Funding startups in the tech industry
Written by Jinashri Samarakoon Wijesundara
A much-needed boost for economic growth
“Globally, startups create nearly $3 trillion in value, a figure on par with the GDP of a G7 economy,” documents Startup Genome, an International innovation policy advisory and research firm on startup ecosystems.
Startup Genome also shows that among these, not only do tech companies create most of the net new jobs, they also have significant job multipliers, indicating that for every high-technology job, five other jobs are created in the economy.
In June this year, the BOI Chairman Sanjaya Mohottala announced at the Invest Sri Lanka forum, that the Sri Lankan government expects the manufacturing sector to take root in the country to reach US$ 1 billion in export or import substitution and the IT industry to contribute US$3 billion to the economy by 2025. SLASSCOM, the industry association for IT in Sri Lanka has a more ambitious target of US$ 5 billion for IT. To meet these targets, startups will have as much a role to play as established companies.
“Currently we have 550 tech startups and we aspire to reach 1000 by 2024” Sachindra Samararatne, Director, Startup Ecosystem Development at the ICT Agency of Sri Lanka informs.
This 1000 tech startups, is also the magic number that Startup Genome indicates as the critical mass required to catapult Sri Lankan startup ecosystem to an exponential growth phase.
Tech startups that solve big problems stand the chance to make it big, pushing the economy along with their own growth. We know how the likes of Airbnb and Facebook disrupted the standard order of their respective industries. While we have local success stories such as Ikman.lk a digital marketplace, Roar Media-a content platform, PayHere – a digital payment platform, Pickme – a service that enables real-time connection between the passenger and the taxi driver. A supportive ecosystem can ensure that many more such success stories emerge from Sri Lanka. Such an ecosystem has to provide a conducive regulatory framework, access to funding, expert advice to fill gaps in the entrepreneurs’ knowledge and support for market access. In this article, we will be limiting our scope to funding options available particularly for those companies that are still in the infancy of their startup lifecycle.
Startups need funding
Transforming a concept into a real product or service needs capital. A new company formed to commercialise an innovation should plan to fund their business concept till paying customers are acquired.
“Most businesses need a runway of 12-18 months till strong customer acquisition & profit generation” explains Dammika Ganegama, Co-Founder & Managing Director, Mitra Innovation.
Generally, a company would first turn to banks for a low-interest loan. Banks are risk-averse and will ask for immovable collateral to grant a loan. While mature companies may provide these with more ease, it is a quandary for the typically asset-light startup IT company. It is also important to know that, while a loan may provide founders total control over their startup operation, it is not always the best option. An early-stage innovation by a first-time entrepreneur, who lacks business experience, market connectedness and sometimes even expertise in certain technical aspects, may benefit more from an equity-based investment option.
Where should a startup go for funding
Where a founder should look for funding depends on the stage his company is, in the startup life cycle. The correct fit will also depend on how much funds the startup needs, how much of its control the founders will be willing to let go of, and how likely it is to be successful. Giving up too much equity too early will put a spanner in the works of securing good value in later funding rounds, as the entrepreneur may give away equity at a lower valuation. Giving too little equity will not secure the interest of the investors.
Many classifications can be found to explain the different funding stages in a startup’s life cycle (as illustrated by Figure 1); however, the following oversimplified version is all one needs to understand this seemingly complicated process. They are the pre-seed stage, where the entrepreneur is testing the market acceptance for his innovation and tries to build a prototype, seed stage, where the startup has now developed a minimum viable product (MVP) and is ready to go to market, growth stage, where the company is aiming to expand markets, customer bases and product or service range, and exit stage where the founders cash out on the business and exit from day to day operations. A recent tech giant having its origins in Sri Lanka that reached this stage is Virtusa, which was acquired by Baring Private Equity Asia (BPEA) for USD 2 billion. Another is NCinga which was acquired for USD 15.5 million by the fashion platform Zilingo, a company on its path to be South East Asia’s next Unicorn.
Pre-Seed Stage – This is where the entrepreneurs will build a rough model or prototype of their concept. Founders may not have a polished business plan, but they will have a basic idea of how their innovation, be it a product or service, can be monetised. A majority of the entrepreneurs will consider bootstrapping funds at this stage, meaning, they will turn to friends, family, or personal savings, or even take a personal loan to finance their business venture. Other options will be to approach micro financiers or government-supported funding programmes (of which the writer found only one that supports Tech startups), business incubation and acceleration funds, and the more recent method of crowdfunding, where entrepreneurs will list their innovation on crowdfunding sites to test market acceptance, secure pledges for future orders and funding from the public, prior to embarking on the planned business venture. Equity crowdfunding platforms do not seem to operate in Sri Lanka owing to the financial regulations of the country.
