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What do a chain of pre-school nurseries, new technology to manage supermarkets and a plan to grow lemons in the Atacama Desert have in common? Not much at first glance, but they are all beneficiaries of Chile’s surging venture capital sector.

The industry barely existed at the turn of the century but thanks to aggressive state support and a network of talented entrepreneurs, administrators and investors, venture capital is showing vigorous growth.

“The development of the sector in the last five years has been explosive,” says Gonzalo Miranda, CEO of Austral Capital Partners, one of Chile’s new breed of venture capital funds.

Venture capital has, in theory, always existed: behind every great innovation have been investors willing to risk their money to support it. Christopher Columbus would never have discovered America without the financial backing of the Spanish monarchy.

But modern venture capital was invented in post-war United States, coming into its own in the information technology revolution of the 1980s and 90s.
Apple, Oracle and Google are just some of the firms that benefited from venture capital.

Unlike more conventional sorts of investors, venture capitalists, whether direct investors or fund managers like Miranda, usually take a more hands-on approach to their companies, tweaking the business plan, identifying promising markets and also looking how to exit the investment with a healthy profit.
“We are trying to connect worlds: that of talent with the world of capital and markets,” explains Miranda.

Without someone willing to stump the money early on, inventions could take decades winning acceptance.

In exchange for the increased risk of supporting a fledgling company pushing an untried technology or business model, investors expect big profits if they succeed. In Chile, that means returns of at least 20%-30% per annum.

CORFO Innovation Funds

As in most countries, including the United States, the United Kingdom and Israel, Chile’s venture capital sector has benefited from state intervention.

Spotting a gap in the country’s financial sector, the Chilean Economic Development Agency, CORFO, began to develop a series of funds designed to encourage innovative projects.

Under this mechanism, CORFO doubles or triples the original investment in the fund and, when it comes to liquidating the fund, the winnings are paid back inversely so that the private investors walk away with the bulk of the profits.

This significantly reduces the risk for investors and increases their potential profits, says Patricio Reyes, CORFO‘s head of financial intermediation.

So far 30 such funds have been launched under CORFO totaling US$ 570 million. Through the end of 2009, the funds had invested in 86 companies and still have around US$300 million to invest in new projects.

Investments range in size between US$ 1 and US$ 5 million. And the range of businesses supported through the scheme is equally impressive.

Austral Capital specializes in new technologies and biotechnologies, such as producing bio-fuels from microalgae or using computers to help supermarkets monitor customer behavior.

Others have more modest goals, like applying modern management techniques to running a kindergarten or planting new fruit or grain varieties.

But many of the investments supported by CORFO are not what would count as venture capital in the United States or Europe where start-ups need to offer a significant innovation to obtain capital.

Of the 30 funds which have received funding from CORFO, only two or three are genuine venture capital funds, says Alan Farcas, CEO of Endeavor Chile, an NGO that promotes entrepreneurship.

Austral is one; Fundación Copec-UC – a partnership between Santiago’s Catholic University and one of the country’s largest industrial conglomerates - is another.

Many have acted more like private equity funds, taking stakes in privately-held companies to fund a major expansion or turn-around of the business. As a result, of the US$ 570 million managed by the funds, less than US$100 million will go to start-up businesses.

“The funds are being misused: legally they are doing nothing wrong but it’s not within the spirit of the law,” Farcas argues.

At CORFO, Reyes concedes not all the money has gone into new companies but says changes have been made to the original model to ensure that funds are more focused in the future.

For example, the F3 line of credit, launched in 2005, added incentives to ensure more of the money goes to innovative companies or industries and the new F4 program will be directed 100% at innovative projects.

And, despite its initial lack of focus, CORFO is likely to continue to play a major role in venture capital for at least another four to five years, says Reyes, after which the sector should be strong enough to grow on its own.

Entrepreneurs Wanted

Already CORFO’s support has helped Chile leapfrog to the vanguard of venture capital in Latin America. For three straight years Chile has topped the regional ranking by the New York-based Latin American Venture Capital Association and many governments are looking to replicate the CORFO model.

But it is not just a question of strong state support.

Chile’s financial stability, clear accounting rules and social stability, all qualities long appreciated by multinationals investing in the country, also make it a good place to start a new business.

And there are plenty of rich individuals willing to risk their money in new businesses. But some fret there is a lack of attractive opportunities.

“There are not as many good projects as we would like to have – that’s a structural problem,” said Farcas.

The poor quality of education significantly reduces the number of potential entrepreneurs. Farcas estimates that no more than 10% of the population has the skills and contacts necessary to develop a business. While Chile’s high-impact entrepreneurs total no more than a hundred, Israel, a much smaller country, can call on almost 2,000.

And when they do dream up a business, entrepreneurs rarely consider its potential beyond the narrow confines of the Andes Mountains and the Pacific Ocean.

“As a country, we tend to think small,” said Farcas.

But that is starting to change. Chile’s business incubators are an important source of innovative companies ripe for investment, says Reyes.

Thanks to CORFO, 19 such organizations exist, often based at major universities, which have supported 500 projects in the last four years. CORFO’s innovation promotion arm, InnovaChile, has also provided seed capital for 650 early stage start-ups over the same period.

But there is a long way from projects at this stage of development, with investments normally in the US$ 10,000-US$50,000 range, to the point where they ready to be taken on by a venture capital fund, which rarely invest less than US$1 million in a business.

