When Silicon Valley-based Yahoo acquired Maktoob.com last August for a reported $85 million, it barely made a ripple in U.S. technology circles. But the acquisition of the leading Arabic online community had a seismic effect on the Middle East, a region that is just getting to grips with what Silicon Valley and the like have been doing for years. Samih Toukan and Hussam Khoury, Maktoob’s co-founders, became overnight stars, not to mention inspiration for budding entrepreneurs across the region. Among the many kudos, the King of Jordan awarded them the King Abdullah Medal of Honor and subsequently decided to set up funds to back hundreds of new businesses over the next few years.

While extraordinary for the Middle East, Maktoob’s story would be familiar to anyone following Silicon Valley. The founders began their careers as consultants in the early 1990s, eventually gravitating toward web services before launching Maktoob.com at the end of the decade. But finding local sources of capital to help the company grow was tougher than what their Silicon Valley counterparts have to go through.

Because there were no regional venture capital firms at the time, Maktoob’s founders scrambled to make ends meet until they were able to turn to a U.S.-based hedge fund called Tiger Global for financing. As for other funding sources, they didn’t even entertain the thought of an initial public offering since that was simply something Middle Eastern technology startups didn’t consider. But ever since the deal with Yahoo was struck, the bar for what an Arabic startup can achieve has been dramatically raised. “For a country like Jordan, this was a big deal,” Toukan says. “In fact, it was unheard of in the whole Arab world.”

‘A Problem and An Opportunity’

No one will mistake the Middle East for Silicon Valley any time soon. But the buzz around startups is unmistakable. There is a nascent technology press emerging to cover the Arabic tech scene and networks of entrepreneurs are growing. After years of looking to the United States for financing, a handful of Arabic venture capital firms and angel investors has been established. At the same time, various other public- and private-sector initiatives have been launched to boost the regional entrepreneurial economy.

There is little time to lose. The region’s economic growth could soon be increasingly dependent on its budding tech entrepreneurs for generating new jobs and investment. Economists estimate that the region needs to create 90 million new jobs in the next 10 years to keep its burgeoning younger generation out of unemployment. That is a tall order — the oil-driven economy only created 60 million jobs in the last 50 years. The region’s oil and gas sector “doesn’t generate jobs, and it isn’t spread around enough to support everyone,” says Peter Cappelli, Wharton professor of management and director of the school’s Center for Human Resources. “Populations are growing faster than the oil money. Having lots of unemployed people sitting around is bad for society, even if the countries could afford to support them.”

Habib Haddad, the Lebanese born co-founder of Yamli.com, an Arabic language search engine based in Cambridge, Mass., adds that with 70% of the region’s population under the age of 35, “the population is super young.” According to Washington, D.C.-based Population Reference Bureau, the current “youth bulge” is “unprecedented” in the region’s history.

At the same time, the younger generation represents a huge potential market of technology consumers, notes Haddad. There are 22 million mobile phones in use in the region and it’s one of the fastest-growing markets in the world in terms of Internet usage. “The next billion Internet users will come from the Middle East,” and most of those will be from the younger generation, he predicts. “That makes the region’s youth a problem and an opportunity.”

Clearing the Cultural Hurdles

For the moment, though, the odds are still stacked against someone who wants to start a company in the Middle East. Consider the difficulties Elie Khoury, 24, faced in launching his company, Woopra. Khoury studied hardware engineering at Lebanese American University before switching to software. Along the way, he had a classic entrepreneurial moment: He wanted to track who was visiting the websites he was building. When he couldn’t find a tool he liked, he decided to build his own, and reckoned others would want it too. But after deciding to start a company, Khoury faced the hurdle that trips up many Middle Eastern entrepreneurs: culture. For one thing, starting a company does not carry the prestige that getting a job with a well-known large company does. For another, there is little support and lots of skepticism. “My friends said, ‘This can’t happen from Lebanon,'” Khoury says. “My parents were supportive, but of course they didn’t believe it would succeed.”

Having read Silicon Valley blogs like TechCrunch for years, Khoury had reckoned that venture capital and angel funding were easy to come by. But the Middle East attracts so little venture capital that no major VC indices track it. According to the Zawya Private Equity Monitor, Arab private equity funds raised US$5 billion in 2008, of which only US$72 million was allocated to venture capital funds. In its most recent annual Venture Capital Attractiveness Index, consultancy Ernst & Young ranked the Middle East fifth out of eight regions, ahead of Eastern Europe, Africa and Latin America. According to Renaissance Capital, the Middle East has accounted for only 3% of the world’s 197 initial public offerings so far in 2010.

Finding out how difficult it is to raise startup capital in the Middle East was an eye-opener for Khoury, whose team took on freelance projects to pay the bills. But there was an upside, he contends. “When you do things on your own and you use your own resources, you can be more efficient,” he says. But eventually he needed more money for additional servers and employees. He renewed the search for investors, this time outside the Middle East, and managed to raise US$500,000 from a group of American investors.

While Khoury lives in Beirut, Woopra’s headquarters are now in Dallas, Tex., near most of its investors. The new location provides additional advantages over being back home, like access to faster broadband connections. Despite the obstacles, Khoury views his story and Woopra’s as a sign of progress. “It’s easier these days to connect with people in other regions,” he notes. “That wasn’t really there a few years ago.”

Click here for an expanded version of this article.