The coronavirus pandemic forced the economy to come to a standstill. Its disruptive effects were felt by everyone. Here in Sri Lanka, much attention has been given to the salary cuts enacted by large corporates due to lost revenue. But the impact has been even harder on smaller businesses. Already, several startups have seen their revenues dry up and are now fighting for their survival. Recognizing this issue, Hatch and KPMG prepared a report on the current state of the ecosystem and what needs to be done to fix it. Announcing its launch, Hatch organized a webinar to discuss the topic further and explore what can be done to help startups through this crisis.
Challenges startups face & potential solutions
Even before the coronavirus pandemic, one of the biggest challenges faced by startups was access to funding. Naturally, given the curfew forcing the economy to come to a standstill, this was one of the biggest issues faced by startups. “Around 70% of startup funding comes from friends and family. Banks are a small portion. Private equity, angel capital, and venture capital is only 10%. So it’s a very small community funding startups,” said Shiluka Goonewardene.
He added that it’s next to impossible for startups to obtain credit, “for reasons that are no faults of theirs nor the banking system.” From the standpoint of the banks, given they take money from the public, it’s a hard ask for them to take a chance with a young company. Hence, Shiluka argued that the government should consider stepping in to assist both parties.
The challenge of financing is also deeply linked to another. Due to the economic downturn, companies everywhere have laid off staff and reduced salaries. Startups have also been forced to make this choice, with Shiluka adding, “two-thirds of their costs are dedicated to staff.” Further, Sri Lanka has strict labour laws, which alongside the strong pension scheme with the EPF & ETF, offers great protection to employees. But during this crisis, it presents companies a tough challenge.
Despite all these challenges, Shiluka pointed out that startups, “must still meet their tax obligations.” Thankfully, the VAT threshold being increased alongside that of income tax has eased the burden for several companies. Yet, given how startups may not be able to get a skilled accountant or tax advisor, there’s more that can be done to support them. This includes improving the process to award government tenders.
In response to these challenges, Founder of Veracity AI and Co-Founder of Hatch, Jeevan Gnanam proposed a few solutions. Among them were to subsidize the cost of utility payments for startups in the short-term, help identify the risk profile of startups to allow banks to make more informed decisions, offer workers the option of investing their EPF/ETF into the company, and tax incentives to encourage investors to fund startups.
Listening to the founders
Earlier this month, ICTA in partnership with Startup Genome, conducted a survey. Its purpose to identify how startups have been affected by the coronavirus pandemic. During the webinar, Chairman of the ICTA, Jayantha De Silva alongside Program Head at ICTA, Sachindra Samararatne highlighted some key findings from the survey.
The survey had 107 respondents, which was the highest number of responses Startup Genome received globally. Unfortunately, when digging into the data, things look bleak. In Sri Lanka, 88% of startups only have 3 months of runway left. From that number, 43% don’t have enough cash to survive until the end of June. Further, 39% of local startups have seen their revenues drop by 80%. Even worse, 22% have seen their revenues drop by 100%. You can check out the full report by clicking here.
Shedding more light on the struggles startups are going through, Cofounder of Hatch, Brindha Selvadurai shared the story of one of their members, “They operate in the travel sector and began recovering from the deadly easter attacks. But when the coronavirus struck, they had to cancel bookings and refund customers. With the dollar appreciating, they were struggling.”
Having seen several other stories like this, Hatch began running several programmes to support startups. Reflecting on these initiatives, Brindha noted that a critical need among founders was mental health support. She also added that during their Kickass bootcamps, they noticed several women with business ideas are still keen to learn the skills needed to run a startup.
Lessons from a neighbouring startup ecosystem
Taking a step back and looking across the region, it’s evident that Sri Lankan founders aren’t alone in their struggles during this pandemic. Senior Partner & Co-Founder of ScaleUp Malaysia, Dr. V. Sivapalan shared that Malaysian startups were in equally dire straits. Quoting a study done by the Malaysian Global Innovation & Creativity Centre, he pointed out that Malaysian startups too are in dire straits..
