Private equity and venture capitalists in Egypt expand financial options for smaller companies

Despite strenuous economic circumstances in recent years, Egyptian banks displayed a relatively robust performance in 2016 in terms of profitability, which has, in turn, led to a jump in credit for small and medium-sized enterprises (SMEs) and start-ups. While healthy sector numbers and regulatory reforms have helped foster an increase in lending from traditional players, there is still a funding gap, which has resulted in the emergence of private equity and venture capital industries.

While lending to SMEs has historically been neglected in favour of big-ticket lending to corporates, which generally brings higher returns at lower levels of risk, banks are now looking to change this. Certainly, there is plenty of capacity to increase lending to SMEs; Egyptian banks have one of the lowest loan-to-deposit ratios in the MENA region, at 41.5% as of December 2015.

Sme Boost

Although a standardised definition of what constitutes an SME has yet to be agreed upon in Egypt, it is certain that there are a plethora of small businesses driving Egypt’s economy, functioning at a level below the domestic and international giants. “Egypt does not have a unified official definition of SMEs, as there is an array of different terms and phrases,” Omar El Maghawry, CEO of financial services firm FEP Capital, told OBG. “Some institutions define SMEs based on employee size, like the Social Development Fund, the Ministry of Investment and International Cooperation, and the Ministry of Foreign Trade; while others, like the Central Bank of Egypt (CBE), base it on capital size, asset value or turnover.”

In terms of capital, most of Egypt’s SMEs are on the lower end of the scale. “Results from a recent National SME Census by the CBE, the Central Agency for Public Mobilisation and Statistics, and Cairo University found that the country’s SMEs are generally small,” El Maghawry told OBG. “Roughly 82.6% have capital below LE250,000 (equivalent to $13,250 as of December 2016); 7.6% are between LE250,000 ($13,250) and LE1m ($53,000); and only 2% are above LE15m ($795,000).”

New Guidelines

As these businesses are responsible for the bulk of economic activity and job creation in the country, successive governments and CBE governors have highlighted the importance of extending credit to them. To encourage further lending activity, in January 2016 the CBE took a decisive move to limit interest rates on loans to SMEs to 5%, and directed banks to increase the share of SME loans in their overall loan portfolios to a total of 20% by the year 2020.

“The regulatory changes made by the CBE in 2016 are helping banks to support SMEs and encouraging the formal lending economy over the informal,” Dante Campioni, managing director and CEO of ALEXBANK, told OBG. “A key part of this has been the introduction of a subsidies lending scheme based on a very effective mechanism easily handled by the banks.”

In fact, a number of non-government-owned commercial banks have already taken specific steps to increase their lending to SMEs. Commercial International Bank, for example, serves SMEs through its Business Banking unit, a relatively new component within the bank’s structure, while other banks like QNB Alahli, Faisal Islamic Bank and National Bank of Kuwait Egypt have made increasing their SME portfolios a primary objective. A number of lenders have also seen positive results come out of their efforts to expand lending. Crédit Agricole, for example, which has operated a dedicated SME division since 2006, increased its SME portfolio six-fold in the three years leading up to 2014.

As a result, much of the sector is reasonably well positioned to meet the CBE’s new target, and with the robust performance of the country’s lenders, the ability to ramp up SME lending is clear – although with the entire industry chasing a limited number of bankable SMEs, competition is likely to be fierce as the four-year deadline approaches, which could spell more attractive lending terms for smaller businesses.

Expansion Of Private Equity

In the meantime, with demand for SME and start-up credit currently exceeding the available supply, a number of alternatives have come to fill the space, including most prominently private equity (PE) players.

The nation’s status as a target for PE dates back to 2001, when it was included in the MSCI Emerging Markets Index, a development that transformed what was previously a conservative environment dominated by staid institutional investors into a more dynamic arena populated by asset managers, exchange-traded funds, hedge funds, sovereign wealth funds and PE players.

The government’s decision to implement a privatisation programme further spurred PE growth, and between 2005 and 2009 the country was the number one destination for PE investment in the MENA region, attracting an estimated $2.5bn.

Rapid Rise

Political unrest and concerns regarding currency risk have dented enthusiasm over recent years, but in 2015 the country still accounted for 19% of PE investment in the region, according to the MENA Private Equity Association, behind only Saudi Arabia in terms of value. Egypt was also the source of one of the biggest regional PE developments of that year, when the Duet-CIC Egypt Opportunities Fund raised $300m.

