Take pretty much any of the well-funded Pakistani startups and you will find one thing in common: their registered (parent) entities for legal purposes are almost always abroad. Be it Bykea, Tapmad or anyone else. Why? For starters, tax considerations.

It’s a fairly common practice in the business arena, especially the tech sector, to set up offshore companies in countries with lax fiscal rules. Perhaps even more importantly, let’s not forget that we are still a particularly high-risk state. So despite the much-cited population dividend, many investors aren’t still not too open to invest here directly no matter how attractive the opportunity.

However, until recently even this offshore route was beyond the reach of most founders, at least those with tax residence in Pakistan. The foreign exchange regulations didn’t allow them to hold equity in a foreign holding company. This meant that even when an entrepreneur had managed to woo an investor to fund his/her startup via a registered parent company abroad, they were barred by law from having any ownership in it.

“At the time of raising our Series A in 2019, we asked the regulator that the money be marked repatriable so that at the time of exit, whenever that happens, there are no complications or discounts to be paid. They required a shareholding capitalisation table and refused to grant the request since being a Pakistani resident, I was not allowed to hold equity in a foreign holding company,” Bykea’s founder CEO Muneeb Maayr explains his experience.

“For me to have ownership in an entity abroad, the law sought the money trail as to how I got those funds in the first place. But in startups, that ownership is because of the employee stock options, which again didn’t have legal recognition,” he adds.

The offshore route was beyond the reach of most startup founders until recently because they couldn’t hold equity in a foreign holding company

“We had to take a very expensive legal route instead and simultaneously started engaging with the State Bank of Pakistan (SBP) to drive two major changes: first, that a Pakistani can be on the cap table of a foreign holdco, and second, employee stock options are given legal recognition,” tells Mr Maayr.

“This was the biggest regulatory hurdle facing local startups and limited their chances of securing foreign investment, which most of the time has to be routed through the establishment of a foreign holdco. The amendment also gives the right signal to international investors regarding Pakistan as a market for investment and to our young population that they can fulfil their ambitions without having to move abroad,” says Mubariz Siddiqui, general counsel at Sarmayacar, who was instrumental in driving this policy change.

Much to the relief of the local startup community, that restriction was done with by the SBP the past week as it amended Chapter 20 of the Foreign Exchange Manual. Now a tax resident founder, living and doing business in Pakistan, will no longer be at a disadvantage compared to his/her dual national counterparts who were not barred by any such restrictions.

Not so surprisingly, far too many of the startup founders in the country raising any serious investment usually happened to have a foreign citizenship. Can we say that this new regime will trigger a wave of born-and-bred-in-Pakistan local entrepreneurs in raising money? Maybe. For both Mr Maayr and Mr Siddiqui, this has been the case because of their skillset or, more appropriately, the exposure that comes along with an international background.

“Honestly 99 per cent of the people don’t even know about this issue. That said, the change will definitely help the next generation of entrepreneurs who are being groomed in the local ecosystem,” says Bykea’s founder CEO.

Moreover, the general permission granted for employee stock options should also make it easier for young companies to attract better talent. Around the world, startups, which are often under-resourced, offer some equity stake to compensate for their inability to match market-competitive salaries. Allowing the same provision to Pakistani upstarts will provide them with a greater pool of candidates which, according to most founders, is their biggest challenge.

The new rules also make it easier for Pakistani export-oriented companies to set up subsidiaries abroad against specified remittance criteria. That again has eliminated the need for entities to run from the windows of one government office to another seeking permission, then waiting for months and even years for approvals.

There’s also something in store for the small retail investors who have long been fascinated by the international markets but were barred from investing in them. They have been allowed to invest up to $25,000 (or less than 1pc of the investee’s value) in foreign companies. Hence, no longer one has to find a distant relative in the United States and then trade through their Robinhood accounts.

In a dollar-obsessed country like ours where half of the macro policy is about making sure the external account is stable, offering (much-needed) relaxations to startups is a serious show of confidence from the regulator and should not be understated. Let’s hope the local founders manage to make the full use of it.

Published in Dawn, The Business and Finance Weekly, February 15th, 2021