By Amir Farha
We’re not in Silicon Valley, we’re in the Middle East. We don’t have the luxury of having an abundance of capital to drive innovation, nor do we have the large tech companies that make acquisitions on a regular basis. Focusing on what users want is essential, but understanding how to make money is crucial to building sustainability.
As an investor, we try to assist entrepreneurs in eliminating the risks associated with their companies as they grow. One of the key risks I constantly face is that of the business model. I see many companies that approach me with interesting concepts. Some of them are in the prototype stage, some have built traction and others have started generating revenue, and are occasionally even profitable. The ability to generate revenues is one of the important things I analyse in the investment opportunities I receive. Once a prototype has been tested in the marketplace and gained traction, it needs to start making money otherwise it’s chances of survival becomes limited. It’s essential to have a monetization strategy when starting a tech company in the Middle East due to the current state of the ecosystem.
Unfortunately we are in a nascent venture capital industry in the MENA region, with limited capital available to fund startups and early stage companies. Unlike the US, where capital is in abundance and companies can raise sizeable rounds to grow their traffic/users without the need for generating revenues, the Middle East does not have that luxury. Investors are unable to pursue the “grow first and make money later” strategy, since growth requires a lot of funding and exits are not commonplace (unlike the US where Instagram got acquired by Facebook for $1 billion without any revenues, and received $57.5m in funding to grow its user base). The Middle East does not have a Facebook or Google of it’s own, i.e. a large tech company with large cash surplus to make acquisitions, and as such, companies need to be able to become profitable in order to be sustainable incase an exit doesn’t materialise. Having a revenue model in place from the start gives investors more security and foresight. By launching with a revenue model, even if it cannot scale into meaningful size, the entrepreneur will learn a lot about what customers want and how much they’re willing to pay for it, allowing them to pivot into a better model over time (if need be). I have invested in companies that have had to pivot because of an ineffective business model and have managed to create a new revenue stream that is innovative based on its feedback from customers and its ability to scale effectively.
Revenue brings much needed stability and cash flow that fledgling startups need to grow. It’s also a great indicator of performance and enterprise value in the event of an exit. There are very few businesses that raise capital, even in the US, who focus specifically on scaling users rather than revenue. Facebook, Instagram, Snapchat and a few others are the anomalies and that’s why they are covered in the news and showcased in the limelight. There are thousands of companies that are funded every day with a viable business model in place, and often generating significant revenues. Even with these companies, the requirement of funding is great. For us in MENA, we are constrained by the lack of capital and the limited exit opportunities. So as investors we look at businesses that have scalable ways of making money rather than focusing purely on growing the user base. Both should go hand in hand. Create a prototype. Gain traction. Find a revenue stream. Prove the business model works. Scale users accordingly.
I recently read an article on Skype founder, Niklas Zennstrom, who talks about exactly this subject: monetisation before scale. Skype had a business model before it grew it’s users, which is one of the reasons for its huge success.