A funding crunch for Egyptian startups: what do we make out of that?

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Devaluation, soaring inflation, rising interest rates and supply chain challenges fueled by a protracted Russian-Ukraine war are making it a turbulent time to do business. With an influx of recent news about several startups going through cost-cutting and layoffs to declining valuations, it is evident that 2022 has been a tough year for entrepreneurs, and experts predict it will get even harder before it starts getting better.

Investment banker and CEO of private equity firm Mezzan, Minoush Abdelmeguid, commented in a talk hosted by the American University in Cairo (AUC) Alumni Office last June, that the current market dynamics will result in a ‘correction phase’ for startup funding. “There had been more funds than startups that were actually ready. There may have been some distortions, and this is a time to re-assess and accept that not all startups will become Swvl and Fawry,” she had said.

Have there been over-valuations in some startups? How did this happen?

Egypt has seen an unprecedented boom in the number of startups over the span of the past few years. From only 10 startups in 2015 to 114 in 2020, the startup scene in the country quickly filled up with talented, bright, young, tech-savvy entrepreneurs introducing tech-based solutions and innovations in various aspects of life, particularly cashless transactions, delivery, e-commerce, health and education, all promising ease and efficiency. More so, the funding secured by these young companies has grown quite strongly, as illustrated in the below chart cited from “The Egyptian Startup Ecosystem Report 2021”.

“Where did all the [funding] come from? All the stimulus packages that the governments of the US, EU and other countries pushed into the global market to save people from COVID,” Ayman Ismail, associate professor, and Abdul Latif Jameel Endowed Chair of Entrepreneurship at the American University in Cairo (AUC) School of Business, tells Business Forward. “There was a lot more money chasing few good startups, so valuations started going up. Some people would say these were not realistic, others disagree. At the end of the day, the market mechanism made the choice, and the investors were happy,” explained Ismail, who is also the founding director of the AUC Venture Lab, the award-winning and first university-based startup accelerator in Egypt.

Questioning the term ‘over-valuation’, Ismail argues that the overflow of funding during 2021 was not a phenomenon exclusive to startups only, but also reflected at the global level on stock markets, real estate and commodities markets such as wheat and oil and gas. “When an economic downturn starts, valuations go down across the board,” reflects Ismail on the current situation, describing it as the beginning of a down cycle in which corrections across all sectors are likely to happen. “Recessions are a normal part of the economic cycle, and they happen regularly. They affect startups as they do affect other companies,” Ismail adds.

Taking a step back, what is the impact of startups on the economy?

Besides their potential to generate jobs as other types of business, startups play a crucial role in contributing to innovation in any economy. Think of how Fawry revolutionized financial transactions for instance. Startups are born out of a new idea or solution; are more about pioneering a business venture that is largely funded by investors, betting on the likeability of the business model to be scaled up in terms of value and market share.

In Egypt, 94 percent of startup activity is in Cairo alone. Employment-wise, the average number of employees per startup is 23, according to the list tracked in ‘The Egyptian Startup Ecosystem Report 2021’. While a few startups might have slipped out of count as the report disclaimer states, the total number of employees in the surveyed startups is 13,000 individuals; a rather small figure compared to the country’s labor force of 28 million people.

Having said that, the difficulty of doing business in Egypt is undermining the potential of the whole private sector in Egypt, not only startups.

“The ecosystem is not conducive to business. The big ones go by favoritism rather than being intrinsically competitive,” says Ali Awni, professor of practice at the AUC School of Business and director of the Gerhart Center for Philanthropy, Civic Engagement and Responsible Business. “You need the whales and planktons and everything in between. We do not have that yet in the business ecosystem in Egypt, and so you have no real industrial base.”

About 63 percent of early-stage Egyptian entrepreneurs surveyed for the latest Global Entrepreneurship Monitor (GEM) report were motivated to start new businesses in 2020 in order to build great wealth or very high-income (opportunity entrepreneurs). This figure is higher than the global average and the average for middle-income countries. In comparison, 54 percent of surveyed early-stage Egyptian entrepreneurs were motivated by earning a living because jobs are scarce (necessity entrepreneurs).

Awni sees that there is much innovation driven by startups; some like those offering logistical solutions are addressing real gaps. However, most of what is offered just serves gaps that are triggered by a strong consumerist trend.

