Magma Partners Q4 2022 Investor Letter

February 15, 2023

February 23, 2021

We send quarterly investor letters to our LPs about what we're seeing in the Latin America startup market. We share edited versions with our portfolio. We’ve decided to share a further edited version publicly.


Magma LPs,Hope you had a great end to 2022 and start to 2023. We’ve continued to work helping founders understand market conditions, while being opportunistic about doubling down on our current portfolio and selecting new startups to invest in.

As we talked about at the end of Q3 2022, Magma is well positioned to thrive in this new normal since we mostly stayed disciplined during the past two years of exuberance. While most of our portfolio has adapted to new market conditions, many founders, especially founders who have only operated in sunny weather, either didn’t make changes fast enough, or made some changes, but not at the scale we have recommended.

Some of these companies will end up going bankrupt. Others will learn their lesson and double down to become more lean.

As we’ve seen the Latin American ecosystem react to these changes, we are very bullish on Latin American tech for the long term. Many companies that raised significant money are well positioned to use the capital they raised as an advantage to consolidate leadership in their categories, while companies that have capital efficiency in their DNA are using their operating skills to grow in a capital scarce environment.

TLDR Macro: Wet powder vs. dry powder, potential for startup extinction level event in late 2023, the LP/VC reckoning, advice for founders

  • The industry has mostly moved away from growth at all costs and momentum investing toward profitable unit economics and solving real problems.
  • Many startups are likely to die in Q3/Q4 2023 and early 2024, including some from Magma’s portfolio. Some predict an “extinction level event” coming for early stage startups.
  • Founders and some VCs think a record $298B “dry powder” might save startups in 2023, but we believe much of this dry powder is really “wet powder” that VCs will use to save portfolio companies.
  • There’s a reckoning happening in VC, as LPs reevaluate potentially underperforming VCs that raised fees and carry during the boom, and changed their fund strategy by growing significantly from one fund to the next.
  • Latin America valuations are down significantly at Seed and A. Much of the pre-seed or seed extension prices haven't adjusted yet.
  • Many investors are giving self-serving or bad advice to founders about runway. They’re giving founders very optimistic advice about valuations that they themselves won’t pay.

Deep Dive Macro: What’s happening in the startup and VC market?

The move away from FOMO-driven growth at all costs

As we wrote in the Q3 update, rising interest rates led to a stock market pullback in unprofitable tech, which is making its way down into the private markets. Tourist capital has mostly left Latin America and seemingly most of the industry is looking to invest in startups with solid unit economics, lower burn, and are evaluating if companies can generate real money in the future, rather than invest money in momentum bets.

Latin America’s battle tested startups that had to learn how to survive on relatively little venture capital are poised to take advantage of the new ecosystem rules, whether they can raise money or not, and startups that raised warchests but are able to pivot from growth at all costs to more efficient growth are poised to win.

We’ve been advising startups since November 2020 that they need to be cutting costs, forgetting about being valuation sensitive, and focusing on great unit economics. In 2020, most startups targeted at least 3x annual growth to get funded, regardless of unit economics or burn.

In 2023, VCs generally would rather see a startup grow 50% to 100%, but have great unit economics, lower burn and longer runway. In extreme cases, it might be more impressive to grow 0% in 2023, but significantly improve margins and payback period while lowering burn to more reasonable levels.

Magma Advice to Founders: Hope for the best, prepare for the worst

The cambio de chip (attitude change) from easy money to harder fundraising conditions has been really hard on founders, including some from our portfolio. 

Some founders have made the adjustment, but others only made small cuts because they seem to think that the market will go back to the go-go days of 2020/2021. I don’t believe we’ll see 50x-1000x multiple deals until the next bubble.

The hardest founders to convince that things have changed fall into two groups:

  1. Founders who were able to raise easily understand it will be harder to raise, but they haven’t truly internalized just how hard it's likely to be, and have not cut spending enough.‍
  2. Underestimated founders that had trouble raising money during the boom. VCs told them “you’re not growing fast enough” as an excuse not to fund them, but founders took it as real feedback and are trying to grow faster in a bad market in hopes of raising money.

It’s hard work convincing a founder with great unit economics who should have been able to raise during the boom to not increase burn when VCs used growth as an excuse to not fund them, rather than be specific about why they were really passing.

In addition to many 1 on 1 meetings, board meetings and whatsapp conversations, we have been holding monthly founder Zoom meetings to share advice. In Jan 2023, Truora’s Daniel Bilbao and Neivor’s Caterine Castillo shared their experiences and advice to survive the downturn. In Feb 2023, Frete’s Federico Vega shared his experiences. Here’s the short version of what we’re telling founders:‍‍

  • “Survival is a precondition of growth” - Josh Wolfe, Lux Capital.‍
  • Any business model that doesn't scale profitably, meaning it has negative gross profits, will very likely not be able to raise money, no matter the growth.‍
  • Most investors aren't expecting high growth rates this year. It's likely smarter to grow 40-50%  but improve unit economics and burn multiple. Growing 2x this year might be more impressive than growing 3x or 4x during the boom.
  • ‍Investors generally want to see: good unit economics, good burn multiples, and a plan to have at least 18-24 months of runway, ideally more.‍
  • 2020 and part of 2021 were the exception. Don’t expect the market to go back to that until the next bubble.
  • Companies with short runway (less than 18 months), should try to extend runway either with cuts or raising more money, or both.‍
  • If you have under 1 year of money left, ask your current cap table if they’d invest more money into the company, and at what valuation. It’s good to have this information ASAP, rather than when you have 6 months left.

