Doing the Dirty Work

In 18 months since starting Magma, we’ve invested in 18 companies. The biggest predictor of success so far is very simple: does the entrepreneur value doing the dirty work and is he or she willing and able to identify it and then do it.

Paul Graham calls it doing things that don’t scale. Sam Altman’s How to Startup class 8 is devoted to it. Successful entrepreneurs and VCs all have different names for it. But at the end of the day, it’s the same idea: the stuff that takes you from 0 to 1 and then 1 to 2 gets you on the path to validating your business and start to scale it without building software and business processes. (I wrote a blog post about doing the dirty work in an commerce company here.)

But many (most?) first time founders (including some in our portfolio) either don’t see the value of doing the dirty work or can’t correctly identify what the dirty work they should be doing actually is. It’s one of the biggest, if not the biggest, red flag that goes up when I meet entrepreneurs. If they’re not doing the dirty work on their own when they don’t have any funding, they probably won’t just start doing it when they do have our money in their bank account.

I’m not sure why, but I think it’s a combination of the following factors. Founders:

  • Don’t see the value in the dirty work
  • Think they don’t need to do it.
  • Think they’re too good for it.
  • Think that most successful startups didn’t have to do it, so why should they do it?

The biggest common factor with all four of these reasons is a big one: ignorance.

The most successful companies that many people think are overnight successes struggled for years trying to find success. Look at Airbnb. Dropbox. Whatsapp. And so many more. Most people think they’re overnight successes, but they’re really not. The media hypes up massive companies and talks about overnight successes, but overnight successes are the once in a decade occurrence. Even Instagram, which went from 0 to $1b, still took two years.

Many first time entrepreneurs think that you can skip from step 1 to step 100, just like the big successes that they see in the media, but the reality is that nearly all big successes that they see in the media actually went from step 1 to 2 to 3, to 2 to 4, to 5 to 4 etc etc. It’s almost never linear.

If you want to bet your time, effort, money that you’re the once in a decade company, go for it, but the odds are massively against you.

The second most common factor is that the entrepreneur just doesn’t have the stomach for the dirty work. It’s hard. It’s dirty. It’d called dirty work for a reason.

But if you do the dirty work, you still may not succeed. But at least you’ll find out fast and probably will be able to find a new, real opportunity in the process.

Startup Chile Application Help

Startup Chile just opened the 15th round of applications this week and will stay open from now until September 29th with the winners being announced in December. In each of the previous rounds, 1500+  startups from more than 60 countries applied for the right to come to Chile for $20m Chilean pesos (US$34,000). Chile invited 100 of these 1500+ companies who applied and they will begin to arrive in the next months, joining the 1000+ startups who have participated in the program since 2010.

Startup Chile has become more competitive as the number of applications has grown. Round twelve saw applications grow and more than 2500 companies will likely apply to Round 13.

It’s a great program, especially for entrepreneurs who are bootstrapping or already have developed a product but need more time to figure out the correct business model for their business. It’s a perfect fit if you’re looking to target the South American market or if you’re in the Robotics, Healthcare & Biotech, Clean Energy and Education industries.

My company, Entrustet, was part of the pilot phase of Start-Up Chile and I’ve been in Chile since November 2010. I blogged extensively about my experiences in the program and in Chile, along with advice on how to get selected for Start-Up Chile. I tracked down the stats from the pilot round companies a year later, which was published on The Next Web. I also wrote Startup Chile 101, the book that will tell you everything you need to know about living, working and doing business in Chile and Chile: The Expat’s Guide

From the the third round to the ninth round, I’ve helped startups review their applications and prepare them to get accepted into Startup Chile. Overall I’ve now reviewed, 47 applications for prospective Startup Chile teams and 28 have been accepted.

Round 3 – 6/9 66%
Round 4 – 3/4 75%
Round 5 – 3/6 50%
Round 6 – 3/6 50%
Round 7 – 5/10 50%
Round 8 – 3/5 60%
Round 9 – 5/7 71%

Overall: 28/47 60%

In rounds five through twelve, ~4% of applicants were accepted into the program and 60% of the applications I’ve reviewed have made it.

Many companies that have applied as many as three times previously were accepted after we worked together.