In terms of sectors, almost 21 percent of startups in Egypt are in e-commerce and retail, making up the most prevalent activity by startups. This share is almost double that of fintech startups, which also exceeds the share of other sectors such as health-tech, ed-tech, and logistics.

Encouraging more entrepreneurial activity that is facilitated by different platforms, not just accelerators and incubators, is much needed, according to Awni. “Base of the pyramid type of entrepreneurship might not be as appealing as startups, but we need both for variety and diversity in ideas that serve more population segments. More funding needs to be directed towards that,” he said.

Egyptian startups have no doubt been attractive for investors, with total funding directed to startups increasing tremendously from just US$8.6 million in 2015, reaching US$403 million in 2021. It is only natural that this is the case, “because there is already enough uncertainty just to operate a business. Businesses with higher growth potential will attract entrepreneurial ventures,” Awni tells Business Forward, and adds, “when you have the right environment, everything will grow, startups or not.”

So, what is missing in the entrepreneurial ecosystem then?

Economic experts, policymakers and industry leaders agree that Egypt’s private sector is far below its potential. Purchasing Managers Index (PMI)- an indicator of the performance of the non-oil private sector- has been below or at 50 points since 2011 showing shrinkage or no growth in private sector activity.

Bureaucracy, red tape, complicated regulations, lack of legal awareness and fair competition are the usual suspects hindering entrepreneurial activity in Egypt. In addition to those, the GEM 2021 report, also mentions the difficulty of new taxation policies, lack of market access and information, unfavorable fiscal policy, limited procurement from SMEs, and an education and culture that do not yet encourage entrepreneurship.

Awni hopes that the current situation will be a trigger to focus on local supply chains, and in that process, addressing the real issues that hamper inclusive entrepreneurial activity in Egypt, that goes beyond fast-growing startups. “Do you want to just get the gold medals, or do you want more people to play sports? It might take longer but getting more people to play, will eventually get you more gold medals.”

Preparing for another layer of uncertainty

The 2021 GEM report had outlined some promising changes for Egypt, such as more prevalence of entrepreneurial mindsets and more social approval of such careers despite their instability. Availability of new funding tools and activities such as venture capital, rise of a strong supporting ecosystem that includes incubators, organizations that support startups and entrepreneurs, a growing government interest in entrepreneurship as well as a more advanced digital network are also some of the enablers that the report recognizes.

“Startups are young businesses where success is not guaranteed, where people choosing to work for the company are forgoing stability in exchange for innovation and the promise of tremendous growth. This ability to grow is key, what differentiates startups from small businesses is the potential – and desire – to scale regardless of geography,” according to the Egyptian Startup Ecosystem Report.

Egypt has the fourth largest startup ecosystem on the continent by number of companies, behind only South Africa, Nigeria and Kenya, with room for expansion. Besides the contextual hurdles that affect all entrepreneurs in Egypt, the market situation is adding a new layer of uncertainty to the promising startup scene.

With hopes for a more involved and leading private sector, and a high-potential startup ecosystem, what could the next phase look like for startups?

AUC Venture Lab’s director Ayman Ismail sees that startups will experience the current market changes and investment climate differently according to their sector- and how it is affected by supply and demand- and according to which funding phase they are in. For example, early-stage startups that tend not to have so much financial pressures are going to find what they need, with maybe lower funding opportunities. “My advice for them would be not to get hung up on the valuations,” says Ismail, “If you get a good investor, even you don’t like the valuation, take the money, show that the business can grow. A year or two down the road you will be able to attract higher investments.”

Ismail elaborates that for startups that are growing and have substantial burn rate or monthly spending, things will be a bit different. He advises those at a beginning of a fundraising cycle -meaning that they just raised money- to be very prudent with spending to make the money last longer and if possible, move closer to profitability. “Do not spend like you would have a year ago. Markets have changed so you may not be able to have that amount again soon. If you were lucky, enjoy your luck,” he says.

Those startups at the end of a fundraising cycle are advised to cut their costs, look for different types of financing, perhaps a mix of bank loans plus equity. “They can also look for what we call bridge rounds: some additional money that maybe your current investor might be willing to put,” Ismail advises startups at this stage.

“It’s all about cash flow management. Have another look into the business model so that you can reduce the areas where you are burning a lot of cash. If that comes at the expense of growth, that is fine,” he adds, clarifying that startups were advised to do this about three months ago, and the wiser ones have already started doing so.

“Those who survive these tough times will be positioned to be winners once the economy rebounds,” he concludes.

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