HOF Capital is a global venture capital (VC) firm founded in 2016 by three Egyptian entrepreneurs, Fady Yacoub, Onsi Sawiris and Hisham Elhaddad. It focuses its investments on nascent technologies that have the potential to solve big societal problems and counts Uber and Alibaba among its portfolio of investments. 

In this interview, the three co-founders share their thoughts on the impact of Covid-19 on the investment landscape in the Middle East and North Africa (Mena). 

What do you think is the impact of the Covid-19 outbreak on VCs, especially those in Mena?

Sawiris: Despite the obvious challenges that this pandemic poses towards the broader economy and technology industry, it is not all bad news for startup founders and venture capitalists. Many of the most successful technology companies today were started or built during challenging times. Past crises have inspired entrepreneurs to build new innovations, and also led to consolidation of capital and talent towards the most promising companies. We expect that this pandemic will be no exception.

Venture capital in Africa and the Middle East had seen promising growth in the years leading up to the pandemic, with 2019 marking a watershed year for these ecosystems with Uber’s $3.2bn acquisition of Careem as well as record-setting funding volume. As such, while startups and VCs in Africa and the Middle East will feel the negative impact of this pandemic, these ecosystems have tailwinds and new capital inflows that may cancel out the virus’ consequences to some extent. Therefore, while VCs in these regions should proceed cautiously, they may be less likely to experience down rounds and write-offs than those in other regions.

How does the pandemic affect the future of investments and where do the opportunities lie in a post-Covid-19 world? 

Sawiris: In the post-Covid-19 world, VCs will no longer be able to achieve superior returns through a momentum investing strategy, and will instead need to diligently search for investment opportunities that have asymmetric risk-reward profiles, many of which may be non-consensus bets.

Yacoub: Challenging times inevitably bring new problems that need to be solved, leading to the creation of new market opportunities and the accelerated growth of some existing ones. This certainly holds true for the current Covid-19 pandemic, which for the first time in modern history has caused the majority of people in affected countries to socially isolate themselves, resulting in the accelerated adoption of technologies needed to survive in such a world, such as those enabling or related to remote working, telemedicine, e-commerce, digital payments, and robot-powered delivery. Even after this pandemic has passed, it is likely that many of these resulting changes to society will persist and that many of the organisations and people who started using these technologies for the first time will continue using them. Hence, the startup founders that can quickly adapt to this challenging time and solve the new problems that have arisen will likely find themselves building the next generation of category-leading businesses.

What impact will that have on the amounts that will be raised in the future? 

Elhaddad: Data suggests that global VC investment volume fell by around 8 per cent year-on-year (YoY)  in Q1 2020, a statistic which likely understates the eventual impact on funding, since many investors did not appreciate the severity of the pandemic until late February or early March. We anticipate that the YoY drop-off in investment volume will be even steeper in Q2 and Q3. The number of deals has fallen as well, though not as sharply as the volume of funding, suggesting that average round sizes are shrinking. This means that even founders who are in a position to raise successfully will need to plan to run their businesses at a lower cash burn rate.

One positive for startups that can successfully raise is that challenging times also lead to less competition. Too much competition in a given market usually leads to market fragmentation, followed by price wars, compressed margins for all players, and dispersion of the best talent among too many companies. In contrast, challenging times usually lead to market consolidation, followed by increased pricing power, stronger financial performance, and higher concentration of the best talent among surviving companies.

Is this a moment of convergence or divergence of interests between founders and VCs?

Sawiris: Fundamentally, we believe that our interests at HOF are as aligned with founders as they have ever been. We seek to invest in founders with the ambition to build category-leading businesses in large, fast-growing markets. We succeed as a firm if and only if our founders achieve their missions, and a pandemic does not change this fact.

We do caution founders that in a more austere fundraising environment, they should expect to see some VCs offer term-sheets with more aggressive anti-dilution and liquidation preference clauses, and that they should think carefully about the potential long-term implications of these terms before accepting offers.

What kind of pressure will that put on founders? 

Yacoub: Founders will need to be more conscious than ever to maintain a reasonable cash burn, and if possible, achieve profitability. While blitzscaling and growth at all costs have been the mantra of many Silicon Valley investors in recent years, in the current environment, having a  higher-than-necessary cash burn is a risk that founders should make every effort to avoid.

Will the pandemic kill off certain sectors as far as investment is concerned? 

Elhaddad: Companies with unprofitable unit economics are likely to struggle most severely, since these companies may find that follow-on funding is unavailable when next they need it. We expect certain sectors like coworking, micromobility (e.g. scooters), physical retail, and travel/hospitality to be most impacted, since these businesses tend to be capital-intensive, have low gross margins, and are heavily affected by social distancing measures. Some startups in these sectors will inevitably shut down. With that said, we doubt that the pandemic will kill off investment in these sectors entirely. It is likely that by the time this pandemic finally ends and the global economy begins to recover, these markets and others will have significantly consolidated. In the post-Covid-19 world, the startups that are able to survive and grow will likely find themselves with greater pricing power than before and an even higher proportion of the best talent in the industry, enabling them to become even more successful than they would have been in a pre-Covid-19 world.

Will “pandemic-resilience” become a criterion for investment? 

Yacoub: Pandemic-resilience will become a criterion in the sense that investors will now be even more focused on investing in founders who are capable of fending off threats to the company by any means necessary. Founders who are perceived as overly lax or generous may find that they have a much harder time fundraising than they did in the bull market.

In addition, we expect that investors will prioritise startups that do not require any large gatherings and minimal in-person interaction to execute their business models. Many investors fear that even after lockdowns are relaxed, consumers will shy-away from public gatherings for the next few years in order to protect their health.

What effect does the fluctuating oil price have on VCs’ ability to raise investment in the region?

Sawiris: It’s too early to say with certainty, but we do expect it to become more challenging for VCs to fundraise in the region. Many of the economies hit the hardest by oil prices have been among the largest LPs in recent years, so if the price wars continue and these nations scale back their investment in VC, it could have a significant impact on the ecosystem, especially at the growth stage.