Design intent and start-up law

28 Sep 2020

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The writer is a lawyer.
The writer is a lawyer.

BY now, it’s old news that Pakistan’s start-up scene is hot. Barely scratching the internet’s surface throws up a robust showing of all the usual suspects: venture capital funds, incubators, accelerators, and so on. A late 2019 study by the research arm of the accelerator Invest2Innovate, written with the World Bank, reminds us that the ecosystem burgeons thanks to supportive demographics: we’ve got plenty of young, tech-savvy hustlers. When that’s coupled with a ubiquitous scarcity of resources, well, we all know what necessity does for innovation.

One gaping hole, until recently, was facilitative legislation. An earnest SECP (Securities and Exchange Commission of Pakistan) has now put out amendments to the Companies Act 2017 and the Private Funds Act 2015 aiming, in part, to make the start-ups’ path less fraught with pitfalls. The laws, which confer the ability to issue equity more readily and remove regulatory hurdles, have clearly been formulated with noble intentions.

Pakistan’s legislature has long been criticised for its inability to translate good intention into intelligent law. Another frequent lament is that laws are mere publicity stunts, designed to be impotent so as to ruffle no feathers. Government agencies have been accused of being a confederacy of warring dunces as far as subordinate legislation and implementation are concerned.

It’s premature to speak of the efficacy of these laws. What is already clear though is that Pakistan’s start-up landscape will remain more jungle than ecosystem until a) laws are designed in conjunction with other government agencies, b) the desire to innovate is better reconciled with the bureaucracy’s instinctive resistance to change, and c) private lending institutions get with the programme.

Shortcomings include the circularity of requirements in getting start-ups off the ground.

Before the medicine though, some sugar: credit is undoubtedly due. The consultation on these start-up laws was wide-reaching and well done. The most vaunted feature of the amendments is the ability to pay employees in stock. Previously, this was only allowed by public companies but is a standard feature of start-up legislation internationally. The significance of this was made famous by the kid who was paid in stock for spray-painting Facebook’s first office because they didn’t have the cash. He became a multimillionaire overnight when it went public years later.

This and other time-/paperwork-saving changes such as no longer needing a company seal, and the ability to delay paying in the initial capital, help pave the way for fresh graduates and otherwise cash and time-strapped founders. There’s also good news for those wishing to set up a venture capital fund: the non-banking financial company licence, which used to take up to a year to obtain, is no longer required.

Shortcomings, however, include the persistent circularity of requirements in getting start-ups off the ground. There are myriad complex instances of this, but a simple illustration is that registration of a company requires a landline, but you can’t get a landline in the company name without registered company documents. So founders end up capitulating to the expedient route and getting the landline in their personal name. This in turn causes a host of accounting issues down the line. That causes unnecessary frustration and time needlessly spent on non-start-up activities. This is where the agency coordination for legal design and implementation comes in.

Secondly, Pakistan’s historical reflex to view change as upheaval, and its stubbornly abysmal rating in ‘Doing Business’ indices, is no coincidence. Much of the demonisation is well deserved, and in particular, Pakistan’s business infrastructure remains painfully wedded to the status quo. At each instance of legal and policy innovation, a common theme to emerge is mistrust. Specifically, mistrust between agencies and private individuals remains rampant. Wanna set up an associated company outside the country to issue shares to international investors? “Thieves!” bellow the authorities. Are you a State Bank official worried about outflows of currency from the country? “Dinosaurs won’t let us pay out dividends,” cry the founders.

Nonetheless, there are encouraging reports of leadership at the SECP being a lighthouse for start-up policy. By all accounts, the State Bank under Reza Baqir is making great strides too. Further, fund managers, investors, accelerators and founders now feel much better heard than in the past: they’re invited to consult on and contribute to draft laws. That’s crucial for inspiring confidence in the business environment and injecting goodwill into old wounds. Seeking buy-in from those the policies purport to benefit may seem basic but it is in fact a massive concession of turf for old Pakistan and therefore, a master stroke.

Finally, sparse access to early stage capital continues to leave a large proportion of start-ups to wither in their nascency. Though the number and size of funds has grown, as many as two-thirds of founders still rely primarily on friends and family. Where the law is as yet unable or unwilling to incentivise the plugging of this gap otherwise, banks should step up. They don’t have to reinvent the wheel to do so. For example, while traditional collateral for loans won’t be available, there is ample precedent in more mature start-up industries of the practice of discount invoicing.

So there’s some work to be done yet. And while there’s pain in the truth that the bureaucracy and legislature remain slow on the uptake, anyone who’s tried to get any law passed will recognise that even incremental shifts in the law require a gargantuan effort. For laws seen to affect people’s pockets or the country’s coffers, the impediments line themselves up. As such, while those tasked with nurturing start-ups are far from entitled to rest on their laurels, perhaps we can concede some cynicism: good intentions are sometimes a reliable defence with which to buy time, if implementation follows shortly. We owe our hustlers and their beneficiaries a job done properly.

The writer is a lawyer.

Published in Dawn, September 28th, 2020