with five managing organizations, describes
the critical factors for the development of the industry. Using a sample of 20 VC-backed
companies, Botelho, Harckbart, and Lange (2003) examine the value-adding role played
by venture capitalists as board members.
Our study is based on data supplied by all the 65 PE/VC managing organizations
with offices in Brazil (a full census of the industry). The analysis focuses on the industry’s
size and structure. We also relate the industry’s structure to economic and institutional
factors and provide international comparison (especially with the US, Europe and other
BRIC economies). For structural comparison, we refer mostly to Sahlman (1990) and
Bottazzi, Da Rin, and Hellman (2004, 2005). Our results suggest that the size of the
114 L.L. Ribeiro and A.G. Carvalho

Brazilian PE/VC is restrained by the local economic and institutional idiosyncrasies


prevalent in Brazil.
International comparison between the Brazilian PE/VC industry with the US and
Europe shows that, even though there are significant similarities with the US PE/VC
model, the Brazilian model has been adapted to function in the idiosyncratic local
environment. The main differences are related to the stage focus of investments, avoidance
of leveraged transactions, lack of sector specialization, concentration of managing firms in
the country’s financial district, and the forced use of arbitration for dispute settlement.
The rest of this article is structured in the following manner: Section 2 describes the data;
Section 3 describes the Brazilian institutional idiosyncrasies; Section 4 concerns the
relative size of the Brazilian PE/VC industry. Section 5 presents an overview of the
Brazilian PE/VC industry. Section 6 concludes.

Data sources
Our study is based on information provided by all of the 65 domestic and international
PE/VC managing organizations1 that were operating and had offices in Brazil2 (a full
census). As far as we know, there is no other history of a full census of PE/VC in Brazil or
elsewhere. This study considered only funds/managing organizations that (1) invest
through equity or quasi-equity (e.g. convertible debt); (2) target mostly non-listed
companies; (3) actively monitor portfolio firms and exert influence on corporate strategy;
(4) invest with exit perspective; and (5) have a team of professional managers. The data
collection occurred around the end of 2004 and beginning of 2005 and answers were given
for December 2004. While the 65 managing organizations were responsible for 94
investment funds,3 information was gathered for only 90 of them.
Our dataset is based on two extensive questionnaires, one organization-specific and
another fund-specific, covering (1) structure of funds and management organization; (2)
the investment process, from origination to exit; (3) governance between investors and
management organizations; (4) governance between investment funds and portfolio
companies; and (5) compensation to the managing organizations. The two questionnaires
were crafted to keep a parallel with Sahlman (1990) who describes the US VC model in
terms of those topics. In this paper we focus only on the first two topics (Carvalho,
Ribeiro, and Furtado 2006, present descriptive statistics on all five topics).

Institutional environment and idiosyncrasies


Sahlman (1990) describes the structure and governance of venture capital organizations in
the US as mechanisms to deal with information and incentive problems. The efficiency of
particular mechanisms depends on institutions. In this way, local institutional
idiosyncrasies may force changes to the US model of PE/VC, generating different models
of PE/VC. This dynamic is explained by Leeds and Sunderland (2003) who observed that
pioneers obtained mediocre returns in emerging markets and, because of this, PE/VC
managers in these markets had to review their investment model in order to continue
operations.
The Brazilian institutional environment is notoriously different from the North
American and the other BRIC economies. Table 1 depicts some of the economic and
institutional variables that should affect the size and structure of the PE/VC industry for
Brazil, the US and other BRICs. In general, Brazil has a large economy with severe wealth
distribution issues and institutional shortcomings. Until 1994, the country experienced a
Venture Capital 115

Table 1. Economic and institutional indicators.