After round nine, I stopped doing application review because I ran out of time, after starting Magma Partners, a seed stage investment fund in Chile.

meg _ profilo apr 2015For round 15, I’ve teamed up with Margherita Pagani (blogtwitterlinkedin), founder of Fly The Gap and round 11 participant to restart the review. Margherita will take the lead and I will provide advice and guidance so that your application gives you the best chance of successfully applying to Startup Chile.

In addition to her startup she’s worked with other CEOs and VCs in Latin America, the US, UK and Europe as a consultant and mentor focusing on communication, marketing and strategy with a special focus on metrics and impact measurement.

After her startup was selected for Startup Chile in 2014 she has successfully engaged with the local tech scene creating initiatives like ImpactON, a social good, design-focused, hackaton that connects designers, developers and founders with the international community and 20 partners, including companies, universities and government entities.

She has a great handle on what it takes to be selected into the Startup Chile program and can help you with your application by using the methodology that I’ve used over the past three years to help 60% of startups who I’ve worked with get into the program.

If you need help with your application, please contact us. Editing, writing, review, advice. Just like before, we charge a small flat fee to review and edit your application, plus a larger success fee if you are selected for the program after we’ve helped you.

Want help? Got questions? Want a quote? Fill out my contact form and we’ll get back to you right away!

Note: Margherita and I WILL NOT write paid letters of recommendation.

Advice to My 20 Year Old Self

I’ve been listening to Tim Ferriss’ podcasts lately and am really enjoying them. Highly recommended. He ends many of his interviews by asking his guests a list of short answer questions, one of which is some variation of “what advice would you give to your 10 years younger self.”

Most people give one or two answers, but others expand and give in depth answers. As I was wandering around Buenos Aires last week listening to Ferriss’ interview with Naval Ravikant, I started to think about what I would tell my 20 year old self. I stopped for some ice cream and started to write my list. After thinking some more, I came up with 20 things I’d tell my 20 year old self. I think there’s four really important things, then 16 more. Here’s what I’d tell my 20 year old self.

1. Never say you know something when you really don’t.

If you say you know something you don’t, there’s only two possibilities:

  1. You end up looking like an idiot because the person now expects you to be able to talk intelligently about the subject
  2. You missed an opportunity to learn something you didn’t know.

I used to do this in high school and college. But as I got older, I realized it was really dumb. One of Entrustet‘s mentors used to test prospective employees and business relationships by saying something like “have you heard how well xyz company is doing?”

Xyx company didn’t exist. And if the person said “oh yea, they’re doing amazing!” he immediately knew that the person was bullshitting. Don’t do it.

Most of the very successful people I know immediately ask for an explanation when they don’t know something. I think it’s one of the biggest reason’s they’re successful.

2. Don’t be afraid to look dumb. You’ll learn stuff faster.

The only way to learn something new is to get your hands dirty and make mistakes. As a 20 year old, I remember not liking to look dumb in front of people, which caused me to learn things less quickly than I do now. I had to get over my embarrassment of looking dumb by force: when you learn a new language, you’re going to look dumb and say the wrong thing all the time.

In my first six months in Chile, I didn’t learn much spanish because I didn’t want to risk saying the wrong thing. But after working at Welcu for about a week (and getting bullied whenever I said something wrong!) I got over it quickly.

3. Develop an exercise routine. It’s really hard to get back into it when you stop, even for a few weeks.

I remember being a 20 year old, playing soccer, basketball and racquetball a few times a week, reffing soccer, biking hundreds of miles a month. I never thought I’d stop. And as soon as you stop, it’s hard to get back into it.

4. Read and write like you’re doing now. Don’t stop. It’s like exercise, hard to start, but easy once you’re in the habit.

At 20, I read at least a book a week. I now read in spurts, nothing for a month or two, then three in a week. I used to write almost daily, now in spurts. Reading and writing are key to staying mentally active. Do it, don’t stop.

Here’s the rest of my list, in no particular order:

Don’t share anything publicly that’s not providing value for other people. It’s going to be tempting to show off or be mean online. Don’t do it. Value your privacy. Low profile is the way to be.

Don’t be lazy with close friends. You have them across the hall and down the street in college, but as they graduate, you’ll drift apart if you don’t make an effort. You can’t expect them to make the effort. It has to be mutual.

Don’t do business with unethical people. It’s just not worth it. Short term it might seem to be good, but long term, it’s not.