Moving on to Government-funded programmes, Spiralation is a strategic initiative implemented by the Information and Communication Technology Agency (ICTA), to encourage entrepreneurs to bring disruptive technological innovations to the market.
Since 2010, Spiralation has supported more than 90 tech startups across multiple industry verticals providing more than 500 job opportunities in the industry. Spiralation supported startups to date have collectively reached markets in 30+ countries
Spiralation provides a maximum of LKR 1.5 million no equity pre-seed funding. New start-ups, already registered or planning to, and companies that are less than 3 years in existence are eligible to apply. In addition to the funding, selected applicants stand to receive support and training for capacity development and business mentoring in technical, financial and managerial competencies. Spiralation hosts workshops and supports participation in international trade fairs and technology events to provide global and local exposure.
“The EU-SL Innovation Partnership platform and the Startup Genome network are collaborations we made in order to connect with global incubators,” Sachindra Samararatne further explained their strategies to increase the global connectivity for the startups they support.
Wellington Perera, who is a selection committee member of the Spiralation programme, explained that investors pay attention to the founders’ commitment to the startup, product quality, technical superiority and speed of going to market. “… ideally within a year or year and a half from the start, for Spiralation”.
Lankan Angel Network launch. Standing from left to right Prajeeth Balasubramaniam, Eric Wikramanayake,Jeevan Gnanam,Chandi Dharmaratne,Mano Sekaram,Dumindra Ratnayaka,Adil Mansoor, and Chalinda Abeykoon
Lankan Angel Network investment fund (LAN) is an angel fund that is the first of its kind in Sri Lanka. Their purpose is to bring the Sri Lankan investor and mentor community together and scale the startup ecosystem. Among the investors are individuals who are all professionals and experts in different business disciplines, venture capitalists, and angel investors. Of the investors, 15% are female and 30% live overseas. They are from 7 countries and represent over 30 verticals. The Angel fund is industry agnostic and has Rs. 100 million in investments from 100 investors each contributing Rs. 1 million, per round. For a minority stake in the company, which leaves the entrepreneur in control, LAN provides business building, functionality and Industry experience, contacts for partners and customers, and follow-on financing, through its high-profile members.
“Among our investors we have Sri Lankans who were a part of the core team that launched Blackberry, former dean of the Imperial College Business School, we have board members of leading international investment banks to successful entrepreneurs who have built and sold their ventures” informs Chalinda Abeykoon, Chief Executive Officer of LAN, to indicate the impressive knowledge pool an entrepreneur stands to gain access to.
Since August last year LAN has received over 300 applications representing 19 out of the 24 districts. The majority of these startups are first-generation entrepreneurs. Angels of LAN give them advice and counsel not only to take their start-up to the next level but also to shape the entrepreneurs’ business skills. They favour companies that can scale out of Sri Lanka, and have a business idea that has a personal connection with the founders rather than one developed simply to take advantage of a market opportunity. An MVP, tested and validated in the target market is key. The fact that a start-up is not yet generating revenue is not considered a disadvantage.
“We look at the chemistry among founders and their determination to solve problems. For us, the potential of the team is crucial as the growth of the startup is directly correlated to the growth of the founders. If there are gaps in the knowledge, we help them fill those,” Chalinda mentioned further.
The company at this stage has a working prototype of the innovation or an MVP with at least one or a limited number of paying customers. Angel funds invest in a startup company during its toddler years, when it still needs some hand-holding. This support may not be just in capital, but also in marketing, finance, or any other of the plethora of knowledge a business needs, to set sail in the chosen market. They undertake big risks, as a startup at this stage has big dreams to offer but most often no profits or assets to back the investment.
There are several options available for funding in this phase. We covered the largest angel investment fund LAN, as a pre-seed investor. LAN also provides seed capital of LKR 10-50 million. A sound business plan and a working MVP would be crucial at this stage while having paying customers will definitely be advantageous.
The Digital Innovation Fund (DIF)and BOV capital: DIF is a venture capital fund fueled by Dialog Axiata Plc and is managed by the Sri Lankan and Singapore-based venture, BOV Capital. These funds focus largely on series A funding (or after a start-up has already secured funding from angel investors, proved product-market fit, and the founders’ capability to deliver on business goals.
However, Kishan Nadarajah, Principal, BOV Capital said that DIF also allocates 20% of its funds for seed investments for companies that are building digital solutions to solve problems impacting big markets- either through disruptive technological innovations or creating new markets. Seed investment ticket size will typically be around LKR 15-25 million.
Both DIF and BOV Capital exclusively invest in tech or tech-enabled companies, and BOV Capital led the landmark buyout of Sri Lanka-based startup nCinga Innovations, one of the largest in the Lankan tech industry worth approximately LKR 2.8 billion in cash and stock.
