It was never the same for the Lebanese ecosystem after 2014. Banque du Liban’s (BDL) Circular 331 was meant to create the foundations of a new ‘Lebanese knowledge economy’, a new productive sector along with banking, telecom, and services in the country. And so it did, despite all the ups and downs, the pros and the cons, and the antagonists and the protagonists. Now, four years after the implementation of the regulation, the sector looks much more solid, even if more in-depth resolutions and structuring need to be put in place.

Creating a new economy

In August 2014, the BDL announced Circular 331, which injected $400 million into the Lebanese enterprise market. The limit was raised in 2016 to $650 million to foster even more innovation and to drive banks to invest more. The Circular guarantees 75 percent of the banks’ investments in the knowledge economy through direct startup equity investment or indirect startup support entities.

Sami Abou Saab, CEO of Speed@BDD, the first acceleration program to see the light post-Circular 331, told Wamda that the BDL has been historically conservative, only investing in secure areas. But in 2014, speculating the slowdown in the Gulf which would echo the local market, the central bank wanted to create a new sector [the knowledge economy] that does not rely on Gulf remittances, on oil, neither on unstable real estate prices.

“The main positive achievement of Circular 331 is removing the money constraint,” Paul Chukrallah, managing director of Berytech Fund II, told Wamda. The BDL has tackled that issue but improving the appetite of banks to actually fund startups, which are naturally less appealing to these financing bodies due to all the risks and the few guarantees they have.

Presella, an online e-ticketing platform, was the first startup to get funded under Circular 331. It raised $200,000 from Bank Al Mawarid. Walid Singer, cofounder and CEO, told Wamda: “Money is an important factor in any startup's success and different money is needed at different stages of the startup's lifecycle. 331 helped Presella test different markets. It would have been more difficult to succeed without it,” he added. Singer explained that his startup pivoted several times since its launch, and it is currently in a transitional period from offering B2C to B2B services.

But having so much ready-to-be-invested money does not mean it is easy money. Abou Saab said that even though money is now available, it is there for the right talents and concepts. “We need to be aware that entrepreneurship is not for everyone, and not every idea will get funded.”

Though Marianne Hoayek, director of the executive office at BDL, was not available for an interview, she had mentioned in a talk with the Financial Times, that since the inception of Circular 331, the sector has grown eight percent a year, creating 9,000 jobs, and is on track to reach a target of 25,000 jobs by 2025. Until November 2017, the central bank had approved investments of $368 million, of which $203 million have been executed. Investments worth a further $132 million were still awaiting approval.

A mismatched VC market

Besides supporting entrepreneurs, Circular 331 has parented VC activity in Lebanon. Walid Hanna, founder and CEO of Middle East Venture Partners (MEVP) told Wamda that prior to Circular 331, the Lebanese ecosystem suffered from an equity gap which left startups with just bank and Kafalat subsidised loans as a funding channel: Unlike loans, equity is a patient capital, and it is the right funding route for startups. “What BDL did is magic, as it fostered that VC industry. We were the first licensed VC by the BDL, and we raised $70 million in 2014, out of which we invested 80 percent in 20 companies,” he said. Today there are nine to 10 VC funds operating in this market according to Hanna.

However, the negative aspect of that was the mismatch between the offer and the demand. “Most authorized funds were Series A, but the real gap was at the Seed Stage,” Hanna stressed. This means that the BDL addressed a part of the equity gap, Series A, but it over-addressed it, whereas most startups needed Seed money. Hanna further explained: “Some VCs pretended they wanted to fill in the Seed Stage funding gap, but they ended up doing Series A, because they did not want to take all the risks. Series A is safer than Seed.” According to him, fund managers were after bigger returns and profits, and running big funds with high tickets would grant them higher yearly management fees. But this is an ‘unhealthy behavior’, and it won’t help the ecosystem grow further.

He added: “The BDL should have directed and forced other VCs to look at different investment stages in order to not have an overcrowded Series A.” According to him, running a Series B fund was nonsense back in the days because no startup was mature enough for it. “In one or two years, there will be a need for Series B, but the need for Seed funding will always be there.”

Hanna believes that the BDL should facilitate and fund acceleration and incubation programs, such as Flat6Labs and Speed@BDD, as they generate seed funding. “If the base of the pyramid [startups at seed stage ]is weak, it will entail a weak Series A, and Series B will be even weaker.”

The World Bank’s Tech Startup Ecosystem in Beirut - Findings and Recommendations’ report recorded 43 investors in Beirut, about half of them are VC firms and the other half are angel investors. They made a total of 58 investments in 35 startups, and all investments were identified as equity financing.

Abou Saab said that not all VC are risk-takers, and many of them are run by ex-bankers who have naturally less risky funding decisions. “We do not need VCs that brag about one success. We need VCs that brag about four failing startups, but also about that one startup that did 30x in return, and covered all the other failures. Failures need to be funded for us to have successes.”

Did it come in the right time?

Many claim that Circular 331 came in the wrong time, and various infrastructure reforms should have been done prior to pumping so much money into the ecosystem.

But Hanna does not approve that say.