Indicator Description Year Brazil Russia India China US


Income and Richest 20% (%) 2003 62.1 46.6 43.3 50 45.8
consumption
GDP per capita PPP US$1.000 2005 7.9 9.8 3.0 5.4 38.3
Total Index (%) 2005 12.4 2.5 17.9 12.9 11.9
entrepreneurship
activity
Growth % of GDP 1990–2000 2.9 74.7 6 10.6 3.5
Growth % of GDP 2000–2004 2 6.1 6.2 9.4 2.5
Inflation (%) 2004 7.6 11 2.6 3.9 2.7
Real interest rate (%) 2004 43.2 75.6 5.4 71.2 1.7
Creditor protection Index (0 to 4) 1 – 4 – 1
Investor protection Index (0 to 10) 2005 5 3 4 4 7
Enforcement of Time (days) 2005 566 330 425 241 250
contracts
Enforcement of Cost (% of claim) 2005 15.5 20.3 43.1 25.5 7.5
contracts
Legal environment Index (0 to 10) 5.75 – 8 – 10
Cost of capital Index (0 to 10) 2005 1.8 4.29 5.33 5.13 7.37
hampers business
Starting a business Cost (%) (income/ 2005 11.7 6.7 49.5 14.5 0.6
capita)
Starting a business Time (days) 2005 152 36 89 41 5
Trading across borders Time for export 2005 39 29 36 20 9
(days)
Trading across borders Time for import 2005 43 35 43 24 9
(days)
Closing a business Time (years) 2005 10 1.5 10 2.4 3
Closing a business: (cents/dollar) 2005 0.2 48.4 12.5 35.2 68.2
recovery rate
Bureaucracy Index (0 to 10) 2005 1.45 0.97 2.69 1.94 3.37
Corruption Index (0 to 10) 2005 3.7 2.4 2.9 3.2 7.6
Paying taxes Time (hours) 2005 2600 256 264 584 325
Total tax rate % of profit 2005 147.9 40.8 43.2 46.9 21.5
Informality % of GDP 2000 39.8 46.1 23.1 13.1 8.8
Internet users (per 1000 people) 2005 195 152.3 54.8 85.1 439.4
Internet cost Cost for 20 hours 2003 28 10 8.7 10.1 14.9
(USD)
Routes Km (million) 2003 1.7 0.5 3.8 1.8 6.3
Paved routes (%) 2003 5.5 67.4 62.6 79.5 58.8
Railroads Km (thousand) 2004 30.4 85.5 63.2 61 141.9
Crimes hamper firm % of answers 2005 52.2 9.3 15.6 20 –
activity
Labour market rigidity Index (0 to 100) 2005 72 27 48 30 3
Firing workers Costs (weeks of 2005 165 17 79 90 8
wage)
Market capitalization % of GDP 2003 47.6 53.5 46.5 48.1 130.3
Capital markets Index (0 to 10) 2005 5.8 3.25 6.68 3.68 8.51
accessibility
R&D expenditure % of GDP 2003 0.98 1.28 0.85 1.31 2.6
Enrolment in higher % gross 2005 16.1 71 11.4 20.3 82.7
education

Notes: Data sources are: World Bank Development Indicators (2005); World Bank Doing Business Survey
(2005); IMD Global Competitiveness Yearbook (2005); Minniti, Bygrave, and Autio (2006); Lambsdorff
(2005).
116 L.L. Ribeiro and A.G. Carvalho

vigorous inflation process that used to blur market competition. Since the stabilization,
high interest rates have prevailed and growth rates have been mediocre when compared to
other developing economies (e.g. India and China). This has translated into fewer
opportunities for business creation and development, and a weak competitive position in
terms of attracting foreign capital.
The country features high entrepreneurial activity. However, very few entrepreneurs
can be classified as ‘high-expectation entrepreneurs’ (Reynolds et al. 2003). The country
presents high labour market rigidity even when compared to other BRICs economies (72
in a scale from zero to 100). Workers tend to stick to their jobs and entrepreneurs assume
great liabilities when employing workers. Bureaucratic procedures are an endemic problem
in Brazil. Usually it is worse than in other BRIC economies. This can be observed, for
instance, through the difficulty to start and close a business, obtain construction licences,
pay taxes, as well as export and import goods (Table 1). According to Kaufmann, Kraay,
and Mastruzzi (2003) bureaucracy and corruption are strongly correlated. Delays and
bribery impose direct and indirect costs for businesses. These costs tend to be higher for
smaller enterprises, penalizing early-stage investments.
The tax burden in Brazil is extremely heavy for companies. Tax procedures are
complex and the government has difficulty enforcing correct tax payments. Consequently,
40% of the economy is informal. Companies with hidden fiscal and labour liabilities
present increased risks for PE/VC managers and their investors. Their financial reports are
not reliable and the monitoring process can be quite difficult to outside investors. Thus,
PE/VC managers tend to overlook some industrial sectors or development stages in which
informality prevails.
Brazilian law is weak in terms of protecting creditors and investors. Besides that, the
judicial system is quite inefficient at enforcing the law. Consequently, capital is expensive
and very few companies have access to external capital. Since PE/VC portfolio firms’ access
to leverage is very limited, buyouts (e.g. MBOs) are rare. In a bad legal environment, the
complex contracts used in PE/VC deals are difficult to enforce. While legislators are
working to solve the main regulatory issues, the real problem seems related to the judiciary,
which should ultimately enforce laws and contracts. Fortunately, the recognition of
arbitration has brought some relief, by allowing some disputes to be settled privately.
Several PE/VC funds already stipulate arbitration in their bylaws and all funds established
under the local security and exchange commission (CVM) regulation number 391, enacted
in 2003, must indicate an arbitration court to solve potential conflicts between managing
organizations and portfolio companies. This marks a sharp difference with the US, where
parties decide whether or not to rely on arbitration or court decisions for dispute settlement.
The existence of infrastructure is an important element for the PE/VC industry. If the
right infrastructure is in place, businesses of all sizes can build on it, creating investment
opportunities. Otherwise, building and maintaining infrastructure (e.g. routes, railways,
ports, sanitation and energy) require large sums that could be provided by PE/VC and
covered by government guaranties in public private partnerships (PPP) schemes, similar to
the English private finance initiatives (PFI).
Brazil has a relatively small stock market, suggesting the existence of high direct and
indirect costs for raising capital directly from investors. The stock market has taken
important steps to increase its quality and accessibility (see Carvalho and Pennacchi 2007).
In the period 2004–2005 the market was buoyant. The 2004 offerings represented 1.5% of
GDP, while contemporaneous US IPOs raised 1.0% of GDP. According to Gompers and
Lerner (2002), healthy stock markets are essential for PE/VC investment funds to exit their
investments while providing the entrepreneur with the option to regain control.
Venture Capital 117