Bad advice from VCs: “I think you’ll raise an extension at your last valuation” or “I think you’ll raise at $X valuation”

Many VCs are giving bad advice to startups either unintentionally or because founder and VC incentives are not truly aligned. The conversation goes something like this:

In this example, let’s use a fictional company that raised at $25M cap SAFE and has 15 months of money in the bank. The founder has a few options:

  1. Raise an extension at the same $25M cap, or similar.
  2. Try for a Series A at a higher valuation.
  3. Cut costs and extend runway to 24-30 months, and raise with better metrics in the future.

Here’s how many conversations have gone with founders in the portfolio:

Magma - You’re unlikely to raise at your last valuation. Even growing 4x from today in the next 9 months, you will be hard pressed to raise at that same valuation, based on the comparables we’re seeing in the market.

Founder - I've had these conversations with most of our investors and most of them believe we can definitely raise an extension at the $25M valuation, but are not sure we can raise a full Series A based on our traction.

Magma - We for sure could be wrong. You might be able to raise at the same valuation. But what we’re seeing in the market makes it seem like a long shot.

If VCs think you can easily raise an extension at that valuation, ask them if they’d invest at that valuation today. See what they say. If they say yes, take the money. You just extended your runway at a good valuation.

I hope I’m wrong, but my guess is you're gonna be a bunch of "ahh well we cant right now, but i think you should be able to raise it," type responses.

The worst version of this bad advice went to one of our current portfolio companies. We told a founder we’d invest at an $x valuation. Their other investors thought the round would price $2x-2.5x higher. We’re wrong all the time and we wanted the founders to get the best deal possible, so we told the founders they should go to the other investors who said they could raise at $2-2.5x our offer, tell them that Magma would follow, not lead, and see who would invest. Nobody did. 

We offered at $xM, which was up from the startups' previous valuation. All the other investors told the founder not to take it, because our offer was insultingly low. The founder told them to put money at the same $xM if they thought it was a good deal. None did, except a few small angels. We wrote the check.

Long story short: Ask anyone who seems confident that you’ll be able to raise at a good valuation if they’d invest at that valuation today. Get the information from your investors ASAP to see if they're going to put money where their mouth is. Take any VC advice, including ours, with a grain of salt unless they are actually willing to write a check.

Best case, they do, you extend your runway. Second best case, you know they aren't going to do it, and you can ask outside investors ASAP or make a bigger cut now knowing how much real runway you have.

Reframing burn as dilution, pushing founders to cut more

We have been reframing a founder’s burn as their monthly dilution. Here’s the simple exercise from an example company:

  • $50k monthly burn
  • $900k cash in the bank18 months runway
  • $250k ARR

This company’s last valuation was $15M, or at 60x ARR. Today, public market SaaS is trading at 5-10x, which would imply a $1.25M to $2.5M valuation for our startup.

This startup will need to start raising money in 9 months at the latest to have enough runway to make sure they don’t run out of money.

What revenue will this startup need in 9 months to raise at a $15M valuation again?  At least $1M ARR (4x growth). Maybe even more.

Is it likely that this startup will grow 4x in 9 months? Probably not. More likely they could double in 9 months and be at $500k ARR. If they’re at 500k ARR, they’ll be lucky to raise a $15M cap, and likely will be at $10M or even a $5M cap. If they can raise at all.

The $50,000 burn is costing founders 0.33% dilution if they can raise at the $15M valuation, and might be as much as 1% monthly if they have to raise at a $5M valuation to stay alive.

Our advice is to cut to $25k burn or less today, get to 36 months of runway, and then grow more slowly and ride out the storm.

Many founders are finding it hard to do this math, or don’t like what they see. Some don’t cut enough. If you're not growing into your valuation, not cutting enough leads to more distressed founders and the potential for a mass extinction event later this year or early next year.

Most Magma founders who aren't growing into their valuations have gotten the message, but some still haven’t.

A potential “mass extinction event” for startups in Q4 2023?

Tom Loverro, a VC at IVP, wrote a thread about the potential for a mass extinction event for startups in 2023. 

His thesis is that startups raise 12-24 months of money in 2021 and 2022, then cut burn to extend runway an additional 6-12 months.

According to industry data, 80% of US early stage startups have less than 12 months of runway. They have all been following conventional wisdom to conserve cash, improve margins, lower burn and then try to raise “when market conditions are better.”

