VC’s on the rise in MENA – The Opportunities and Challenges

Lynn Bizri, Nov 24 2016

More than $800 million has been invested in regional digital startups in the last 3 years, with $400mil invested in 2016 alone, according to ArabNet’s 'The State of Digital Investments in MENA' report done in collaboration with Dubai Internet City (DIC). With over 100 active institutional investors across the region, MENA has witnessed a significant proliferation of new funding institutions in the past 5 years, with Venture Capital (VC) funds, in particular, capturing the largest percentage of the investor community and doubling in number from 2013 to 2015.

Venture Capital firms in the region are on the rise, according to the latest MENA Private Equity Association Report, and are playing a significant role in fuelling innovation in the region and increasing its visibility as an innovation hub. More funds, from both inside and outside MENA, are providing new and state-of-the-art technologies with a place to grow and prosper, transforming the industry into one that is attractive for VCs to explore, and allowing startups with limited traction to access major markets. Yet despite the triumphs, raising funds remains a challenging process in the MENA region, for startups and investors alike.

Making the Right Choice

Venture Capital Funding can make or break a startup, so choosing the right venture-capital opportunity is key and critical to a startup’s future success. ‘Entrepreneurs really need to study the investor and investment landscape and know their audience’, said Dany Farha, Co-founder and CEO of BECO Capital. While on the surface most VCs are pretty similar, there are a few things that can distinguish one VC from the next, and startups must make sure their company’s vision and product(s) align with the interests of their chosen VC before they make their pitch. ‘As a founder, you [the startup] have VCs that invest in different stages, VCs that invest in different segments, and VCs that are experts in investing in clone ideas rather than innovative ideas’, revealed Hasan Zainal, Partner at Arzan Venture Capital.  

Some VCs also have a geographic preference, as being in the same general location as the portfolio company allows VCs to better assist with business operations such as marketing, personnel and financing. Other VCs look for startups at different stages or levels of maturity; some focus on early or expansion funding while others may invest at the end of the business cycle. ‘For every stage it’s important that one speaks to the investor he’s interested in to get feedback as to where he is in a stage, how much funds he should be raising, and what the considerations are for valuation’, said Dany Farha, Co-founder and CEO of BECO Capital.

Meeting the Criteria

VCs are very selective in choosing the companies they invest in and given the demanding expectations, most venture funding goes to companies in rapidly expanding industries. For MENA-based VC MEVP, and many other VCs in the region, that industry is technology. ‘It [the startup] has to be technology-based. The key thing we look for is people who have developed a technology or solution that addresses a widespread problem’, stated Ihsan Jawad, Managing Partner of MEVP. Yet generally, most VCs follow a set of criteria when it comes to choosing the startups they invest in.

At VCs like Arzan Venture Capital, every startup is evaluated based on three points: 1) Team, 2) Product and Business Model, and 3) Market. This entails looking at everything from the personality of the founders, to the problem the startup is trying to solve, and the state of competition in the market. For Numan Numan, Managing Director of 212 in Turkey, growth is also a key factor, as startups that position their companies for explosive growth beyond their home market are more likely to attract VC financing. ‘What we always look at are companies that can go beyond the borders and go regional’ said Numan.

Reasons for Rejection

While most global VCs receive an average of 200 business plans per month, less than 5% are invited to meet with VC’s partners, 2% will reach the due diligence phase, and less than 1% are offered a term sheet. In the MENA region, where VCs receive around 300-500 deals per year, the chances are even slimmer. ‘Last year we looked at 300 investments and we invested in 6; this year we will be exceeding 300, and I think we are going to be hitting the target of 12 investments this year alone’, stated Zainal. There are several reasons and red flags that may lead a VC to reject a startup, which vary depending on the opportunity and the market. They range from unclear presentations and inadequate business plans to inexperienced teams and not enough traction.

Yet many of the reasons for rejection revolve around timing. Venture capitalists often reject startups because they are too new, or aren’t far enough along, which is often a serious red flag for investors. Moreover, entrepreneurs who receive funding too early, tend to give away too much equity and control, whereas entrepreneurs that wait too long can experience a cash crunch as they try to scale. ‘There’s a right time for everything. Sometimes if you [the startup] get too much money before you’ve figured it out, you just spend it in the wrong places, and then you in fact take the wrong direction. It’s critical that you actually get bigger and bigger checks as the thing crystalizes and you become more confident about the model,’ said Jawad.  

Overcoming the Obstacles

The investment ecosystem in the region is steadily growing and maturing. In 2015 alone, a total of 175 VC deals were closed, three times the number in 2014, and today, both regional and international seed stage VC firms, early stage VC firms and growth stage VC firms are leading big rounds and investing millions of dollars in startups the region. ‘In the Middle East we’ve had a multitude of investors and VC funds […] who have raised $400mil and deployed it in the last two years and that has really created an ecosystem of accelerators, incubators, angel networks, seed Micro VCs, VCs and hopefully soon growth VCs, […] and that in the long term, will change the landscape of MENA,’ said Farha.

Yet despite improvements in the space, both VCs and entrepreneurs continue to face challenges when it comes to funding startups in the region, mainly due to lack of access to finance and the controlling environment.

Firstly, the lack of exit options within the region makes VC investors wary of investing in startups. Moreover, raising funds for VCs is challenged by limited track records and family groups choosing to invest through their own private offices. ‘Family offices and entrepreneurs have money, but it’s not only about the money, it’s about investors that will add value to you [startups]. You [startups] should approach them and get some ideas out of them. We don’t get that in Kuwait and GCC companies, and hopefully this will develop as we go further,’ said Hasan. 

Secondly, the controlling environment and regulations in the region are still problematic for startups and VCs, and in order for the industry to evolve and grow, governments will have to play an important role in fostering the innovation and investment ecosystem in the region. ‘Governments should not compete against us , we’re building expertise in this field and definitely governments should be supportive, in the end it’s going to be fruitful for the industry and the countries themselves’, stated Hasan.

Related Articles:
MENA Corporates Dive into Innovation Investments
Why Investing in Start-ups Accelerates the Innovation of Mobile Operaters in Emerging Markets
BECO Capital Invests in Wrappup, Marking its Tenth Investment
Arzan VC Investing in On-Demand Technology

 

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