Why is the caretaker govt offering free money to Pakistani startups?  

Early on January 9, 2024, every person imaginable from the Ministry of Information and Technology congregated in Islamabad to launch the Pakistan Startup Fund (PSF). What followed was a typical “launch ceremony” organised by the government. 

The minister gave a speech to a packed audience. The protocol flunkies nodded vigorously, the ministry lackeys clapped loudly, and the press minions (including two of Profit’s own correspondents) took notes diligently. There was talk of ‘revolutionising Pakistan’s IT landscape’, and ‘uplifting the youth’ was mentioned for good measure. 

It was as standard as it gets. We won’t even question why a caretaker minister is launching funds and making policies and plans that will have far-reaching effects well beyond his constitutionally mandated time in office. 

But what exactly is the Pakistan Startup Fund? To hear Dr Umar Saif (caretaker minister of IT & Telecom) and his ministerial entourage speak of it, the government wants to use the annual Rs 2 billion fund to help Pakistan’s nascent startup ecosystem. 

But what exactly does “helping” startups mean in this context? The Rs 2 billion up for grabs here are being offered equity free which makes this, for all intents and purposes, a subsidy. The money isn’t being given directly by the government but is instead being managed by Ignite, a non-profit company run by the Ministry of Information and Technology. So how will this fund work, and is it the best idea in the world?  

Why create the fund? 

This part is simple. Over the course of the past year startup funding has tanked all over the world. Pakistan, which since 2018 has been home to a steadily growing startup industry, has been adversely affected with many large startups having to shut shop.  

The government clearly believes in the potential of Pakistan’s startup ecosystem. That is why they have introduced the Pakistan Startup Fund. The Rs 2 billion are meant to act as a cover for underwriting risks for startups. What that means is if a startup needs to raise, for example, $700,000 in a particular year to stay on track but only end up raising $500,000 they can approach the fund to bridge the gap. 

As funding has dipped in Pakistan potential founders might be becoming more risk-averse. Startups are already a risky business with 90% of startups likely to fail from the get-go. So in an environment where investment is rare and business risks are high, the appetite to create a startup might be significantly lower. The PSF, at least as envisioned by Saif, would offer an encouraging cushion for startups. 

The Pakistan Startup Fund has also been launched to bring in the much needed FDI (foreign direct investment) into the country. For starters, the fund has been launched with the backing of the Special Investment Facilitation Council (SIFC), whose mandate is to facilitate investments into Pakistan to alleviate hurting macroeconomic conditions. If the risk of the VCs is underwritten by the government, they would be more likely to invest in the country, than in the absence of such a fund. This brings in dollars into the country while the fund gives the money to the startup in rupees, resulting in a net gain of dollars. 

What are the terms of the fund? 

Now this is where things get interesting. As mentioned above, the fund has been created in collaboration with the SIFC which means it has the backing of state institutions. This makes the fund a serious investment pool that startups can look towards. 

The only problem is that this fund has been created entirely equity free. Profit was informed that this fund will essentially function as the last cheque of equity free money in a round, whereby startups can access this government grant after they have raised 70% of the initial amount from VC funds. The government would be facilitating rounds by underwriting the last cheque for 25% to 30% of the round, without claiming equity and helping VCs by sharing some burden and helping startups finish the round.

This means the government will be giving the startups this money and not taking any equity in exchange. Essentially, they are offering the startups money for free. If the startup still ends up failing the money has been burnt. If it does succeed, the government does not get any returns. 

The fund will be fueled by revenue from Ignite, a program funded by a portion of the federal government’s telecom receipts. This is the earlier mentioned company which also looks after and funds the network of eight National Incubation Centres (NICs) established in major cities of the country. 

The minister had previously told Profit that the government already gives quite hefty grants, which go to waste the majority of the time. However, in this case the government would tie this money to a VC round, or a private risk capital, essentially giving these grants to a company with a promising idea and commitment. 

What do the caretakers hope this will do? 

At the launch of PSF, attended by Secretary IT Hasan Nasir Jamy, Additional Secretary Ayesha Humera Chaudhry, and representatives from prominent investment firms and foreign diplomats, Saif emphasised that the PSF is particularly tailored to assist startups in securing their initial external investments, as the fund’s grants will be essentially underwriting risks for investors and venture capitalists.

Saif, confident in Pakistan’s potential, said, “Pakistan is the fifth-largest country, and with smartphones in every household, there is no reason why we won’t see unicorns.” He highlighted that Pakistani startups had received over $800 million in investments in recent years, with some poised to become unicorns.

And this isn’t a new plan. In October last year, Saif told Profit that venture capital growth in Pakistan needs to be encouraged and to assist with that, the government will be introducing the Pakistan Startup Fund, with a billion rupee value each year. However, the value of the fund was revised and bumped up by another billion rupees. 

The fund’s equity-free capital is expected to encourage more foreign VC funding in the country. Saif highlighted its role by stating, “If a foreign VC is considering a $1 million investment in your Pakistani startup, they only need to invest $700,000 — the Pakistan Startup Fund will provide a $300,000 grant to facilitate closing the round.”

