A mural, by americano-cuban artist Jorge Rodríguez-Gerada, on an old building in Beirut Digital District. Joseph Eid/AFP
Lebanon’s startup sector is worth nearly a billion dollars and represents 1.5 percent of the country’s GDP, Riad Salame, governor of the Bank of Lebanon (BDL), announced in September. That’s a far cry from where the sector was just five year ago. The progress has come largely thanks Circular 331, an initiative launched by BDL in August 2013 that encouraged banks to invest in startups by issuing loan guarantees of up to 75 percent.
In the past five years, the circular has paved the way for hundreds of budding businesses and dozens of incubators and accelerators to receive financial support directly from commercial banks or through special venture capital funds. According to a report by ArabNet, a Lebanese research firm, Lebanon’s tech sector received 162 investments between 2013 and 2017. Most of them were paid for through Circular 331. During that period, Lebanon moved from fifth to second place regionally when it comes to the quantity and value of tech investments, now only trailing the United Arab Emirates (UAE).
"The circular… boosted the ecosystem at a time when Lebanon was unattractive to entrepreneurs," says Marwan Kheireddine, a former minister of state, and current CEO of AM Bank, who helped to draft the circular with Salame and BDL’s executive director, Marianne Hoayek.
$800 million invested
Supporters of the circular claim that it has injected $800 million worth of investments into Lebanon’s digital economy. But, except for the ArabNet report, there has been no independent assessment of its impact. There is no official public record of how much money has been paid out to entrepreneurs or what the results of these investments have been. The Central Bank refused multiple requests by Commerce du Levant to disclose these figures. As a possible explanation for this lack of transparency, well informed sources told Commerce du Levant that the circular has not kept all of its promises.
Unacceptable conditions
After the initial excitement accompanying 331’s launch, many entrepreneurs say they grew disillusioned while negotiating with venture capital funds linked to the initiative. "The banks generally have very conservative positions, and this shows clearly in the clauses they want to impose on startups,” Sami Tueni, the founder of Ihjoz, an online ticketing platform, says.
Tueni gave up on the idea of raising capital through funds connected to Circular 331 after entering negotiations with three of them and finding their conditions for investment unacceptable. "They all know each other,” Tueni says, “and no more than two or three are dedicated to each stage of investment.”
Opposing interests
Jad Atallah, the founder of the startup Mobi Taxis, a ride booking app, also says he negotiated with three different funds and ended up coming away empty handed. Entrepreneurs are bold by definition, he argues, while banks are more cautious because they face a high level of sovereign risk due, in part, to Lebanon’s high gross domestic product (GDP) to debt ratio. "This is an inherent issue in the 331 Circular. Banks have a natural dislike of risks,” Atallah says.
As a result, entrepreneurs find themselves stuck when it comes to raising funds and are forced to adopt strategies that are not always faithful to their visions for their companies. The bankruptcy of well known startups, such as Presella, which received a $200,000 investment through 331 in 2014, and the Keeward Group, which received $23 million between 2013 and 2016, has not helped the situation.
In the United States, investors have integrated failure into their strategies. “Failure is an integral part of Silicon Valley, it even is a reason for its success,” former Apple CEO Jean-Louis Gassee said recently.
In Lebanon, high-profile failures have made investors more cautious. "After seeing a number of projects fall apart during the first years that followed the 331 announcement, banks… have become much more careful, despite the fact that their investments are partially guaranteed by the BDL,” Atallah says.
Administrative burdens
BDL has also become more vigilant. In early 2017, it modified the circular to require quarterly, instead of annual, investor reports. The change has led to better budget management, but it also considerably increased the workload for venture capital funds.
"In the beginning, the procedures were pretty simple. This allowed us to act excessively fast and make about fifteen investments in 18 months,” says Paul Chucrallah, head of Berytech Fund II, a $ 51.5 million venture capital fund. "But then the regal frame has tightened. The demands in terms of necessary declarations and authorizations increased sharply, which considerably slowed down our activity.”
The new requirements added to administrative procedures that were already incompatible with the needs of startup companies. MakerBrane, a digital toy maker, learned this the hard way. The young company was almost forced to fold as it waited for almost a year for BDL to approve a $1 million loan from several investors, including two that were part of 331. "From March 2017 to June 2018, after the signature of the shareholders' agreement, the loan was put to a halt,” says MakerBrane co-founder Ayssar Arida. The sticking point? BDL did not want to validate $200,000 coming from AM Bank, one of the 331 investors.
Bubble risk
For their part, investors say they quickly discovered that it was difficult to find promising startups with a strong team, idea and potential market to actually invest in. To address this problem, BDL encouraged banks to finance incubators and accelerators for budding businesses. But even these support structures have a limited pool to choose from. "We were aiming to add 20 new [startups] to our program every year. But in the end, we only retain 12 to 16 projects,” says Abdallah Jabbour, co-founder of Speed@BDD, a Beirut-based accelerator.
This situation sometimes leads to defaults on investments and certain companies being overvalued. In a report published in September 2017 on the Lebanese entrepreneurial system, the World Bank cautioned against the risk of creating a speculative bubble. "The problem is that the funding tap was opened very quickly in an ecosystem that is not mature enough,” Jabbour says.
Few exit scenarios
The verdict on Circular 331’s success will not be known until the liquidation of funds. With a maximum duration of seven years on investments, there is still some time to wait. "These funds’ profitability is one of the most important criteria for assessing the true success of the circular,” Jabbour explains. The lack of transparency regarding the details of investments that have already been made is “not a very good sign,” he adds.
The next two years will be critical in determining 331’s legacy. Funds will have to be issued from the startup capitals, whereas the scenarios seem for the time being limited. "As a general rule, the resale of venture capital units takes place either through a buy-out by a large private equity fund or through an IPO,” says Bassel Attieh, CEO Cedar Mundi, a Kuwaiti-Latin American venture capital fund partly financed by 331.
But the risks of investing in Lebanon “discourages large companies and foreign funds from betting on a Lebanese company," says Berytech’s Chucrallah. As for international scholarships, "they are way too competitive for the average local start-up,” he adds.
Kheireddine, director of AM Bank, is betting on the electronic trading project announced by BDL months ago. "This market, which should emerge in 2019, will allow startups and SMEs to open their capital to the public," he says.
Jad Salame, CEO of the venture capital fund Phoenician, is more skeptical. He suggests that the electronic trading project will not see the light of day "for several years". Because of these complications, the most promising startups often prefer to settle abroad, especially to the UAE, even if it means giving up on funds from 331.
No matter how ambitious the circular was, it cannot compensate for the absence of a state and of an economic policy favorably to innovation both in terms of infrastructure and regulation. While BDL’s initiative has allowed for the emergence of some projects that may, one day, compete with American of European rivals, it has not been able to turn Lebanon into a startup nation.