Why investing in start-ups is still attractive during the pandemic

Tech ventures focused on solving pandemic challenges are proving especially popular for VCs and angel investors

Illustration by Mathew Kurian

When movement restrictions ground the UAE to a halt, forcing schools, businesses and malls to close, start-up entrepreneurs may have assumed all investment activity would stop as well.

However, angel investors and venture capital funds have continued to inject capital into young businesses in the Mena region, particularly those that tackle pandemic-related challenges.

There has been a shift towards more established later stage start-ups than riskier earlier stage start-ups in the venture space

In February, Jassim Al Marzooqi, the founder and chief executive of Abu Dhabi angel investor network Path Investment Partners, chose to invest in a seed stage round of Dubai-based CleverX – a platform that connects people and organisations with experts in various domains – when the full effects of the pandemic were starting to be realised.

“The coronavirus situation accelerated the growth of this business proposition," he says. "With people at home not able to meet experts face to face, this platform served as a very useful tool to be introduced to them. We also chose the start-up because it is very asset light."

Although the number of start-up deals have reduced during the pandemic, Mr Al Marzooqi says, there has been an increase in the average ticket size of transactions. However, the true impact of the pandemic on the UAE’s start-up ecosystem will only be gauged in the second half of this year because it takes on average nine to 12 months to raise funds, say industry experts.

“Our data has shown that there has been a shift towards more established later stage start-ups than riskier earlier stage start-ups in the venture space,” says Philip Bahoshy, founder and chief executive of Magnitt, a start-up data platform.

As the UAE and the rest of the world adapt to the new normal of doing business post Covid-19, companies have accelerated their digitalisation drive, encouraging investors to turn their attentions to start-ups in the technology space.

Mr Al Marzooqi says his investor network will exercise “cautionary optimism” and focus on investment in four main tech sectors: sustainable technology, cyber security, artificial intelligence and financial technology.

Similarly, Middle East Venture Partners (MEVP), a Middle East-based venture capital firm, has targeted UAE and Mena high-growth technology companies at the Series A and Series B stage over the past six months. These include a second round in Nana, a grocery delivery platform in Saudi Arabia; OneClick, a B2B delivery and logistics platform in the UAE; and Rise, a UAE-based FinTech platform offering access to financial products for the unbanked.

Walid Hanna, founder and CEO of Middle East Venture Partners, says his company will focus on investing in cash flow positive start-ups with low cash burn. Courtesy Walid Hanna

“Last month, we approved an investment in the cryptocurrency space. This transaction is still in process and we expect to make an announcement in the next few weeks,” says Walid Hanna, founder and chief executive, MEVP.

Mindshift Capital, another venture fund based in Dubai, that has seven companies in its portfolio and invests in early stage women-led technology companies, closed an investment two weeks ago in a Singaporean food tech company called Shiok Meats that creates sea food from stem cells.

“We invested in Shiok Meats because we need alternatives to solve food security and supply chain challenges during the pandemic," says Heather Henyon, founding partner of Mindshift Capital and founder of the Women’s Angel Investor Network. "Mindshift Capital invests in the foodtech, edtech, healthtech and FinTech sectors where zillenial consumer values are driving new business models that have been accelerated by Covid."

Rather than become more risk-averse amid the fallout from the pandemic, Mr Hanna says VCs have instead “adapted to the new reality and continue to invest in good opportunities under these conditions".

"We are placing more importance on cash flow positive start-ups with low cash burn, and we have added a new ‘social-distancing-proof’ criteria”, Mr Hanna adds.

While some investors are waiting for signals of an economic recovery before committing capital, Mr Al Marzooqi says some start-up founders are holding off on fund-raising due to lower valuations.

“A lot of VCs are negotiating hard and pushing down valuations to obtain a good discount on their investment. For start-ups that are willing to potentially accept a lower valuation, there is still capital available,” he says.

