KARACHI: The first quarter of the year 2023 has been disappointing for Pakistan's startup funding. According to a report released by VC and insights firm Invest2Innovate (i2i), even though startup funding rose around 52 per cent in Q1 2023 to $23.1 million from $15.2 million in Q4 2022, the amount is 86 per cent less than what startups raised in Q1 2022 ($172.8 million).
Speaking to The News, Mustafa Fahim, a strategy consultant in the Middle East and former head of finance and strategy at Sastaticket.pk, explains that financial troubles started for most Pakistani startups in 2022 primarily due to supply chain disruptions caused by the Russia-Ukraine war.
'In 2022, the problem exacerbated in Pakistan because of the trade deficit and the resulting balance-of-payments crisis.' He adds that 'startups rely on external funding' and 'when the funds ran dry most startups failed to convince venture capitalists (VCs) to invest in their ventures purely based on their unit economics.'
The reason VCs became wary of investing in startups in Pakistan has its roots in the global monetary policy and Pakistan's fragile political climate. Fahim says that venture capitalists 'will invest in a firm if they know that their investment's rate of return (RoR) is higher than what they would get anywhere else....investors do not need to know who is in power. They are more concerned about consistency in economic policies. This is, unfortunately, missing in Pakistan. In his comment to The News on how the ongoing economic crunch has affected Pakistan's startups, Mubariz Siddiqui, founding partner of Carbon Law -- a startup and VC focused law firm says: 'Pakistani startups have had to face a host of challenges due to current macroeconomic conditions. Talking about the impact of interest rates on startup funding, he adds, 'decrease in available funding and high interest rates have reduced the viability of debt, and the devaluation has shrunk [startups] revenues in dollar terms (which is the currency in which most startups raised funding and would need to return it in). Increased inflation has also affected the demand for products/services and see their costs go up.'
Things became even more difficult for Pakistan when it got hit by unprecedented floods in mid-June. Says Fahim: “VCs became more hesitant and even asked for detailed reports on how our startup™s business would be affected by the destruction caused by floods. And while we tried to convince them that their investment would be safe and profitable in the long term, some of them were not convinced.
Fahim adds that monetary policy measures (raising interest rates) taken after the Ukraine war increased the rate of return for startups demanded by private investors to extremely high levels which are difficult to achieve by a majority of the startups.
In 2020 -- the year of Covid-19 -- the Fed reduced interest rates as a measure to revive the US economy. This, he says, restricted investors' options for income-generating assets. œSince other financial instruments (like treasury bills and government bonds) were not profitable for investors, startups along with public equities were a much more profitable option for private investors.
He explains that for VCs, investing in businesses that are high risk (like startups) makes sense when it promises a justifiable rate of return, however, when the risk increases significantly due to macro factors then the investors question whether the return is achievable or not.
But this phenomenon is not restricted to Pakistan. Siddiqui shares that 'startup funding has declined globally. This is due to several factors. As a result, investment to markets like Pakistan have also been affected. Further, most Pakistani startups have already deployed substantial amounts of funds available and are now looking to raise their next funds.'
Syed Ommer Amer, a social entrepreneur currently working as partnerships and placement manager in a non-profit Web3 tech skills accelerator, Institute of Emerging Careers, spoke to The News on a more optimistic note: 'I personally feel that the future is promising for startups provided that Pakistan has a stable government and policies.' Â Explaining that further, he says that 'a lot of good work that was almost finalized is still up in the air because of regime change. Many programmes which were to be launched nationally have been put on hold by the new government. With inflation soaring high, it is indeed worse than what we had to tackle during the Covid-19 phase.'
Whether or not the Pakistan startup sector will recover in 2023 depends on a lot of factors. Ommer says, 'I have been closely monitoring AI-transforming industries globally, and we still have a shot at this once-in-a-lifetime opportunity. Last year was 'crazy valuations' and this year is the market correcting itself. Every stakeholder is getting a reality check and the bottom line is: are you profitable and do you know your unit economics or not? Founders who embrace the emerging technologies and get their units right from Day 1 will bring in high revenue.'
Fahim identifies three reasons that have made the investment environment difficult for Pakistani startups: the Russia-Ukraine war and the resulting rising interest rates, Pakistan™s political instability which is translating into economic issues, and the natural calamities that are affecting the country. He believes that for now, 2023 will be a tough year for Pakistani startups in terms of funding.
Siddiqui also feels that the year 2023 may not bring much stability for the startup sector: 'Pakistani founders mostly face the same fundraising challenges as founders in other parts of the world. But in addition, there is a big challenge around building conviction in Pakistan as a market. The economic conditions and political uncertainty make it harder to make an investment case.'
