Traditional financing approach is rarely suitable for companies of the new digital age
Governments in emerging markets, along with the international development agencies that often support them, need to adapt their investment philosophy and efforts. They need to respond to the changes of how companies and ecosystems are funded and the subsequent transformation of how new jobs are created in the new digital age.
In the old days, it was about buying assets or land and employing people to maximise the return on those assets. Today, it is increasingly about hiring people to create solutions to make new products, optimise utilisation of existing assets or do away with the need for the assets altogether.
We have all seen how successful technology-orientated start-ups tend to have a steep growth curve, with the potential to scale internationally and produce thousands of jobs quickly without a need for large investment in physical assets. A decade ago most the top companies in the world defined by market capitalisation were in the oil and gas or banking sectors; today they are technology companies. The digital revolution ignited a paradigm shift in business models: the performance, and valuation of the company are no longer tied to its ability to manage its own physical assets. Our funding of start-ups in the top three economies in the Arab region – Egypt, Saudi Arabia and the UAE – has been seeking to promote youth and small-business development, which we consider to be key to their future. Based on these countries, we believe there are important steps that the governments of these countries can take to act as enablers.
The true assets of the top companies such as Alphabet (Google) and Facebook are the people employed by them and the innovative products they generate. The sharing economy negated the need for a company to own assets; the world’s largest taxi company, Uber, doesn’t own a single car nor does the world’s largest accommodation company, Airbnb, own any property. These latter two companies – considered to be part of the sharing economy – are also very powerful job-creation engines as they generate direct and indirect jobs at rates unseen before.
While several governments and development organisations have rightly identified the need to promote the creation of a large base of small and medium-sized businesses as a one of the cornerstones of macroeconomic policy, they have tended to heavily focus on specialised loan schemes
Here, then is the crux of the issue: the traditional, debt-heavy financing approach is rarely suitable for high-growth companies. Debt does not match the equity financing these companies need since the speed of their growth outpaces the stable historical track records banks look for when making lending decisions, and they do not tend to have the assets banks typically demand as collateral. Traditional initiatives are better-suited for capital-intensive businesses whose funding needs are for tangible assets rather than high-growth technology-orientated companies.
Furthermore, traditional employment-focused development programmes, which usually rely on training and subsidies to encourage employers to expand their employment needs, tend to create old-economy jobs that are likely to become obsolete.
Risk equity financing, or venture capital, has been proving its worth for decades by supporting innovative ideas and guiding their materialisation into transformative companies, spurring job creation and leading to the ripple effect of launching additional entrepreneurs.
One of the notable local success stories that reflects this change is an Egyptian company, ITWorx. Co-founded in 1994 by one of my partners, Wael Amin. ITWorx specialises in writing custom software for large corporate clients and early on had outstanding growth and performance with the clear potential for a strong regional and international presence. It was this that led to the first round of funding in 1999, from a fund managed by another of my partners, Hany Al Sonbaty, and then a further round of financing in 2000 from the International Finance Corporation (IFC).
Today, ITWorx employs more than 1,000 people and has expanded into 12 countries. What is even more noteworthy has been the effect beyond the company itself: ITWorx’s growth in size sparked a new generation of entrepreneurs and created a remarkable ripple effect in job creation. Working at a high-growth company instilled technical grounding and entrepreneurial spirit, which led to the creation of more than 200 start-ups by former ITWorx employees. The cycle of economic growth continues exponentially, as each of these companies attracts its own investment, creates more jobs and has more employees leave to establish new companies
Even with its notable successes, the VC industry itself is transforming rapidly. The rise of equity financing through start-up accelerator programs, which make small equity investments and provide training and mentorship to entrepreneurs is creating more dynamic and responsive financing options for seed stage SMEs.
In essence, equity-based funding in its traditional format is a cash flow-positive job-creation tool that generates sustainable long-term jobs in higher growth, profit-generating start-ups and new jobs in the new economy.
It is high time emerging-market policymakers and the leaders of international development organisations take note of what has already proven to be a winning formula for both creating meaningful and sustainable economic development in emerging economies, as well as addressing unemployment and redirect their funds to programs creating long term and sustainable impact. With its newly announced catalyst programme and its expansion of regional allocations to VCs, the IFC is one of the institutions adapting to the changes.
Imagine the growth and overall benefit for emerging markets if there were 1,000s of companies like ITWorx creating jobs and seeding the business environment with additional start-ups. That paradigm shift would be a global economy game changer in its own right.
Ahmed El Alfi is the founder of Flat6Labs, a major start-up accelerator in Egypt and Abu Dhabi
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