Start-ups: How to fight for your funding

Apple, Google and Amazon are just some of the companies that famously began operations from a garage, their founders starting with little more than their wits and what proved to be an epoch-changing business plan.

The Arabian Gulf’s visa rules – and sometimes high living costs – make it unlikely that any of the region’s start-ups will follow a similar genesis and the tech sector, while growing, is still in its infancy. As such there are still big funding gaps many would-be entrepreneurs find it tough to plug.

A survey by entrepreneurial platform Wamda, which interviewed 494 entrepreneurs based in Egypt, Jordan, the United Arab Emirates and Lebanon, showed that 43 percent of respondents received backing from family and friends.

About a fifth of entrepreneurs in Lebanon and the UAE had obtained commercial bank funding, but these countries had the lowest proportion of venture capital and angel investor-backed companies at 11 and 23 percent respectively, Wamda wrote in a September report that notes the number of funding sources had increased substantially.

“The bulk of this growth is comprised of early-stage investment institutions including venture capital funds and angel investment networks, while other new institutions offer loan and grant programs,” the report states.

“Incubators and accelerators have also grown in number, providing entrepreneurs and their companies with mentorship, as well as technical and financial support.”

Gaps between angel investment and venture capital are slowly shrinking following the launch of public and private funding initiatives, Wamda’s report notes.

Industry protagonists disagree on whether the MENA start-up sector is sufficiently funded. Perhaps unsurprisingly, company founders complain of unrealistic expectations among many potential seed or angel investors – those investing relatively small amounts during a firm’s infancy – while venture capitalists, who typically invest $300,000 to $3 million in more established companies, argue it is meant to be tough.

“Often, investors don’t understand the journey and the pain of a start-up,” said Mahmood Jessa, co-founder of NgageU, a Dubai-based start-up specialising in providing mobile solutions to restaurants and which is now evaluating potential investors having launched operations in January 2015.

“Many we spoke to were “okay, when do I get my initial investment back”? That’s not investment, that’s a loan.

“Many angel investors see the buzz around start-ups think “I could make a quick buck out of this, but I don’t want to lose my money”, they don’t understand how to help.”

From a venture capital perspective, the most important factor in determining whether a fund will invest is the quality of the management running a start-up.

“An A team with B-grade business plan will always outperform a B team with A-grade business plan, it’s all about the people,” said Dany Farha, who co-founded and subsequently exited online jobs portal Bayt.com before becoming co-founder and chief executive of BECO Capital.

“We look for defensibility in the way of IP, lock-in, some sort of sustainable competitive advantage that over the long term can build a defensible business and then if whatever is being done, particularly in the technology space, is offering only an incremental improvement we wouldn’t touch it. It would have to be transformational.”

Seed investments are typically into companies that have demonstrated little traction, but show some evidence that this traction will increase.

“If it’s e-commerce it could be looking at if they can hit the targets for customer acquisition costs and LTV (life-time value) per customer,” said Khaled Talhouni, Managing Partner at Wamda Capital.

“The understanding is that at the seed level a business will change a number of times, so whether the management team will accept this and are the right team to be able to adapt is another important consideration.”

There are 115 private players operating in the Middle East and North Africa’s venture capital sector, up from 92 a year earlier, according to a 2016 study by BECO Capital.

Of these, 24 are MENA venture capital funds, 14 are venture capital arms of bigger corporate entities, 11 are venture capital funds from outside the region and three are family offices.

There are also 20 incubators – or accelerators – providing seed capital, 12 angels – whom BECO define as high net worth individuals investing their personal money – plus a further 12 angel groups in which wealthy people pool some of their money to invest in start-ups together.

Other players include 10 tech acquirers, which are tech sector corporations that buy start-ups, and five late-stage investment firms.

“In the last 3-4 years, there’s been a good uptick in early stage venture capital,” said Louis Lebbos, co-founder of AstroLabs, a Dubai-based co-working space and training academy that is home to about 150 start-ups. He was also a co-founder of online fashion retailer Namshi.

“Any start-up at that stage has many options. Start-ups before that stage, generally are looking for seed or angel investors and generally they struggle more.”

Astrolabs has helped ease the financial strain of setting up a business in the UAE, which Lebbos estimates can be more than $10,000. Members pay a monthly fee, but can get a business licence free of charge through Astrolabs and by working from its facilities don’t have to rent an office, buy office supplies or pay utility bills.

“In most cities there are multiple hubs where the tech ecosystem gathers, connects and works together. We didn’t feel that existed in Dubai,” said Lebbos.

BECO’s Farha cited a change to United States’ law that allowed pension and endowment funds to invest a small portion of their assets in venture capital as a turning point in the development of the country’s tech sector. Similar reforms would also aid venture capital in the Middle East, but for now the sector is too small to be able to absorb a huge influx of pension money.

“It’s never easy to raise money and nor should it be,” said Farha. “If it is you’ll have bubbles occurring where businesses are able to obtain money they shouldn’t receive because they’re not transformational or scalable.”

GLOSSARY OF TERMS

Angel/seed investors – invest in start-ups, usually near their inception and are often family or friends of the company founder. They typically take an equity stake in the company and offer more favourable terms versus other lenders, with banks usually unwilling to lend.

Angel investors usually invest their own money. More formal angel investors – rather than family or friends – can take the form of a limited company and in the United States must have an annual income over $200,000 and a minimum net worth of $1 million.

Angel investors’ rate of returns from a portfolio of investments is typically 20-30 percent.

Venture Capital – provide start-up companies with funding to expand and as such invest more money and at a later stage than angel/seed investors. Venture capitalists usually acquire a sizeable stake in a company and will also seek to influence its operations/activities.

Incubator – are similar, but more professionalized version of seed/angel investors. As well investing in start-ups, incubators can also provide advice and consultation services, office/work space, access to research resources, according to Investopedia.com. Incubators usually take a stake in a company for providing these services.

Accelerator – act like a competition for start-ups to get their help and usually include mentorship and educational components. They will make an equity investment ($20,000 to $50,000 in the U.S.) in a start-up, which is given a short deadline e.g. three months to “graduate”, during which they receive intense training and mentoring.