The relative size of the Brazilian PE/VC industry


Even though the first PE/VC organizations were created in Brazil in the early 1980s, this
industry did not reach significance until the mid 1990s after the Brazilian currency
stabilization. By the end of 2004 this industry had accumulated US$5.07 billion in capital
under management (i.e. capital already invested plus capital available for new
investments), representing 0.84% of GDP. Table 2 presents the evolution of the
committed capital between 1999 and 2004. Fundraising was low in the 2001 to 2003
period, but resumed in 2004 when it reached US$473 million. Compared to the size of the
economy, the fundraising figure is modest, only 0.08% of GDP in 2004. In some developed
countries it can reach more than 1.0% of the GDP (OECD 2002). However, in Brazil it
has never been greater than 0.2%.

Table 2. Capital flows in the Brazilian PE/VC industry and exit activity.

Capital (US$ million) 1999 2000 2001 2002 2003 2004 Avg.
Under management 3583 4778 4846 4553 4577 5071 4568
[0.67] [0.79] [0.95] [0.99] [0.90] [0.84] [0.86]
Raised – 1.212 290 260 159 473 479
– [0.20] [0.06] [0.06] [0.03] [0.08] [0.09]
Invested 456 379 281 261 256 253 314
[0.08] [0.06] [0.05] [0.06] [0.05] [0.04] [0.06]
Divested 203 282 65 41 52 261 151
[0.04] [0.05] [0.01] [0.01] [0.01] [0.04] [0.03]

Exit mechanisms (Number of deals) 1999 2000 2001 2002 2003 2004 Total
IPO – – – – – 9 9
– – – – – (29.0) (5.6)
Trade sale 4 13 8 6 6 15 52
(57.1) (39.4) (21.6) (24.0) (27.3) (48.4) (32.1)
Secondary sale – 16 1 1 4 2 24
– (48.5) (27.0) (4.0) (18.2) (6.5) (14.8)
Buyback 3 1 8 3 9 8 32
(42.9) (3.0) (21.6) (12.0) (40.9) (25.8) (19.6)
Write-off/down – 3 20 15 3 4 45
– (9.1) (54.1) (60.0) (13.6) (12.9) (27.8)
Total number of exits 7 33 37 25 22 38 162
Partial exits 1 3 6 5 2 4 21

Notes: Aggregated values of capital under management, funds raised, investment and exits for the 65 firms. Funds
raised were calculated based on the increase of capital in each firm from one year to the next. Since the series starts
in 1999, this year’s figure is unavailable. Figures in brackets are percentages of annual GDP. GDP figures
obtained from the Brazilian Central Bank. Investment figures are underestimated since eight of the responding
firms did not provide this information. Capital under management is more precise, as only two small-size firms
did not provide this information. Exits are measured in number of transactions made annually, by mechanism.
Full exit means sale of all the stock owned by the PE/VC fund in a specific firm, or a complete liquidation of its
assets. Where exit took place by means of several partial exits, the last transaction is regarded as a full exit and all
prior ones are classified as partial exits, except for IPOs, since the listing represents a liquidity event. IPO: initial
public offering. Trade sale: sale of all the stock to a strategic buyer, generally an industrial group interested in the
vertical or horizontal integration of the target firm. Secondary sale: means the sale of shares to a temporary
investor. Buyback: means the stock repurchase by the business owner or entrepreneur. Write-off/down means full
liquidation of the firm’s asset and implies termination of operations. Partial exits: includes secondary sales,
buybacks and amortization of convertible debt. Average divestment is the value of divestments to number of full
and partial exits (except write-offs/down). Figures in parentheses stand for percentages of the total.
118 L.L. Ribeiro and A.G. Carvalho

