Publish in Special Reports - Wednesday, February 5, 2014
Baby.com.br founders Davis Smith and Kimball Thomas. (Photo: Baby.com.br)
Brazil’s infamous red tape is alive and well, undermining growth and entrepreneurship.
In the winter of 2011, Davis Smith was cruising at 35,000 feet. His spirits should have been even higher. He had just obtained US$23 million in funding to secure the first stage of growth for his promising new start-up in Brazil, baby.com.br. As with any start-up, there would be a multitude of challenges to overcome before his fledgling company could fulfill its sky-high potential. However, instead of celebrating his recent victories and focusing on building his company, Smith was on a flight back to the U.S. to resolve Brazilian work-visa issues that had arisen during the final stages of putting everything in order.
These visa issues, while serious, were merely the latest in a series of headaches Smith faced in getting his company off the ground. For example, he had just finished a six-month process to incorporate his business as a legal entity, wading through huge amounts of red tape and schmoozing the gatekeeper officials. After all his efforts, baby.com.br was finally up and running, but he had to return to the U.S. to obtain a specific type of visa so he could manage his company legally as a foreigner in Brazil.
Ultimately, obtaining this visa took Smith two pivotal months — during the embryonic stage of the company’s launch. “The process is a black box,” he states. “Sometimes you have no idea you are missing a document or some other deliverable until at the next milestone when government agents notify you there will be an unforeseen delay due to some undisclosed new stipulation, even if you have fulfilled all of the process requirements. There is definitely a lack of transparency, and it requires serious patience.”
Starting a company in Brazil is a difficult process that is not exclusive to any one entrepreneur or industry. Widespread bureaucracy and administrative hurdles create major challenges that all entrepreneurs face there. According to the International Finance Corporation, the private-equity arm of the World Bank, it takes on average 130 days, approximately R$2,038 (US$900) and 43 documents to open a new business in Brazil from scratch. Some of the required steps include registering with the commercial board of the state, registering with federal and state tax organizations (which takes a month on average) and applying to the local municipality for an operations permit (an additional 90 days). In its most direct form, there are more than 13 official steps in the process. Unfortunately for entrepreneurs, most of these steps build on each other sequentially, thus making it impossible to tackle them simultaneously to hasten the process.
Moreover, the actual experience faced by many entrepreneurs indicates that the total amount of time and total cost can far exceed the aforementioned figures. For example, the estimates fail to include the additional costs required for a few Brazilian jeitinhos (an expression used to describe the local way of doing things in Brazil, often circumventing rules and social conventions), which are essential in many instances to taking certain mandatory steps. “For an early stage start-up here in Brazil, you spend more than 50 percent of your time tackling administrative issues, such as visa, local residency, proof of address, [and] registration, and 50 percent of your time on your own company’s operations and strategy. In the U.S., the ratio would be more like 20 percent (administrative) to 80 percent (strategy and implementation),” notes Ben Gleason, CEO of Brazilian start-up Guiabolso, which provides services in Brazil similar to those of Mint.com, a free web-based personal financial management service in the U.S. Other entrepreneurs have stated that it is actually advisable to hire a full-time employee to focus solely on administrative issues to expedite the company’s registration process. While this solution may seem costly, the long-term benefit could greatly exceed the short-term frustration of attempting to tackle the many steps involved.
One alternative to starting the entire six-month process of creating a company from scratch is to buy a “shell” company — typically purchased from a law firm. For several thousand dollars, a founder can take legal possession of an entity and start in the middle of Brazil’s onerous incorporation process. This strategy shortens the procedure and speeds up an entrepreneur’s access to his or her target market. Those who have employed this approach report varied experiences. Some have cut the process in half, to just over three months, while others have managed to save only a month or two. But in general, everyone has the same experience — disbelief and frustration with delays, bureaucracy and cost.
Enter the Fire Department
Entrepreneurs maneuvering through the process — in either form — often discover steps that are unnecessarily inefficient, complex or even redundant. For example, establishing a nationwide online portal to check the availability of a company name and logo would save a great deal of time and increase efficiency. Currently, registering the name of a new business involves personally visiting the local Junta Comercial and asking the staff to run a search for your proposed name. While the cost is low, results can take several days. Establishing a logo is even more difficult, as no formal process currently exists. This lack of structure often generates unnecessary delays and can lead to involuntary copyright infringements; frequently, entrepreneurs are unable to determine if a logo is already being used by an existing company in another state. By creating an online registry of this information, the government could simplify both steps.
Another example is the requirement that the fire department certify the safety of the business location. The cost of this two-part step represents about 25 percent of the total company-creation process (US$200). It begins with an extremely detailed in-person presentation of the chosen location’s layout, which must meet very rigorous standards. The fire department must then visit the location to verify the information provided. While safety is an important matter, the process is unnecessarily long and expensive. In addition, it fails to differentiate companies that require specific inspections, such as industrial firms, from those that could undergo a much simpler and cheaper process. Such examples, which are different or altogether absent in other similarly situated countries, highlight but a few of the inefficiencies that could be improved or removed.
