The Middle East’s thriving technology start-up scene is set to attract a flood of venture capital according to the founder of ArabNet.
But an underdeveloped funding landscape is creating problems for Middle East tech firms, leading some investors and start-ups to seek alternatives to the venture capital model.
“A ton of money” is set to enter the region’s tech start-up scene, according to Omar Christidis, the Lebanese, Yale-educated founder of the company, which runs tech conferences around the Middle East.
As Middle East tech venture capital funds (VCs) boost their spending power from an average of US$10–$15 million, to an average of $30–$60m, the region’s VC market will become “more competitive, [which] will result in better terms for entrepreneurs,” Mr Christidis said.
VC firms BECO, MEVP, Wamda, Fenox, Berytech are all soliciting or have solicited capital for larger future investment rounds.
But Juan Jose de la Torre, a vice president at Intigral, which supplies digital products and platforms to telecoms firms, and who helped found Afkar.me, an incubator for tech start-ups, thinks that the availability of capital is only part of the story.
“Even if [VCs] bring the funding, they will find that the land is unprepared,” he said. “VCs come to the Middle East with the same standards that they apply to [firms based in] Silicon Valley. They’re still looking for firms that target a global audience. If they decrease their standards, they increase the risk. And the cost of capital is, if anything, higher in the Middle East.”
Khaldoon Tabaza, founder of iMENA Holdings, a hybrid venture capital and incubator firm, doubts the suitability of the VC model for the region.
“The VC model is based on being in a mature system [like Silicon Valley] when you have specialised funding across the growth stages – angel, seed, early, growth, late – where a company can sail seamlessly from seed and early to late stage funding in two years, without having that much friction with investors.”
For the VC model to work, he said, “you need to have large companies that can acquire small companies to create exit opportunities. Where you have seasoned professionals who have been in the industry for 10 to 15 years, and who can become mature founders who can start new companies.”
He also pointed out: “Most tech start-ups in the Middle East fail not because of their business models, but because they run out of cash. And they run out of cash because there are huge gaps in the funding graph [from angel to late funding]. There is a huge concentration of funds on the seed and early stages, but very little money in the growth and late stages.”
As Mr Christidis said, “If you look at the companies doing the $20 million deals... they’re international funds, not regional funds.”
Lack of late stage funding means a lack of exit opportunities for investors. And that increases the risk for a VC firm that it will end up sitting on a portfolio of companies it can’t divest from, Mr de la Torre said. IPOs are a difficult option, because floating on local exchanges means ceding control of the company, while regulatory hurdles are high.
But even early stage financing remains underdeveloped. The region’s business angel networks, said Mr Christidis “are very nascent... they’re starting to form communities, but it’s not easy to find an angel investor. In Silicon Valley, angels are successful entrepreneurs who have made exits, and we just don’t have enough of them.”
Walid Singer, who works for Presella, a Lebanese hybrid event planning and crowdfunding site, said that while venture capitalists in the the Middle East are in many ways similar to those in the US – “same in approach, personalities, methods”, their expectations are unrealistic in comparison.
These VCs “expect multiples of between 10x [return on investment] and 100x – which may be reasonable for a firm in Silicon Valley, but you can’t expect that from a first-generation entrepreneur in the Middle East”, he said.
Presella received seed funding of $76,000 from Seeqnce, an accelerator firm based in Lebanon, before receiving $300k from several local investors. The company is talking to VCs, but Mr Singer said that “if we can show scalability, and a plan for growing from revenues from $500k to $5 million and $10 million, then the conversation we’ll have with the investor becomes more interesting.”
“Because there aren’t as many venture capitalists in the Middle East, there’s a low level of competition. Their terms are not as good, because they know they’re the only ones around.”
Mr Tabaza agreed. “Some [VCs] come up with crazy terms.” This means VCs can end up “killing companies by putting their money in them. One of the things that bugs me about VCs is that they invest in a company just to kill it a few years later.”