Table 2 also shows that the investment rate has been less volatile than capital
commitment. It reached a maximum of US$456 million in 1999 (0.08% of GDP). Since
then, it has stabilized between US$200 million to US$300 million annually. Investments
made by the Brazilian PE/VC industry average 0.06% of the country’s GDP. On the other
hand, divestments increased significantly over time, reaching US$261 million in 2004
(0.04% of GDP). 2004 is the first year in which exit proceedings surpassed investment
amounts. This reveals a very positive exit window, as experienced in 1999 and 2000 during
the Internet bubble.
A comparison with other developing economies shows that Brazil leads Latin America.
However, its numbers are modest when compared to East Europe and Asia: in 2004
Brazilian PE/VC organizations raised US$473 million, representing 0.08% of GDP. In this
same year, in terms of GDP, Chile raised 0.07%, and Argentina and Mexico nearly 0.05%
(WorldTrade Executive 2005). Some East European countries have raised more capital
(EVCA 2005), especially Poland (0.16% of GDP) and Hungary (0.14%). Some other
European countries have lagged behind Brazil (e.g. the Slovak Republic at 0.02% and the
Czech Republic at 0.01%). While fundraising figures were unavailable for Asian countries,
2004 investment values for China, South Korea and India were at 0.10%, 0.37% and
0.13%, respectively, well above Brazil.

An overview of the Brazilian PE/VC industry


This section offers an overview of the Brazilian PE/VC industry and also provides
international comparison.

Organizational structure
In 2004 the Brazilian PE/VC industry was composed of 65 managing organizations with
offices in the country. Most were independent: 42 representing 64.5% of the total number
of organizations and 53.6% of the total capital committed (Table 3). There were 17
organizations affiliated to financial institutions, representing 26.2% of the number of
organizations and managing 36.8% of that capital. There were only four corporate
ventures with offices in Brazil, managing 6.6% of capital. Finally, there were two
institutions with governmental affiliation managing only 3% of the total capital. This
distribution puts Brazil on a par with Europe, where 66% of the 750 firms surveyed by
Bottazzi, Da Rin, and Hellman (2004, 2005) were independent. However, captives of
financial institutions are less common in Europe (representing only 19% of the
organizations), while corporate venture and government-owned firms are more numerous
(representing 8% and 7%, respectively). One should note that even though the role of the
Brazilian government as PE/VC manager in terms of capital committed is discrete, it is
significant in terms of firms funded: 15% of the number of PE/VC-backed companies.
Moreover, it also acts as investor in several independently run funds.
Even though PE/VC has its roots in the US, Brazilian organizations make up the
majority of the industry: 47 organizations, representing 72.3% of the total of orga-
nizations and 59.7% of the total capital under management in the country (Table 3). The
US comes as the second most common origin, with 10 organizations, representing 15.4%
of the total of organizations and 34.7% of the capital. Altogether, these two groups
manage 94.4% of the capital committed. This reveals the close ties between the US and the
Brazilian PE/VC markets, with possible implications for investment style (see Kaplan,
Martel, and Strömberg 2003).
Venture Capital 119

Table 3. Survey selected variables.

Organizational structure
Affiliation Independent Financial institution Corporate Government
64.5 (53.6) 26.2 (36.8) 6.2 (6.6) 3.1 (3.0)
Origin Brazil US Europe Other
72.2 (59.7) 15.4 (34.7) 6.2 (1.8) 6.2 (3.8)
Investment Inactive/Inactive Inactive/Active Active/Active Inactive/
activity Undecided
10.8 (n.a.) 10.8 (7.9) 76.9 (80.3) 1.5 (n.a.)
Geographic São Paulo (Total) São Paulo (Faria Rio de Janeiro Other
concentration Lima/Berrini)
67.9 (79.9) 40.9 (66.8) 24.6 (18.7) 7.5 (1.4)
Capital 5 biggest 10 biggest 15 biggest 50 smallest
concentration (50.5) [513] (68.6) [348] (79.9) [270] (20.1) [23]
Human capital
Job title Managing partner Manager Analyst Other
128 (27.9) 87 (19.0) 135 (18.1) 108 (35.0)
Education Ph.D. MBA/LLM Specialization College or less
8 (3.8) 123 (57.7) 31 (14.6) 51 (23.9)
Experience Financial CEO/Entrep./Angel Consulting Other
75 (35.6) 74 (35.0) 39 (18.5) 23 (10.9)
Years of x  20 x  15 x  10 x5
experience 12.3 (21.3) 29.2 (37.4) 38.5 (49.0) 75.4 (92.7)
Portfolio companies
Investment type Independent Syndicated (lead) Syndicated non-lead –
223 (70.8) 42 (13.3) 50 (15.9) –
Geographic Southeast (Total) Southeast South Other
distribution (São Paulo)
171 (65.0) 100 (38.0) 67 (25.5) 27 (9.5)
Industry Software/Internet Industrial products Biotech/Pharma Other
68 (22.1) 23 (8.7) 13 (4.9) 161 (60.8)
Stage Seed & start-up Expansion Later stage Other
108 (41.1) 98 (37.3) 42 (16.0) 17 (5.7)
Investors
Investor Pension funds Corporations Banks Other
category 17.2 {24.0} 15.9 {43.0} 10.3 {78.0} 56.6 {83.5}

