The 411 on 331

The torrent of “free” money that Banque du Liban (BDL) Circular 331 was expected to release is still but a trickle. Approved by Lebanon’s central bank in August 2013, the circular allows banks to invest up to three percent of their tier 1 capital in startup companies contributing to the so-called “knowledge economy” or venture capital funds focusing on these types of companies. BDL is guaranteeing 75 percent of these notoriously high-risk investments, and – if every bank in the country participates to the maximum limit – the circular would pump around $400 million into the local entrepreneurship ecosystem. From an economic perspective, the rationale is simple: create jobs and build up a value-creating new sector. In a best-case scenario, some even hope Lebanon will become a techy, entrepreneurship hub for the region. At this early stage, however, the building blocks for this new sector are only now being put into place.

Marianne Hoayek, one of several BDL officials responsible for monitoring 331’s implementation, tells Executive that the bank has approved $280 million for investment to date. Publicly disclosed transactions – namely 9 venture capital fund investments and one direct bank investment – however, total around $20 million, or roughly 7 percent of the approved $280 million. Fund managers tell Executive they will close more deals by the end of the year, and even if 331 has not massively increased deal flow, it is certainly helping the ecosystem evolve.

Passing the buck

While BDL Vice Governor Saad Andary told Wamda in 2013 that 331 might push banks to create in-house “specialized units familiar with startups” to follow-up on direct investments with entrepreneurs, the vast majority of 331 money will flow through venture capital funds. “The needed experience [for a bank] to be able to follow-up [on an investment in a startup] is huge. These are not existing companies,” says Fadi Osseiran, general manager of BlomInvest Bank, which has invested with three existing VC funds and is sponsoring another currently awaiting BDL approval to launch. “These are entrepreneurs. It’s a whole new area. Banks are lenders. So to become investors already is a major move. To go from investing in an established company to investing in a startup is even harder. There is no way we can do it.”

[pullquote]Some even hope Lebanon will become a techy, entrepreneurship hub for the region[/pullquote]

Experience is only one barrier keeping banks from rushing to invest in and nurture entrepreneurial enterprises. Cost is another, explains Marwan Kheireddine, chairman and general manager of Al-Mawarid Bank and a former minister of state who pushed for the creation of 331 while in office. “Managing any investment that is less than, let’s say, $500,000 would prove too costly. You need resources to be able to follow-up on those investments. In some cases, we put people on the board. We assist companies in building their corporate culture to ensure they are adopting best practices in terms of corporate governance. And all of these things cost money. Imagine if we have to do that, as an investor, in a company where we invested $25,000 or $100,000. It becomes economically not viable. You’d be putting in resources that are costing you by far more than the actual investment itself.” That said, Al-Mawarid has made direct investments. In fact, it made the first 331-compliant investment of $200,000 in Presella, an online ticketing platform, in June 2014. Kheireddine admits he’s overworking his staff to keep an eye on the bank’s bets.

Al-Mawarid is not alone as a direct investor, but information on the practice is scant. BDL’s Hoayek says, “now what we’re seeing is that many banks are investing directly in startups.” Asked how many banks have directly invested, she answers “more than 20.” She adds that the bank is considering a public database of direct deals so “everyone knows the names, the numbers and the money allocated, but we’re seeing with the governor how to do it.”

Meet the money managers

So far, there are three VC funds operating with 331-backed investments from Lebanese banks. Berytech and Middle East Venture Partners – existing market players – are each running a fund while a third is under the auspices of a new entrant – Leap Ventures.

Berytech Fund II has raised $51.5 million but has approval for $70 million and expects to close between nine and 11 deals soon, says managing director Paul Chucrallah. The fund has not invested yet and is eyeing deals with ticket sizes between $1 and $3 million, although Chucrallah notes “we can go up to $5 [million], even $7.5 [million]. We do not, however, forbid ourselves from going below that. We like people who have brilliant ideas, even if it’s a very small idea. So we have more than a couple of investments that will be below $1 million. And one or two of those will be significantly below $1 million.” He cautions that seed funding is out of the picture unless Berytech is really floored by an idea. The fund charges a 2.5 percent management fee.

Middle East Venture Partners (MEVP) Impact Fund has been the most active with eight investments to date and two more in the pipeline says Walid Mansour, an MEVP managing partner. Impact is focused on ticket sizes between $2 and $4 million and charges a 2 percent management fee.

Leap Ventures’ first fund stands at $71 million with plans to close a second round of fundraising in November 2015 with a goal of reaching “north of $80 million,” explains Hala Fadel, a partner at Leap. In August, its first investment of $3 million went to Energy24, which builds a new type of energy storing device to help residents and businesses endure long power cuts. Fadel says two more investments should be made by the end of the year. She says the fund’s management fee is “capped at $2 million, so 2 percent, effectively.”

The fund representatives Executive interviewed agreed they’ve cast their nets quite wide to find good deals and have to fight to defend them in front of internal fund investment committees. MEVP says they met with 215 companies. Leap saw 91 entrepreneurs, and Berytech spoke with 250.

New players should be entering the market soon. The BDL’s Hoayek says three additional VC funds have received BDL approval but are currently raising money before officially launching. She adds two more VC funds are in the approval process. As noted above, BlomInvest’s Osseiran says his bank is sponsoring a new fund, and Khaled Zeidan, executive general manager of MedSecurities Investment, tells Executive his bank is also sponsoring a fund dubbed Azure which will invest in “fashion and design and technology,” he says, admitting it’s a “niche play.” He explains three banks are committed to invest in the fund, but that it will be a “smaller fund” reaching “$30 million at most.”

