Why Has Kavak, Latin America’s Most Valuable Unicorn, Chosen the Debt Route?

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Bloomberg Línea — Mexico-based Kavak, Latin America’s most-valued private startup, said Tuesday it has signed loan agreements for $810 million with HSBC, Goldman Sachs and Santander to support its secondhand car transactions.

Kavak, valued at $8.7 billion after a General Catalyst-led equity financing in 2021, is an e-commerce platform for used vehicle sales and purchase, a similar model to US-based Carvana, which laid off 2,500 people in May, about 12% of its workforce.

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Is Mexico’s Kavak Headed Down the Same Road as Carvana?

Over the last nine months, the U.S.-based used car platform has seen its shares tumble, arousing fears that Mexican unicorn Kavak, which is based on the same business model, could also be heading for a crash

Kavak also laid off staff in São Paulo and Rio de Janeiro in June, when it announced it was investing $180 million in its global expansion in Turkey, Colombia, Chile and Peru.

At the time, Kavak said it already had the money for the expansion budget from the previous $700 million Series E round.

Now, HSBC is providing $675 million in financing and Goldman Sachs is providing a $100 million credit line, while Santander is furnishing the company with $35 million. Kavak says it will use the funds to develop its business model and grow its inventory as it continues to expand across Latin America.

But why is a company that managed to attract SoftBank, General Atlantic and Greenoaks as investors to pump more than $1.6 billion into the company in five equity rounds now chasing banks for funding at a time where interest rates are going up?

One reason could be that Latin America’s venture capital funding has dropped by half from last year’s peak, according to Latin America Digital Transformation Report 2022 by Atlantico, part of the same investment firm behind Canary, Latin America’s preeminent seed- and early-stage fund.

“Foreign investors appear to be taking their feet off the funding gas pedal, but are far from abandoning the region as in times past. Local funds are stepping up to make the difference,” according to Atlantico’s Julio Vasconcellos.

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Banks Want to Bet on Startups’ Debt, but Equity Investors May Be Wary

Itaú has $57 million to invest in venture debt for early-stage startups, but for General Atlantic, taking on debt requires caution

In some cases, opting for credit is a way companies can avoid down rounds, Brian Hutchings, a partner at Gunderson Dettmer, a law firm specializing in startups and tech, said in an interview with Bloomberg Línea. However, he thinks more often late-stage companies are borrowing because of the amount of capital involved.

“Financial technology companies or lending companies need a large amount of money to provide to their customers, and the amount of capital they need is more than they can raise from equity, or the dilution from an equity investment would be more than they are willing to accept in terms of the amount of capital it provides,” Hutchings said.

And it’s not only Kavak that is going down this road.

In recent days, Goldman Sachs (GS) provided a $140 million credit line to Chilean fintech Xepelin, and Mexican payments fintech Clip secured a $50 million three-year unsecured revolving credit facility with Morgan Stanley (MS), JP Morgan (JPM) and HSBC (HSBC). Goldman Sachs also provided a $150-million collateralized credit line to Mexican loan and expense management firm Clara.

Goldman Sachs also lent $233 million to MercadoLivre in July, participated in Nubank’s (NU) $650 million credit line earlier this year, and provided $160 million to Mexico’s Konfio last year.

In Brazil, Itaú BBA said in an interview with Bloomberg Línea that it has built a venture debt book with its own funding from the bank’s balance sheet.

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Wall Street Banks Funding More Startups in Latin America

Chile’s Xepelin has obtained a credit line of $140 million from Goldman Sachs, in a fundraising move similar to that received by other unicorns in the region

In this separate venture debt structure, Itaú has 300 million reais ($57 million) to allocate to startups by the end of this year, with the idea of investing smaller amounts in more early-stage companies.

Rodrigo Catunda, head of General Atlantic in Brazil, said venture debt is a more “defensive instrument” for when the company really needs to take on expensive debt, because it doesn’t have equity available, he stated during the Bloomberg Línea Summit held earlier this month in São Paulo.

Hutchings thinks opting for credit financing will be more common going forward because there is a growing demand and there is an increasing number of lenders interested in offering it.

“Banks are becoming more interested in tech, in private technology companies, and also debt funds are becoming more interested in this region,” he told Bloomberg Línea.

“I do think when an equity investor is deciding whether to invest in a company, they don’t like their money going to a lender. I’m sure it happens sometimes, but they prefer it not to be the case, they prefer for it to go toward growth. But they can control that through the contracts of investment, and they can specify how the investment would be used,” he said.