Notes: In Organization structure, numbers represent percentage of firms and capital under management (in
parentheses), except for Capital concentration, where the numbers in brackets mean the average fund size. Activity
refers to the actual/intended investment activity. In Human capital, figures represent the number of professionals or
managers and percentage of the total (in parentheses). Job title presents statistics on all professionals while other
variables refer to managers only. In Experience, the job as CEO of a financial institution was categorized as
financial. Years of experience refer to the number of firms with at least one manager with the accumulated
experience, and the percentage of capital under management at these firms (in parentheses). In Portfolio companies,
numbers presented in Investment type refer to deals. All other variables consider only invested companies
individually. In Geographic distribution, Industry and Stage, the two portfolio companies for which we have no
data were considered as Other. In Investors, the numbers refer to the percentage of capital under management and
the percentage of foreign capital (in braces). Unidentified sources of capital were included in Other.

Out of the 65 firms examined, 50, with US$4.07 billion in capital committed (80.3% of
the industry’s capital), were actively investing by December 2004. The other 15 were
inactive and only managed their existing portfolio. However, seven of these 15, with
US$0.4 billion in capital (7.9%), stated their intention to resume investment activity in
Brazil. The low abandonment rate reveals a maturing industry and suggests that necessary
conditions are already in place to allow adequate PE/VC investing and exiting.
120 L.L. Ribeiro and A.G. Carvalho

In terms of regional distribution, the industry is highly concentrated: PE/VC


organizations with headquarters in the States of Sao Paulo and Rio de Janeiro represent
98.6% of the capital committed to PE/VC (Table 3). Moreover, 66.8% of the whole
capital is managed by no more than 27 organizations located in Faria Lima and Berrini
avenues (two avenues in the financial district of Sao Paulo). Regional concentration is
typical of the PE/VC industry. For instance, in the US, technology clusters such as Silicon
Valley and Route 128 receive 34% and 15% of all venture capital investment, respectively
(PWC, Venture Economics and NVCA 2005). In India, the industry is mostly
concentrated in Mumbai (financial cluster), with 31 organizations, followed by New
Delhi and Bangalore with 10 and 8 organizations respectively (Dossani and Kenney 2002).
The clustering of Brazilian PE/VC firms seems related to the geographic concentration of
service providers to assist in closing deals, as well as potential partners and acquirers for
portfolio companies. As Ribeiro and Almeida (2005) show, Brazilian PE/VC managers
tend to spend considerable amounts of time networking with potential acquirers and
analysing their strategies, besides interacting with their own portfolio companies.
The capital is also concentrated within a few managing organizations: the 10 largest
organizations manage 68.6% of all capital in the industry. On the opposite side, the 50
smallest organizations manage 20.1% of the capital. Data from the North American
Venture Capital Association (NVCA 2005) suggests that capital concentration is similar in
the US, but on a different scale. Among the 476 NVCA members, 62 have more than US$1
billion under management (and up to US$6.5 billion). The smallest 247 firms have less
than US$100 million each.

Human capital
The profile of PE/VC managers is a key element in the analysis of a PE/VC industry, as it
influences the type of company that receives funding and the intensity of monitoring
undertaken (Bottazzi, Da Rin, and Hellman 2004; Cornelius 2005). In terms of staff, the
Brazilian PE/VC industry is quite parsimonious (Table 3). The 65 managing organizations
had only 458 professionals divided into 215 managers4 and 243 staff personnel (e.g.
analysts). Sixty per cent of managers are partners in their firms, and thus have long-term
commitments with the organization.
Brazilian PE/VC managers are highly qualified: 76.1% have graduate degrees (3.8%
are PhDs, 57.7% are MBAs or LLMs). This number is similar to what Bottazzi, Da Rin,
and Hellman (2004, 2005) found for Europe: two-thirds of European PE/VC managers
have graduate degrees. However, the prevalence of Doctorates within Europe is much
higher at 16%.
While 35.6% of Brazilian PE/VC managers have their most relevant professional
experience in the financial sector (e.g. investment banking), more than half (53.5%) have
amassed experience more closely related to the formation and execution of business
strategies (e.g. CEOs, entrepreneurs, consultants and angel investors). Only 10.9% of them
come from the government, academia or law firms. Cornelius (2005) shows that the share
of non-financial executives acting as PE/VC managers varies across countries. Bottazzi,
Da Rin, and Hellman (2004) find that non-financial executives prevail in the US, while
financial sector executives are predominant in Europe (especially among the new entrants).
It is important to highlight that 25 firms, with 49.0% of the committed capital, have at
least one manager with 10 or more years of PE/VC experience. This number reaches
92.7% when we consider tenure of five years or more (Table 3). Generally speaking, the
experience of Brazilian PE/VC managers is similar to what Sahlman (1990) found in the
Venture Capital 121

US in the early 1990s: 68% of independent firms had at least one manager with five or
more years of PE/VC experience and one-third (with 60% of the capital) had at least one
manager with more than 10 years of experience.

