What’s fueling Pakistan’s emerging start-up ecosystem

With a massive young, English-speaking population and a fast-growing, tech-savvy middle class, Pakistan has many ingredients for a thriving start-up ecosystem.

What’s fueling Pakistan’s emerging startup ecosystem

With a massive young, English-speaking population and a fast-growing, tech-savvy middle class, Pakistan has many ingredients for a thriving start-up ecosystem. So why is it only now starting to live up to its entrepreneurial potential, and where is it headed?

In this episode of the McKinsey on Start-ups podcast, McKinsey executive editor Daniel Eisenberg speaks with investor Aatif Atwan and McKinsey Partner Abdur-Rahim Syed about the burgeoning start-up ecosystem in Pakistan. An edited transcript of their conversation, which took place earlier this year, follows.

Daniel Eisenberg: Based on demographics alone, Pakistan’s start-up ecosystem should already have been thriving for many years. It has, for starters, the fifth-largest population in the world, approaching 230 million. And that population is both overwhelmingly young, with a median age of 22, and bilingual, with the fourth-largest number of English speakers in the world. Add to that one of the fastest-growing middle classes, more than 100 million mobile broadband subscribers, and hundreds of thousands of tech professionals, and you have all the makings of a fertile market for new enterprises and digital services.

Yet until recently, venture or growth funding in Pakistan was barely a trickle compared to similar countries in the Middle East/North Africa region or in other parts of Asia. In the last couple of years, however, global VCs and other foreign investors have begun making significant bets on local start-ups as many regulatory and cultural barriers have started to soften.

To gain a better understanding of the changing dynamics of this start-up market, we are pleased today to be joined by two experts based in the region. Aatif Awan is the founder and managing partner of Indus Valley Capital, a Pakistan-focused venture fund he launched in his native country after working as a tech executive in Silicon Valley for several years. Abdur-Rahim Syed is a McKinsey partner based in Dubai who co-leads the firm’s start-up work in the region. Earlier in his career, he also worked in Silicon Valley.

Aatif, Abdur-Rahim, welcome to the podcast. Thanks so much for joining us today.

Aatif, you launched Indus Valley Capital in 2019 after working in high-ranking positions at both Microsoft and LinkedIn. What has been changing in the Pakistan start-up ecosystem in recent years that convinced you it was the right time to focus on it in this way?

Aatif Awan: The funny thing is I didn’t see myself moving back to Pakistan at all, let alone starting a Pakistan focused VC fund, until I found myself in a position where I knew I had to do it.

In 2018, after leaving LinkedIn, I decided to take a year off. I spent about half of it in Pakistan with my parents. That’s when some Pakistani founders started reaching out to me, seeking advice on growth, product, or fundraising.

It was mind-boggling that between 2016 and 2018 Pakistani start-ups were averaging about $10 million a year in VC funding, which is $0.05 per capita, or about one-third of a basis point of the G.D.P. That did not make any sense whatsoever. Next door, MENA was doing $800 million in annualized VC funding. And when you looked at the fundamentals in Pakistan, which I started looking at closely, it’s the fifth largest country with 200 million plus people. The median age is 22, which makes it the fourth largest Gen Z and younger population. It’s also the fourth largest English-speaking population and has had the fourth largest absolute increase in middle class.

So, the foundational elements were all in place, and then you had this population increasingly adopting the internet. We had more than 50 million broadband subscribers back in 2018. Now it’s 110 million. The tech talent to build those start-ups was there as well, with 300,000 plus tech professionals. I realized that it was just a matter of time, as we are at the cusp of this inflection point of a very large economy making that offline to online transition.

We’ve seen that happen in the U.S., in China, Indonesia, and India. Whenever that happens it creates massive opportunities for impact as well as financial opportunity. That made the decision obvious and quick for me. I knew if I didn’t do it, I’d regret it. I decided to move back and start Indus Valley Capital, which is a Pakistan-focused early-stage VC fund.

Daniel Eisenberg: Abdur-Rahim, you also worked in Silicon Valley early in your career. First at eBay and then at McKinsey, and you’re now based in Dubai.

For years the Middle East has far outpaced Pakistan in attracting VC funds, as Aatif pointed out. The gap now seems to be closing a bit. Why in your view did it take so long for Pakistan’s start-up ecosystem to start to take off, even though it had this foundation that Aatif was talking about?

