Venture first, capital later

Elsewhere in this issue the challenges of delivering a credible version of venture capital to emerging markets are discussed in detail (see page 46). It's clear that for VC to provide both the macro- and micro-economic stimulus evidenced in mature economies such as the US there needs to be a sufficient infrastructure (be it financial, regulatory or actual ?hard? items like telecommunication) for entrepreneurs and their investors to rely upon. And in emerging markets it's much more likely that this infrastructure is incomplete, prompting some to shy away from developing any VC initiatives in such markets. Latin America is a good example of an entire region that is so categorised by many.

Darby Overseas Investments, the Washington-headquartered private equity firm set up in 1994 by former US Treasury Secretary Nicholas Brady that has a particular appetite for Latin American private equity, doesn't think this is much of a response, but equally is not keen on embarking on an ill-defined solo journey into venture investing in the region. The alternative proposition is Darby Technology Ventures (DTV), a company majority owned by Darby that also has firms like IBM, Amerada Hess, Comcast Interactive Capital and Bechtel Enterprises as shareholders.

?DTV is our way of establishing a leading position within a particular sector that is ripe for development in Latin America, with high payoffs as investors,? says former World Bank and IFC managing director Richard Frank who is both CEO of Darby Overseas Investments and DTV. That sector is technology, one that has many venture and private equity firms reaching for their gun at its very mention. But continues Frank: ?With 20 Latin American portfolio companies, we could see first hand how technology could significantly boost bottom-line results by increasing operational efficiency. It has transformational potential, particularly in areas such as logistics, procurement, production and management.? And with that conviction in mind Darby set out to garner support for establishing a business that was part fund, part advisor and part hard infrastructure provider. Besides the aforementioned international firms who bought into the proposition, a number of Latin American shareholders came on board: the Reute Group out of Argentina and Boa Esperanca Ventures of Brazil are already on board and another major, locally based but globally active, company is coming on board very soon too.

Business development, not incubation
The objectives that encouraged these firms to invest in DTV are an interesting mix of the pragmatic and strategic. Richard Birney, Vice President at IBM Ventures Investment Corporation, was the key person at the IT leviathan who worked on the DTV proposition and is quick to point out that his unit is the part of Big Blue that engages with venture development – as opposed to venture investing. ?Our venture fund is of course investing directly in VC firms but our mandate is different: we're doing business development. The first question we ask is does [an investment] make strategic sense? Only then do we ask: will it lose money?? And Birney, just as Frank, is alive to the opportunity of gaining a window on an entire regions' technology requirement and usage via DTV. ?Our first thought when reviewing Latin America was to look at country funds but found them lacking the [technology sector] focus as well as the geographic scope. With DTV we get the focus and the coverage we were looking for.? IBM was also able to play an active part in defining DTV's business: ?We negotiated for nine months, working through what Darby's thoughts were and what we were looking for.?

But don't call DTV an incubator. Besides bridling at what has become a tarnished label, the team behind DTV are not wanting to become engrossed in the nurturing of fledgling business: ?We consider ourselves investors and when we examined the incubator model it was too fundamentally hands on and start-up company building and hence not for us,? says Frank. Instead DTV is a chance to become a nexus point for technology providers and users wanting to grow their business in Latin America: this includes US firms keen to grow their business there (just ask IBM), as well as local companies eager to work with an international, well-connected firm. It does not have to involve leading edge technology, better even if it does not as the objective is to get robust solutions into the market quickly. Nor must it require capital immediately from DTV: the firm can invest at present but is ready to provide advisory and consultancy services as standalone services. ?We're a point of presence,? says Jorge Salvatierra, the managing director and COO of DTV, ?and that even extends to providing the right kind of office space.? DTV has opened the first in a planned series of technologically sophisticated offices – Darby Technology Centres – in Miami for client and partner firms to use, ensuring that the hard infrastructure problems found in emerging markets can be countered. The next such centre is going to be in Monterrey.

Besides this advisory and operational support though, and for Darby in particular, DTV has to be seen as an investment conduit. One reason is the simple imperative of generating investment returns: and DTV can help nurture a business that, as it grows, becomes a portfolio company of Darby when follow-on finance is required. There is also the opportunity though for Darby to move further upstream in the financing process by having DTV raise country specific technology funds. This is already being planned and

Salvatierra reports that the first two funds will target Mexico and Brazil with a target total size of $50m apiece. Crucially, the funds will be managed jointly with experienced, local partners. This not only ensures the on-the-ground network and knowledge that is so valuable in all (but especially emerging) markets but also brings an important political bonus as well.

Both the governments of Brazil and Mexico are keen to see venture financing play a much more prominent part in their countries economic development but have been wary of committing capital to relatively inexperienced local operations. But they would equally baulk at channelling local finance via an external agency where political ructions would almost certainly ensue. So the chance to work with a firm that is a combination of local and international specialists is hugely attractive. And that's why development banking institutions in Mexico and Brazil are currently working with DTV to participate in these country specific funds. Frank sees this as an important move to remedy another structural impediment to VC in emerging markets: a financing gap that appears at a critical stage in a company's development. He says: ?There's clearly a capital constraint that comes after the friends and family round of financing [of a company] as there is a dearth of angel investors and VC funding. New companies that get a successful start still face problems getting funding from the bank financing capital markets – which are severely depressed at present anyway.?

DTV, as the manifestation of what happens when a seasoned private equity investor in Latin America brainstorms with global technology companies, local governments and businessmen, is a considered response to the challenges – and opportunities – that exist in a sector and a region that have both taken a roller-coaster ride of late. No one else is trying what it's trying: and that's another reason why the firm is multi-facetted and multi-phased. Venture first: capital later.