The “new normal” oil price of $45 per barrel has encouraged a spurt of start-up activity and diversification across markets in the Middle East. It was recently reported that over 22,000 SMEs were registered in Dubai in 2015 alone, an 18 per cent year-on-year increase.
This blossoming start-up sector has presented great opportunities for venture capitalists, with seasoned fund managers predicting the “floodgates opening” and a growth boom in the next four years, particularly given the relaxation of sanctions against Iran in The first quarter of 2016. The current squeeze on liquidity and a struggling jobs market contrasts with an insatiable consumer appetite for new and more convenient products and services from a young and tech-savvy population — it is no wonder then that the start-up scene is doing so well.
Despite reports claiming that SMEs constitute some 60 per cent of the UAE’s GDP, one of the major issues facing entrepreneurs is lack of access to appropriate funding, with debt finance not really being a viable option given how “risky” lenders view start-ups. As SMEs are forced to look elsewhere for financing, well-placed venture capital funds and angel investors are on hand to add real value to start-ups, and capitalise on the exciting opportunities presenting themselves.
The venture capital market in the Middle East has seen significant development in recent years, with the number of private and government-sponsored VC funds and initiatives growing rapidly. Such incentives include the $400 million per annum allocated by the Central Bank of Lebanon for Lebanese banks to invest in start-ups. These initiatives are also well demonstrated in the UAE, where a number of long-established government-backed funds such as the Khalifa Fund for Enterprise Development (currently committed to financing at least Dh150 million to Dh200 million annually), Dubai SME, and the decision by Expo 2020 to encourage SME involvement in projects by simplifying the tender process.
There are also initiatives launched through free zone authorities such as Dubai Silicon Oasis’ fund and its “Silicon Oasis Founders” incubator facility, and similar incubation facilities in DMCC and DCCA free zones. These are designed to help generate a successful start-up culture in the Middle East, and to help them grow.
However, despite the public sector initiatives, it is arguably the private sector venture capitalists who have been stealing the lion’s share of headlines of late, led by specialists such as BECO Capital, Middle East Venture Partners, STC Ventures and Wamda Capital. While these firms have demonstrated a commitment to the market through the number and scale of their regional investments, it is the proven ability of these funds to complete successful exits (BECO has completed six already) that is the real success story.
This success instills confidence in the SME market, and in turn helps venture capital funds to raise further capital for deployment. For example, Middle East Venture Partners closed its fourth fund at the end of last year bringing it to a total of $120 million.
This invigoration of a booming sector has led to some interesting and encouraging developments. Whilst it is a given that venture capital funds can provide the financial support required, these funds must now differentiate themselves from the market to compete for opportunities. It is no longer just about capital; now the fund’s management team must be able to demonstrate an ability to grant SMEs access to the new markets, customers, sectors or jurisdictions, and to bring the business onto the international stage.
A further development is the opening up of a new stream of investment opportunities for growth capital/Series C and PE (private equity) funds. In sharp contrast with venture capitalists, many PE investors describe the Middle Eastern M&A market as “nervous” at best given the current macroeconomic climate.
The lack of organic PE deal-flow has resulted in some funds turning to the secondaries market in lieu of traditional opportunities — something which was virtually unheard of until recently. Therefore it is with some degree of relief that a successful venture capital exit market has developed, offering a new spectrum of potential investments for PE funds.
A prime example is Careem’s success, which led to the well-publicised involvement of PE investors including the Abraaj Group and the Kuwait Investment Authority in its Series C fund-raising. The flip side of that coin is that venture capitalists are encouraged by the existence of a proven exit strategy.
Overall, the outlook for the venture capital community (and its beneficiaries, the SMEs) is fascinating. The region still suffers from relatively high red-tape and high cost of establishing new businesses.
However, the existing low tax regimes and government incentive plans are helping facilitate some exciting innovation, helping to offset the negative effects of the “new normal” price of oil.
John O’Connor is a Partner at CMS, Dubai, while Katherine Winny is an Associate.
