The coronavirus pandemic proved to be a stimulant for Pakistan’s startup ecosystem, with venture capital rising from $66.4 million in 2020 to a staggering $365.8m in 2021 and $136m in the first quarter of 2022.

Changing work patterns and emerging challenges led entrepreneurs to capitalise on market gaps through innovation and digitisation. For example, airlift, a notable startup, raised an astronomical $85m in funding, but regardless of its exponential growth in its first year, it eventually declared bankruptcy in 2022. The fall of Airlift indicates how much progress remains to be made to sustain startups by improving the regulatory framework to ensure the longevity of the startups.

The government of Pakistan recognises the need for appropriate legal changes to address new and changing challenges. It took various initiatives in recent years to develop a comprehensive and coherent industry policy to shape regulatory thinking and promote a conducive fintech environment in the country.

The aim is to attract local and international innovators and to facilitate the growing startup ecosystem in the country. The Securities and Exchange Commission of Pakistan (SECP) has a dedicated startup portal which features a list of startups, a simplified user experience for registration, access to mentors and incubation centres, online guides, and video tutorials for startup companies.

In recent years, the government has taken various initiatives to develop policies that promote a conducive fintech environment

The portal is a gateway to information and collaboration hub for facilitating and uplifting existing and future entrepreneurs to connect and excel. Additionally, SECP established a regulatory sandbox for conducting limited-scale, live tests of innovative products, services, processes, and/or business models in a controlled environment.

It enables the market entrants to assess the viability of the products/services to be launched on a full scale. The regulatory sandbox allows innovators to test new products, business models, and services across all sectors regulated by SECP, including insurance, capital market, and nonbanking financial services.

The SECP, through the regulatory sandbox, is trying to create an enabling regulatory environment conducive to innovative solutions. By issuing the Companies (Further Issue of Shares) Regulations 2020, the SECP recently amended subsidiary legislation under Pakistan’s primary company law, the Companies Act 2017, enabling startups to raise equity investment in new ways.

The Companies (Amendment) Act 2021, passed by the legislature, amended the Companies Act 2017 once more. The Amendment Act defines what constitutes a “startup company”. It gives the SECP the authority to take action to enhance regulatory quality, promote innovation, and promote the use of technology in business.

The Companies Act now has a new section 458A, thanks to the Amendment Act. Section 458A allows the Commission to implement measures for providing greater ease of doing business, improving regulatory quality and efficiency and facilitating corporate sector innovation and use of technology in conducting business.

These amendments are considered to be critical measures to simplify compliance and promote startups. Moreover, startups, typically private limited liability corporations, can now reserve a portion of their shareholding for employees thanks to the passage of the Amendment Act.

This is done to aid startups in retaining talent. The laws are getting flexible each day to facilitate investors to structure their businesses best suited to them. For example, the State Bank of Pakistan (SBP) issued a circular allowing Pakistan-based startups to incorporate holding companies abroad.

The holding company’s shares may be exchanged for equity investment in the domestic entity. The SBP regulates foreign investment in Pakistan and since most of the funding comes from direct foreign investment, the startups are required to abide by the various guidelines issued by the State Bank.

The SECP has recently decided to amend the ‘Non-Banking Finance Companies and Notified Entities Regulations 2008’. SECP wants to allow the lending/licensed Non-Banking Finance Companies to operate as peer-to-peer service providers.

In this regard, the peer-to-peer service provider will undertake due diligence of the participants. It will undertake credit assessment and risk profiling of the borrowers, disclose it to the lenders and provide advice relating to peer-to-peer services on credibility, determining creditworthiness, extending a loan, and determining the price of transactions for users on its platform.

This demonstrates the regulator’s persistent efforts to support technology-driven market entrants and the advantages of regulator-startup cooperation. The Special Technology Zones Authority (STZA), an independent statutory body, has been established under the Special Technology Zones Authority Act 2021.

The zones will help increase high-tech exports of Pakistan and facilitate technology transfer from major global science and technology hubs. The function of STZA is to provide a one-stop shop for investors, provide legislative and institutional support, create opportunities and avenues to attract foreign direct investment into the emerging startup and tech ecosystem, and provide an enabling environment.

One of the major obstacles in sustaining startups is that they are unable to get loans due to a lack of collateral security and creditworthiness. Limited access to capital for small enterprises warrants government intervention. To help startups to evolve into big businesses, credit guarantee schemes should be launched by the Pakistani government. For example, China launched a Credit Guarantee Scheme (CGS) in 1998, which established credit guarantee agencies (sponsored by provincial and municipal governments), mutual guarantee funds (sponsored by small and medium enterprises) and commercial guarantee companies (sponsored by private investors) to provide collateral and guarantees for startups to secure bank credit.

As of 2009, there were 5,547 CGS in China with a total guaranteed capital of $54.4 billion and guaranteed loans of $0.4 trillion, supporting around 1.12 million SMEs. To ease financing so that startups can raise capital to sustain and grow, the Pakistani government should help extend financing channels by promoting microfinancing and cracking down on illegal lending activities.

China, in 2012, introduced government-backed bonds which enabled small enterprises to raise more money as bonds backed by the government are believed to have lower default risk. Furthermore, tax redemption can be given to startups to reduce their borrowing costs.

The writers are financial and commercial law students at the Lahore University of Management Sciences

Published in Dawn, The Business and Finance Weekly, November 28th, 2022

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