As the Covid-19 induced economic crisis affects the tech world globally, Pakistan’s startup landscape too has faced the brunt. The global capital market has seen significant downswing; it’s the working class that has been the first to take a hit. Pakistan is no anomaly but what makes it seem unexpected is the fact that the country had experienced an unprecedented accelerated growth in global institutional VC funding in the recent past. In the year 2021, USD 350 Million were raised, whereas USD 163 Million were secured in the first quarter of 2022 alone. After this extra-ordinary boom in the startup ecosystem, this sudden flipping of the economic outlook has resulted in a shock wave in the entrepreneurship sphere of the country. The startups that were growing at a lightening pace, not just halted their growth plans but rather began downscaling. A considerable number of employees were laid off over night and operations closed in various markets in a matter of days.
This might be puzzling for a layman. How come companies that raised millions of dollars don’t have enough financial resources to pay employees and run operations at scale? Before we dive into the why, it’s important to understand the characteristics of venture capital.
Long term in nature, usually, VC funding is provided to startups on a piecemeal basis spread over a number of stages. One way to implement this is ‘milestone-based financing’. According to this, a venture capitalist commits an upfront amount to the startup to finance their operations and grow while the rest of the funding is committed for future, contingent upon the company meeting certain milestones. Upon meeting the pre-decided goals, the startup qualifies to receive additional rounds of investment.
However, despite the pressure of meeting milestones that comes with VC funding, why do startups still opt for it instead of resorting to other financing means such as long-term bank loans?
First of all, banks often do not provide loans to startups as opposed to traditional businesses for the risk of failing that comes with a startup. For idea to early stage startups, there is hardly anything for the banks to hedge as collateral. VCs on the other hand, look at other metrics to evaluate extension of funds to startups such as product viability, market size and above all the potential of founders. Secondly, since startups pay for venture capital in the form of shares, venture capital allows them to finance their operations and scale without incurring the burden of a debt. Third, venture funds usually have a lifetime of 10 years which implies that any fund invested in a startup is difficult to pullout until the startup exits in the form of either going public, acquisition or merger. Lastly, the experience, network and resources that VCs bring with them is of high value for startup founders. On the whole, VC funding is a lucrative financing option for startups as it equips them to outpace the competition and at the same time keep raising more funds at every growth stage.
Coming back to the earlier question, how does a startup arrive at the brink of being cash strapped despite raising a significant amount as investment?
Blitzscaling.
Reid Hoffman, Founder LinkedIn and a venture capitalist, came up with the terminology of “blitzscaling” as a strategy to grow very big, very fast. In today’s era of deeply networked global landscape, the path to creating a high-growth, high-impact startup can be painstaking. Through blitz-scaling, entrepreneurs can rapidly build their companies to serve a large and often a global market aiming at becoming the first mover at scale. A startup choosing to blitzscale, has two key advantages of being a first mover: focus and speed.
Predominantly adopted by software companies since the marginal cost of serving market of any size is close to zero, blitz-scaling involves growing on three types of scale - revenues, 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 the increased operations without compromising on quality. In addition, they expand their operations to multiple geographic markets simultaneously to increase their revenue, and slash prices to cut competition in order to increase customer acquisition. Amazon, Google and LinkedIn are some of the most prominent case studies of the blitz-scaling discipline.
Why is such a speed necessary for startups wanting to grow fast? For two main reasons. First, the business requires a certain scale to become valuable. For example, LinkedIn became a valuable platform once millions of people joined the network. On the other hand, for e-commerce market places such as Amazon and eBay, having a large number of buyers and sellers is a must as these businesses have low margins that necessitates having a very high volume of transactions. Second, such companies want to scale faster than their competitors because the one that is first to reach out to customers, acquires them; it becomes a matter of who has the most number of customers.
However, blitzscaling brings with it, its own set of inefficiencies. A lot of capital is burned at a very fast rate. And this is what we recently saw happening to the home-grown startup – Airlift.
