Startups and their founders: a new normal for all

Last year was a breakout one for Pakistan’s startup sector. More than 80 deals were disclosed and around $350 million raised for funding.

To put this in context, the funding Pakistani startups brought into Pakistan in 2021 was 20% of the total FDI the country received for the financial year 2020-2021.

The valuation of Pakistani startups was estimated at $1.5 billion and some of the biggest venture capital companies were looking at Pakistan as a fast-developing frontier market, the way the BRICS (Brazil, Russia, India, China and South Africa) had been perceived in early 2000s.

As January 2022 started, there was widespread talk of funding for Pakistani startups crossing $1 billion in the next 12 months and the arrival of the country’s first unicorn. Sadly, things didn’t exactly turn out that way.

For the past decade, startups across the world were enjoying a bull run, brought upon in the wake of the 2008 crisis.

To bolster growth, the US Federal Reserve flooded the markets with cheap capital and slashed interest rates down to almost zero. This incentivised cash-rich investment companies to pour their funds into high-risk businesses in hope of hitting a lottery.

Thus, was born the go-go 2010s and as in the 1920s, the bulls were running wild everywhere including in the tech world in which startups like Uber, Lyft, Airbnb, and others were able to easily raise billions of dollars despite an unclear path to profitability.

The first crack in the system appeared when exchanges did not fall in love with the gig economy. Uber’s share price did not explode as had been expected and it seemed long time critics like Warren Buffet were right: the retail investor is not happy without sound financial outcomes.

Other startups like Lyft and Airbnb faltered and WeWork’s IPO was wiped out.

However, the overall startup bull run continued as long as the interest rates in the US remained close to zero. Then in past 12 months four interconnected events shook the edifice. The first was the post-Covid supply chains breakdowns which drove up inflation.

As the world recovered from the pandemic, markets opened and there was a demand flood. Many people had excess cash given by governments to offset job losses and the people were buying everything in sight: from crypto currencies to chocolates.

However, the supply chains had been broken in the pandemic and manufacturing units could not respond fast enough. It also didn’t help that China, the world’s factory, was the epicenter of the pandemic and closed for almost two years.

When it slowly reopened, it was operating on a Covid zero tolerance policy and shutting down entire cities at the discovery of a single case. Supply could not meet demand and the invisible hand came into play leading to global inflation.

The second inflection point was when Russia invaded the Ukraine on February 24. This affected global commodity and fuel markets as exports from both countries took a nosedive for different reasons: Russia was slapped with sanctions while Ukraine faced supply chain disruptions.

Russia and Ukraine jointly account for nearly a third of global wheat supplies. In 2019 Ukraine accounted for 16% of the world’s corn supplies and 42% of sunflower oil. Russia accounts for 14% of the world’s annual crude oil production. The breakdown of oil, gas, and commodity markets meant a capital flight into low-risk sectors such as gold and more damaging: further inflation.

This was a new scenario for tech startups that had enjoyed a long period of low inflation and low interest rates in the US.

The Pakistan startup scene really took off in the second half of 2020 when inflation in the US was hovering around 1% and interest rates almost 0.25%. Investors did not want to block funds in such low returns and looked to other vehicles.

Venture capital firms found it easy to raise funds through their limited partners and invest across a broad range of startups, some risky, some not so. The idea is to spread risk and if one investment becomes a large and highly-valued company, then it more than offsets the risk of any other failures. Till rates stayed low, this would be an easy game.

Unfortunately, due to the factors listed above the inflation in US kept creeping up through 2021 eventually crossing 9%. When it crossed 8% in March 2022, the Federal Reserve decided to swing into action and started raising interest rates.

In its announcement last week, the Fed even said more hikes are coming as it battles soaring prices. It was the third consecutive increase of 0.75 percentage point by the Fed's policy-setting Federal Open Market Committee (FOMC), continuing the forceful action to tamp down inflation that has surged to the highest in 40 years. It took the policy rate to 3.0-3.25 percent, and at its highest level since 2008.

This interest rate increase, plus the bear run on shares of tech giants such as Microsoft, Tesla, Facebook, Uber, Apple, Amazon, and others led to a dampening of the animal spirits in the investment space.

In uncertain times capital flows to secure investments and the high interest rates makes the flow that much easier and faster. That made the VC space limited and almost suddenly startups found themselves swimming against the tide when trying to raise further funds.

All this has affected Pakistan’s nascent tech boom. In the first half of the year, Pakistani startups have only raised $285 million in funding across 45 deals.

The billion expected for the year seems a million lightyears away.

Meanwhile, Airlift, Pakistan’s largest startup, shut down abruptly and many others curtailed their growth plans. Pakistan’s evangelists and advocates in Silicon Valley became a little reticent.

However, the nimble startups read the writing on the wall and understand that the music has not stopped, it’s just a different song.

While the past decade was about high growth, even if it was coming through a “spray and pray” financial model, the focus is now on sustainability, sound unit economics, and realistic profitability.

Some had learned lessons early and never did burn the cash candle at both ends. For them growth had to be balanced with controlled expenses, focusing on high dollar value verticals, and hedging risks by spreading operations across different markets.

There is still capital ready to be invested but startups will need to start operating more responsibly and using their capital and resources where they are most needed i.e., in revenue generating work streams. It is up to startup founders to align themselves to the new normal and get value out of their work.

Startups with this focus have been able to weather the storm much better than others. They battened down the hatches and are stretching their dollars, whether they come from operations or from investors.

The survivors will emerge stronger while others who have not been prudent or slow to respond to the new normal will fall by the wayside or be acquired. Eventually the ones still standing in 12 months will be able to pick up the pieces cents to the dollar.

With a growing and young population, Pakistan still retains its frontier market status. There are problems to be solved: transport, logistics, supply chains, etc. Where there are problems there are opportunities. And where there are opportunities there is revenue to be made and the capital to realise that revenue.

Smart founders know that, as do smart investors.

In the words of Jerry Maguire, it's very much “Show me the money!”

The article does not necessarily reflect the opinion of Business Recorder or its owners