In modern tech world, new businesses are growing in a shape which is vastly different from the conventional form. The conduct of private equity firms, venture capitals (VCs), and angel investors is in contrast to that of conventional lenders or equity investors. Previously, start-up businesses in Pakistan were not able to attract attention of foreign VCs and angel investors, and that had hindered good ideas from blooming and flourishing. State Bank of Pakistan (SBP) has held consultations with the tech companies, VCs and those seeking VC investment from abroad for the past many months. Finally, it has announced amendments in the Foreign Exchange (FE) Manual with a view to giving the start-up and Fintech culture in Pakistan a much-needed boost. It’s a welcome move. It is therefore important to note that good ideas are not confined to geographical boundaries and should be insulated from the higher cost of doing business associated with manufacturing companies in Pakistan. All they need is a certain class of investors that appreciates the ideas and invests in order to nurture them. That investment was not possible before. These amendments are likely to open floodgates for thousands of start-up businesses.
The VCs largely invest in the form of convertible debt. They bet on the ideas and take measured risks. If an idea blooms and begins to flourish, they usually convert the debt into equity and the company goes into the second round of fund raising. If the company’s growth is limited, they prefer to exit. Previously, such options were missing in Pakistan for companies to borrow from international lenders/investors. There are certain terms and conditions stipulated by SBP to minimize the incidence of misuse under these relaxations. These include: the borrowing company shall have an annual turnover of less than Rs2 billion since its inception and equity (including retained earnings) should be less than Rs300 million. The tenor of the loan should be of 1 to 5 years with an option of a rollover with limits on the risk premium charged by the borrower.
The existing companies in Pakistan can access foreign borrowing but the start-ups must meet the minimum criteria such as credit rating, and the access is primarily confined to conventional sources. But new ideas generally grow from the metaphorical garage offices. Unfortunately, however, such ideas in Pakistan, to this day, are never welcomed by the conventional lending system within the country dominated by the commercial banks which issue credit based on name lending and only against personal guarantees of the company directors. In Pakistan, commercial banks are interested in the financial health of the persons owning the groups they are lending to; banks show little or no interest in the ideas and products the potential borrowers come up with. The start-ups are aliens to our banks. Such reluctance is not peculiar to our banks alone as conventional banks in the world usually stay away from new and untested ideas. These investments are considered highly risky and require lenders/investors with a different mindset. Such investors/lenders do exist in Pakistan as there are many rich groups and individuals who can bet on the new budding companies. But the real valuation the new companies or start-ups can only get by accessing the big foreign credit markets. Now with the option to do so, start-ups are more likely to get first round of investment from the local angel investors/VCs as the local angel investor may seek valuation gains on its investment in case of subsequent rounds of investment.
In a nutshell, SBP appears to have struck the right chord with its target audience by opening up the capital convertibility regime for businesses. There are some other facilitations for the companies to make investment abroad for attracting angel investment as well. Moreover, the repatriation of dividends or capital gains has been rationalized for start-ups and Fintech companies. This can help develop the Fintech and start-up segments of businesses in Pakistan.