Entrepreneurship: Beware a bubble

Venture capital funds must boost the Lebanese entrepreneurship system

Too much money and not enough good companies will lead to a bubble
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Last August, after much speculation Banque du Liban – Lebanon’s central bank – released Circular 331. The $400 million plan aimed at encouraging the country’s start-up sector by guaranteeing 75 percent of commercial banks’ investments in fledgling companies. The long-term aim was to boost Lebanon’s ‘knowledge economy’.

Many in the startup world greeted it with enthusiasm as a move that could potentially revolutionize the ecosystem, but others were more skeptical of how banks would go about investing in startups.

In recent months, as the mechanisms have become clearer, banks have begun to make deals with venture capital firms that will invest the money into startups on their behalf. Several funds already have money pledged from banks and are waiting to invest (see full article).

While documents structuring the funds are still waiting for approval from the central bank, Lebanese startups are faced with a lot more money than ever before. Yet a large injection of capital is not necessarily the best thing for the ecosystem.

As Executive reported in November, potential investors were already concerned about a weak deal flow: not enough exciting startups worthy of investment. The increase in available finance has done nothing to change this. If the increase in capital is not paired with a concomitant increase in the number of investment opportunities, there will be too much money chasing too few deals.

This could create an inflationary pressure on valuations, with companies able to play different funds against each other. This would in the short run be good for Lebanese entrepreneurs to a certain extent; many have complained of low valuations and having to relinquish large equity stakes for relatively little money. With more bargaining power, they can fight to retain more ownership over their companies.

But too much inflationary pressure could also create a bubble, which could lead to riskier investments. Funds with plenty of capital but few enticing companies to invest in could end up paying inflated prices or making bad deals. Inflated valuations could also lead to the funds not deploying their money.

While many in the entrepreneurship sector admit the possibility of a bubble down the road, they do not seem overly concerned. Venture capital funds already have a number of companies earmarked for investment, and each seems confident they will deploy all of their share of the $400 million and beat the market.

It is important that this confidence does not turn into complacence. The issue of Lebanon’s weak deal flow must be addressed and some venture capital firms are already making efforts to boost the pipeline. These efforts should be given the utmost priority, no matter how comfortable the funds feel with their potential investments. Lebanon needs a dramatic and timely increase in startups over the next couple of years for the central bank’s incentive to have the desired impact on the ecosystem.

Circular 331 is a great opportunity for Lebanon’s startup ecosystem, but it is equally important that the right measures are taken to prevent a bubble.

One Comment;

  1. Habib Kairouz said:

    Good article and fair point but too early for this type of title. Let’s give the program a chance to work. It is groundbreaking and a real catalyst for the ecosystem. It can always be improved but it is a very strong leadership initiative by the Central Bank to energize the sector.