Don’t use an alarm clock to wake up unless you absolutely have to. Humans weren’t meant to get up to a horrid noise.

Trust your instincts, they’re probably right. If something feels wrong, it probably is.

When someone’s doing something poorly or screwing up, give them honest feedback as soon as possible. You’d want them to tell you if you were screwing up, so it’s mean, almost unethical not to tell them. You’re not giving them a fair chance to improve. Most people who you want to be friends with or do business with will appreciate it.

Via negativa is the way to go. If you’re unhappy, cut stuff out until you’re happy again, don’t add stuff in. If you’re stuck in business, make it simpler until it works.

Don’t be scared of brutal feedback. Seek it out.

Study or live abroad as soon as possible. Chile made me a different person for the better by forcing me to see things from other people’s perspectives.

Being a big fish in a small pond feels good, but not challenging yourself enough won’t make you happy. Take chances to test yourself against the best.

Don’t be lazy and stop cooking as you get busier. It’s healthier, its cheaper and you like it.

Look for even more Talebean low risk, high reward opportunities.

You were right about valuing experiences over things. Keep it up.

Take present value cash unless you have a Talebean logarithmic upside possibility. If the upside is linear, take the cash.

Tell people exactly what you want as clearly as possible.

Case Study: Ecommerce Opportunities in Chile and Latin America

Una versión de este post fue traducido a español por @Joseia (muchas gracias!) y apareció en Pousta con el nombre Conversamos sobre cómo montar tienda online con alguien que aprendió DEMASIADO al respecto.

In late 2012, I met up with two ex startup chile friends over beers. Like most beery conversations between entrepreneurs, the conversation devolved into new business ideas. All three of us had seen ecommerce’s steady growth in Chile and were certain that it would continue to grow toward levels seen in other developed markets. After a few more beers, one of us said, “why don’t we just start a small ecommerce business, it’s the best way to learn about the market and see where the real opportunities are.”

That conversation led to more conversations and we got serious about launching a small ecommerce business to really get a handle on the market. But what product should we sell? And how would we validate the market to know if the product we wanted to sell made sense? And how would we do it without spending huge amounts of money?

I’m writing this post to shed light into our thought process and to show how we validated our ecommerce business without spending a single dime (peso in this case) for two reasons:

  1. To give an overview of Chilean (and Latin American) ecommerce opportunities
  2. To help other entrepreneurs think about how they can validate their own ideas without spending months and thousands of dollars buying inventory, developing software and wasting time on unimportant things.

By now, almost all entrepreneurs know about lean startup methodology and try to use it, but the how remains mysterious to a high percentage of entrepreneurs. I hope this post is useful.

Preview: tl;dr (Too Long Didn’t Read)

After much research, we launched La Condoneria, to sell condoms online in Chile. We validated the opportunity by spending less than $100 and didn’t build any technology. We learned a ton, reached $8000 monthly sales and 100k unique organic traffic using Jumpseller, a Latin American Shopify.

We tried to scale by creating our own product or taking representation, but because of regulatory issues based on the product, we decided the best we could do is a small business. We believe that the two best ways to make money in Latin American ecommerce are by having exclusive representation of a product, or creating your own product, a la Warby Parker. We believe there is a massive opportunity in full stack ecommerce startups in Latam.

Step 1. Research

We first wanted to see if countries adopt ecommerce in a predictable manner. We knew that ecommerce in Chile was growing at 30% per year, but the vast majority of people hadn’t ever bought anything online. We found a Forrester report that showed the phases of ecommerce adoption. It corroborated our hypothesis that new markets tended to follow similar paths:

phases of ecommerce

We firmly believed that Chile was nearing the end of phase 2, and the early adopters were already moving into phase three. Chile is young and social, people are comfortable online. LAN airline ticket offices and travel agents were going out of business because of online purchases. We saw early successes like Buscalibre and Clandescuento (acquired by Groupon) and large retailers were starting to sell online. One of our best friends, Tiago Matos, is the founder of Jumpseller, a Shopify of Latin America, and we saw his business taking off. It was clear to us that we were on the cusp of phase three and we decided to go after it.

Step 2. What should we sell? A product? Or pickaxes to the miners?

