Banks’ new dilemma

Investment in startups will require new skills

Central Bank of Lebanon (Karan Jain | Flickr | CC BY-SA 2.0)

For years, big Lebanese banks have operated under a cushy deal: finance government debt, and be rewarded with a handsome profit. While this arrangement has been arguably necessary, it has also led to an unwarranted level of risk aversion and capital hoarding in the sector — notably harming the development of business startups, who are simultaneously in dire need of investment.

Sensing this distortion, Banque du Liban issued Circular 331 in August of last year. The order sets up a facility at the central bank that subsidizes 75 percent of commercial banks’ investment in startup companies — making such deals much more appetizing to the banks.

This new facility presents an opportunity that cannot be missed. It could be a huge boon to the economy by facilitating finance to companies at their earliest stages. The amount of money that could be pumped into the ecosystem — up to some $400 million, divided into small tickets — could be just the push needed to stimulate the creation of small companies. This is something badly needed in Lebanon’s business ecosystem.

If taken advantage of, banks would at once be opening their doors to new sources of revenues that could potentially be made off of successful startups, as well as boosting the economy — potentially creating opportunities for more and larger transactions in the future.

But due to their overly conservative nature, equity investments in small and risky ventures do not typically strike one as something the Lebanese banks would want to touch — indeed, they never have on any scale. But Circular 331 ought to change that. Banks now face a choice: use the circular as an opportunity to invest in startups, or ignore it altogether and go about their regular banking business.

Failing to use the circular would be a missed opportunity, both for the banks who are closing their doors to a potential stream of revenue, as well as to startups who need cash.

But rushing to invest in startups would also present dangers since banks have no institutional experience investing in such companies. They are used to dealing with SMEs, but mostly in a lending — not investing — capacity. While they have numbers to support the profiles of who they are lending to and know how to assess the riskiness, they currently have neither the knowledge nor the background in investing in startups.

This then is the banks’ new dilemma. To take advantage of the new opportunity, they must learn how to invest in startups, which will require setting up specialized departments and hiring or training individuals in this field.

These departments would ensure that best practices are followed for startup investment, which are often counterintuitive. For instance, risk averse banks might want to play it safe by taking large stakes of equity in exchange for their investment. This, however, would likely demotivate startup founders, ultimately weakening the company’s chances of success. When Marwan Kheireddine sat down with Executive to talk about Al-Mawarid Bank’s investment in local startup Presella (see pages 28 and 30), he said that he would only take 20 percent for precisely this reason. The circular lets banks take up to 80 percent equity in any single company.

Banks may also try to minimize their risk by only investing in a few companies. This is also counter to best practice, which is diversifying by investing in at least 10 to 20 startups to guarantee that at least one investment is successful.

Several banks have already taken measures that indicate both an aversion to risk and a deferral of the responsibility to learn the best practices by pledging significant sums of money to venture capital funds, which would invest on their behalf.

This may generate some returns for the banks, but will not create the same economic disruptions. Because venture capital funds can pool many banks’ money together, they intend on investing in bigger ticket sizes to the likes of over $2 million, despite many fund managers complaining that there is not always enough deal flow. Whereas investing in smaller tickets would have helped increase the deal flow from the bottom of the food chain, investing in larger tickets does not have the same ramifications, and will not create the broader economic change the central bank was hoping to achieve.

For everyone’s sake, banks should learn how to invest in startups and begin taking advantage of Circular 331. But as banks’ long-term performance is inevitably pegged to the performance of the local economy, perhaps most of all, they should do it for their own sake.

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