According to him, Circular 331 came in the right time. “Infrastructure, talent gap, and legal frameworks among others, are all excuses. Today you can start a company in a garage with a slow internet, and you don’t need all the luxury. But once you make it, and start to have some traction, there are hundreds of ways to register your business, and overcome the small obstacles,” he said, referring to paying little extra to improve the internet speed, and to shareholders agreements that would mimic preferred shares. “We’ve done it hundred times. We have many successful companies out of Lebanon despite the infrastructure issues they faced. These success stories were established in 2009, 2010, and 2011 when the situation was way worse than it is now.”

“The BDL’s approach was right because it stimulated the government to follow and cooperate,” Abou Saab said. In 2014, the government did not adopt the same mindset as it does today, and was not convinced about the value of the knowledge economy. “Back then the pressure [the money] was not there. But now it is, which could be the reason behind triggering legislators and public authorities to collaborate.”

Chukrallah added that public authorities are at a stage where they should act responsibly and proactively. “Ministries, Parliament members, and all official stakeholders must be more proactive and do what they have to do. Work needs to go hand in hand in a positive direction,” he said, referring to the lack of synergy between the BDL’s act and the government.

According to Abou Saab, if putting together the right environment came first, the initiative would have encouraged more private parties to invest, rather than just relying on the BDL’s cash. “It is not the role of the BDL to keep on pouring money. It did that once, but now it is time to push the government to help those early successes who raised their first funds under 331 to raise a second round, through private investors.”

Private sector parties, including family businesses, should be incentivized to fund startups. Abou Saab explained that in the UK for instance, companies get tax cuts if they invest in funds: If a company makes 500,000 British pounds a year, almost 250,000 pounds are due as taxes. But if it invests 100 million pounds in startups, it’ll get a 50,000 pounds as a tax rebate. The second year, there is a second incentives, and if the startup fails, the company will also be compensated.

Success is still early to judge

Most stakeholders agreed that measuring the success of Circular 331 is still early stage, especially if a so-called ‘success’ would be a $100 million exit. This does not neglect some stars, including the exits of Diwanee, and Shahiya.

Hanna said that post Circular 331, hundreds of companies have seen the light, generating thousands of jobs, maybe half of them is sustainable. “Will they have exits? Yes. But will we have unicorns? No. I don't see any unicorn out of 331. There is no one company growing fast enough to reach a one billion dollars of valuation. And it’s not because of the lack of money, it’s because of concepts themselves,” he said.

A major faux-pas

As of last June, a major issue was rising in the ecosystem: the BDL refrained from releasing capital calls so VCs pay startups the due amounts of money. This was mainly due to liquidity issues, and to rumors in the market which led the BDL to extremely scrutinize and request continuous reporting. “Within the BDL departments, there was a lot of skeptics, who led to freezing the release of the capital call,” Hanna explained. The scenery was a pure dilemma: The BDL was blaming the banks for not paying, which in their turn were blaming the BDL for not paying its subsidy. The BDL in its turn was requesting VCs to continue reporting, something they were actually doing. So banks ended up defaulting on the capital call because the BDL is defaulting on its subsidy, and VCs ended up not getting their management fees, and startups getting no money. “We promised and committed to invest in companies and we ended up unable to pay. This drove startups to slow down their activities, many even started to downsize, which destroyed the created added value,” Hanna said. However, the problem saw happy endings lately, and the capital calls were finally released. “The total amount that we got was $7 million, and things are back to normal now,” Hanna revealed.

Chukrallah insisted on the importance of building a more transparent relationship between banks, VCs, and the central bank. “More transparency needs to be there, in addition to a stable and understandable framework. We need more predictability and less arbitrary behaviors,’ he said, referring to the reporting the BDL requires VCs to prepare, in order to release the capital calls.

What still needs to be done

Abou Saab concluded that for an ecosystem to grow, it is crucial to have an inventory of the startups, the investments, the successes, the failures, and the reasons behind them. “We should summarize these, in order to recommend to the future entrepreneurs the dos and the don'ts,” he said.

The World Bank’s report found that Beirut’s ecosystem is an early to middle-stage one that has passed its nascent growth phase but is still far from maturity. Abou Saab believes that assessing the ecosystem on a scale from one to 10, we stand at four or five. “To move growth faster, you need to attract talent to the right environments with new laws,” revealing that the government is currently working on improving infrastructure, and have some new drafts about bankruptcy laws. This means, the newborn economy needs to be institutionalized and put in the right framework.

Abou Saab said: “This is a critical stage now in the life of Circular 331. It has delivered a lot and pushed for the creation of something that hopefully will be self-sustainable. VCs will start raising their new rounds of funds, away from 331 and will be able to go regional and global in their search for private money, which will boost the sector even more.”

With the emergence of this new economy which puts new skills and employment opportunities at the forefront, Chukrallah,  Hanna, and Abou Saab, spoke about the importance of synchronizing this new economy with universities.

“There is a gap in the R&D centers in universities. The best startups come from Stanford Universities for example, where the best professors coach and mentor their students.We need more grassroots to support Circular 331. It is not the role of the BDL to push universities to create R&D. Universities must find a way to fund R&D get better professors with startup experience. You need millions of dollars to create these centers and sustain them,” Hanna said.

Circular 331 was a first attempt in the journey of diversifying the Lebanese economy, and to give the new generation not only a promise for a better tomorrow, but also a funded plan. Measuring its true success is still early stage, but the scenery is looking opportunistic, despite the bumps.