Jassim Al Marzooqi, founder and CEO of Path Investment Partners, will focus on investment in four tech sectors: sustainable technology, cyber security, artificial intelligence and financial technology. Courtesy Jassim Al-Marzooqi

Magnitt's Mr Bahoshy says now is an opportunistic time for those with experience to make investments because of lower valuations.

“There are three buckets of companies in the venture space right now: those that were likely to have failed because they didn’t have the right product market fit; those that have benefited from increased consumer demand and whose valuations have likely gone up; and those that have struggled because of the economic crisis but are fundamentally strong businesses," he says. "These include businesses in last mile delivery, travel and tourism and entertainment, which now have attractive valuations than they would have historically."

Philip Bahoshy, founder and chief executive of start-up data platform Magnitt, says there has been an investor shift towards more established and later stage start-ups than riskier earlier stage start-ups. Pawan Singh / The National

Among angel investors, however, Mr Bahoshy says there has not been an increase in investor appetite during the pandemic. Instead, they will "look for companies, especially in the hot industries that have seen increased revenue demand like healthcare, education and e-commerce", he says.

"They look for strong founding teams as well as companies that have a large scale beyond a specific city, country or region.”

Angel investors may be more cautious about investing at the moment, says Ms Henyon, because they invest their own wealth in start-ups. With many affected by Covid-19, either in terms of their own wealth shrinking or economic insecurity, they may scale back their entrepreneurial investment. “Early stage investors are recommended to invest between 2 to 10 per cent of their net wealth in this space because it is risky,” Ms Henyon says.

She also raises the issue of female start-up founders, who have struggled during the pandemic because distance learning in schools added to their workload.

“The virtual world induced by Covid-19 gives women greater access because we are not limited to some of the social events that would have typically favoured men," she says. "But, because a lot of women are limited to their current networks, it is harder for them to break into those circuits now through Zoom calls or virtual meetings."

Other start-up founders may struggle because of a lack of funding or shrinking customer bases.

StartAD, an Abu Dhabi-based global accelerator that steers seed-stage tech start-ups to launch, develop and scale their ventures, has launched several initiatives to support struggling SMEs.

“The pandemic has presented difficult challenges for entrepreneurs whose sources of funding and customer base are currently fragile. We have transitioned our current programmes and trainings online,” says Hana Barakat, interim director at startAD.

Also, in its seventh instalment held virtually this year, the startAD Corporate Sprint Accelerator identified 10 start-ups with strong traction in their home markets ready to scale into the UAE and the wider Middle East.

“Over the last month, these start-ups have customised their businesses for the local market and built their fit with corporates. These include technologies in wireless IoT devices that monitor the strength of materials, wearable smart devices for process improvements and others. Despite challenging economic conditions, our start-ups have shown resilience and adaptability,” says Ms Barakat.

Hana Barakat is the interim director of startAD, a global start-up accelerator in Abu Dhabi. Picture credit: Courtesy startAD

According to a May survey of almost 250 Mena start-up founders, conducted by Arabnet and Wamda, 50 per cent of respondents said they have less than six months’ cash runway (how long a company can survive if its income and expenses stay constant) and around 25 per cent only have a runway of two months. To help solve this, startAD launched a financial relief fund for start-ups called the ‘Runway Grant’ worth $30,000 (Dh110,175) in association with VentureSouq and Scalable CFO.

“We also launched a community fund-raising initiative, titled #LengthenTheRunway, in which we encouraged people and businesses to pledge support to start-ups with services and goods. So far, around $90,000 worth of services have been committed by members of startAD’s community to help start-ups overcome this difficult period,” says Ms Barakat.

To be successful in the current market is a challenge, “but those who find themselves looking at the bigger picture will gain a sense of perspective that will benefit them in the long run”, she says.

“Those who are able to nimbly adapt to the changes in circumstances by ‘pivoting’ their solutions to meet new market needs will reap the rewards,” Ms Barakat adds.