We made a map of the industry in Latin America and looked at the businesses that make money in ecommerce in the US. By late 2012, we saw seven opportunities in the ecommerce market in Latin America:

  1. Amazon clone (high volume, low margin)
  2. Niche products with amazing stories and customer service (Dollar Shave Club)
  3. Create your own brand (Warby Parker)
  4. Shopify – Sell the pickaxes to the miners and create the infrastructure
  5. Payment systems
  6. Logistics and delivery (dropshipping)
  7. Get the exclusive representation of a foreign brand (medium margin business, low competition)

We quickly discarded doing an amazon clone because we believed that the Amazon of Latin America will likely be Amazon or potentially Linio, from Rocket Internet, which had recently launched. We also saw Buscalibre potentially struggling and discarded that idea.

We discarded doing a Shopify clone because our friend Tiago was already working on it and having some success. We looked at payments, but although a massive problem, we didn’t think we could solve it. We decided that it was likely that someone like Stripe, Braintree, Paypal or Venmo would use VC funding from the US to attack the Latin American market. We looked at selling a commodity product with an amazing story, but decided that if you have a commodity product, in the medium term, your margin will go to zero.

That left us with three options:

  1. Getting the exclusive distribution rights to a product that didn’t exist in Chile
  2. Creating our own product from scratch Warby Parker style
  3. Starting with a commodity product, knowing that our margin would eventually go to zero, with the goal of adding an exclusive representation or our own product after we got clients.

We chose option three for two reasons:

  1. Creating our own brand was too expensive and time consuming
  2. Introduce a new brand that people didn’t trust into the equation would be difficult because the vast majority of our potential clients would be buying online for the first time.

Step 3. What product should we sell?

We made a list of 50+ products that we were interested in selling including:

  1. Diapers
  2. Condoms
  3. Brand Name Sunglasses
  4. Birth Control Pills/tampons
  5. White label Sunglasses
  6. Cosmetics
  7. Pet Supplies
  8. Eyeglasses
  9. Men’s personal grooming items
  10. Disposable shavers
  11. Perfume
  12. Women’s Shoes
  13. Jewelry/Accessories
  14. Custom Tshirts
  15. Bikes
  16. Purses/Wallets
  17. Wine, Beer
  18. Tea and Coffee
  19. Electronics Accessories (iphone cases etc)
  20. Headphones
  21. Watches
  22. Baby stuff
  23. Women’s underwear
  24. Artwork
  25. vitamins
  26. Soccer jerseys
  27. Kids Toys
  28. Home Furniture and Accessories
  29. Office Furniture
  30. Custom Shirts
  31. Backpacks

We created a list of criteria to find the perfect product for us to get start with. Our criteria was:

1. Easy to ship

Shipping in Latin America was (still is) expensive and unreliable for larger products. We needed a small, lightweight product. That quickly eliminated products like furniture, diapers, pet supplies, beer and wine.

2. High margins

We wanted to be in a high margin business, which eliminated all the low margin businesses.

3. Few Returns

Since shipping is a big problem we wanted a product with as few returns as possible.

4. Repeat orders

If we had to struggle to get our first client, and many of our clients would be buying online for the first time, we wanted them to be able to buy again. That knocked sunglasses, bikes, watches, backpacks and artwork off the list.

5. Try before you buy?

Chileans didn’t trust ecommerce, so we wanted a product that you didn’t have to try before you bought, which knocked a significant amount of products off the list.

6. Average cart size

We wanted an average cart size of around $30, which would allow us to give free shipping, but still allow people to buy online without taking too much risk that their expensive purchase wouldn’t arrive.

7. Average item price

We wanted a lowish average price of around $5 so that the buyer would buy multiple items to get to our average cart size, and so that people could buy one cheap item to make their first ecommerce transaction low risk.

8. Market penetration

We wanted a product that was popular, but that you couldn’t find on every corner.

9. Current available selection in Chile

We wanted there to be few choices in the market, so that our product was a commodity

10. Easy access to supply?

Was it easy for us to buy the product to resell? Was it available in Chile? Or did we have to import it?

11. Access to supply outside of major cities

Did people outside of major cities have a problem finding the product?

12. Poor customer buying experience and customer service after sale

Could an online experience be a better than the current offline experience? How was the post sale experience?

13. Potential competition

What did the competition in Latin America look like?

