Where’s the cash?

Access to capital for start-ups is not an easy thing in this part of the world, and unless entrepreneurship is encouraged by a show of tangible support the brain drain syndrome will flourish

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By  Massoud Derhally Published  January 30, 2002

|~||~||~|You have a business idea and decide that you are going to drop everything to pursue it. Your next step is to try and sell your business plan to prospective investors. But then you discover that this is not the US or Europe. Things are not that simple. The culture here, while it is shaping up to that of the West, in terms of financial services, still lags behind when it comes to the various outlets one can use to finance projects.

Yes there are private equity and some venture capital firms, but the Levant region has a scarce supply of resources, where commercial banks are risk averse when it comes to lending or financing start up initiatives. You cannot really blame their attitude in the absence of credit bureaus or established risk management measures.

“Unfortunately, the severe conditions and guarantees required by these institutions, together with their cumbersome decision-making process, are not well suited to young vibrant digital ventures,” says Nasri Tehini of Chescor Capital. There is a clear disparity in the level of financial sector development between the various countries of the Middle East and North Africa (MENA).

In general, the financial sector continues to play a smaller role in the region’s economic development than in other emerging market countries. Banks tend to dominate MENA financial systems, but in general have not achieved levels of activity or efficiency that allow them to play a central role in economic development. Lending remains predominantly short-term and trade-related, with relatively little being directed to long-term investments.

“In the absence of venture capital, people with bright ideas will have to go to a risk averse bank manager, or fight through the bureaucracy of a government development institution that may not be receptive to innovation,” says Henry Azzam, CEO of Jordaninvest. “In the US some of the most famous companies like Cisco, Dell, Sun Microsystems, Apple, and Compaq may have not done it so fast had their only source of finance been a bank,” added Azzam. Conversely, the Gulf region has poor demand but a sufficient supply of venture capital.
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When you examine the situation in both regions you begin to comprehend the different barriers entrepreneurs face. Illiquid stock markets put a ceiling on unlocking a company’s value, its ability to secure capital to finance growth, or attract investment from a foreign entity because of poor exit conditions. But an exit strategy is one segment that the finance industry should be looking at closely as it provides an incentive for investing in start ups and brings about some form of confidence that a particular company will bear fruit and that dividends will be reaped.

“If you can exit one company a year that is positive because a procedure is in place. A major mandate should be transcribed in order to make markets more dynamic,” says Jassim Alhamadi, an entrepreneur who started his own company, Tronikom. To date, there is really no appetite for financing early-stage initiatives as opposed to late-stage ventures in general. That reluctance is very much indicative of a risk averse culture and an inclination to avoid the high cost of failure associated with early stage start-ups. “We will not invest in early stage companies only late stage ones, in companies that have started booking revenues and have kept expenses down,” says Mohamed Mejai, a partner at Injazat Technology Fund, a VC fund for the MENA region, operating according to Shariah principles.

Traditionally and until now, you can always find entities that are interested and have the mandate to invest in large-scale, infrastructure-related projects. However, early-stage ventures have traditionally been started by family-based businesses and that is due to the fact that family businesses can incubate early stage ventures within their current business, thus lowering the cost, and can also afford to have a longer perspective.

“Incubating within your own business is something that is a must in our part of the world,” says Ramzi Abdel Jaber, a veteran management consultant and CEO of MENAFN. “Of course, the fact that there are usually no proper corporate structures and control mechanisms makes it hard for entities to trust entrepreneurs,” added Abdel Jaber.
There is an abundance of cash in the Middle East, but at the same time there is also an amazing lack of on-hand experience and support that is required to build and nurture new ventures. Most entities do have the ‘stomach’ or appetite for such risk, but inadequate respect for intellectual property and talent has led most potential financiers into the, ‘we can build it in-house mentality’.