Portfolio companies
In December 2004, 77 out of the 90 investment funds managed by the 65 PE/VC organi-
zations had an aggregated portfolio of 265 invested companies. The other 13 funds for
which we gathered information were still originating their first deal. Because of syndica-
tions, these 265 companies represented a total of 315 deals. From the total, 233 companies
had only one PE/VC investor, while the remaining 32 had between two and five co-investors
(Table 3). Consequently, less than 30% of deals in Brazil were syndicated (92/315), while
the comparable figure can reach 50% in Europe (Bottazzi, Da Rin, and Hellman 2004). In
fact, two-thirds of European organizations have already taken part in syndications. The
comparison suggests that PE/VC organizations in Brazil cooperate little. Possibly, fierce
competition for deals and reputation building promotes independent action.
Owing to the geographical concentration of PE/VC organizations in Sao Paulo and
Rio de Janeiro, 65% of portfolio companies are located in the Southeast region (Table 3),
which encompasses the States of Sao Paulo, Rio de Janeiro, Minas Gerais, and Espirito
Santo. In fact, almost 90% of portfolio companies are located in the cities where the
PE/VC firms have offices.
While IT and electronics (especially software) are preferred investment sectors (Table 3),
the Brazilian PE/VC portfolio is fairly dispersed across industrial sectors, covering both
high technology and traditional industries. In 19 out of 29 countries compared by the
OECD (2005), at least 40% of investments go to IT, telecom, biotechnology and healthcare.
In Ireland, Canada and the US, these sectors receive more than 70% of PE/VC investments.
On the opposite side of the spectrum, PE/VC firms in Spain, the Slovak Republic, Portugal
and the Netherlands have less than 25% of their investments in these sectors. While we have
no data on the amount invested in each sector in Brazil, we compare the number of
portfolio companies in different sectors with Europe. The analysis shows that 30% of
European PE/VC-backed companies are in the software and Internet sectors (Bottazzi,
Da Rin, and Hellman 2004). In Brazil, 22.1% are in these sectors. Industrial products
represent 11% of the European portfolio and 8.7% in Brazil. The main difference between
European and Brazilian portfolios is in the biotech and pharmaceutical industry: these
sectors constitute 14% of the European portfolio, but only 4.9% of the Brazilian PE/VC-
backed firms. According to Sahlman (1990), PE/VC firms tend to specialize according to
industrial sectors. However, the three sectors that receive the most deals in Brazil represent
only 45% of the portfolio. This number reaches 55% in Europe, suggesting that PE/VC
managers in Brazil take a more generalist approach towards industry sector specialization.
Sahlman (1990) describes venture capital as a mechanism designed to finance
companies in the early stages of development, when little or no track record has been
built, few tangible assets are in place, and negative cash flows prevail. Depending on their
growth potential, firms in more mature stages can also be considered for PE/VC
investments. In Brazil, 41.1% of portfolio companies received their first PE/VC injections
in the form of seed capital (13.7%) or start-up capital (27.4%), both considered as early-
stage investments. However, the majority of the investments (37.3%) were in expansion
deals. Later-stage portfolio companies represented 16% of investments made. Other
stages, such as acquisition finance, manager buyout/in, bridge financing and turnaround
accounted for only 5.7% of the deals. According to Bottazzi, Da Rin, and Hellman (2004),
122 L.L. Ribeiro and A.G. Carvalho

the European PE/VC industry is more reliant on early-stage deals, as 42% of PE/VC-
backed companies were start-ups and 17% received seed capital. In the US, PE/VC is also
inclined to finance early-stage companies. In a recent survey, NVCA (2005) discovered
that their members were expecting 51.5% of deals to be made in early-stage companies.
The focus on advanced stages is similar to what Pereiro (2001) found for Argentina.