14. Press potential

Could we get into the press with this product easily?

15. Success in the US?

Was it one of the first products that was successful in the early days of the US ecommerce?

16. Do we like it/will it be fun?

One of the most important criteria. It doesn’t make sense to work on something you don’t like, unless you have to.

We scored all of the products and quickly found that there was one product that was clearly better than the rest. It was small, lightweight, easy to ship, didn’t need to be tried on, had zero returns, cost about $3 per product, but could have an average cart size of around $30. It was also a terrible customer experience to buy offline for cultural reasons, had decent margins. We had a contact in the distributor who would help us buy our initial stock quickly and easily. What was the product? After our research, we’d decided to sell condoms online.

Since Chile is a very Catholic country where sex-ed is almost nonexistent, we knew there wouldn’t be much competition and it would be fairly easy to get press. We were also motivated to try to help solve a social problem by providing an online sex-ed resource where scared, young people could learn about one of the most important decisions in their lives. And most of all, it would be interesting and fun.

Step 4. Validating without spending any time or money

Now that we’d chosen condoms based on our research, it was time to validate that people would actually buy them online without us spending thousands of dollars on a website and initial stock. We mapped out a plan and started to execute.

First, we looked on Mercado Libre (Latin America’s Ebay) to see if people were selling condoms online. We quickly found that they were and googled to see if there were any other stores selling condoms online. There weren’t, so we decided to create our own Mercado Libre listings to see if we could get any buyers. We received numerous messages from potential buyers, but we always told them we were sold out, as we didn’t have any condoms to sell them. We’d found that there was a market.

Next, we put up new ads on Mercado Libre and actually made sales. When someone said they wanted to make a purchase, we walked to our local pharmacy, purchased the products and then met the buyer, usually in one of Santiago’s metro stations, to make the exchange. At this point, we didn’t allow online payment or shipping for two reasons:

  1. We wanted to make the barrier to purchase as low as possible
  2. We wanted to meet our clients to learn more about them.

We found that most of our clients were young, ignorant, uneducated, scared 15-21 year olds who were clearly going to have sex, many for the first time, and weren’t comfortable buying at the pharmacy.

After about a week and ~5 purchases, we allowed people to pay online with a free instant bank transfer to validate that people would pay online. They did. After another week, we added free shipping and the orders kept coming in. We kept filling them by walking to the pharmacy.

Walking to the pharmacy put us in the shoes of potential clients who we were trying to help: it shined the spotlight on the terrible process we were trying to fix, especially when we had to purchase large quantities of “climax control” condoms for premature ejaculation and XXL condoms at the counter in front of massive lines of people who can hear and see what you’re buying.

In Chile, condoms are high up, behind the counter. You must order in front of a long line for the condom you want.

In Chile, condoms are high up, behind the counter. You must order in front of a long line to get the condom you want.

Next, we had to validate that people would buy from a stand-alone website outside of the friendly confines of Mercado Libre, so we setup a landing page using Jumpseller with a 99designs logo and send some Facebook traffic to the site. We saw that people were adding products to their cart, trying to buy. We quickly added DineroMail, a Latin America payment processor that charges 7% fees and holds your money for 1-2 months and started to sell online, still filling orders at the pharmacy.

By this point, we’d spent a total of $300 on 99designs, Facebook ads, and postage filling orders. We’d validated that people wanted to buy condoms online, that they’d buy from a site they didn’t know, off Mercado Libre and that we were ready to try to scale the business.

5. Building the Foundation

We decided to spend another $500 for a custom Jumpseller design, purchased $400 of stock of Chile’s three best selling condoms (Lifestyles in case you were wondering), wrote 20 educational articles to get organic traffic and officially launched La Condoneria. We launched with the three most popular brands (Lifestyles, Trojan and Durex) and all 24 popular styles you could find at pharmacies even though we only purchased stock of three styles. We priced the other 21 styles we didn’t have in stock 50% higher than in the pharmacy so that we could see if people were price sensitive, and also because I was sick of walking to the pharmacy to buy condoms each day.