Airlift (an erstwhile transit startup that pivoted to e-commerce during the pandemic) became the first startup in the history of Pakistan to raise the most amount of investment – a gross of USD 110 Million, in a brief time span of just two years. After raising its Series B round worth USD 85 Million, it expanded itself to multiple cities across Pakistan and South Africa. Recently, in the past month, it announced what came as a shock in the country’s startup landscape. The company slashed off straight 31 per cent of its employees along with pulling out of South African market and tier two cities of Pakistan. With the founders’ eyes set on making Airlift the first unicorn of the country and soon announcing its valuation of USD 1 Billion with another mega round of funding worth USD 350 Million, the decision to scale back its breadth of operations has been to contain the cash flow burn.
Airlift is just one example. In the recent past, the post-pandemic reset has resulted in a wave of lay-offs gripping tech-startups globally. For example, just around the time when the Egypt-born mass transit startup, Swvl, was expected to enter Africa’s billion-dollar companies group, it announced laying off 32 per cent of its team 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 an outcry after publicly posting the list of 700 employees that it was laying off. Klarna had been growing at breakneck speed, devouring smaller companies and rushing to IPO, all while clocking record losses. The decision to layoff, as the founder claims, was a course correction to right-size the company.
The above are just a few examples; a number of 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 pullback first impacted the publicly listed tech companies, then trickled down to late-stage deals and later to well-funded early-stage startups. This global downscaling has become a point of inflection as a consequence of tech unicorns realizing that either they may have overpromised a growth trajectory, over-hired or over-estimated their ability to raise the next round.
The intention here is not to pin-point any particular startup but rather to bring in the perspective of the future of venture capital in Pakistan. Does the future for venture capital seem bleak for Pakistani startups?
Not at all. With 5th largest population in the world, 7th largest projected consumption class by 2030, 360,000 plus tech professionals and 22 years as the median age, Pakistan, for sure, is the next big hub of startups in the world.
For example, very recently amidst the sinking economic situation, Dastgyr (a Pakistani B2B e-commerce platform) raised the country’s largest ever Series-A funding of USD 37 Million in a deal anchored by the global giant Veon. This investment is indicative of a positive future outlook of Pakistan in terms of VC funding.
After 2021, Pakistan’s startup landscape has become a hotbed for global venture capitalists. Where the last two years saw a number of institutional global VC giants investing in Pakistani startups, at the same time the local VC ecosystem rose to prominence. Indus Valley Capital, Zayn Capital, Fatima-Gobi Ventures, Sarmayacar, Walled City Co., Deosai Ventures, 47 Ventures and Zamindar Capital are some of the names that have not only readily backed Pakistani entrepreneurs but also brought in interest from around the world.
Nonetheless, the current economic crisis and its potential to adversely affect the local startups cannot be ignored. But then how can our startups cushion themselves from the repercussions of a global economic downturn?
By treading the path of gradual growth. More than anything, this requires a thorough, vertical understanding of local market dynamics coupled with something I call a virtue – patience. There is no harm in opting for horizontal expansion but not at the cost of burning more cash than what is earned. This can be done only when the entrepreneurs have understood the market, its unit economics and the driving factors deep down. Bykea’s growth is an example of that. Raising USD 22 Million to date since its inception in 2016, the startup steadily grew its customer base by working diligently on optimising its unit economics. Today, Bykea is a profit earning business with a geographic footprint across metropolitan cities of Pakistan.
Another way our startups can be protected from getting hard hit by the looming global economic meltdown is ‘government backing’. For example, earlier this year under the premiership of Imran Khan, the government had announced 100% tax exemption, 100% foreign exchange exemption, and 100% exemption from capital gain tax for investments, for tech startups. Specialised Foreign Currency Accounts for IT companies with 100% retention and establishment of Pakistan Technology Startup VC Fund via public-private partnership were also announced.
To sum it up, for Pakistani entrepreneurship landscape to bounce back from the prevalent local and international financial crunches, it’s imperative that the foundation of the country’s startup ecosystem is strengthened. This can only be achieved if home-grown VC players and government stakeholders come together to support and inject money in the emerging startups of the country.
Published in Aurora Magazine on 8th September, 2022