Investors
Pension funds are the main investors of PE/VC in Brazil, representing 17.2% of the capital
committed (Table 3). When the roll of investors is broken into international and domestic,
one observes that 78% of the domestic commitment comes from pension funds (Table 3).
Corporations are the second main investors with 15.9% of the commitments (43% of which
is of foreign origin). Banks come next with 10.3% of the commitments (most of which come
from international banks). The Brazilian government, through its several arms,5 has
fostered the PE/VC industry by investing in 30 different funds (its whole contribution
amounts to 6.4% of the capital committed). A similar role has been played by multilateral
agencies6 that contributed 3.3% of the industry’s capital by investing in 20 different PE/VC
funds. The other relevant investors are fund of funds, trusts, endowments, wealthy
individuals, international PE/VC funds, insurance firms, and partners. Megginson (2004)
reports that pension funds are the main investor in the US PE/VC industry, while the
European PE/VC industry relies more on banks, insurance firms and government agencies.
According to Sahlman (1990), managing partners in the US usually invest 1% of the
funds in order to align their interests with investors. In Brazil, the management team is
responsible for an average 5% of the funds. However, this share can reach 14.5% in the 27
funds in which both outside investors and managing partners are shareholders. The
difference between the US and Brazil suggests that in a maturing PE/VC industry, in which
managers have not yet amassed a solid track record, and where enforcement of rights are
weaker, managers may have to contribute with more resources in order to attract investors
to their funds.

Exits
The history of investment exiting by the Brazilian PE/VC industry between 1999 and 2004
is reported in Table 2. As one can see, until 2004 IPOs were not used as an exit mechanism
for PE/VC investments. Most exits performed in Brazil between 1999 and 2004 were
realized through trade sales and buybacks. The divestment reached its peak in 2000 with
US$282 million. The years of 2000 and 2001 were intense in write-offs (most likely due to
the investment cycle of the Internet bubble).
The lack of IPOs until 2004 was not specific to the PE/VC sector because there were
practically no IPOs in Brazil (Table 4). In 2004 and 2005, 16 Brazilian companies went
through IPOs at the local stock exchange (BOVESPA), raising approximately BR$10
billion (nearly US$3.6 billion). Remarkably, nine issuers7 had received PE/VC capital.
These nine IPOs were responsible for more than 50% of the funds raised. This is an
important signal that the Brazilian PE/VC industry has the capacity to perform the whole
investment cycle. In the US, IPOs tend to occur more often than trade sales, while
European PE/VC firms usually have 30% of exits performed through trade sales and only
5% through the stock market. The recent trend in the Brazilian IPO market may lead exits
in Brazil to be more IPO oriented, with positive consequences to the whole PE/VC
investment cycle.
Venture Capital 123

Table 4. IPOs in Brazil.

Year Number of IPOs Amount issued (R$ mil.)


1995 2 185
1996 0 0
1997 1 100
1998 0 0
1999 1 434
2000 1 33
2001 0 0
2002 1 351
2003 0 0
2004 7 4803
2005 9 5348

Source: BOVESPA.

Conclusion
This paper offers a first description of the Brazilian PE/VC industry in terms of size and
structure. It also compares the Brazilian PE/VC industry with that of the US, Europe, and
other developing countries. Most specifically, this study identifies differences and
similarities between the US and the Brazilian PE/VC models. Similarities were expected
since PE/VC was imported from the US and most managers have close ties with their US
peers. Some differences were also expected because of the specificities of the Brazilian
institutional environment.
In terms of describing PE/VC in Brazil, some of our main results are:

(1) The Brazilian PE/VC industry is relatively small compared to the size of the
Brazilian economy. Nevertheless, the industry has proven economically relevant,
bringing several companies to the stock markets.
(2) The industry is concentrated: geographically (around Sao Paulo and Rio de
Janeiro) and in terms of capital committed (just a few organizations representing
the bulk of capital committed).
(3) The Brazilian PE/VC portfolio is fairly dispersed across industrial sectors.
(4) The managing organizations are quite parsimonious in terms of personnel and
managers are highly educated.
(5) Trade sales have been the main mechanism for exiting investments, but a recent
trend indicates that in the near future IPOs will become a major exit mechanism.
(6) The majority of the industry is composed of independent organizations.
(7) The industry has a modest but important participation in government and
multilateral organizations.

Comparing the Brazilian PE/VC industry and the North American one, we find that
the main similarities are:

(1) The managing organizations are mainly independent and manage capital that
comes mostly from institutional investors.
(2) Capital is heavily concentrated regionally as well as in few organizations.
(3) Investments are made within a close geographical distance from firms.
124 L.L. Ribeiro and A.G. Carvalho

(4) Software and IT are preferred sectors; and


(5) Managers are highly qualified.

The main differences are that for Brazil:

(1) In line with a lack of high-expectation entrepreneurship, there is a tendency to


invest in more advanced stages of corporate development.
(2) Since credit is scarce, few LBOs take place.
(3) Low levels of sector specialization (i.e. PE/VC investing in different sectors) suggest
few opportunities within each sector.
(4) The concentration of firms in the Sao Paulo financial and business district suggests
a quest for commercial partners and strategic buyers for portfolio companies; and
(5) Brazilian PE/VC regulation recognizes the inefficiency of the legal system and
forces the use of arbitration.

