Lebanese start-up funding threatened

2020, where things stand

Eager to capitalize on the tech-savvy population,high education rate and entrepreneurial spirit, Banque du Liban’s (BDL) Circular 331, released in 2013, paved the way for the creation of dozens of startups in Lebanon, in addition to accelerators and incubators. Despite this support, events of the past few years have put a stop to the generous investments in startups.

Circular 331 was meant to incentivize local banks to invest in the local tech scene to turn Lebanon into a start-up nation. The circular encouraged banks to allocate up to 3 percent of their capital in startups, incubators, accelerators and venture capital funds by a mechanism that would guarantee reimbursement in case of failure of the said venture up to 75 percent of direct startup equity investment or indirect support entities. Local banks would be authorized to obtain a seven-year loan from BDL with zero interest, in exchange for investing it in Lebanese Treasury Bills with an interest rate of 7 percent, in return for the banks committing to invest in the knowledge economy with BDL guaranteeing the investment up to 75 percent and sharing the profits with the banks at 50 percent.

The structure of the initiative allowed for more guarantees. In 2014, this allowed for an injection of $400 million in the Lebanese knowledge economy. According to Bassel Aoun, program manager at Kafalat for the Innovation in Small and Medium Enterprises (ISME) program, a project supported by the World Bank, the major source of startup funding has come through Circular 331 subsidies. Banks are the main suppliers of funds through Circular 331, so the current banking crisis has resulted in this money drying up overnight.

“Most of the funds came from the banks’’, says Fadi Bizri, a partner at B&Y Venture partners. Indeed, in the absence of well-developed capital markets in Lebanon, the attempts to reach international investors have been lukewarm, and the ecosystem has been resting mostly on BDL’s shoulders.

Nevertheless, in light of Lebanon’s financial woes, and due to regulatory hurdles and other shortcomings of the Lebanese economy, the support mechanism established through Circular 331 have stalled.

Due to the current financial crisis, and to capital controls, it has been difficult to get investments from abroad to local startups, and trying to attract such investors is, according to Aoun, “counter intuitive”. “Capital controls are affecting the performance of our companies,” Aoun continues.

Indeed, startups in Lebanon are being barred from wiring money abroad to pay for marketing, software, ads, and foreign talent, which is having an adverse effect on their financial standing. “It’s a nightmare” says Fadi Bizri, taking into account that the value of a startup is heavily related to the value of its software (hosted on servers such as Amazon Web Services), data and cloud management, all of which require international payments to be maintained.

To add, startups are no longer able to hire talent from abroad, and are even losing talent to emigration. “Between the thawra, capital controls and Covid-19, there is a lack of trust from abroad in the local economy and therefore very little to no investment,” says Nicolas Rouhana, general man-
In collaboration with 43 ager at IM Capital, an initiative funded by USAID
which provides capital and support to companies through early-stage investors like angel investors, venture capital funds, accelerators and incubators .

Efforts to mobilize international investors have had little to no tangible result, most finance experts say. Consequently, many startups are considering moving abroad to re-incorporate in a different jurisdiction. Start-ups are also being pushed to relocate by investors, who are nervous about the current situation and Lebanese judicial regulations, as Lebanese commercial laws are deemed too rigid for the corporate structures needed in venture capital. Also, the relocation of these start-ups abroad would allow them to raise capital from different pools of investors, in jurisdictions where money would be more easily accessible.

Nevertheless, initiatives to channel foreign money into Lebanese startups have not fully dried up. IM Capital, for example, to help provide relief for affected SMEs in light of the August 4 Beirut port explosion, recently launched the “heartfelt support to Beirut” – initiative supported by USAID
to help channel 2 billion LBP through its companies across four sectors: education, housing, food and water, securities and business platforms. The
money will be used to provide relief packages to clients and beneficiaries who have been affected by the port explosion.

HAVE START-UPS TRIED TO CHANNEL SOME OF THE LOCAL EPOSITOR MONEY?

Startups would, in principle, be seen as attractive investments to local depositors worried about capital controls and talks of haircuts on deposits. “We have witnessed this trend”, says Aoun, mentioning investments in local dollars – “lollars” – in startups, “though it has been minor for early stage startups”.

Nevertheless, for startups less dependent on foreign money, Rouhana believes that this could result in a mix of “fresh” dollars and local dollars
as an investment tool in the near future. Such a mix of local and international dollars, according to Fadi Bizri, would not depend so much on the startup’s industry, but more on how mature the company is. Mature companies wishing to pay higher salaries, for example, or needing to transfer money abroad, would be less interested in the use of local dollars.

Other ways to circumvent the difficulty of accessing capital and sending money abroad is the use of crypto-currency and crowdfunding. The use of crypto in Lebanon is not obvious as such tokens would have to be converted to hard cash – and buying them would prove difficult due to capital controls. Regarding crowdfunding, there have been minor initiatives but they have been made on a small level. According to Bizri, “You have small initiatives from people abroad who want to help”, but those happen mainly for companies with exportable (or potentially exportable) products who are in need to import things like raw materials or machinery, and that can repay investments with ‘fresh’ dollars, which is not the case for most startups in Lebanon who are engaged in the local production and distribution of services.

“The last 14 months have been challenging in abnormal ways for any entity across Lebanon” says Mouhamed Rabah, Chief Executive Officer of the Beirut Digital District (BDD), a privately-funded community space that
hosts startups, incubators, accelerators and funds. According to him, startups are looking for international funding, but this comes with a requirement to reincorporate abroad. He argues that two elements are driving these companies to reincorporate: the drying up of funds for startup investments in Lebanon, and a loss of trust in the government and institutions due to the August 4 explosion. Indeed, the latter seems to have been the breaking point for many talents, who do not see the need to risk their lives or their childrens’.

“We are seeing an increase in demand from companies wanting to set-up their back office in Lebanon due to a more competitive financial cost and this could help Lebanon transform into an added value outsourcing hub, building on the yearly graduating talents” says Rabah. For example, a Saudi company is opening up their engineering office in Lebanon at BDD to profit from these now more affordable talents. More of these examples can be found at BDD, according to Rabah.

As local funds dry up, startups can turn to their networks in the diaspora, as incorporating outside of Lebanon doesn’t necessarily mean to pack bags and leave. Indeed, reincorporating abroad can mean setting up another legal structure and bank account for cash management outside of Lebanon, but does not imply leaving the Lebanese market as a whole or moving out completely.

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