OBSERVER NEWS

Lebanon’s Accelerating Startup Ecosystem

BY GEOFFREY KING

Fallout from the 2011 uprisings in the Arab Middle East has disguised a more hopeful phenomenon gathering momentum since the 2000s. Driven by proliferating access to the Internet, mobile phones, expanded education, centralized economies unable to absorb a youth population bulge, and a leadership vacuum in the region, many Arab youth have turned towards economic innovation and initiative. Private financing for startup companies that utilizes the region’s ample capital accumulation offers a promising route to sustainable economic growth. Tech-based startups and venture capital (VC) firms have been developing rapidly in many Arab countries. Although this trend has great implications for regional political economy, it is little understood. With the support of the Fouad Ajami Fellowship in Middle East Studies, I conducted field research in Beirut this past summer to explore recent developments in finance and support for emerging high-growth companies in Lebanon.

Why Lebanon? Historically, institutional equity financing opportunities for new companies in Lebanon, and across the region, were nearly nonexistent. However, in 2014, after intense advocacy by investors and others in the nascent startup ecosystem in Beirut, and with advising from the World Bank and the EU, the Lebanese Central Bank issued Circular 331. This new regulation encourages private banks to invest up to 3 per cent of their assets into companies registered in Lebanon within the “knowledge economy” sector, providing guarantees covering up to 75% of investments. Industry experts say this reform has mobilized around $400 million in equity funding over the next few years. Lebanese banks, lacking direct investment experience, are channeling nearly all of these funds indirectly through VC firms based in Beirut. To give some perspective, VC firms across the Middle East and North Africa (MENA) region as a whole raised just $205 million for investment in 2014, according to the MENA Private Equity Association. Lebanon is the new VC boom town in the region. As new VC firms emerge and the incumbent firms ramp up activities, the ecosystem is preparing to absorb this funding to secure Beirut’s reputation as a regional hub for tech entrepreneurship. I travelled to Beirut to explore and document how VC firms, startup incubators and accelerators, private banks, civil society organizations and advocacy groups, journalists and activists, trainers, and current and aspiring entrepreneurs are reacting to the repercussions of Circular 331.

Despite its tumultuous history, its dysfunctional politics most recently highlighted by the “You Stink” protests over trash build-up in Beirut, and ongoing repercussions from the Syrian civil war next door, Lebanon also enjoys certain advantages as a hub for entrepreneurship. Lebanon has a history of individualism and private sector–led growth. A small country with little industrial base, its highly skilled and commercially savvy workforce has historically led the region in service sectors such as banking, design, media, entertainment, and tourism. Lebanon enjoys relatively cheap labor and living costs and easier visa procedures when compared with its primary competitor: Dubai. Lebanon’s intangibles—its cultural depth, cosmopolitan history, freedom of expression, Mediterranean weather, beaches and mountains, great food and nightlife—provide a high quality of life for those with means. Beirut still retains what many believe to be the Arab world’s finest university system. Furthermore, its far-flung and highly successful diaspora community is a source of strategic depth in mentoring and finance for the entrepreneurial ecosystem. Despite Lebanon’s small domestic market, venture capitalists are focused on digital technology business models that can be scaled internationally and offer profitable exit opportunities. They envision the emerging tech sector as an alternative to emigration for Lebanon’s talented engineers and business students. As many in the industry told me, “All we need is one big exit.”

The influx of money provides many opportunities as well as some challenges for the Lebanese ecosystem. Most VC firms freely admit they are newcomers to the investment game and learning as they go. The community differs on whether funding gaps still remain at the early or late stages. Regardless, the half-dozen VC firms have coordinated amongst each other to specialize in financing particular stages of the startup life-cycle. Some investors and analysts are worried about a dearth of Lebanese startups worthy of VC investment and able to absorb $400 million over the next few years. These analysts believe Circular 331 funding might inflate startup valuations and lead to unwise investments. One new VC firm described their investment strategy to avoid this problem: source deals from larger companies based outside of Lebanon that would open a Lebanese subsidiary as a new venture. Civil society organizations such the Lebanese International Finance Executives are undertaking creative initiatives to channel the energy of the Lebanese diaspora in reversing brain drain, attracting investment back to Lebanon, and nurturing the next generation of successful entrepreneurs in Beirut. Several VC firms partnered with NGOs to launch Beirut’s first startup accelerator, Speed, in Summer 2015. Another regional accelerator, Flat6Labs, is set to open its doors in Beirut soon.

Myriad structural obstacles remain. The primary and secondary education systems still do not include any curricula on entrepreneurship to speak of, let alone civic education. Although the major universities recently launched entrepreneurship programs, university R&D in the sciences and engineering remains minimal and cross-disciplinary university training remains the exception. However, incubators such as AltCity and UK-Lebanon Tech Hub are planning to ramp up awareness, competition, and training programs with universities across Lebanon this year. While infrastructure concerns such as electricity and broadband are daily nuisances and provide long-term disincentives for investment in many sectors, most venture capitalists believe these are not deal-breakers for the ICT sector. Rather, they simply necessitate additional operating costs: backup generators can be purchased and startups can use data centers abroad. Beirut Digital District, where much of the startup space is located, enjoys high quality broadband. Brain drain remains a problem as the brightest Lebanese university graduates seek higher salaries in the US, Europe, or the Gulf. However, VC firms can begin to reverse this trend and attract high quality talent back to Beirut. Many argue that VC firms—staffed primarily by those with expertise in ICT, banking, and tech consulting—still need to broaden their focus to include media, entertainment, and design, all areas in which Lebanese have traditionally thrived. Almost without exception, the private banking sector remains a conservative lender, whose high collateral requirements hampers growth of debt as a financing option for most small companies, especially outside of the major cities.

Many would argue Lebanon is fighting an uphill battle, with the Syrian civil war threatening to spill over its borders, internal politics in disarray, and weak governance institutions. Nonetheless, Lebanon’s entrepreneurs and venture investors are forging ahead, making headway in creating a supportive startup ecosystem despite the challenges. Those I spoke with know they have a long way to go, and most are eager to learn. Many mentioned Chile, Ireland, and even Israel, as countries with some similar characteristics to Lebanon that succeeded in introducing a knowledge innovation sector. Those in the entrepreneur and investor community around the Middle East are eagerly awaiting the outcome of Circular 331 to see if Lebanon will forge a path that others will follow.

Advertisements