“We will refrain from seeking any equity, shares, or board positions in your startup. The PSF is strategically crafted to mitigate the risks for international investors venturing into Pakistani startups. Once we have issued a check, we commit to a hands-off approach, placing our trust in you and your VC investors to drive your success,” he asserted.

The government’s objective with this fund is to generate a value of at least Rs 50 billion annually in Pakistan’s startup ecosystem.

Not a new idea not the same fund 

Not only is this an old idea that Saif has pitched, it was floated before by the previous government as well. It is pertinent to note that the Pakistan Tehreek-e-Insaf (PTI) government had also announced a Rs1 billion fund for startups in Pakistan, which was reportedly going to be managed by the National Investment Trust Limited (NITL). The said fund was never formally launched. 

When asked if the new fund was the continuation of the earlier fund announced by PTI, a representative from the Ministry of IT and Telecommunications expressed shock at the question, insisting that the idea was completely from Saif. 

In a conversation with Profit, Saif said “Markets are largely for service provision, whereby no serious risk is involved and steady returns are generated when you invest in a good IT company. It takes a while for startups to reach a level where they can turn to financial markets and unlock more value and potential. However, we need to warm up markets to mobilise resources because a lot of IT companies are still sole proprietorships.”

Possible concerns

But is the fund an efficient way of bringing in investment? An economist told Profit that subsidies are generally unhealthy for any industry. “The government has not released more details around how much investment is expected to come into Pakistan with this measure, what would be the potential for taxation and how many jobs would be created to say if this is going to be a good policy.”

There could be better uses for the money that is being used for the fund. While there is a precedent for governments to fund startups, like in India, they also have ecosystems that allow for the growth of these companies. VCs are often less willing to risk their money investing in Pakistan because of unstable macroeconomic conditions, no precedence of gains from exits for investors, concerns around ease of doing business and persistent uncertainty about political situation. 

Pakistan has a perception problem and if there are some exits in the market where foreign investors and founders are able to make some hefty gains, the perception changes. For gains, investors would be willing to take more risk in Pakistan and the government wouldn’t have to underwrite their risk. To achieve this, the government needs to craft a long term strategy and create a conducive environment where startups are able to achieve high valuations and exit successfully. Funding is just one aspect of it. 

Many onlookers have expressed concern over two aspects of the fund. Firstly, the PSF has been launched without sufficiently transparent and inclusive debate. Secondly, eyebrows were raised over how a temporary government is starting new projects and initiatives instead of overseeing existing ones. The government’s representatives eluded this particular question. 

Ali Hasnain, the head of the Economics Department at LUMS, told Profit, “In the last 18 months, the Pakistani state has rapidly redrawn the rules governing it, throwing out long-standing structures and replacing them with a concentration of unchecked and ad hoc power. A caretaker government’s normal mandate per the Elections Act is to attend to day-to-day matters of the government and it must restrict itself to activities that are routine, non-controversial, urgent, and in the public interest. Reading narrowly or in principle, it is hard to understand how a caretaker government can launch a new and multi-year program like the Pakistan Startup Fund (PSF).”

Hasnain explained how this may have been legitimised and continued to add, “However, the recent Board of Investment (Amendment) Act which established the Special Investment Facilitation Council (SIFC) empowered that body with practically unlimited and unaccountable powers to raise new investments, including the ability to issue binding advice to other ministries. These powers can presumably be used to provide legal cover to the IT Ministry’s new program, notwithstanding concerns of principle and legitimacy.”

It is a fact that caretakers’ authority is usually limited to overseeing elections, however the current interim set-up is the most empowered one in Pakistan’s history. This is largely due to recent legislation and mandates that allow it to make policy decisions on economic matters, so that measures could be taken to keep a nine-month $3 billion International Monetary Fund (IMF) bailout on track. So, this particular caretaker government is dissimilar to the orthodox understanding of the term. 

When asked whether it is advisable for the government to invest in startups as a means of encouraging digitization and tech integration in Pakistan, Hasnain postulated, “Supporters of public investment into private firms argue that the potential upside is high. Since its first Unicorn – or company valued above $1 Billion – in 2011, India has established more than one hundred such companies. Indonesia, Philippines and Vietnam all have three or more. If Pakistan can create even one, the investments into PSF will have been worthwhile.”

Meanwhile, he also highlighted that detractors point to the lack of capacity within the government to manage such a fund and question whether this money couldn’t have been better spent elsewhere – e.g. on improving our derelict schools or expanding child nutrition programs. “They argue that the recent slowdown in IT sector investments in Pakistan have more to do with country risk, repatriation challenges, and the substantial skilled labour brain drain that has resulted from the political and economic upheavals of the past two years, than with valuation concerns. Sporadic and unexplained internet outages and the throttling of websites adds to the overall negative picture we are portraying to the world.”

He added, “I am cautiously pessimistic about the PSF: I see some arguments in favour of it, but I am concerned about the lack of capacity in the IT ministry and elsewhere in government to run such a program productively and on merit. At a minimum, the ministry should put the program’s feasibility studies and other background documents in the public domain and invite debate. It should also lay out program targets and clarify how these will be evaluated in the future.”