Abdur-Rahim Syed: The gap is certainly closing, but the whole region is accelerating. If you take Saudi Arabia, the largest economy in the MENA region, they had $140 million of VC funding in 2020. In 2021, they had $548 million. That’s almost quadrupling in one year. Pakistan is on a faster trajectory, so the gap is closing.

As for why it took so long, if you look at the macroeconomy of Pakistan it’s been long dominated by agriculture, and by conglomerates that often have captive businesses. There’s not a burning platform, a driving reason to innovate, to take risks. I’ll give you one example. Take gross capital formation, which is a critical enabler of future growth. Pakistan’s gross capital formation in the last couple years has been roughly 15 percent of G.D.P, compared to 30 percent for India and 32 percent for Bangladesh. Hopefully this will change now that we have a significant acceleration in the start-up space.

Daniel Eisenberg: Aatif, you have a unique perspective with your investments in Pakistan right now. What sectors or horizontals are dominating as the scene emerges?

Aatif Awan: It’s been super exciting seeing this dramatic rise of Pakistani start-ups over the last couple years. In 2021, Pakistan raised close to $350 million in VC funding. That ratio of 80 to 1 relative to MENA is now at seven to one, which is in line with the G.D.P. ratios. If you break that down, a vast majority has been e-commerce start-ups. This is very typical of emerging markets. At the beginning you see founders going after the largest chunks of the economy waiting to be online. That tends to be e-commerce followed by logistics and that’s what has dominated in the Pakistani start-up ecosystem for the past couple of years. Fintech is now rising on the back of some positive regulatory changes, including the introduction of new Electronic Money Institution (EMI) and digital banking licenses. We have also started seeing a pattern in the digitization of education and the health sectors, which can have a major impact on the country.

Overall, in 2021 more than half of all funding was e-commerce start-ups, which was split between the B2C and B2B start-ups. On the B2C side it’s ranged from commerce start-ups offering quick delivery of groceries and convenience items, to online ticketing, pharmacy delivery, and fashion shopping. On the B2B side we’re seeing a rapid digitization of the informal retail sector, which is essentially mom and pop corner stores that we call kiryana stores in Pakistan.

In terms of notable examples, I’ll mention two of the most well-funded start-ups, which in full disclosure were our first two investments. Airlift is a quick commerce start-up that has raised over $100 million in funding. They offer 30-minute delivery of grocery, pharmacy and household items. They are also expanding to electronics and have some very notable investors. They’re backed by First Round Capital, which is one of the earliest investors in Uber, Square, Notion, and Roblox. They typically don’t invest much outside the U.S. Airlift also got funding from Josh Buckley and Harry Stebbings, who are some of the leading solo capitalists, as well as from founders of Twitter, DoorDash, TransferWise, and many other top start-ups in the Valley. The other one I would mention is Bazaar, which is a B2B commerce and fintech start-up. They’ve raised over $100 million in funding.

If you look at the last two years, there’s been a little over $500 million in fundings. Airlift and Bazaar consumed $200 million of that. Bazaar’s investors also include some top tier investors like Target Global, Dragoneer and Acrew. They are essentially building the operating systems for B2B commerce in Pakistan with a platform that covers the marketplace, last-mile logistics, software, and fintech offerings.

To put things into perspective, Bazaar is just two years old. What’s exciting to see is that in a large, untapped market, when these start-ups come, they can grow very, very rapidly.

Daniel Eisenberg: Abdur-Rahim, I’m not sure if it’s too early to judge, given how young these start-ups are, but how concerned are you about a disparity between early-stage capital and later stage funding. I know in some markets early-stage capital has been relatively easy to come by, but obtaining later stage funding has been more of a challenge.

Abdur-Rahim Syed: It is a concern. But it’s not an uncommon concern among similar markets. Were we to have this conversation two years ago we would be asking if there is enough capital for series A. At this point, it’s clear there is enough capital for pre-seed, for seed and for series A.

Is there capital for series B? Aatif mentioned Airlift disclosed a large series B round recently and they have funding north of $100 million now as well. That’s only one example. The real question as we go forward is will the funding continue to flow? And at what speed?

There are three drivers of this question. The first is obvious. In the global macro venture capital environment there’s a lot of liquidity, a lot of global investment. Some of it is flowing towards Pakistan at an accelerated rate. Will that remain generous?

