Completing the startup ecosystem

To flourish, Sri Lanka’s startup ecosystem will need to plug many gaps

To succeed, founders of new businesses need all the support they can get. They often turn to friends and family for financial support, and accept a morale boost from just about anyone who offers it.

Most young firms will not make it, but those that survive their difficult first years will find Sri Lanka’s state of economic development constricting. As disposable incomes here are low, people consume fewer goods and services. So, any business here is limited by the low buying power of consumers and Sri Lanka’s small population. But, that hasn’t meant the opportunity is necessarily limited for startups.

Ones leveraging technology to introduce new efficiency to an industry or target consumers overseas are more successful. These technology-savvy new economy businesses are fast growing, and their needs often cannot be met by a system led by banks that has supported entrepreneurship in the past.

These fast-growing startups, at worst, could end up a local technology bubble, leaving many disappointed. At best, it may result in a disproportionate number of globally competitive new economy companies from Sri Lanka, resulting in benefits to employees, shareholders and the country.

A few years ago, some investors – SLASSCOM, a software and BPO umbrella body and entrepreneurs – started organizing to build what’s known as a startup ecosystem. Aspects like access to finance, talent and ideas are important for startups, but so are informal networks where entrepreneurs help each other for the ecosystem’s success. In many cities with thriving startups, networks or ecosystems are instrumental in their success.

Founders are often young and have little or no experience in identifying opportunities and tapping funding sources. Unless the ecosystem is visible with plenty of activity and engagement, entrepreneurs won’t even know it exists. For startups, an ecosystem can provide access to experienced entrepreneurs who can give invaluable advice on business models, the technology best suited for it and recruitment. Sometimes, all a young entrepreneur needs is encouragement from someone he/she respects.

Since its beginnings around five years ago, Sri Lanka’s informal set-up is fast maturing. A group of startup investors called the Lanka Angel Network (LAN) started organizing competitions, coding gatherings and providing seed funding for startups.

Since LAN, informal networks have expanded into an ecosystem. Many individuals and companies, including private equity firms, now fund startups at different stages.

Angel investor Jeevan Gnanam says the startup ecosystem needs to evolve beyond the four fundamentals of the current model: competitions, mentorship, funding and incubators

One of LAN’s early backers, Jeevan Gnanam, however, says the ecosystem needs to evolve beyond the four fundamentals of the current model: competitions, mentorship, funding and incubators. In Sri Lanka, accelerators and incubators focus on developing a select group of startups over a finite duration, often in return for equity.

The ecosystem has evolved from five years ago, when none of these were consistently available, to being plentiful now. Pioneering work by the group, including Gnanam, has made startups far more common than they were half a decade ago with some remarkable success stories. However, Gnanam argues that the ecosystem, which has evolved, contains many gaps that will impeded its ability to grow at the same pace as it did in the past.

Startups typically raise funding a number of times before they become independent enough to depend on their own cash flows, are acquired by someone or issues shares to the public. Lanka Angel Network invests in startups at its earliest stages, when the business is just an idea or has developed an early prototype. Early stage failures are high, and some investors like the certainty of a startup with paying customers.

“We are mapping the entire ecosystem, so it’s easy for someone new to figure out where they fit in,” says Gnanam about the need to map the entire ecosystem to minimize duplication and make it easier to identify opportunities.

First-stage investors are those who back a business idea when it’s little more than a sketch on a napkin. The second stage is when an early prototype is available. Beyond this point, the business will have paying customers and need larger amounts of funding to grow market share since the product is proven. Those funding the fourth or later rounds, when the business expands, will be eyeing an exit by selling to a larger company or listing shares on a stock exchange.

Sri Lankan investors willing to back businesses at each of these stages exist; however, there are also gaps because entrepreneurs want more than just money. A successful investor will bring domain expertise, access to a network and be a mentor to the entrepreneur.

“If someone wants to fund a business, they will be able to figure what the missing piece is and plug themselves there. Right now, everybody is trying to do the same thing,” according to Gnanam, who ranks capital availability as the top enabler for startup success. A supportive regulatory framework and celebration of failure are also critical enablers, he says.

He points out that, currently, an organisation or specialist able to contribute valuable industry insights aren’t available to fund an early stage startup focused on agriculture.

Besides funders, of whom Sri Lanka has some, other bases for a vibrant ecosystem are yet uncovered.

Characteristics like the tolerance of failure, the constant hype and links to other institutions are weak. Institutions include the education system, particularly universities, policymakers, markets where startups will sell products and services, and the community with which businesses interact.

Many links are weak, while others simply don’t exist, because the startup ecosystem is still growing. Gnanam, who is chief executive of a family controlled manufacturing business and founder of Orion City, a real-estate venture that is the largest office space renter in the country, contends that it’s critical to identify the ecosystem’s gaps, as startups today are a preview to how Sri Lanka’s future economy will be structured.

The one thing Sri Lanka lacks, thus far, is a big ‘exit’ that can galvanize the ecosystem to plug its every gap. Sri Lankan startups, like ones for ride hailing and online travel booking, have achieved valuations many times their revenue from investors funding expansion, proving that it is possible to scale a business here quickly. Gaps in the ecosystem won’t prevent a big “exit”. However, Chalinda Abeykoon, chief executive of Crowdisland, a firm investing in early stage startups, hasn’t found success attracting global investors due to small deal sizes here, even by the scale of the most successful startups.

“We’ve tried to partner internationally, but their minimum investment is about a million dollars. Even if a company does a $200,000 (around Rs30 million) raise, they are unlikely to be able to raise a million dollars in the next round.” Abeykoon, who managed a grant programme at ICTA, a government agency spearheading Sri Lanka’s digitalization, points to this second critical gap in addition to the first one (investors with deep domain knowledge). “These are the challenges for which we don’t have solutions yet.”

Self interest has encouraged two large diversified business groups, John Keells Holdings (JKH) and Hemas, to unveil their own accelerator programmes for startups innovating around their areas of business. Hemas’ programme, called Slingshot, has invested over Rs150 million in healthcare and logistics startups over two years.Similar data was unavailable for John Keells X, the accelerator programme of JKH.

However, funding sources thin out for companies further along the growth path, hitting a bottleneck at one point. “We need to attract investors focused on the venture capital space,” Gnanam says about VCs that invest in companies requiring funding in the final stages. At this stage, a company may be too small and a risk for private equity, but too large for a single funder to finance.

Private equity funds managed by Ironwood Capital Partners and NDB-Zephyr are seeking established ventures for investment, ones that are less risky to those VCs typically finance.

Gnanam wants to encourage more venture funds, corporates, diaspora and angel investors to facilitate foreign market access and offer affordable, high-quality accelerator space.

By discussing the gaps, Crowdlsland’s Abeykoon expects more people will appreciate them and ‘come with their thinking caps on’.

Social and economic shifts provide added momentum to startups, which are better placed to capitalise on opportunities of the future. Sectors like banking, telecom, retail and media are being transformed by startups. For technology to succeed, however, it must be backed by an institutional set-up and an ecosystem.