Bounce off the brink

As the economic crisis caused by Covid-19 affects the tech world globally, the startup scene in Pakistan has also faced the brunt. The global capital market has experienced a major downturn. It was the working class that took the first hit. Pakistan is not an anomaly but what makes it seem unexpected is the fact that Pakistan has experienced unprecedented growth in global institutional venture capital (VC) financing in the recent past.

In 2021, $350 million was raised, while $163 million was secured in the first quarter of 2022 alone. After this extraordinary boom in the startup ecosystem, this sudden fluctuation in the economic outlook has sent a shock wave within the entrepreneurial field of the country. Startups that were growing at a rapid pace not only halted their growth plans, but also began to scale back. A large number of employees were laid off overnight and operations were closed in various markets within days.

This may be confusing to the average person. How do companies that have raised millions of dollars not have enough financial resources to pay employees and run operations on a large scale? Before we delve into the reason, it is important to understand the characteristics of venture capital.

Long-term in nature, venture capital financing for startups is usually provided on a piecemeal basis, spread over several stages. One way to implement this is “milestone-based financing”. Accordingly, the venture capital holder commits an amount up front to the startup to finance operations and growth while the rest of the funding is committed for the future, provided the company achieves certain milestones. Upon achieving the pre-set goals, the startup qualifies to receive additional rounds of investment. However, despite the pressures of meeting the milestones that come with venture capital financing, why do startups still choose this method rather than resorting to other financing methods, such as long-term bank loans? First, banks often don’t make loans to startups unlike traditional companies due to the risk of failure that comes with startups – in the case of early-stage startups, there’s hardly anything that banks can hedge. as a guarantee. On the other hand, look at other metrics to assess the extension of funds, such as product viability, market size, and above all the potential of the founders. Second, since startups pay for investment capital in the form of equity, it allows them to fund and scale their operations without incurring debt burdens. Third, VC funds usually have a 10-year lifespan which means that it is difficult to withdraw any fund invested in a startup until the startup emerges in the form of either a public offering, acquisition, or merger. Fourth, the expertise, network, and resources that venture capitalists bring with them are invaluable to startup founders. Overall, venture capital financing is a profitable financing option as it prepares startups to outperform the competition while still raising more funds at each stage of growth.

Going back to the previous question, how does a startup on the brink of financial hardship end up despite raising a large amount as an investment? The answer is “flash scaling”.

Reed Hoffman, founder of LinkedIn and a venture capitalist, came up with the terms blitzkrieg as a strategy to grow big, very fast. In today’s deeply interconnected global landscape, the path to creating a high-growth, high-impact startup can be daunting. Through lightning expansion, entrepreneurs can quickly build their companies to serve a large and often global market that aims to become the first mover at scale. Choosing a startup for a lightning bolt has two main advantages for being a first mover: focus and speed.

Mostly relied on by software companies because the marginal cost of serving a market of any size is close to zero, false scaling involves growth on three types of metrics: revenue, customer base, and organization. Startup founders usually end up focusing mostly on the first two. Such companies create a large number of jobs to carry out increased operations without compromising on quality. In addition, they expand their operations into multiple geographic markets simultaneously to increase their revenue and lower prices to reduce competition and increase customer acquisition. Amazon, Google, and Linkedin are some of the most notable case studies in the field of hijacking scaling.

Why is this speed necessary for startups wanting rapid growth? For two main reasons. First, a business requires a certain scope to be valuable. For example, LinkedIn became a valuable platform once millions of people joined the network. On the other hand, for e-commerce marketplaces like Amazon and eBay, having a large number of buyers and sellers is a must because these businesses have low margins that require a large volume of transactions. Second, such companies want to expand faster than their competitors because the first to reach customers is the one who acquires them – it is a question of who has the most customers.

However, scaling up the blitzkrieg brings with it its own set of shortcomings. A lot of capital is being burned at a very fast rate. And that’s what we’ve recently seen happen to a local startup, Airlift.