We saw that we had four distinct niche clients and created content and packs for each one:

  1. Young adults between 15-21 who didn’t know the first thing about sex and were scared to go to the pharmacy – “First time pack” that included a sex-ed pamphlet that helped people decide if they were ready for their first time and if they were, how to be safe their first time.
  2. Women who didn’t want to go to the pharmacy because of social stigma – Women’s pack, plus dozens of articles about female sex-ed.
  3. 24-25 year old men who bought 2-3 months worth of condoms at a time to stockup – Pack “heavy user“, a popular 30 pack.
  4. Professionals” who were looking for a good price – “Bulk Pack“, a 90 pack, that offered big discounts.

After four months, we’d now purchased all 24 styles and were growing quickly. Our content was incredibly popular, leading to 100k monthly organic traffic, a loyal following and lots of newspaper articles and radio appearances. Our clients loved us because we were really helping people. In a country where most people have incredible misconceptions about sex, abortion in any situation is illegal, getting the morning after pill is very difficult and young people don’t really have anyone to talk to about making this important life decision, we were clearly doing good.

Our live chat was incredibly important for two reasons:

  1. It became the place for people to go when they had questions about sex and many times we had to refer people to their local clinician or to a specialist to help them solve their problems.
  2. We could guide people to purchase our highest margin, best products. If we talked to someone on our chat, they converted at around 33%, whereas we had 1% conversion rates on the site.

By the sixth month in operation, we were selling about $5000 per month, but just breaking even. We were convinced that we had found a good niche, learned how to logistics well and know how to acquire clients cheaply, but we needed to explore other ways to up our margin. We knew that if we continued to sell imported commodity condoms, we’d never do better than a 10% final margin, even at scale.

6. New Opportunities for Scaling Revenue

After a few weeks of brainstorming we came up with this list and worked to validate each one:

  1. Take the exclusive representation of a well know, foreign condom brand and get 65% net margins, up from 10%.
  2. Create our own white label condom brand and get up to 95% net margins.
  3. Add high margin sex toys
  4. Convince local condom brands to advertise on the site

We first looked at taking the exclusive representation of a well know, high quality brand. We had multiple meetings in Santiago with an executive from one of the best condom companies in the world, but in the end, he decided to award representation to another, only offline, Chilean business. We talked to a fast growing, well know, US brand that had already launched in Latin America, but it quickly became clear that they didn’t understand the Chilean market.

They wanted us to purchase a half container’s worth in our first order, and 2 containers worth by year two. Unfortunately, Chile’s entire market only uses about 8 containers per year, so we were being asked to purchase 5% of the condoms sold per year in our initial order and then close to 20% by year three. It just didn’t make sense. As an aside, Chile’s condom consumption isn’t low because Chileans are much less sexually active than their neighbors, they just use fewer condoms (under 1 per capita per year, compared to 5 in Uruguay, 4 in Peru and Argentina.)

Next, we looked at manufacturing our own brand and importing. This opportunity was extremely attractive because the unit cost delivered in Chile was about 2 cents, and the final sale price was about $1.20. Massive margins. But the minimums were high and Chile’s regulatory barriers were almost impossible to comply with. For example, we needed to give the government 10,000 units for testing before we could get the brand registered and we were told off the record that Chile wouldn’t approve a new brand that wasn’t approved in another developed country in the world.

We looked at adding high margin sex toys, but we didn’t think it would work for multiple reasons.

  1. Japi Jane, a highly successful online sex toy store, controlled the market.
  2. We weren’t sure that our clients would purchase many toys.

We did some tests using products we’d purchased on Amazon (I brought them to Chile in my luggage and got a letter saying TSA had opened my baggage for extra security checks), but we couldn’t make the numbers work.

We tried to convince local condom brands to pay us, but they all had traditional, conservative views and weren’t interested. The best we could do was to negotiate free samples that we could later sell, but it quickly became clear that this method wouldn’t work in the long run.

After a year in the business, we were selling $8000 per month with 100% free organic and social traffic, making about 10% net margins and it clearly wasn’t worthwhile to keep trying to expand. La Condoneria had turned into a nice small business that will continue to grow, but will never be a massive business.

But it served it’s purpose. We learned everything there is to know about Chilean ecommerce and the massive opportunities that entrepreneurs can attack. We decided to spin off La Condoneria to one of my partners who wanted to operate the business to continue to help Chileans buy condoms online.

The three of us are ready to launch our next ecommerce business taking everything we learned from our first La Condoneria to create a highly profitable business.