Following the crisis, the Malaysian government has also offered stimulus packages. But these are aimed at SMEs rather than startups. Dr. Sivapalan pointed out, “There’s a difference between startups, especially those in technology and conventional companies. For tech startups, the biggest expenditure is staff costs. Whereas for conventional SMEs they’ll have several other material costs.”
Despite this difference, Dr. Sivapalan acknowledged the Malaysian government’s efforts to support startups. Many of these efforts mirror the recommendations presented by the report prepared by Hatch and KPMG. These include staff salary subsidies, rental relief for those in government facilities, government-backed low-interest loans, grants for those developing solutions tackling the coronavirus, tax benefits for angel investors, among others.
Having analysed the situation in Sri Lanka, Dr. Sivapalan suggested, “You need to present a holistic plan for the startup ecosystem. Look at funding from the early stage to the later stages. Identify all the different methods available from grants, debt financing, and anything else. This plan should be created and presented to the government. The collective voice of the industry should push for its implementation to develop the startup ecosystem.”
Of course, Sri Lanka’s massive debt is no secret. The current crisis has only further complicated the issue, with the Treasury stating, “state revenues had regressed, and fiscal space had reduced due to rising costs from Covid-19 and climate-related damage.” Acknowledging this, Dr. Sivapalan stated that the Malaysian government has also been cash strapped given the crisis. “They were creative. Instead of offering money, they offered a guarantee to the banks and allowed crowdfunding platforms to operate. This lowered risk and offered a gateway for startups.”
How Investors are adapting to the crisis
Back in March, the Lankan Angel Network announced the launch of its Angel Fund. Worth Rs. 100 million with 100 individuals each investing Rs. 1 million, its purpose is to invest in local startups. The Angel Fund also aims to offer wider visibility while curating and preparing founders with the knowledge they need when pitching to investors.
Further, LAN will adopt a hands-on approach for startups accepted into the programme. “Once you invest in a company, there’s a lot of effort you have to put into supporting it. Especially through tough times like what we’re seeing today. With this initiative, we will provide this support on behalf of the angel investors,” said CEO of the Lankan Angel Network, Chalinda Abeykoon.
He went on to share that the original vision of the fund was to be open to startups across all sectors. But only a week after the fund was launched, the strict lockdown due to the coronavirus came into effect. Forced to adapt to changing circumstances, Chalinda explained, “With the coronavirus, what we’ve done is to focus on industries, which have potentially regionally – not just in Sri Lanka. Equally, we’re also focusing on industries the government is promoting. Ideally, we want to be at the intersection where it benefits the Sri Lankan economy as a whole with companies that can expand regionally and globally.”
What to expect down the road
Looking towards the immediate future, Chalinda expects to see more entrepreneurs. “Towards Q3 or Q4, I expect there’ll be more mature entrepreneurs. We saw the corporate sector had to enact heavy pay cuts. Experienced individuals in their 30s and 40s preferred to have a steady paycheck over pursuing a startup idea. But with reductions as high as 50%, some may change their minds. Capital is available and given the support structure we’ve built, especially with a few expats involved with the fund, we’re looking to build bridges to new markets.”
However, if Sri Lanka is to position itself as an attractive startup destination then there’s much to be done. Shiluka highlighted that due to the existing tax laws, “It’s better to set up a fund offshore and invest in Sri Lanka rather than setting it up here. We don’t have the appropriate financial vehicles, but if LLP structures were to be implemented, things would change.” It should be noted that the budget has called for its implementation. While calling for the same measures, Jeevan also posed the question of the government matching the amount investors put into startups.
Over the years, Sri Lanka has built a robust support network of startups with private investors, accelerators, and other organizations. But in extreme scenarios like the coronavirus pandemic, the system can only mitigate so much. This is evident as seen in the report prepared by the ICTA and Startup Genome. There’s a clear need for government support. However, given Sri Lanka’s debt obligations this too is limited. Yet, despite the odds, some remain optimistic. To quote Jeevan, “These are challenging times. But if we can put our heads together and take bold actions, I think we can make Sri Lanka an exciting startup destination.”