The airlift (a former transit project that was pivotal to e-commerce during the pandemic) became the first project in Pakistan’s history to raise the most investment – totaling $110 million, in just two years. After raising her $85 million Series B tour, she has expanded to multiple cities across Pakistan and South Africa. Recently, last month, she announced what came as a shock to the startup ecosystem in Pakistan. The company reduced 31% of its staff and pulled out of South Africa and second-tier Pakistani cities. With the founders’ eyes focused on making Airlift the nation’s first unicorn and announcing its $1 billion valuation with another massive $350 million funding round, the decision to scale back its operations was to contain the cash flow burn.

An airlift is just one example. In the recent past, post-pandemic resets have led to a wave of layoffs that have taken over tech startups globally. For example, just when Egyptian mass transit startup Swvl was expected to enter a multi-billion dollar conglomerate in Africa, it laid off 32% of its employees in a bid to become cash flow positive and pursue profitability.

Recently, Klarna – the Swedish fintech startup behind the ‘buy now, pay later’ online shopping revolution – sparked outrage after publishing a list of 700 laid-off employees. Klarna has been growing by leaps and bounds, gobbling up small businesses and rushing to go public, all while posting record losses.

The above are just a few examples. Several tech giants such as Meta (Facebook’s parent company), Twitter and Uber have announced hiring freezes and slowdowns as fear of a global recession looms. This downturn initially affected publicly listed technology companies, then moved to late deals and later to well-funded, early stage startups. This global downsizing has become an inflection point as a result of tech unicorns realizing that they may either have over-promised a growth path, over-employed or overestimated their ability to raise the next round.

The intention here is not to identify any particular startup, but rather to offer a perspective on the future of venture capital in Pakistan – and is this a bleak future for Pakistani startups?

not at all. With the world’s fifth largest population, seventh largest consumption category projected by 2030, plus 360,000 tech professionals and 22 average age, Pakistan is, for sure, the next big hub for startups in the world.

For example, in the midst of the recent deteriorating economic situation, Dastgyr (Pakistani B2B e-commerce platform) has raised the country’s largest ever Tier 1 funding with $37 million in a deal brokered by global giant Veon. This investment indicates a positive outlook for Pakistan in terms of venture capital financing.

After 2021, the startup scene in Pakistan has become a hotbed of global venture capital. The past two years have seen many global venture capital giants invest in Pakistani startups, and at the same time, the local venture capital ecosystem has come to the fore. Indus Valley Capital, Zayn Capital, Fatima Gobi Ventures, Sarmayacar, Walled City, Deosai Ventures, 47 Ventures and Zamindar Capital are some of the names that have not only supported Pakistani entrepreneurs but generated worldwide interest.

However, the current economic crisis and its potential to negatively affect local startups cannot be ignored. So how can our startups protect themselves from the fallout from the global economic downturn?

On the path of gradual growth. More than anything, this requires a thorough and vertical understanding of local market dynamics along with something I call a virtue – patience. There is no harm in choosing horizontal expansion but not at the cost of burning more money than is being earned. This can only be done when the entrepreneurs have fully understood the market, its economic unity and the driving factors. Bykea’s growth is an example. Having raised $22 million so far since 2016, the startup has steadily grown its client base by working hard on improving the economics of its unit. Today, Bykea is a profitable company with a geographic footprint across major cities in Pakistan.

Another way our startups can be protected from being hit hard by the looming global economic meltdown is with “government subsidies”. For example, earlier this year under Imran Khan’s presidency, the government announced a 100% tax exemption, 100% foreign exchange exemption and 100% capital gains tax exemption for tech startup investments. Specialized foreign currency accounts for IT companies with 100% retention were also announced and the Pakistan Emerging Technology Fund established via a public-private partnership.

In short, for Pakistan’s entrepreneurial scene to recover from the prevailing domestic and international financial crisis, the foundations of Pakistan’s startup ecosystem must be strengthened. This can only be achieved if local venture capital players and government stakeholders come together to support and inject emerging startups.

Nabil Kadeer (PMP, SCPC) is CEO of Infinite Scaleup and CEO of DirAction.

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