6. What we learned

If you’re not going to be Amazon or have millions of dollars of VC to attack payments or drop shipping we believe the opportunities are:

  1. Focus on creating your own product, a la Warby Parker
  2. Getting exclusive representation of a product, like our friend Stephen Stynes did with Pouchee.

Delivery, in Chile, for everything except large items is pretty much solved. Payments pretty much work. Infrastructure is well executed with Jumpseller and other competitors, plus Shopify will be moving into the rest of Latam shortly.

From our original list in 2012, many of the ideas have been launched:

  • Baby Tuto – $1m+ annual sales of baby products in chile. Have their own branded delivery for large items.
  • Obzes – makeup marketplace, closed in 2014, probably low margins
  • Briu – Coffee subscription club
  • Mangacorta – Custom tshirts, just raised $120k on Broota, a Chilean equity crowdfunding platform.
  • Pouchee – Purse organizers
  • Linio – Amazon clone from rocket internet
  • Dafiti – Zappos clone from rocket internet
  • Bike stores – Many
  • Dperfumes – Perfume
  • Adorate – Women’s underwear, closed in 2014, low margins, hard to sell online.
  • Depto 51 – Design marketplace


The VAT Trap: Why Is Chile’s VAT System So Poorly Setup?

Chile’s VAT system doesn’t make sense. Once you are in the system, the reporting system is world class and has been ranked in the top five in the world for ease of use. The Chilean IRS’ website works incredibly well, is fast, reliable and makes paying your taxes a breeze. It blows the US system out of the water and it’s not even close.

But getting legally approved by Servicio Impuesto Interno (the Chilean IRS) is a bureaucratic, capricious, time consuming process that doesn’t make any sense. After the long and complicated process to incorporate and get a bank account (that I’ve talked about before), you need to get your boletas (receipts) and facturas (official invoices) so that you can legally sell and pay your taxes.

The boleta process is straightforward and allows you to sell to individuals or companies that don’t want a tax refund. But if you want to sell to a business, you need to have a factura (official invoice) or nobody will buy from you and your business will fail. And that’s where the problems start.

Facturas are government issued documents that break out the VAT tax so that the buyer can get a VAT credit and get to keep the money if they’ve sold items subject to VAT. For example, if a business sells something for US$10.000 + VAT with a factura, they’ll have to pay US$1.900 of VAT. At the end of the month, they’ll have to go online and pay the government US$1.900 on the top notch SII website. But if they buy something for US$10.000 with a factura, they get a credit in their favor for US$1.596, which lowers their VAT liability.

It would seem that getting a factura should be simple, but its not. If you intend to sell product, in an ecommerce store for example, you need to go to the IRS with paperwork showing that you’ve purchased product that you will later sell. You need to take that purchase facturas to the IRS, wait in line, and ask for your factura. So if you want to start a business and sell legally, you need to take money out of your pocket and purchase product that you can’t legally sell. This makes small business owners dig into their startup capital just to be able to legally sell.

In my ecommerce business, I went to the IRS with my factura that showed that I purchased US$200 or product, waited in line for 30 minutes. When I finally got to present my factura, the bureaucrat laughed in my face. He told that one factura and US$200 of purchases wasn’t enough. I asked what the rule was: how many facturas and for how much money. The bureaucrat told me he couldn’t tell me, that there wasn’t a bright line rule, but that he knew that if he presented my factura it would be declined and that I wouldn’t be able to sell legally.

I came back a week later with another factura, this time for US$1000, in addition to my US$200. The same thing happened. I got fed up and hired an accountant to do the dirty work. It took the accountant three trips to the IRS to finally get it approved. She was sent home one time because the notarized copy of my company’s tax ID wasn’t sufficient, even though the plastic card vs. a notarized version are exactly the same in the eyes of the law. It took four months before I was finally able to start to sell legally. My $1200 was tied up the entire time and I couldn’t legally operate my business.

Entrepreneurs with less startup capital would have started to sell illegally, depriving the government of tax revenue and making the entrepreneur into a tax evader.

The whole process doesn’t make any sense. First, why does the government care if you’ve purchased goods to sell in order to have a factura? It’s ridiculous. Why put another barrier to successfully starting a business and paying the government tax revenue? A barrier that makes entrepreneurs have months of extra startup capital or incentivizes them to skirt (or break) the law?