This impressive performance in terms of PE is not surprising, given the country’s underlying comparative advantages. The country’s domestic consumer market is considerably larger than its regional neighbours, for one, and Cairo is among the most densely populated cities in the world, with a population of approximately 45,000 per sq km, which is one and a half times the population density of Manhattan.

These factors make Egypt the ideal stage for the demographic plays global investors are so enamored of, but the appeal of the nation extends beyond basic indicators. While the government’s reform agenda may not have been implemented as quickly as some would like, its approach has in general been a usefully disruptive one in important areas of the economy, with policies such as the flotation of the Egyptian pound in November 2016 and the consequent easing of capital flows doing much to help Egypt realise its potential.

Venture Capital

These traits have also helped attract private investment at the smaller end of the scale, particularly in terms of venture capital (VC). While traditional PE in Egypt has historically focused on more established enterprises, early- and growth-stage investment is becoming increasingly prominent, with a broadening network of funders and incubators. Among the most recent examples of this is Alexandria Angels, an Alexandria-based VC company, which launched in late 2016. The initiative is a joint venture between a group of funders led by the founder of the Techie Summit – itself an important component of the country’s emerging start-up universe – and Germany’s international development agency, GIZ.

While details regarding Alexandria Angels’ operations have yet to be revealed, the new venture, which is the first of its kind in Egypt’s second city, is already accepting business proposals from start-ups in Alexandria and the Nile Delta. The initiative joins several other high-profile angel investment networks, such as Cairo Angels and KI Angels, although there are very few individual angel investors in Egypt.

Incubators

The same month saw the Federation of Egyptian Industries (FEI), one of the country’s largest employer organisations, announce the launch of a new incubator. The facility will be operated by the Federation’s CIT division and focus on digital media initiatives.

The FEI incubator is only the latest entrant in the country’s ecosystem of independent start-up incubators, which include projects such as Flat6Labs, Delta Inspire, Start-up Egypt, Tamkeen, Endeavour Egypt, Intilaaqah Egypt, Nahdet Masr and the government-run Ayady. The American University in Cairo also houses the AUC Venture Lab, which was established in 2013 as one of the country’s only university-supported incubators in Egypt, catering to early- and growth-stage start-ups.

However, while there has been a noticeable rise in supporting infrastructure for start-ups and young companies over the past few years, the overall capital inflows to the segment are limited. Egypt accounted for just 2% of MENA VC volume in 2015, with countries such as the UAE, Lebanon and Saudi Arabia outpacing it. The result is a structural weakness in the investment ecosystem, whereby early-stage VC investors are faced with limited prospects, as the lack of a vibrant angel investor community constricts the potential deal flow.

Barriers To Development

The situation is a frustrating one for players in the regional investment community, given the promise of Egypt as a useful destination for capital and the efforts that both the Egyptian government and the private sector have made to develop a healthy and robust start-up environment continue to face a large number of challenges.

One of these is a narrow focus by early- and growth-stage funders. A report by the Swedish Trade and Investment Council noted that the Social Fund for Development, which is the government body that supports small and micro-enterprises, largely targets traditional start-ups that lack the elements of innovation angel and VC investors are more interested in. At the same time, both angel and VC players tend to ignore established sectors, such as industry and agriculture, even though they are among the primary sources of income in the domestic economy.

Regulatory Constraints

The legal and regulatory framework surrounding investment also acts in places as a significant hurdle to the development of the start-up arena. Such barriers include somewhat complicated procedures for starting a business, despite the efforts of the General Authority for Investment and Free Zones to streamline the system.

The cost of closing a business – an inevitability at some point in the careers of many entrepreneurs – is also quite high, with the process often taking up to one or even two years. Egypt ranked 122nd out of a total of 190 countries in the 2017 ease of doing business index published by the World Bank, down from 109th in 2013.

Lastly, a lack of formal entrepreneurship education or training represents a further block. This includes fundamental areas, such as writing business plans, financial feasibility studies and management skills, but also a more generalised problem of accessing data.

Establishing trends and collating market information is particularly challenging due to poor bookkeeping and reporting in many sectors, the inconstancy of data, and because the government in some instances shares too little information with the public. This is compounded by limited support for SMEs more generally, as well as educational and social norms that tend to limit entrepreneurial risk-taking by young graduates.

Ultimately, these challenges have not deterred a handful of VC investors from moving into the country, nor have they prevented some lucky early-stage start-ups from benefitting from both the tutelage and capital of private players. However, the industry is far from realising its potential. In light of Egypt’s attractive underlying traits and strong growth in the larger PE sector, there is ample room to expand the financing of younger companies, if these hurdles can be cleared.

 

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The Report: Egypt 2017

Banking chapter from The Report: Egypt 2017