Don't be afraid to scale
This is a crosspost with LinkedIn.
The MENA entrepreneurship landscape has come a long way since the days when I was at ABAN (2008) until now. In 2008 there were only a handful of interesting tech companies backed by knowledgeable and capable entrepreneurs who took the risk of launching a startup. Today I see hundreds of startups being launched on the web and mobile every year, and this is only going to grow in the future as the fear of failure that previously stopped many entrepreneurs from starting up diminishes. With this change, other challenges emerge, and one that I would like to discuss in this post is… the fear of scaling (or perhaps more appropriately defined as the limited ambitions of entrepreneurs).
At BECO, we receive hundreds of investment opportunities from tech startups around the MENA region and meet many entrepreneurs each year. As part of our investment process and diligence, we try to identify those entrepreneurs that can grow to a significant size, something we defined as $20m in annual sales or $100m in enterprise value over a relatively short period of time (say 5 to 7 years), in order for us to generate significant returns on our capital.
This number is based on the revenues of the largest tech businesses in the region (Bayt.com, Yahoo/Maktoob and Zawya) who generate more than $20m in annual sales, which indicates that tech companies should be able to grow to that size today, at an even faster rate (it took those companies 8 to 10 years to grow to that level of sales, hence the 5 to 7 year timeline).
As we continue to meet with entrepreneurs and analyze investment opportunities, I have witnessed a growing problem faced by entrepreneurs that has become a real concern, and that is their fear of scaling.
Most entrepreneurs that we meet with have interesting businesses but seem to lack in ambition. They are content if their company can grow to $3m in annual sales with $1m in profit, which seems fine for the entrepreneur but is a problem for the investor, especially if that investor is a VC. This problem is amplified, when taking into account the valuation (something that I will discuss in future posts).
Companies that come to us with these sort of projections, and with minimal revenues (and therefore a lot of risk), have a pre-money valuation of between $1m and $3m (and sometimes more) and are looking to raise about $1m. If an investor invests $1m in the business and it grows to $3m in annual sales over a 5 year period (without raising further funds), then the company could be worth $12m (on the high side) and the investor would make about four times their money. This may be a good angel investment, or even a lifestyle business, but is not for venture capitalists. A VC deploys large amounts of risk capital that has to generate significant returns (around 7x to 10x their money, when factoring in failed investments/businesses), and therefore looks to invest in fast growing, sizable companies.
If we break down ambition against the nationalities of the entrepreneurs, we find a growing trend. Jordanian and Egyptian entrepreneurs are the least ambitious when it comes to scale. They believe that $3m in annual sales and $1m in profit is a great opportunity. Lebanese entrepreneurs are the complete opposite, overly ambitious and a little too extreme, often believing that they can create businesses that generate $100m in annual sales. The GCC entrepreneurs are relatively modest and aim for $15m to $30m in annual sales.
There could be many drivers of this trend but I believe it’s a combination of market size and commercial acumen. Jordan is a tiny market and therefore the Jordanian entrepreneurs are forced to think small from the outset. This habit has made most Jordanian entrepreneurs have limited ambitions and set modest goals for themselves.
Lebanon, also a tiny market, has entrepreneurs with strong commercial mindsets. They are salesmen and therefore they think big, setting huge goals and thinking global from the outset. Perhaps the reason for this is the civil war that ripped the nation 30 years ago, forcing the population to think outside their locality and hence solve large, regional/global problems and attempt to create large companies.
Egypt is a large market full of amazing engineers with little commercial awareness and they often struggle to understand how their product/service can make money or expand into new geographies, building business models that are not scalable or cannot reach significant size. Finally, the GCC entrepreneurs understand a lot more about their market and its potential size since they are located in the region with a sizable population of real consumers that spend money, and are therefore better equipped to gauge the size of their business.
To solve this fear of scaling, entrepreneurs need to open their eyes to the potential of the region rather than the potential of their local markets. They have to think about unique and scalable business models that can allow them to reach significant size. They need to understand their target market and their customers a lot more and really shoot for the stars.
Today, we have a real market of consumers and businesses in the Middle East that are using technology to transact and consume content (over 100m Internet users and 40% of the population own a smartphone). There has been a huge influx in venture capital and angel investing over the past 4 years, much more than what previously existed over 10 year ago. Combined, this presents a great opportunity for entrepreneurs today. They can now build a company much faster than before, raise enough capital to scale and reach a large enough audience to build a sizeable business.
Entrepreneurs only have a few shots at success, so they have to make sure that they pursue a business that can capture the largest opportunity. If they see a business that can only generate limited enterprise value, then they should look for something else. The time and effort it takes to start and grow a business is an opportunity cost, and should be thought about in great detail. If they choose to pursue a relatively small opportunity as I highlighted earlier, then the size should be reflected in the valuation, and they should target angel investors rather than venture capitalists.
Personally, as I continue to meet with entrepreneurs across the region, I am optimistic about overcoming this mindset in the short term as I see more entrepreneurs think big, as more success stories and sizable businesses emerge from the ecosystem.