Despite a clear slowdown in fundraising around the globe and in Pakistan, the last two weeks have been pretty happening. First, Tania Aidrus-led DBank announced a $17.6 million seed round, marking the first investment of Sequoia — one of the most renowned venture capital firms — in the country. This was followed by a few more deals, including OneLoad’s $11m which had Bill and Melinda Gates Foundation joining the capital table.

Sure, some of the deals were likely done months ago but that doesn’t dampen their importance, especially considering the profile of the investors. Anyway, that is beside the point. The question is with all this investment coming into the country, where is the local money? All those uniformed and non-uniformed seths with their conglomerates. Their absence has long been a cause of concern for it deprives the local ecosystem of a major avenue for growth capital and limits the potential mergers and acquisitions activity.

In fact, their lack of participation is alarming. According to numbers compiled by Data Darbar, of the 464 disclosed investors who invested in the country between January 2019 and June 2022, only 126 were local. That includes everyone: from angels to funds and everything in between. If we filter them out and limit ourselves to venture capital (VC) and corporates, the picture becomes even bleaker: 171 of the 216 institutions that took part were foreign.

Mind you, that is despite classifying firms domiciled abroad but focused on Pakistan as local. Basically, all the top active VCs over the past few years, be it Zayn, Fatima Gobi, or Indus Valley, are registered in foreign jurisdictions. In its Pakistan Startup Ecosystem Report 2021, Invest2Innovate also highlighted this problem: “the existing Private Fund Regulations (2015) do not allow foreign VCs to raise money from Pakistan unless licensed in the country, which carries ramifications for the scale at which local capital from family businesses can be mobilised.”

The absence of local money deprives the ecosystem of a major avenue for growth capital and limits mergers and acquisitions activity

The Securities and Exchange Commission of Pakistan (SECP) also seems to have realised the extent of the problem and released “A Diagnostic Review of Pakistan’s Private Funds Industry”. While it’s common knowledge (to those tracking the space) that the number of locally registered private equity (PE)/venture capital (VC) funds has remained largely static, the report puts numbers on how much behind the curve we are.

As of March 2022, there were only seven entities with a PE/VC license from the SECP which had a combined asset base of Rs10.99 billion, despite a healthy 64.3 per cent increase compared to Rs6.69bn in June 2021. Don’t get excited by the growth though, for it dwarfs in contrast to the investments raised by Pakistani startups.

For example, the size of the SECP-regulated private funds (PF) was Rs7.89bn by the end of 2020, compared to Rs13.5bn direct investment into startups. The following year, this gulf widened further as the former stood at Rs9.74bn while the latter hit Rs65bn. The report attributes some of the blame to the burdensome tax structure, which has three layers: first 29pc on the income of the investee company, then an equal rate on the income of the fund itself, and finally another 15pc on the dividend to PF investor.

Regulations do not allow foreign VCs to raise money from Pakistan unless licensed in the country, which carries ramifications for the mobilisation of local capital

Another issue pointed out was how VCs were being regulated like asset management companies despite their substantially different nature. For example, the former sources its money from already sophisticated limited partners (LPs), who have access to lawyers and other professional advice, and therefore do not need a similar level of protection as your average Basheer.

The regulator lists a number of remedies taken to address this problem, such as allowing pension funds to invest up to 5pc of the net assets of equity sub-funds in units of SECP registered PEs and VCs. However, it adds that no such investment has been made so far. Even if they had, it would have been a drop in the ocean considering how small the two industries are in total. This is in contrast to the US, for example, where pension funds and endowments were pivotal in driving up the liquidity of the VC industry.

Among the host of recommendations put forward, the SECP alludes to a government fund — in line with the demand of many industry stakeholders. But if the past is prologue, it’s best to take that bit with a handful of salt. After all, it was only this year that the National Investment Trust denied President Arif Alvi’s claim of launching a Rs1bn fund at an event.

While this entire exercise is indeed admirable and a step in the right direction, it ignores the broader issue of misaligned incentives. At the end of the day, capital will be channelled towards the asset class that’s given the most preferential treatment. That is obviously the real estate where one can defraud people, avoid taxes and at the end of the day, whiten all the wealth in the eternal amnesty scheme. But no one really wants to fix that.

Published in Dawn, The Business and Finance Weekly, August 8th, 2022

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