Bouncing Back from the Brink

As the Covid-19-induced economic crisis affects the tech world globally, Pakistan’s start-up landscape too has faced the brunt. The global capital market has seen a significant downswing. It has been the working class who have been the first to take a hit. Pakistan is no anomaly but what makes it seem unexpected is the fact that Pakistan had experienced unprecedented growth in global institutional venture capital (VC) funding in the recent past. 

In the year 2021, $350 million were raised, whereas $163 million were secured in the first quarter of 2022 alone. After this extraordinary boom in the start-up ecosystem, this sudden flipping of the economic outlook has resulted in a shock wave within the entrepreneurship sphere of the country. The start-ups that were growing at a lightning pace not only halted their growth plans, they began to downscale. A considerable number of employees were laid off overnight 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 do not have enough financial resources to pay employees and run operations at scale? Before we dive into why, it is important to understand the characteristics of VC. 

Long-term in nature, VC funding is usually provided to start-ups on a piecemeal basis, spread over several stages. One way to implement this is ‘milestone-based financing’. According to this, a venture capitalist commits an upfront amount to the start-up to finance operations and grow while the rest of the funding is committed for the future, contingent upon the company meeting certain milestones. Upon meeting the pre-decided goals, the start-up qualifies to receive additional rounds of investment. However, despite the pressure of meeting milestones that come with VC funding, why do start-ups still opt for this method instead of resorting to other financing means, such as long-term bank loans? Firstly, banks often do not provide loans to start-ups as opposed to traditional businesses due to the risks of failures that come with start-ups – in the case of early-stage start-ups, there is hardly anything for the banks to hedge as collateral. VCs on the other hand, look at other metrics to evaluate extending funds, such as product viability, market size and above all the potential of founders. Secondly, since start-ups pay for VC in the form of shares, it allows them to finance their operations and scale without incurring the burden of debt. Thirdly, venture funds usually have a lifetime of 10 years which implies that any fund invested in a start-up is difficult to pull out until the start-up exits in the form of either going public, an acquisition or a merger. Fourthly, the experience, network and resources that VCs bring with them are of high value for start-up founders. On the whole, VC funding is a lucrative financing option as it equips start-ups 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 start-up end up at the brink of being cash strapped despite raising a significant amount as an investment? The answer is ‘blitz scaling’. 

Reid Hoffman, the founder of LinkedIn and a venture capitalist, came up with the terminology of blitz scaling as a strategy to grow very big, very fast. In today’s deeply networked global landscape, the path to creating a high-growth, high-impact start-up 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 start-up choosing to blitz-scale has two key advantages of being a first mover: focus and speed. 

Predominantly adopted by software companies since the marginal cost of serving a market of any size is close to zero, blitz scaling involves growing on three types of scales: Revenue, customer base and organisation. Start-up 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 and 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 start-ups wanting to grow fast? For two main reasons. Firstly, 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 marketplaces such as Amazon and eBay, having a large number of buyers and sellers is a must as these businesses have low margins that necessitate a very high volume of transactions. Secondly, such companies want to scale faster than their competitors because the first one to reach out to customers, acquires them – it is a matter of who has the highest number of customers. 

However, blitz scaling 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 homegrown start-up, Airlift. 

Airlift (an erstwhile transit start-up that pivoted to e-commerce during the pandemic) became the first one in the history of Pakistan to raise the highest amount of investment – a gross of $110 million, in just two years. After raising its Series B round worth $85 million it expanded to multiple cities across Pakistan and South Africa. Recently, in the past month, it announced what came as a shock to Pakistan’s start-up ecosystem. The company slashed 31% of its employee strength and pulled out of South Africa and tier two Pakistani cities. With the founders’ eyes set on making Airlift the first unicorn of the country and announcing its valuation of one billion dollars with another mega round of funding worth $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 layoffs gripping tech start-ups globally. For example, just when the Egyptian mass transit start-up Swvl was expected to enter Africa’s billion-dollar companies group, it laid off 32% of its staff in a bid to become cash flow positive and pursue profitability. 

Recently, Klarna – the Swedish fintech start-up behind the ‘buy now, pay later’ online shopping revolution – sparked an outcry after publicly posting the list of 700 employees it was laying off. Klarna had been growing at breakneck speed, devouring smaller companies and rushing to IPO, all the while clocking record losses. 

The above are just a few examples. Several tech giants such as Meta (Facebook’s parent company), Twitter and Uber have announced hiring freezes and slowdowns as the 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 start-ups. This global downscaling has become a point of inflection as a consequence of tech unicorns realising 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 pinpoint any particular start-up but rather to bring in the perspective of the future of VC in Pakistan – and is this future bleak for Pakistani start-ups? 

Not at all. With the fifth largest population in the world, the seventh largest projected consumption class by 2030, 360,000 plus tech professionals and 22 as the median age, Pakistan, for sure, is the next big hub of start-ups in the world. 

For example, recently amid the sinking economic situation, Dastgyr (a Pakistani B2B e-commerce platform) raised the country’s largest ever Series A funding of $37 million in a deal anchored by global giant Veon. This investment is indicative of a positive future outlook for Pakistan in terms of VC funding.

After 2021, Pakistan’s start-up landscape has become a hotbed for global VCs. Where the last two years saw several institutional global VC giants investing in Pakistani start-ups, at the same time the local VC ecosystem rose to prominence. Indus Valley Capital, Zayn Capital, Fatima Gobi Ventures, Sarmayacar, Walled City, Deosai Ventures, 47 Ventures and Zamindar Capital are some of the names that have not only backed Pakistani entrepreneurs but induced global interest. 

Nonetheless, the current economic crisis and its potential to adversely affect local start-ups cannot be ignored. So how can our start-ups 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 fully understood the market, its unit economics and the driving factors. Bykea’s growth is an example. Raising $22 million to date since 2016, the start-up 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 the metropolitan cities of Pakistan.

Another way our start-ups can be protected from becoming hard hit by the looming global economic meltdown is ‘government backing’. For example, earlier this year under the premiership of Imran Khan, the government announced a 100% tax exemption, 100% foreign exchange exemption and 100% exemption from capital gain tax for investments for tech start-ups. 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 Pakistan’s entrepreneurship landscape to bounce back from the prevalent local and international financial crunch, the foundation of Pakistan’s start-up ecosystem must be strengthened. This can only be achieved if home-grown VC players and government stakeholders come together to support and inject money into emerging start-ups. 

Nabeel Qadeer (PMP, SCPC) is Executive Director, Infinite Scaleup and CEO, DirAction.nabeel.akmal@gmail.com