In the past decade many important developments have improved the economic and
institutional environment for business in Brazil. Some of these developments should
contribute to the Brazilian PE/VC industry development. Among them we list:

(1) Pension funds are now allowed to invest up to 20% of their assets in PE/VC. They
have quickly become the major PE/VC investors in Brazil. As private pension
schemes become more popular, their share of committed capital should increase.
(2) The resurgence of the market for IPOs showed that the stock market is a viable
and profitable exit mechanism. As the literature shows, IPOs encourage more
fundraising.
(3) Interest rates are declining and are expected to further decline against short-term
rates, making PE/VC more attractive to investors and reducing the cost of credit,
thus encouraging leveraged buyouts.
(4) Brazil is on the verge of obtaining investment grade; this change in status will
possibly bring investments from several international investors that are currently
impeded from investing in the country.
(5) The PE/VC regulation is sound and protective of institutional investors and
individuals.
(6) The Brazilian legal system has recognized arbitration as a mechanism to solve
conflicts.
(7) The stock market has established mechanisms to differentiate companies with
good corporate governance practices and promote SME listings.
(8) The lack of infrastructure, transportation services and security continues to
represent long-term investment opportunities.
(9) The new bankruptcy law is expected to decrease procedural time, thus facilitating
turnarounds.
(10) Tax authorities are now considering PE/VC funds as closed-end funds for tax
purposes.
(11) Capital gains tax was reduced from 22% to 15%, with full exemption to foreign
investors.
(12) The new corporate law increased investor protection. Nonetheless, the business
environment could still be significantly improved with reforms such as
simplification of tax procedures, reduction of the tax burden on formal
companies, and enforcement of rights.
Venture Capital 125

Acknowledgements
This project was made possible with the full support of FGV Center for PE/VC Research and its
sponsors. The authors acknowledge the important contribution given by Professor Cláudio Vilar
Furtado and the institutional support for data collection provided by the Brazilian Private Equity
and Venture Capital Association (ABVCAP), Sao Paulo Stock Exchanges (BOVESPA), the
Emerging Markets Private Equity Association (EMPEA), Brazilian Ministry of Science and
Technology’s Financing Arm (Finep), Endeavor, and the International Finance Corporation (IFC).
Ribeiro received grants from the National Council for Scientific and Technological Development
(CNPq) and the National Association of Investment Banks (ANBID). Carvalho received grants
from the State of São Paulo Research Foundation (FAPESP) (Project 03/08825-7), CNPq (Process
477572/2003-0), GVpesquisa and GVcepe. Comments from André Aquino, Rodrigo Bueno, Tiago
de Melo Cruz, Joubert Castro Filho, Janine Gonçalves, Elizabeth Johnson, Isak Kruglianskas,
Roger Leeds, Keith Nelson, Fernando Ruiz, David Stolin, Isaias Sznifer and Vitaly Vorobeychik are
gratefully acknowledged. Gisele Gaia and Fábio Barreto provided invaluable assistance. An earlier
version of this paper has been presented at the 2006 Babson College Entrepreneurship Research
Conference (BCERC). It derives from Ribeiro’s MSc. thesis: O Modelo Brasileiro de Private Equity
e Venture Capital.

Notes
1. In fact we also collected data for six PIPE organizations (organizations that make private
investment in public equity), but for the sake of international comparison, they had to be
excluded from the sample, leaving us with 65 organizations.
2. To identify the population of managing organizations in Brazil, we relied on the following
sources: (1) Endeavor’s guide; (2) Brazilian Venture Capital Association (ABVCAP)
members’ list; (3) list of funds regulated by Comissão de Valores Imobiliários (CVM), the
local securities and exchanges commission; (4) IFC’s annual report; (5) Ministry of Science
and Technology’s (FINEP) internal address book; (6) list of firms in Johnson and Pease
(2001); and (7) analysis of news in the media.
3. In Brazil, PE/VC funds can take different legal forms such as holding companies, limited
partnerships, investment funds regulated by the local security and exchanges commission, etc.
Also, a PE/VC organization can manage one or more PE/VC funds.
4. Managers are those with decision power over at least one phase of the PE/VC cycle.
5. FINEP, BNDES, SEBRAE, Banco do Nordeste, etc.
6. Inter-American Development Bank, International Finance Corporation, Overseas Private
Investment Corporation, the Netherlands Development Finance Company, etc.
7. Namely: Natura (cosmetics), Gol (low cost/low fare airliner), ALL (railways and logistics),
DASA (laboratorial services), CPFL (power generation and distribution), TAM (airliner),
Submarino.com (internet retailer), Localiza (car rental) and UOL (Internet service provider).

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