Written by Rami Cassis
Private equity as an asset class initially thrived in the Middle East.
From the late 1990s onwards, fundraising received significant interest, which led to many first-time funds raising a sizeable amount of capital in a short amount of time. By 2007, arguably the better days of the sector, more than $6.2 billion was raised by funds dedicated to investing in the region, with more than 100 private equity firms estimated to be operating there.
However, along came the 2008 financial crisis – and things have never been the same again.
By 2009, fundraising had slowed to just over $700 million, a drop of over 82 percent from the prior year. Fast forward to 2020, you will only count around 12 private equity firms operating in the region, a huge drop from the 100 or so operating before the financial crisis.
Why? After all, the business-pages have been filled with Middle East mega-deals in recent years, giving the view that everything – at least on the surface – is rosy.
However, like most headline-grabbers, deals such as these tend to be isolated. And what about the smaller to mid-sized companies that dominate the region? What needs to change to ensure they can access private equity, helping the MEA region to thrive even further?
Improving deal liquidity in the region will benefit from the introduction of some specific factors – three of which I outline below.
Firstly, greater transparency of reporting and the establishment of adhered-to accounting standards would achieve much greater trust in the eyes of potential overseas investors.
As an example, the USA has the Generally Accepted Accounting Principles (GAAP), a common set of accounting principles, standards, and procedures issued by the Financial Accounting Standards Board (FASB). Public companies in the United States must follow GAAP when their accountants compile their financial statements. However, compare this to the P&L documents in various MEA countries and regions, where there is no common standard and multiple methods of presenting data.
If you are a potential acquirer, such as a private equity firm from elsewhere in the world, it is essential to have complete confidence in the integrity of the numbers.
The ownership structure of companies is also a factor that currently causes some issues.
Up until relatively recently, an overseas investor could not own 51 percent or more of a local company – hence the establishment of free-zones in the UAE. This has recently changed in the UAE and a non-UAE national is able to control their own “on-shore” legal entity. Despite such a positive change, in other countries in the region, one still needs to find a local partner.
Putting aside the potential complexity of a local partner, a recognised legal framework is essential to promoting M&A transactions in the knowledge that there is real recourse to a breach in the terms of a Sale & Purchase Agreement. English law is often used as the proxy legal standard in the region, but this appears to be more discretionary than an established standard.
Of particular importance in the eyes of an acquirer is the notion of Representations & Warranties made by the seller which the acquirer will rely on to seek punitive damages if those turn out to be untrue or misleading (“reps & warranties” are effectively statements / assertions made by the seller about the company). If these are made in the context of a legal framework that renders them unenforceable then this will strongly discourage any acquirers.
The establishment of a robust legal code or framework across the region – effectively a legal jurisdiction – will give confidence to investors.
The recent development of women as a major force in employment and productivity is an area for which the governments of multiple countries within MEA should be applauded. Huge efforts have been made in recent years to ensure women are valued as vital components of the workforce and the leaders of tomorrow.
Such initiatives are undoubtedly a step in the right direction – but further support to ensure women thrive in traditionally male-dominated environments such as line management, technology and sciences will be a major factor to improve the region’s productivity and diversify from oil & gas.
Part of the obstacles to growth and deal flow is access to a talented and qualified resource pool hence the promotion and development of women as a major contributor to the workforce will become increasingly important in the context of inward M&A investment and subsequent regional growth.
By addressing issues such as these, the vitally important mid-tier sector that dominates this thriving region will potentially become increasingly attractive to investors in the knowledge they can transact and subsequently grow companies without relying on expatriate labour.
Whether the private equity market itself will return to the levels seen before 2008 remains to be seen – but increased liquidity within the region will certainly be a step in the right direction.