Implementing change and efficiencies, however, could be among the greatest obstacles to stimulating entrepreneurship in Brazil. Despite what the continued problems may suggest, the Brazilian government has not been completely silent about improving this process. For example, in 2009 it passed a new law that eliminated the need for all the required documents to be notarized. Unfortunately, this law has yet to be enforced. Without effective communication and enforcement of new laws, additional efforts to streamline the process may be futile, further stifling opportunities for entrepreneurship in Brazil.
Another key aspect for foreign entrepreneurs in Brazil is the importance of relationships. According to baby.com.br co-founder Thomas Kimball, “down here, relationships are currency.” At many points in the formation of a business, who people know and how well they know them can be a deciding factor in their success. One solution that could be of significant benefit would be the ability for foreign entrepreneurs to contact and work with locals. A local business in Rio de Janeiro is trying to bridge these gaps. Co-founded by American entrepreneur Benjamin White and Brazilian Marcelo Sales, 21212 was created to connect foreigners with local Brazilian entrepreneurs as a way to facilitate the realization of the latters’ ideas. While efforts such as this have helped, the number of obstacles continues to hinder entrepreneurship in Brazil.
On a global scale, these problems are reflected in Brazil’s rankings relative to other countries. In 2013, the World Bank’s “Doing Business” Index ranks the country at 130 (out of 185 countries) in the world in terms of ease to do business or start a new company. This compares poorly with regional peers such as Chile (37), Colombia (45) and Mexico (48), which have been drawing increasing capital away from Brazil over the last two years while providing attractive frameworks for entrepreneurs to open new businesses. For example, dealing with construction permits is significantly easier in Mexico (ranked 36 in this category) and Colombia (27) than it is in Brazil (131). Similarly, obtaining local credit, a key element for any start-up, is much easier in Mexico (40) compared to Brazil (104). While the government has made efforts to create institutions that encourage entrepreneurship and to fund new companies, such as the Brazilian Innovation Agency (FINEP), or to foster grants from local development banking giants, such as the Banco Nacional de Desenvolvimento Econômico e Social e Social (BNDES), the reality is that the process continues to be highly bureaucratic. A select few favorites and local champions obtain the majority of the funding while others are left in the dust. Finally, high direct and indirect taxes in Brazil (ranked 156) are another major hurdle for entrepreneurs, whose costs may well surpass their budgets.
These rankings are particularly worrisome in light of a currently stagnant Brazilian economy (expected to grow about 2.0 percent in 2013 after growing just 0.3 percent in 2012) that is very much in need of entrepreneurs, new businesses, and capital inflows. According to The Kauffman Foundation, which helps to produce the Global Entrepreneur Monitor reports on entrepreneurship for 90 different countries, “small- and medium-size enterprises are responsible for 96 percent of all jobs in Brazil and 98 percent of all companies in the world,” further reflecting the importance of business creation in the country. The potential benefits, however, are not only economic. Scientists studying entrepreneurship have found that stimulating this sort of activity can have a positive social impact and can further promote economic activity both within and outside the sector. This means that, moving forward, Brazil will need to implement major improvements to facilitate business-creation processes and incentivize investors to take advantage of the massive Brazilian consumer market of just over 200 million people.
As the country with the third-largest index of entrepreneurial activity, it is difficult to believe that Brazil’s government has failed to effectively incentivize this activity to date. Looking to the future, the country has reached a potentially watershed moment in its history of entrepreneurial activity. Whatever the statistics were before, playing host to the Olympic Games and the World Cup should spur a flurry of economic activity. Using these events as a kick-starter, the government should take full advantage of this ideal time to change regulations and processes and support its entrepreneurial population.
The race is on. Other countries have already recognized the value of this entrepreneurial activity to an economy and are introducing enormous changes to become more competitive and to attract foreign investment. Thus, far more government resources must be dedicated to promoting entrepreneurship in Brazil in the near term. The current state of its economy demands that the country find a way to stimulate growth. Given the size of its consumer market and wealth of resources, Brazil presents attractive opportunities for entrepreneurship for both local and foreign sources. However, with such complex and costly processes, when compared with neighboring countries, and no sign of improvement, it risks losing a potentially major source of innovation and economic stimulus. While entrepreneurship is not the only solution to Brazil’s financial situation, as it stands, the country is wasting this opportunity. As a result, the next baby.com.br might well be baby.com.mx.
This article was written by Mauricio Cordero, Pablo Ruiz, Preston Thomas and Tereza Widmar, members of the Lauder Class of 2015.
Republished with permission from http://www.knowledge.wharton.upenn.edu -- the online research and business analysis journal of the Wharton School of the University of Pennsylvania.