Matching Entrepreneurs with Investors             

To bridge this gap, a number of business angel networks have been formed, which seek to bring together promising projects with interested investors.
Such networks play a crucial role by searching for and vetting potential investment opportunities, while building trust between investors since one can only join on recommendation from an existing member.

These earthly angels are often high net-worth individuals, typically executives or entrepreneurs nearing the end of their formal careers. Just as important as their money, however, is the business experience and contacts they can share with their protégés.

“They allow the business to grow much more rapidly than would otherwise be possible,” says María de los Angeles Romo, investment manager with Southern Angels, Chile’s largest and long-running business angel network.

Linked to Adolfo Ibáñez University’s business school, the network’s 65 members have invested a total US$5.7 million in 18 businesses since its creation four years ago, with individual contributions ranging in size between US$ 50,000 and US$ 500,000.

In its wake, five more networks have been created often under the auspices of larger organizations, including other universities.

Although the networks receive funding from CORFO, there is no state support for angel investment itself as exists in other countries.

In Scotland, a development fund automatically matches investments in start-up companies in addition to the tax credits offered by the British government.

“With this type of incentive an investor does not take so long to decide on making the investment,” said Romo.

A private version of the Scottish scheme is run by Santander, Chile’s largest bank, attracting significant interest among entrepreneurs and investors.

Another barrier preventing more angel investment is entrepreneurs’ lack of business experience, so networks spend a lot of their time coaching them how to pitch their idea and negotiate with interested investors.

“When they come to us, they often cannot answer even the most basic questions that an investor would ask, such as expected cash-flow or a proper business plan,” said Nils Galdo, CEO of the investment group GlobalChile Angels.

Finding projects at the right stage of development is another difficulty. Promising projects often spend up to three years in business incubators by which time they are too old, or too well-known, to be of interest.

Instead, incubators should be more selective, deciding quickly which ideas will sink and which will swim and then finding investors to help them grow, suggests Galdo.

Thinking Globally

Given the youth and lack of experience of Chile’s venture capital industry, education and an international outlook are vital to its success.

A new course organized by the Adolfo Ibanez University and CORFO on venture capital investment should help increase knowledge, and what Chile lacks in capital, ideas or demand it can find elsewhere.

Of course, the U.S. is an important source of both ideas and investors. Austral, which has an office in Santiago and another in Silicon Valley, has been able to spot businesses with potential, “whether Chilean innovations for the U.S. market or vice-versa,” said Miranda.

Austral also works closely with U.S. investors who can supply the knowledge and contacts to help a promising project get ahead.

If entrepreneurs are thin on the ground in Chile, the country could import talented entrepreneurs and help them create new businesses here.

Immigration laws should be changed to make it easier for entrepreneurs like Internet entrepreneur Wenceslao Caceres, who hails from Argentina but runs some of his businesses out of Santiago, to set up shop here, suggests Farcas.

But the small size of Chile’s market is of little interest to investors looking to maximize returns. Miranda spends much of his time between the U.S. and Brazil where Austral has relocated some projects, eyeing the greater potential demand in these much larger markets.

Still, Austral has made nine investments in Chile in the two years since it was launched, which suggests opportunities do exist.

An international focus will also help when venture capital funds look to realize the gains made on their original investment.

Chile’s small and heavily concentrated economy could make it difficult to sell a business at a competitive price and the stock market, dominated by large companies and institutional investors, is not a welcoming place for high-risk start-ups.

Although the government and financial institutions talk hopefully of creating an emerging market in Santiago, after several failed attempts Miranda is not holding his breath.

Instead, investors should look abroad for exit strategies.

Austral has already listed shares of one of its investments on the NASDAQ stock market while the backers of the Vitamina chain of kindergartens have signed an agreement to sell the business to one of the United States’ largest providers of pre-school education once they grow the business to an acceptable size.

“If we can’t do it in Chile, we’ll do it elsewhere,” Miranda explains.

Angels on our Shoulders

The new confidence of Chile’s venture capital sector is attracting interest from aboard, but this has yet to translate into investment.

Endeavor’s Farcas regularly meets with U.S. venture capitalists looking for opportunities although none has made a firm commitment. “There are many circling but none have landed,” he said.

This could soon change. San Francisco-based Burrill & Company is close to tying up a deal with Austral Capital and CORFO to create a new business fund in Chile, said the firm’s CEO Steven Burrill.

With investments totaling around US$ 1 billion in over 90 biotech businesses around the world, Burrill would bring a new scale and international flavor to Chile’s nascent venture capital scene.

As well as investing in Chilean innovations, the firm is interested in bringing technology detected by its global network of offices that could find new applications from vaccines for salmon farms to more efficient ways to produce pulp or mine copper.

“We want to bring technology that could be transformative for the local economy… and help Chilean companies be more competitive globally,” said Burrill.

But attracting more funds like Burrill will be difficult unless they are offered more incentives, says Miranda.

In Canada, Brazil and some U.S. states, foreign funds are exempt from paying taxes but in Chile they must pay a capital gains tax of at least 5%.

“To be competitive, we need to reform the tax system: today we are too expensive,” said Miranda.

With such an incentive in place, there could be a couple of dozen funds waiting to swoop rather than just a handful. And the more angels who come down to earth, the more innovative and strong Chile’s economy will become.

Tom Azzopardi is a freelance journalist based in Santiago