Many entrepreneurs have had their chance at launching a business thanks to loans supported by Kafalat, the government-sponsored loan guarantee company. In fact, of the 20 entrepreneurs featured in this month’s Executive report on entrepreneurship, seven received funding from Kafalat. Given the company’s essential role in bracing entrepreneurship in Lebanon, Executive sat with Khater Abi Habib, chairman of Kafalat, to discuss his views on the issue.  

Total Kafalat loans reached $109 million for the first nine months of the year. That’s down 14 percent on the same period last year. Are these loans falling because of a reluctance to increase lending in these challenging economic conditions?

The fall is due to three factors. Most fundamentally, when there is political and economical uncertainty, people defer their [financing] decisions. I suspect that when people get used to the fact that we live in stressed times, demand will increase a little. In addition, we had some banks reducing their lending activity [due to the economic crisis]. Finally, some banks used their limit of Lebanese lira statuary reserves at the central bank as they went into a house-lending spree. They are now waiting for an augmentation of the reserves.

What percentage of Kafalat loans goes toward funding startups?

Fifteen to 20 percent of loans go to absolute startups, companies that are just formed. Then around 30 percent go to relative startups, companies already in business but wanting to expand because [they have a] new idea, there is a new trend, etcetera, and they want to grow beyond their saving ability. Finally about half or more of Kafalat loans are for well-established businesses that want a fresh expansion and need loans.

Do you intend to increase loans to startups going forward?

It is a matter of demand. We are there for them and we have the capacity to do it. Let them come. They have to come and be serious about it. Our innovative loan, which is dedicated to startups, encourages banks to lend as we give a 90 percent guarantee [on the loan]. That’s like saying we take          all the risk.
We are advocating startups to resort to seed capital whenever possible. We are absolutely dedicated to lending to them but from experience, when they have seed capital they behave better entrepreneurially. When they have a loan to repay even though conditions are good, they reduce their strategic vision and become hasty to reach cash. With equity funding, especially from an institutional source such as venture capital (VC) funds, there is less of an urgency to cut corners on governance, transparency and so on. It also brings strategic minds with it, people with experience. We favor this and we have been trying to promote the notion of seed capital and in its absence, we are ready, willing and able to provide loans.

What are the major obstacles you face when looking at startups?

Sometimes good entrepreneurs are not disciplined in their approach to money and that is dangerous. Sometimes, they have a good financial plan but they are weak on execution. Both are sources of failure. When you have a good balance, enterprises take off very smoothly. I encourage people to have the right mix.

Specialized technologies still account for just 1.5 percent of Kafalat loans. Is there a plan to provide more loans to this sector going forward?

We supply the demand. This sector is also getting equity with several VC funds and also implicit VC funds investing, such as family offices. The International Finance Corporation, the private lending arm of the World Bank, has also invested in a tech company based in Tripoli that started with a small loan with us.

I understand that Kafalat is considering investing in equity. Is that correct?

There are advanced stage discussions with the Lebanese state and the World Bank that a certain line of long-term capital will be committed to Kafalat’s care and will be co-invested in equity [along with the Kafalat loans]. But it is not yet here. We are always ready, willing and able but it depends on other parties. The fund will be a few tens of millions of dollars in size but I am afraid I would rather not discuss this further at this point. 

What is missing from the entrepreneurial ecosystem?

We need more and better VC and seed capitalists; more funds which understand both languages, the local market language with its institutional and structural elements as well as the principles of entrepreneurial capitalism. When you have the two, you get very effective results.
If one takes the last five years, we have been filling many bits of the matrix. At the beginning, there was Kafalat, then came the Berytech incubator, then we started to have other incubators — one in Tripoli and one in Saida — universities started tinkering a little, but it was more for show; and then we started having VCs such as the Berytech Fund and then associations like Bader who provide entrepreneurial support; then we got [the] first business angel network where people get seed capital with somebody coaching them. Now in Hamra, there are accelerators. We hope very soon to have most slots in the matrix not just filled but filled amply.

If we play our cards well, all the elements will come together not necessarily like a clock but in mutual support. We have to be serious and not let each other down. The bits are falling into place fairly quickly and consistently. It is not a rushed job but I prefer it not to be a rushed job.

What advice would you give to Lebanese entrepreneurs?

I would tell them to collect as much information as possible and read thoroughly. When they are in doubt go to people who might know and ask. It will never be frowned upon to ask. Come to us, to associations, to incubators and university professors. No one amongst us knows enough. One feels that one has to learn every day of the week if one wants to be close to best practice. We are a very sociable and approachable nation and networking is very easy in Lebanon. Let’s not just use it for pleasantness, which is superb, but for action as well.

Bit by bit, the Lebanese entrepreneurial puzzle is coming into place. A startup in Lebanon now can have access to incubators, accelerators and associations supporting entrepreneurship as well as financial backers. “The entrepreneur does not feel alone anymore; he would get enough support now to succeed; a lot of things are happening,” says Sami Beydoun, managing partner of Lebanon-based incubator Berytech’s fund.

As the bits of the puzzle come together, the financial investors — keen on supporting entrepreneurship but also of course driven by profit — become more interested in the space. Startups can also have access to subsidized loans offered by Kafalat, the government-sponsored institution supporting small and medium enterprises, which guarantees up to 90 percent of a startup loan taken by a commercial bank. Startups are also increasingly getting access to equity offered by various venture capitalists.