Unfortunately, many founders have not been able to cut enough or increase revenue enough and are on target to need to raise money in Q3/Q4 2023 or even Q1 2024. I say unfortunately because there is likely to be a glut of companies all looking at raising at the same time.

Upfront VC’s Mark Suster thinks Loverro’s analysis is spot on, predicting that 50% of US-based A and B businesses will go out of business in the next 4 years. It wouldn’t surprise me to see an even higher attrition rate in Latin America.

Most founders don’t understand that they don’t need to just have great metrics, but that they’re competing against all of the other startups that come across our plates in the market. So if there’s a glut of companies all trying to raise at the same time, many companies that probably would have raised if there was less competition in the market probably will go bust or will have to take really bad terms.

So should founders go to market now? If you have good numbers, yes. If you think your internal VCs might give you money, yes. Get in before the flood. You can earn 4-4.5% by putting the excess cash you raised in treasuries or FDIC insured money markets or Treasuries, which means that the amount you raised is effectively higher.

Dry Powder vs. Wet powder: Why the dry powder overhang likely won’t save underperforming startups

There’s a record amount of  capital committed to VCs that has not been deployed. In VC speak, this is dry powder; money that VCs “have” to invest over the next 2-3 years. According to Pitchbook, VCs raised a record $162.6 billion across 769 funds in fresh capital, following 2021’s own record of $154.1 billion. Q3 2022, there was about $298.5 billion in committed, but uninvested capital.

Many VCs and founders are expecting (hoping, praying) that the massive capital overhang from record LP commitments to funds will open up the spigot again.

In this version of the world, all that backed up dry powder will rekindle the startup ecosystem. Unfortunately, this worldview is likely wrong, especially in Latin America. Even though there’s been a record amount of capital committed to 2020, 2021 and 2022 vintage funds, much of this supposedly dry powder is really wet powder, a term Lux Capital’s Josh Wolfe coined for committed capital that really isn’t investible.

So why is supposed dry powder actually wet?

Deployment Compression

Much of the money committed to VC funds during the boom is already deployed. VC funds used to get deployed in 3-5 years. During the boom, some funds were raising new funds every 12-18 months.

Deployment slowdowns

Some VCs are slowing down deployments in order to wait out LPs who might be struggling to make new commitments. So while a fund may have 50-75% of its capital left, VCs could be trying to make it last 4-5 years, which means that less money is available to invest now.

Reserves to “save” portfolio companies

Even if VCs didn’t deploy faster than normal, many funds are reserving money to support current portfolio companies. Much of this overhang of committed capital is going to go to internal rounds, rather than to new investments.

Sunk costs in funds with overvalued investments mean some of that money won’t get called

Some funds deployed most of their money at the all time highs in companies that don’t have much of a chance of driving good returns. If VCs already invested 50% of their fund in underperforming companies, they are unlikely to get to their carry, even if they do extremely well with the second 50% of the fund. In extreme cases, it seems likely that some VCs will return capital or shut down their funds rather than put good money after bad in a fund that will make it really hard for the VC to get to their carry.

Momentum investing vs. fundamentals investing

Over the past 10 years many VCs deployed capital via momentum investing strategies. Many VCs would ask “who’s in” and if it was a brand name, money would flow. They’d look at top line growth and ignore unit economics. Founders responded to the incentives and tried to grow topline revenue as much as possible, which led to more high multiple rounds and more money flowing. Now the pendulum is swinging toward better unit economics and efficient growth.

The VC Reckoning: How we might see a realignment in the VC industry

Angular Ventures’ Gil Dibner, wrote about his conversations with LPs.

Many of our conversations parallel conclusions in Dibner’s thread, including many conversations we’ve had with some of you. A few of you have told us that you’re cutting back on VC funds, especially those that increased fees and deployment schedules.

Here’s what we’re seeing:

  • VC funds got really big, optimizing for management fees.
  • Many funds, including in Latin America, grew 5-10x during the boom years.
  • Deploying 5-10x more over 2 years is a different game that requires learning different skill sets, different deal flow, etc.
  • Big VC funds generally have lower multiples than smaller funds. Data shows that smaller funds generally have higher cash on cash multiples than their bigger counterparts because it's easier to 3x a smaller amount of money
  • Many VCs raised their fee and carry structures, including some first time fund managers.
  • Many VCs deployed much faster, much of it at the market peak.
  • Higher fees and carry means that DPI for this vintage overall could be even worse than simply having invested in high valuations at the peak.

It will be interesting to see what LPs decide to do. Will they consolidate commitments in ever larger, brandname funds? Will they pivot toward smaller funds? Will some funds not be able to raise money? 

It will be interesting to see how founders continue to navigate moving from easy mode of 2020 to hard mode of 2023 and beyond. We'll be here to keep working with our portfolio, helping founders solve Latin America's biggest problems.


Nathan, Pedro, Francisco, Mak and the Magma team