A moving target

An underreported element of 331 is that it also allows both banks and VC funds to invest in infrastructure components needed for a healthy startup ecosystem, such as accelerators. At the earliest stages, an entrepreneur often only has an idea, with no knowledge or experience in writing business plans or running a company. Training and mentorship are arguably as important as access to capital in helping startups survive and grow. And BDL is actually going a step further than 331 to help make sure these infrastructure elements are built. Hoayek explains that, on a case-by-case basis, BDL is actually backing 100 percent of bank investments into ecosystem components. For example, the bank offered this guarantee to two investments made by Al-Mawarid Bank: $7.5 million into the UK Lebanon Tech Hub, an accelerator and training program, and around $2 million into Bootcamp, an idea-stage training program run out of AltCity, the co-working space in Hamra, Beirut, according to Kheireddine. Hoayek confirms the guarantee and that the investment is not counted against Al-Mawarid’s access to 331 funds. Hoayek says BLC Bank also made a 100 percent guaranteed investment into Startup Megaphone, an international roadshow vehicle for local entrepreneurs. BDL is also backing investments into a coding-focused training program called Torch and part of the financing for Speed at Beirut Digital District. “[BDL] wanted to go even further [than 331] because we thought that this pipeline should be sustained, sustaining startups and deal flow. So we went beyond the 75 percent and said that [BDL] will guarantee 100 percent [of investments into] accelerators, bootcamps and training centers that will create this deal flow that will keep the ecosystem moving.”

Hoayek says that two soon-to-be-announced funds will also focus specifically on small-ticket-size, seed investments, something the market is currently lacking.

Risky business

Berytech’s Chucrallah sums up one of the pitfalls bankers and fund managers need to avoid when investing 331 money. “The onus is on us not to get drunk with valuations,” he says. While everyone Executive spoke with for this article expressed a similar sentiment, only Mansour with MEVP said he had yet seen a problem with valuations. “We had a case, one case, where we were discussing a valuation with a company, and we got overbid by one of the competing funds who paid double the valuation we offered. We obviously didn’t pursue the discussion.” Zeidan, from MedSecurities, disagrees that valuations are becoming inflated and adds that the funds are investing in a way that won’t allow for inflated valuations in the future. “My biggest concern, previously, was to make sure that we don’t have arbitrage opportunities starting to arise among the different funds. We’re invested in all three. I sit on the board of [MEVP’s] Impact [Fund] and have a very close relationship with everyone else. The bottom line is you have three separate investment committees that are, in my opinion, very independent and quality ICs. There is no way that one fund could sell its assets to another fund. We will not allow secondary placements. It’s only primary money. It’s only cash injections into a company. You cannot exit from one fund to another. That way you destroy any sort of potential collusion among the different funds. One cannot sell to another, otherwise they would just do that and we’d all get screwed. They don’t have any interest in creating a little clique.”

That said, Mansour argues that the risk of inflated valuations will increase as more first-time funds come to market with pressure to build portfolios quickly. “Anyone who doesn’t have a portfolio will start acquiring it at a very expensive price, just to show that they have a portfolio. Which means that the returns on these first-time funds will be screwed.”

[pullquote]An underreported element of 331 is that it also allows both banks and VC funds to invest in infrastructure components…such as accelerators[/pullquote]

Of course, not everyone shares this view. Leap’s Fadel argues that new entrants will be good for the whole ecosystem, especially the entrepreneurs. “Especially for early stage [investments,] there were basically only two funds – Berytech and MEVP – and it was almost a monopoly situation. They could impose terms on entrepreneurs and now that you have, in that stage of funding, another two or three funds [coming to market], there [will be] more competition. I think this is very good for the entrepreneur, and the competition is really not on valuation. I feel it’s more on the terms. And I have to say that, at the stage we’re at, we welcome more entrepreneur-friendly terms because some of the deals that would have been obvious deals for us that had been funded by other venture capital firms before us are almost un-fundable because of the terms that came with.”

On the subject of terms, Mansour argues almost the opposite. “Many entrepreneurs are now becoming too focused on what valuation and terms they can get upfront as opposed to worrying about building a healthy business.”

No one Executive spoke with encountered the problem of too few deals to pursue.

Attempted monkey business

However, fund managers and bankers Executive queried said some of the companies seeking funding did not meet 331 criteria, either because the company was not actually based in Lebanon or because it did not contribute to the knowledge economy. Al-Mawarid Bank’s Kheireddine says a local bakery approached him to ask for 331 money. That said, Zeidan from MedSecurities explains that getting his Azure fund – which focuses on fashion, design and technology – approved by BDL was no easy feat as its relationship to the knowledge economy is arguably tenuous. “It took me a year and a half of back and forth and lobbying to convince [Central Bank Governor Riad Salameh] to expand the mandate of 331 to allow me to do this,” he says.

Looking for big wins

Zeidan says that with 331, banks and VC funds need to hit “a homerun” by putting Lebanon on the global startup ecosystem map. Berytech’s Chucrallah is more blunt. “First, we have to make sure we don’t mess up and lose everyone’s money.” For him, big wins down the road would be vastly helped by serious infrastructure investments as well. Financing, he says, is only one of the barriers facing startups. “Infrastructure is a massive battleground,” he says. “There’s no way you can fuel the growth of this economy without 24-7 electricity and good internet. There’s no way.”