A second driver is in e-commerce and logistics. These are working capital heavy start-up spaces. Growth is very clear in a large consumer base, but growth is expensive. Can we begin to pivot to spaces where growth is less expensive and start-ups are less reliant on significantly large amounts of funding? Fintech is a great idea and we are beginning to head in that direction. Where beyond fintech will the start-up space go to next?

The third and often under-discussed driver is can Pakistani start-ups go beyond Pakistan? Once you go beyond Pakistan, go regional, go global, go to the U.S. market, the U.K. market, or to the MENA markets, you begin to tap into other funding pools. There’s the portfolio risk element of your series B, series C, series D being solved.

There is a start-up, a B2B food delivery platform called Retailo, which recently raised a $36 million series A round. They are headquartered in Saudi but operate in Pakistan, Saudi, and in UAE, and their founders are Pakistani. We need more stories like that, where Pakistani companies succeed in scaling in Pakistan, while scaling other markets in parallel.

Daniel Eisenberg: Aatif, what is your view of the potential for going global? It’s obviously a challenge for start-ups all over the world making that move from their home market to regions far afield. Is that going to naturally come, or do certain things have to happen to make that a reality?

Aatif Awan: I agree with Abdur-Rahim that it can be a very strong driver for continued momentum and growth, and we’re starting to see it. Retailo’s a fantastic example. They’ve shown this can be done very early. Prior to that, Careem proved the model as well, although it started in UAE. Another example is Zameen, which started from Lahore, Pakistan. It’s a real estate start-up that expanded out of Pakistan into the MENA region and ended up moving their headquarters to UAE. Zameen is a unicorn now.

So, we’ve seen an appetite among very ambitious founders to say Pakistan is a great market. You can build very large companies, but now that we’ve gotten those early stages of funding, why not go even bigger? I think we’ll continue to see that.

What we haven’t seen a lot of is building for the U.S. market or the European market with more of the enterprise-focused SaaS plays or deep tech plays. I think that is a matter of evolution. Eventually it would be exciting to start building more pure software start-ups and deep tech start-ups, which cater to these very large markets.

Daniel Eisenberg: Abdur-Rahim, we’ve already touched a little bit upon regulatory issues. In your view, what must happen for continued funding and innovation growth, whether it’s regulatory changes or how the private sector operates?

Abdur-Rahim Syed: A lot of it comes down to continued momentum, the evidence from funding rounds, and the success of start-ups. Even exits like Careem, as Aatif mentioned, inspire a new generation of students and professionals to go into the entrepreneurial space.

The question is, at what speed will it continue? Are there regulatory unlocks that can help ease this? Aatif mentioned that on the banking side you’re beginning to see some unlocks there. On the payment side, Pakistan does not yet have PayPal available, so international payment gateways would help the Pakistani engineering entrepreneurial base to move beyond the global gig economy on global platforms as well.

Daniel Eisenberg: I’m also interested in a country where conglomerates have traditionally dominated. Is there a change in attitudes these days toward entrepreneurs and business risk?

Aatif Awan: Absolutely. In terms of the culture, a few years ago the brightest young minds chose to either go abroad or work for multinational companies in Pakistan because that was the way to make big bucks. That has completely changed. Now they want to be founders or join start-ups as early employees. That’s been a phenomenal cultural shift.

In turn, the conglomerates are also seeing the writing on the wall and they want to partner with start-ups. Some of them are launching their own start-ups, which obviously has a mixed history. It’s very hard for large companies to innovate, and the model of having a start-up within a company often doesn’t work out that well. But the recognition is there.

On the regulatory front Pakistan has had some very forward-thinking regulators in recent years. They’re keen on enabling start-ups because the macroeconomic situation in Pakistan doesn’t look that great. There are still balance of payment issues. Businesses cannot grow too fast because they don’t have enough on their reserves. That hampers growth. The government and the regulators see start-ups as an opportunity to break out of that cycle, so they’ve been very keen to help. We have seen several initiatives from the regulator side, the most recent one being the establishment of special technology zones (STZAs). They offer some very lucrative incentives to foreign investors in terms of tax breaks.

In terms of cutting down the red tape, we’ve seen both the State Bank of Pakistan and the Securities and Exchange Commission of Pakistan (SECP) come up with regulations that enable the structuring of start-ups as holding companies abroad.

Originally published at McKinsey & Company