The Middle East’s start-up scene: Is funding still the biggest challenge?

The recent acquisition of Dubai-based Souq.com by global e-commerce retailer Amazon has changed the perception of the Middle East’s digital start-up ecosystem, with the marketplace gaining the recognition it has long deserved, say experts.

The atmosphere at the recent annual Step Conference in Dubai – a hub for digital startup players – was upbeat, with optimism about the future possibilities and expectations of big things to come.

Speaking above the cacophony of sound at the event, one of the most respected entrepreneurs in the region – the founder of logistics company Aramex and executive chairman of Wamda Capital, Fadi Ghandour – asserts that the acquisition is a “fantastic thing for the region”.

“It’s a confirmation of all the things that we have been doing for the past 15 years. It just takes Amazon to make the statement that there is something happening in the region in the digital space, in e-commerce. And it’s a vote of confidence in the region,” he says.

“It would have been good if Souq had grown bigger and then went public eventually. But unfortunately the market is not developed yet. There are no options in the region,” opines Ghandour.

“But this basically tells everyone and puts everyone on notice – from regulators, to start-ups, to the retail industry to everyone in the business across the region – that big players are paying attention and you also need to pay attention internally for your own start-ups.”

Samer Geissah, vice president for consumer new business and innovation at telecom operator du, agrees that Amazon’s entry into the region is an indication of the maturity in the market when it comes to digital services.

“It will fuel more and more companies to look into startups and evaluate them at an early stage and not wait till until it is mature to invest in – because that’s too late,” he states.

The funding question

During the last decade, the main challenge that startups in the region faced has been funding. Few venture capital funds existed in the region, and raising finance from established institutions more often than not proved extremely tough due to the low risk appetite.

In the 10 years between 2000 and 2010, only about $50m went into the tech ecosystem in the region, reveals Dany Farha, CEO and managing partner at Beco Capital – a fund that focuses on investing in early stage internet and mobile companies in the MENA region.

But in the last three years, between 2013 and 2016, over $1bn has been invested in the ecosystem.

“It’s more than exponential growth,” Farha emphasises. The growth in funding has come in line with high digital penetration in the region – the MENA region is estimated to have over 50 million digital consumers.

“Also, we are a wealthy and young region – the millennials want to consume on their phones and tablets. We also have state of the art infrastructure,” he continues.

“But we haven’t had enough money go into the ecosystem to build all the goods and services that we need to consume digitally. It’s all coming now.

“So if all that money goes into the ecosystem, the logical bet is that if it goes into the right hands – whether it is accelerators, entrepreneurs, direct investments, incubators, VC funds – just collectively, it will ensure immense value,” he adds.

However, despite liquidity in the market, funding challenges remain for growth stage start-ups, adds Amir Farha, managing partner at Beco Capital.

“It depends on what stage you are looking at. The early part of the ecosystem is being addressed now with a lot of angel investors coming in from different markets. A lot more government entities and families are also putting money in this stage.

“So that part of the ecosystem is healthy. The challenge is now the level after the early stage – the growth stage –where you are looking at the $5m to $10m-plus rounds of funding. We have a huge gap in the amount of funding,” he adds.

According to Ghandour, more and more money should be poured into the market.

“Definitely more money is needed. You need thousands of start-ups to have one Souq.com. You can’t have one company funded and say it is going to become Souq. You have to have thousands – thousands will fail and hundreds will make it. This is the nature of the industry,” he says.

Dany Farha adds that funding is – and should always remain – challenging.

“The minute funding stops being a challenge, you will have inflation and it will cause major issues,” he says.

“Funding should always be scarce. It should never be too easy but it shouldn’t be like a drought situation. It should be hard but doable.”

Other challenges

Aside from funding, Dany Farha suggests that the biggest challenge in the market is government policy. While some countries in the region are looking at regulations such as a bankruptcy law and a new companies law, more needs to be done.

“The government is talking about doing a lot of things. We haven’t seen enough things actually being implemented yet from a policy perspective,” he says.

“For instance, we need a prudent manual – which means you allow endowment funds and pension funds to invest in the VC asset class. That is something that we need to do. The minute we do that, the floodgates will open and then you will get consolidation. The best managers just get more money and we keep everyone safe and happy.”

“New policies are coming, but the change could happen faster.”

Ghandour also asserts that unified regulations are needed across the region if local companies are to scale – both regionally and eventually internationally.

“The fragmentation of the region, of the market, is the biggest challenge. You will not have more Souqs unless you have a market that is more harmonious, that has more standardised tariff rates, that opens up borders for trade,” he explains.

“If you want to go global from the region, you need to at least conquer the region. The region is so difficult to do business in. The regional regulators need to open up the markets so that people can actually scale their businesses regionally quickly and then go global.

“So the regulatory environment needs to change. Markets and borders have to be opened. If you don’t open markets, you will not have big companies.”

VAT looms large

With the GCC region preparing to implement value added tax (VAT) from early 2018 in most member states, it will soon lose it tax-free status and with it some of the allure for entrepreneurs.

But experts say VAT is good for the region and will not have a big impact on the start-up ecosystem.

“VAT is a global thing and I don’t see why the region shouldn’t charge the tax. We have to adapt to it. It will have a bit of an effect but tax is healthy. We consume, we pay taxes – but the key is that we get services in return,” says Ghandour.

Since the tax will not be selective and will be applied to everyone, it will not specifically deter entrepreneurs, agrees Dany Farha.

“It’s just something we have to live with. It’s a good thing because it will create diversified income for the GCC government that to date have relied exclusively on hydrocarbon revenues – it’s about time we change that,” he argues.

“I don’t think cost is a deterrent. It would be nice if there were lower costs in a place like Dubai but the advantage of being here is that you can serve the entire region. The UAE cannot build a tech ecosystem on its own and neither can any of the other GCC states or Egypt. But put them all together and you have a big enough region where you have a big enough market. It becomes interesting in the scale of businesses,” he adds.

The future beckons

Experts emphasise that while the region’s start-up ecosystem has accelerated to new highs, the current situation is only the beginning of further growth.

“I think this is the beginning of the upwards curve when it comes to the most exciting part to be in. I think the next three to five years will see more and more great ideas becoming billion dollar unicorns. There will be more,” says du’s Geissah.

“With Amazon coming in and rumours that Alibaba and others are coming in, the focus is going to be on the digital services and the ecosystem that supports them. And to be in this ecosystem now is the right time. I think there will be exponential growth in the next few years and what we need is a system, a structure and information being shared openly in order to ensure that this is a smooth transition and that the majority of people are benefitting from it,” he adds.

Ghandour presents a similar forecast.

“The Amazon deal will bring more money to the region from outside. Alibaba is going to be interested in the region. And regional players are finally going to be interested in the region,” he says.

“Watch this space for the coming three to five years – you are going to see a lot of things happening. That’s my prediction.”