Initial backers

The first venture capital (VC) fund to set up shop in Lebanon to invest in local talent only fours years ago, with Berytech launching a $6 million fund in 2008. The fund reached its four-year mandate to complete investments this year, and has extended it by another year with an aim of deploying the remaining 30 percent of the fund in the next six months. Berytech is now raising capital for a second fund expected to be between $20 million to $30 million in size, and be up and running by the first half of 2013. 

Following Berytech’s move into the equity space, other venture capitalists started stepping in. Examples include Middle East Venture Partners’ $10 million fund launched in 2010, Cedrus Ventures’ $5 million fund launched a year ago and the $50 million Lebanon Growth Capital Fund — with $30 million committed so far — of Riyada Enterprise Development (RED), part of Abraaj Capital, the Middle East’s largest private equity firm, also launched a year ago. Accelerators are feeling the equity buzz as well with Beirut-based Seeqnce injecting capital into newly formed startups in August of this year.

“We need more and more venture capitalists” says Khater Abi Habib, chairman of Kafalat. In fact, the government-sponsored institution might be drifting away from just providing loans. According to Abi Habib, there are advanced discussions with the Lebanese state and the World Bank to launch a long-term capital fund to invest in entrepreneurship alongside Kafalat loans. The size would be “tens of millions of dollars” says Abi Habib, while declining to disclose additional information for now.

Finding the right deals

Raising equity in Lebanon with a goal of injecting it into Lebanese entrepreneurial ventures is a different ballgame to the capital raising process undertaken in the developed world. First and foremost is the lack of a key exit strategy for equity investments: a liquid and attractive stock exchange. Other factors come into play as well. “At the international level, pension funds strategically invest in private equity as part of their asset allocation,” says Elie Habib, Lebanon’s country manager of RED. “Here in Lebanon, it’s high net-worth individuals who don’t have a strategy to invest in private equity and as such, it’s a different type of fund raising than what you see in the Western world.”

While raising equity is a demanding task, especially given the dire economic conditions in the country prompting investors to hold tight, some VCs consider the lack of deal flow as the major challenge they face. “Capital raising is the least difficult part; the harder part is the deal flow and finding the right deal to invest in,” says Beydoun. For the deal flow that they do come across, lack of quality management seems to be a key issue. Michel Nehme, founder of Cedrus Ventures, is mostly concerned about the caliber of the team. He has not invested in a single startup yet and says he is looking for “complete teams ready from the get-go”.

Problems with valuation

One gripe that venture capitalists Executive spoke with all agreed on is the valuation issue, stating that VCs and entrepreneurs are often at odds when discussing valuation and the gap between what the entrepreneurs expect and what the VCs demand is significant. “Entrepreneurs spend more time on dreams than on facts. If they spent more time on facts then it would work out,” says Beydoun.

When valuing a startup, each VC adopts its own method, as it is not a perfect science. “There is no truth with a capital ‘T,’” says Nehme. The task becomes more daunting when the startup is newly established and has no historical performance to base the valuation on.

If the venture has been in operation for a few years, the method most commonly used is the discounted cash flow method, consisting of forecasting future cash flow generation and discounting it back to the present. “We always go for discounted cash flow; it is important because it is a good way of looking at the overall health of the organization versus its ability to translate value proposition into free cash flow to investors” says Habib.

Other methods used for valuing companies are less efficient in Lebanon — mainly the comparable method and the multiples method. The comparable method consists of looking at financial transactions such as mergers and acquisitions that have taken place in the same industry as the company being valued and assign a valuation based on those comparisons, but “they are hard to find,” says Beydoun and “if you find them, they are secretive about their numbers”.

The multiples method consists of looking at multiples such as the price to earnings multiple more commonly known as the PE ratio or the EBITDA (earnings before interest tax depreciation and amortization) multiple of companies in the same industry, then applying a multiple to the company being valued in line with the industry. Given the political risk inherent in Lebanon, a discount must be applied to the company being valued. This is done on a case-by-case basis, as it depends on how exposed the company is to the country, what other countries it is exposed to, etcetera. “If a company has contracts in Africa for instance, the discount applied is different to a company with all its business in Lebanon and  so very sensitive to the turmoil going on, but they all get discounted,” says Habib.

A newly formed startup, however, would not have generated cash flow or not enough cash flow to be able to forecast future payments and base a valuation on those payments. In this case, a more subjective method is applied consisting of analyzing the team and the amount of money and time invested. “The highest value we put is on the team at this stage of life of the company. Are they capable of taking it forward?” asks Beydoun.

Different expectations

Regardless of the valuation method used, entrepreneurs need to demonstrate ambition, vision and the determination to succeed, and acknowledge that they are operating in a different environment and cannot expect the same valuation given to companies in the developed world. “I want to tell entrepreneurs: don’t go read TechCrunch or Venture Beat [technology web publications] and come and say, ‘look what’s happening and I want the same thing’. We are in a completely different sphere, planet and galaxy,” says Habib. “Collect as much information as possible and read thoroughly and when in doubt go to people who might know and ask,” recommends Kalafat’s Abi Habib.

With increasing support for entrepreneurs in Lebanon, their chances of success should increase. Despite the lower valuations people need to accept for their startups relative to the developed world, more entrepreneurs will come forward and take the chance of launching their own businesses as the entrepreneurial puzzle completes. “You need more entrepreneurs at the end of the day to make it happen,” says Habib.