Hyperion Ventures is a venture capital investor that supports seed to late-stage companies across all sectors. They are investor-centric and support founders who are passionate, creative, and dedicated to executing their vision. Hyperion provides venture capital where their investment equates to an ownership stake in the startup. They also provide venture loans to high-growth startups. Venture loans are commonly used to provide liquidity to businesses to extend cash runway and accelerate growth whilst minimising equity dilution for the founding team and the investors.
Also available at this phase is John Keells X, which provided seed funding of Rs. 2.5 million each for startups chosen from a competition in their last round of funding. The timeline for their next funding round has not yet been announced. John Keells X website states that competing projects need not be aligned with the industries John Keells Group operates in, however, that they are happy to explore opportunities that lie adjacent to their industries.
Whom out of these options to approach for funding will depend much on the capital requirement of the startup. Spiralation and LAN will connect the projects showing unique potential requiring far above the threshold of funding the two programmes offer, with their investor network to help raise funds.
Growth followed by the expansion phase
Funding options for this stage are many. These include accelerator funds, venture capitals and private equity firms. Even banks are more favourable to tech firms at this stage as they will have a business track record to back a loan. PE firms, VCs and banks all look at key financial metrics, such as EBITDA, cash flow, free cash flow, and, most importantly, the possible IRR.
ICTA loan framework for tech companies: The ICT Agency of Sri Lanka in collaboration with PwC Sri Lanka, jointly developed and introduced a new credit evaluation framework to be adopted by banks when lending to tech companies with minimal collateral. This programme though in its infancy is gaining traction. Seylan, DFCC, Union, and NDB banks have agreed to work with this framework when evaluating tech companies for loans. The local fintech startup PayMedia recently secured an LKR 85 million loan from National Development Bank that adopted this framework.
The application process for this loan scheme requires the tech company to sign an NDA with PwC who will assess the company and derive a credit rating. ICTA will then communicate the ratings to the banks. Following this, the bank and the tech company will mutually agree on the loan rate and amount.
DIF, and BOV Capital, discussed as options for the seed phase, mainly support companies from series A funding onward. Investment size will be in the range of LKR 50-150 million per company
Another is Mitra Ventures, a private equity firm that incubates and supports new ventures through sweat equity. They partner with serial entrepreneurs and established companies who are keen on pre-seed, seed, and Series A funding.
Several other PEs including Ironwood Capital Partners that raised a series B round of funding of USD 2 million for findmyfare.com are available for consideration at this stage. They all will require a proven business model, good financial indicators, and the business to be able to evince its ability to grow beyond Sri Lanka.
Of the options available in the market, this article highlighted some, and Table 1 summarises them.
In the end, there are a few common characteristics that all investors are optimistic about in a startup they are willing to take a chance on. A valid, viable and scalable business idea servicing a growth market segment, a well-thought-out business plan that covers all the operational aspects of the business, and a cohesive committed team of founders are the aspects emphasized by all investors as paramount to an investment decision. Needless to mention, founders paying part-time attention to the startup will not hold out well. Finally, investors always begin with the end in mind-the exit plan of their phase of the investment.
Hiran Embuldeniya, the Managing Partner at Ironwood Capital Partners, explains that companies aspiring to grow to an LKR 1 billion valuation within 3-5 years, should be able to raise LKR 50-100 million within a couple of rounds of funding whilst achieving their growth targets.
Such startups projecting high growth irrespective of the business sector will need to plan to raise funds every 9-12 months, the value of each phase being a multiplier of the previous round.
Therefore, being realistic about the valuation and partnering with the right investor is important to support a startup’s journey. One size or model does not fit all in many products in the market. So it is, with investors. A startup should consider if the investor can raise the needed investment for the required timeline, will be interested in supporting tech companies and more importantly if they have a track record in doing so. It is important that the founders find an investor whose vision is aligned with theirs, and will provide support to fill technical, marketing, corporate governance and business contacts gaps they may have to make the business venture a success.
One thing is clear, the time is ripe for startups. Dane Strangler of Ewing Marion Kauffman Foundation in his 2009 study titled The Economic Future Just Happened shows that over half of Fortune 500 companies started during an economic contraction. So, amidst the pandemic, there is a silver lining for startups, and we have seen that this is especially true for those in IT. The pandemic has prompted speedy digitisation of the offline economy as never before.
As Chalinda Abeykoon says “A lot of people complain about how things are, but I tend to zone such negativity out and work on the positive. That is the way success can be achieved. My advice to entrepreneurs is, this is a great time to start a business. Go for it. Think of solving big problems!