What’s the worst that could happen? If an entrepreneur submits a factura for a sale that never happened, the entrepreneur would be paying 19% VAT tax at the end of the month. So the downside of making it easier for businesses to get started and sell legally is that the government will collect extra 19% VAT taxes?

Second, if the government insists on forcing entrepreneurs into purchasing goods before they can legally get the documents they need to sell them and pay their taxes, why doesn’t the government have a bright line rule? You must have four purchase orders that total at least $1000 and you’ll be approved? Why let capricious bureaucrats decide and make entrepreneurs lives that much more difficult? It just doesn’t make sense.

Now that you have your facturas, the government puts up another, bigger, barrier for small business owners. When you sell with a factura, you must pay your 19% VAT on the 12th of the next month. For example, if I sell US$10.000 + VAT in August, on September 12th, I must pay the government US$1.900. That wouldn’t be a problem if companies paid immediately, but in Chile companies pay net 60 and many times net 90 or even 120. And that’s if they pay on time at all! That means that I have to take $1.900 out of my pocket to pay my taxes and effectively finance the government and large businesses while I wait to get paid.

One of my portfolio companies in Magma just sold US$12.000 + VAT net 180. Without doing net 180, they wouldn’t have closed the sale. That means my portfolio company needs to pay $2.280 in VAT on August 12th and have the funds necessary to finance the government and their large client for six months!

Since most companies don’t pay for 60-120 days, a new business will pay 19% taxes on their sales two to five months before they even get a single cent in revenue. VAT taxes are the biggest barrier to actually starting a business and making it successful. The government and big businesses have teamed up to thwart new entrants to the market.

In Europe and the rest of the OECD, the vast majority of countries allow small businesses to pay their VAT taxes quarterly or even annually, which means that companies have at least 90 days to collect their sales so that they don’t need to pay their VAT out of pocket. Colombia, South America’s fastest growing economy, is Latin America’s only country that doesn’t charge monthly, thereby helping more companies start successfully.

vat regimes$FILE/Worldwide-VAT-GST-and-sales-tax-guide-2014.pdf

Since VAT policy is an administrative issue, the government could make changes immediately to help small businesses. So why don’t they? If Chile moved to a quarterly regime for companies selling less than US$400.000 annually like Italy, the government would take a short term cash flow hit, but after four months, the government’s net revenue would be the same. And the government would have instantly helped thousands of entrepreneurs and existing small businesses survive.

Chile has spent money on Startup Chile, on creating an online business incorporation system, but it still hasn’t done the most basic of all fixes: allowing small business and new entrepreneurs to pay quarterly or biannually. I only see three three possibilities:

  1. The government doesn’t trust small entrepreneurs to be able to plan for four bigger payments per year
  2. The government and the elites in government don’t know this is a problem that kills entrepreneurship
  3. The rules were put in place by the elite to help thwart new entrants to the market

I always ask Chilean entrepreneurs which of the three reasons they think is the real reason. About 25% think its because they think the government doesn’t trust entrepreneurs to manage their finances, half thinks that the government is incompetent and the last 25% think its to thwart new entrants into the market.

My personal opinion is that it’s a mix of all three. The government must know it’s a problem, but probably doesn’t really understand how much of a problem it is. Most people in government are elites who have never run a business before. And those that have are mostly in the upper class and likely had enough money to survive the VAT trap.

Chile is like a country club, with massive classism (which is really just racism), that’s mostly controlled by the top 10%, so it wouldn’t surprise me if the VAT trap was put in place to thwart new entrants to the market.

ASECH, Chile’s entrepreneurs lobbying group, has been pushing for the buyer to have to pay the VAT tax on a monthly basis (Spanish). This change would work, as large companies would have to pay when they buy from small businesses, but its a much more radical and intrusive change for businesses. If you simply allow small businesses and entrepreneurs to report their VAT quarterly or semi annually, you solve the problem for the vast majority of businesses.

I’m not optimistic about the changes that Chile will change the VAT payments requirements from monthly to quarterly in the near future. I think the government doesn’t really trust its citizens, politicians with no knowledge of what it takes to run a business don’t really understand how big a problem the VAT trap is, and elites in power are either ignorant to the problem or like the barrier against new competition.

What do you think?