There is a lot of money sitting around in Lebanon and in the region that could be invested in startups. But in a landscape that barely existed just six years ago, investors are risk-averse, and the ones that do invest frequently ask for exorbitant amounts of equity. Meanwhile, entrepreneurs often expect investors to relinquish their money for too little of a product. Both sides need to make some concessions for the money to start flowing.
While plenty of startups and entrepreneurs have sprouted in the past five years, one of the biggest reasons that relatively few are receiving funding is that investors do not always see a worthy caliber. “Not all entrepreneurs or startups deserve to be funded,” says Tarek Sadi, managing director of Endeavor, an NGO that supports entrepreneurs. “I think there was a huge buzz around entrepreneurship which was great because it brought it out there. But a lot of people jumped on the bandwagon and wanted to start businesses,” he says.
Starting a business is no casual undertaking, and just because there is a lot of money out there entrepreneurs should not expect funding to fall into their laps. “There’s lots of complaints that there is not enough funding, but I really think that there is,” says Habib Haddad, CEO of the business startup platform Wamda. “I’ve been an entrepreneur myself, and I recently became an investor [see box for Haddad’s story]. I know that a lot of entrepreneurs expect that if they have a good idea they expect funding. But it takes a lot of hard work, a lot of sweat to convince investors,” he says. “There is enough funding, but [only] for the good [startups],” adds Walid Hanna, managing partner at venture capital firm Middle East Venture Partners. “You’ll see a lot of startups complaining that there aren’t enough venture capitalists [VCs], there aren’t enough angels. These are the second tier startups that nobody really wants.”
But while it’s fair to say many startups are still somewhat immature, investors have a sometimes overblown aversion to risk. Investors will write off early-stage startups in full, despite evidence through several success stories that these can be good investments if done smartly. Many investors even rule out technology startups because of the huge risk associated with them, despite evidence of the scalability of companies from this industry. Besides creating a funding gap that diminishes the deal flow, investors are shooting themselves in the foot by not taking these startups as opportunities. According to Haddad, investors need to dive into the opportunity presented by the still immature entrepreneurial ecosystem. “We take risks. It’s a completely risky game. The best thing of investing, in our opinion, is really identifying [which startups will succeed],” he says.
For the startup scene to get into its stride, entrepreneurs and investors need to close the gap between each other’s expectations. “It’s about entrepreneurs understanding what it really means to raise finance, and where to raise it from, who to raise it from. And for investors to understand what it means to invest in early stage companies, how to support them, and what it takes for them to be successful,” says Endeavor’s Sadi.
Because of the lack of investments being made, investors have mostly had the upper hand when it comes to bargaining power and often take unusually large shares of equity in new companies. “Sometimes a startup comes and says [they’ve] found [an] angel investor who wants 80 percent of the company,” says Bizri. “Of course, this doesn’t make any sense, but sometimes they don’t have any choice.”
“Even though there aren’t that many entrepreneurs or quality startups, there’s more of them than there are investors. So investors and the ones with the money are the ones wielding the power,” he adds. “As opposed to Silicon Valley, where if you’re a hot startup, everybody is running after you. Here it’s the opposite.”
Even venture capital firms, perhaps the most active institutional investment platform for entrepreneurs, are closely guarding the interests of their investors in fear that failure at an early stage might dissuade them from further investments in the VC space. “Imagine our first fund does not perform well. We lose our investors. They will not come back,” says Hanna, “and they will not invest in VC probably anymore. What good would this have to the entrepreneurship ecosystem? It’s disastrous,” he says.
Over the past year, more investors have come on the scene as they have witnessed success stories among entrepreneurs. Last year, says Hanna, “we were one of the active ones and the lucky ones because we kind of took advantage of the situation and we chose the crème de la crème of the start-ups. And we invested only in the best of the best. But if we had three or four different competitors that are active, the game would have changed completely. We would have competed together and we would have probably been forced to co-invest in the good deals,” he says.
Having more investors has somewhat democratized the market of late. “Some take high [equity], others take low. Some that have been active in the market for a while take more because they are used to being the only player in the ecosystem. But now that there are many investors, the transactional partnerships between the two are stabilizing. It still hasn’t been completely democratized. But something is moving in the right direction,” says Haddad.
Despite the growing number of investors, there are important gaps in funding for entrepreneurs at the institutional level as growing companies require various rounds of funding throughout their life cycle. “Generally speaking it’s harder to get good investments in the early stages,” says Fadi Bizri, managing director at Bader Lebanon. “Those who get the initial money — it’s anecdotal — but they get it from friends, family, or this rich uncle or this guy.” He adds, “The government or banks or public institutions don’t handle that. Either you raise it through family — the first 50k, or you participate in competitions like the Bader ones or the MIT (Massachusetts Institute of Technology) ones. You get your seed money and you start.” This situation could change in the next couple of years, as various players in the ecosystem say talks are happening about the formation of several angel investor networks.
Venture capital funds in Lebanon, though still small, are an island in a sea of less institutionalized investments, and constitute probably the most active form of institutional investment. However the past year has been dry compared to 2012 since many VCs are growing new funds. VCs in Lebanon typically make investments ranging from a couple of hundred thousand to a million and a half dollars. Startups generally migrate to the VC space once they have a tested product, and are looking for subsequent funding and mentorship to grow. Berytech has a $6 million fund that invests in technology startups, through which they have funded around 15 companies. Middle East Venture Partners runs two funds: Middle East Venture Fund and Building Block Equity Fund, with an average ticket size for the region of around $700,000. Wamda also does early stage start-ups for ticket sizes of a few hundred thousand dollars.
But VC’s relatively active role has also seen them take on the roles of other funding bodies. “In Lebanon, VCs behave a bit like U.S. angels. In the U.S., business angels invest anywhere between 50k to a million dollars. And this is what a VC in Lebanon does. Same ticket,” says Hanna. “We’ve done seed capital, startup capital, series A. Even series B… Do we want to invest just 100k in a seed capital type of startup? Sometimes we pass on it, because it’s very complicated. They need a lot of hand-holding, a lot of time to be spent with the company. But our mandate allows us to do so, [although it] doesn’t mean that we like to do so. But we’ve done it several times,” he says. Filling in the gap in the other direction, Wamda, is trying to raise its ticket size to $1 to $3 million in the next year.
The next level
There is another gap: as a company grows it needs larger investments to expand, to the tune of $3 to $5 million dollars. “That’s where it gets stuck,” says Habib Haddad. “The good [startups] today are having a hard time finding a Series B funding round in Lebanon,” says Walid Hanna, managing partner at venture capital firm Middle East Venture Partners. “Our companies, there are 17, four of them are closing series B rounds, from GCC investors.
Because Lebanese investors do not write a million or $2 million checks,” says Hanna. “You need more venture capitalist money at various levels. So you need the ones that are willing to put in the $1 million investment, the ones who are willing to put in the $3 million investment, the ones who are willing to put in the $5 to $10 million investment,” says Bizri.
With cash around, the future could be bright for Lebanon’s startup investment scene. But in order to head down the right path both investors and entrepreneurs need to build trust and start compromising in order to meet both of their desires. As the startup scene grows, competition will push entrepreneurs to mature their business plans, and as more investors test the waters, they will hopefully begin to take a few more risks.