That, coupled with the fact that contacts and networks are essential in the Middle East, results in large conglomerates, such as Orascom— growing larger and larger through both vertical and horizontal integration, a natural phase that all less developed countries have to pass through before companies have to start focusing on core competencies and outsourcing non-core tasks to more cost-efficient producers. Again, the lack of cost measurement tools does not help here either.
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The Internet craze that has taken the entire region by storm personifies a great deal of what is being addressed here. At a recent conference for Arab businessmen and investors, which addressed some of the regions IT achievements and shortcomings, Dr. Abdulilah Dewaichi, regional advisor for communications and computer networking, UN ESCWA, said that there is “Too much emphasis on application of IT, and not on research and development and manufacturing of products. Arabs are in danger of becoming mere users of commodities rather than partners in IT manufacturing and research.”

Venture capitalists and professionals alike echoed Dewaichi’s concerns. “That has been the case historically. Overall, we are consumers and not producers. The massive consumption in the Gulf has been buttressed by oil, and the wealth has been translated into many productive areas, but nowhere near as much as it should have been. When the oil goes away, what do we really produce?,” says Nashat Masri a partner at Foursan Technology partners, a venture capital firm based in Jordan. Eyad Mashal, who heads the asset management division at Atlas Investment Group, agrees that people are not looking within to develop but are relying more on importing, yet he remains optimistic. “A simple comparison between Arabs from one side and Israel and Ireland on the other side will prove that. However, I believe that we have some serious efforts to become manufacturers of IT; this may take time but we will get there.”

“The start has been slow, and there is not much innovative spirit. The inspiration for IT activity usually comes from foreign or external forces, rather than from within. We seem to be working from top down wards, instead of starting from the bottom,” said Dewaichi. So what does an entrepreneur with little personal connections and no access to capital do? What are the alternatives? “I did not go to a VC. I sought a consortium of investors,” says Alhamadi, who started Tronikom, a consultancy for technology and capital markets.

Turning to a venture capital firm usually translates into relinquishing power and having someone on the board of your company who may want to steer the company into a direction that is not necessarily at the top of your agenda. Going to an “Angel” investor is an option for the early stage development of a company. However, the chances of locating such investors in this part of the world, given the tendency to invest abroad, are extremely challenging. More importantly, individuals expect their money back and become emotional when losses are incurred and situations go south.
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Venture capital firms usually want to see a return on investment somewhere around 34% and want to exit an investment to realise such a return- a Catch22 really when you look at the situation on the ground. “When you invest in mid-stage and pre-IPO US companies, you only need one or two companies out of every ten you invest in to make it through to a successful IPO. The losses on your failed investments are outweighed by the gains on your successful ones, encouraging investors to take on more risk,” says Ahmed Samerai, investment development manager at DAMAC Group.

“In the Middle East, however, I would be required to achieve 100% success in my investments. Why? Firstly, if any company manages to go public, its share price will increase by only 4-5% in value, due to the lack of activity in regional stock markets. Secondly, any company that goes bust will wipe out all the profits gained from the rest of the investment portfolio. Why should I take the risk?,” added Samerai.
According to Faisal Ameen, a finance professional at a multinational bank, one alternative is generating a cash cow business like an agency or annuity business to support Internet investment or doing turnkey projects to generate seed capital. Another option is to approach governments to set up an investment fund. This according to Ameen, “represents a small cost for governments as it has potential tangible and intangible returns.”

But innovation requires access to capital and thus far it has been limited. For the trend to change, participation of the public sector needs to be scaled back, corporations need to become assertive and the private sector across the board needs to engage itself in cultivating a culture of partnership. The situation in the region is very much a territorial one, as far as banks are concerned in the Gulf. “The build it in house and they will come” attitude will work but only in a limited fashion.

Outsourcing a project is an option, but the upside to collaborating with competition or players in other sectors is greater as it creates a synergy whereby everyone benefits, be it a start-up, a small to medium size enterprise or an established conglomerate. Physical structure, while important, cannot by itself be the only denominator in the equation. Transparency across all fronts must take place and this includes reforming laws related to setting up a business, competition, and capital markets. Ultimately, success will only take place when risk associated with start-up and project financing is shared between all the players. —By Massoud A. Derhally
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