4 things you need to know before investing in a local startup
“By a show of hands, how many of you identify funding as the primary need of your project?” The room was filled with close to 80 eager, enthusiastic entrepreneurs ready to take on the world, and by the time I finished asking the question, more than 60 hands were up in the air. As co-director of the Founder Institute in Costa Rica, I constantly come in contact with aspiring entrepreneurs from all walks of life: from the 19-year-old college student working on her startup between classes, to the savvy engineer who just quit his job at Intel to pursuit his dream.
Without a doubt, entrepreneurship in Costa Rica has been growing in the past few years, and there are many initiatives that have been contributing to it. From business plan competitions like Yo Emprendedor, to prototyping events like Startup Weekend, from structured entrepreneurship training programs like Founder Institute, to the emergence of dozens of incubators like Auge, Parquetec and UNA Incuba, to name a few, it would seem there’s never been a better time to take the leap and start your own business.
Local startups today need many things besides funding, but it is this sole component that grabs most of their attention. They apply to incubators as a means to obtain seed capital from the Banking System for Development (Sistema de Banca para el Desarrollo) or gain access to angel investment; they flock in masses to business-plan competitions in hopes of winning the prize of a couple thousand dollars; or, if they are brave enough, they go through the ordeal of navigating the bureaucracy of local banks in order to get flexible loans or microcredits.
If you are a potential angel investor, there are many opportunities worth exploring in order to fulfill some of this capital demand, as long as you take some considerations and precautions before embarking on your journey. Before you invest in a local startup, make sure you prepare to cope with these four perks – and quirks – of our entrepreneurial ecosystem:
- Local entrepreneurs still have a hard time understanding the investor’s perspective. As a result of the lack of venture capital markets in Costa Rica and the fact that businesses here are rarely funded by third party investment (as opposed to savings, loans, and your uncle Francisco’s money), many entrepreneurs do not speak the same language as investors. There is still a notion that frames investment as a “help” or something that they should get out of good will. The enthusiastic founder in front of you might not think to discussrisk against return, investment horizon and exit strategy, , so you might need to create a common ground on which to negotiate. From my experience, showing entrepreneurs how other startups abroad got their funding helps them understand the tradeoffs associated with bringing an investor on board.
- You might need to invest more than just money. Although many entrepreneurs will tell you that money is all they need, make sure you assess the young company’s needs thoroughly before taking the checkbook out. The team might not have all the skills required to run the company, there might be lack of understanding of the market they are trying to serve, or they might be over-optimistic about their cash flows. Either way, you might have to step in and invest your time, contacts and knowledge to make it take off. Although someone might argue that’s the job of investors everywhere, that type of active involvement might be even more needed in a country like Costa Rica.
- The natural tendency to over-value the companies might be more accentuated here. Even at very early stages of the project (sometimes as early as the idea stage), entrepreneurs will have high hopes for their company’s valuations when it comes to letting equity go. Perhaps more common locally than in other startup ecosystems, you might find what we could call the “emotional premium on equity,” or the excess in price that the owner expects you to pay to compensate for all those nights he worked so hard, the time away from his family, and the uniqueness of his idea. The truth is that until proven out there in the market, ideas by themselves are rarely worth much, and surely 50% of a company is better than 100% of an idea, but since new entrepreneurs don’t always act (strictly) rationally, you might need to drive a hard bargain.
- Competition is low. On the bright side, venture capital is still in its infancy in Costa Rica, and although there are lots of people with money, there’s not a culture of investing in startups (most investors come from within families). Many local investors don’t understand the inherent risks and rewards of investing in startups and therefore ask for hefty conditions, such as outrageous percentages of equity that entrepreneurs rarely agree with. So if you keep your head cool and roll with the idiosyncrasies, you might strike yourself a good deal.
Costa Rica might not be the Silicon Valley of Latin America (yet), but we’re moving ahead. There’s a very educated workforce that is now finding incentives and programs to help them innovate and turn their ideas into viable businesses. One piece of the puzzle that still seems to be unresolved is the investment, and that’s where many angel investors have an opportunity. Is it the right opportunity for you?
Randall Trejos works as a business developer, helping startups and medium sized companies grow. He’s the Co-Director of the Founder Institute in Costa Rica and a strategy consultant at Grupo Impulso. You can follow his blog La Catapulta or contact him through LinkedIn. Stay tuned for the next edition of his new Tico Times column “Doing Business.”
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