Private Equity Fostering SMEs Development

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Wafik GraisViveris Mashrek

Chairman

SMEs: Behind the WordsOur Neighbors Entrepreneurs

For the EU, an enterprise qualifies as micro, SME, if it meets the criteria below. In addition to the staff numberceiling, an enterprise qualifies as an SME if it meets either the turnover ceiling or the balance sheet ceiling, but not necessarily both

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Enterprise Category

HeadcountTurnoverOrBalance Sheet total

Medium< 250< Euros 50 mnOr< Euros 43 mn

Small< 50< Euros 10 mnOr< Euros 10 mn

Micro< 10< Euros 2 mnOr< Euros 2 mn

SMEs: Mainstay of Most EconomiesEgypt

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Sources: Small and Medium Enterprises Unit, Egyptian Banking Institute, Central Bank of Egypt; CiCapital Research, November 11, 2008; IFC survey and derived calculations

SMEs Size

More than 40% of GDP, or more than USD 75 bn

Number of SMEs

Estimated at 45,000 SMEs

SMEs macro contribution

92% of private enterprises

20% of Egypt’s exports

80% of labor force

Trade29%

Others28%

Manufacturing

43%

Construction

Tourism

Business Services

Oilfield Services

Education & HealthCare

Accessing External Finance Egypt's SMEs’ Challenges in Numbers

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Sources: World Bank Report “Access to Finance and Economic Growth in Egypt”, 2006; World Bank ICA (2004)

15%Access to finance

SMEs vs large firms15%

36%

85%

64%

0%

20%

40%

60%

80%

100%

SMEs Large Firms

Access to finance

No Access to finance

15%

7% of investments and working capital are financed externally (banking)

18% in the rest of the world, and 60% to 70% in most OECD countriesWorking

capital

Major sources of financeEgyptGlobal

Internal Finance for Investment86.2%61.9%

Bank Finance for Investment6.9%17.7%

Informal Finance for Investment0.9%4.4%

Supplier Credit Financing1.4%7.3%

Collateral (% of loan amount)123.6%141.4%

Loans requiring collateral89.4%80.6%

36%

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Accessing External Finance MENA’s Best, but Lagging

EGYPT SAUDI UAE SINGAPORE ARABIA

• Ease of Doing Business 106 13 33 1• Starting a Business 24 13 44 4 • Construction Permits 156 33 27 2 • Employing Workers 120 73 50 1 • Registering Property 87 1 7 16 • Getting Credit Getting Credit 71 71 61 61 71 71 4 4 • Protecting Investors 73 16 119 2 • Paying Taxes 140 7 4 5 • Trading Across Borders 29 23 5 1• Enforcing Contracts 148 140 134 13 • Closing a Business 132 60 143 2 • With Malaysia, UK, US, Israel and New Zealand among the first four, and Syria,

Timor Leste and Palau ranked 181 and 183, last three countries

Source: World Bank Doing Business 2010 5

• Getting Credit Getting Credit 71 61 71 71 61 71 4 4

Accessing External Finance SMEs Perceive Specific Hurdles

On Debt Markets• A size gap: their borrowing needs are

too small to interest institutional lenders

• A risk gap: lenders do not price loans to reflect risk, but reject loan applications if risk exceeds a particular threshold or insufficient collateral is available

• A flexibility gap: financial institutions do not offer flexible terms and conditions (matching)

• A knowledge gap : financial institutions do not understand entrepreneurial spirit and knowledge-based businesses

On Equity Markets• Familiarity gap: SMEs are not familiar

with the PE industry and may not know its existence

• Early stage gap: SMEs believe that small early-stage companies are not a strategic focus of equity investors

• Dollar gap: Many PE funds focus on large tickets and not specialist of SMEs issues

• Institutional gap: SMEs may resent PE’s C-Governance role in their business

• Exit options gap: Limited number and fear of implications

Adapted from: Supporting Small Business Innovation: Review of the Business Development Bank of Canada, Montreal, 20016

SMEs Built Granada’s Patio of Lions

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Private Equity: Behind the Words

• Private equity: capital invested in companies not publicly traded on a stock exchange or invested as part of a buyout of a publicly traded company to take it private

• Here, we refer to FUNDS that raise capital through private placements to invest in not publicly traded SMEs according to a pre-defined investment strategy

• FUNDS’ investment strategies include venture capital, growth capital, turn around, leveraged buyouts, mezzanine capital

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Private Equity FUNDS: Intrinsically Shariah Compliant Instrument

Private Equity Funds Risks

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-Raise Mudaraba resources through Private Placements -Extend Musharaka to SMEs

PE FUNDS : Diversify SMEs risk investing in a portfolio and have strong say in SMEs'

business conduct ;SMEs: share risks with the FUND but accept to open business conduct

to the FUND’s scrutiny ;

PE Funds: Non-Bank Shariah Compliant Instrument to Support SMEs

• PE funds practicing equity growth or other investment strategies become SMEs shareholders offering a service bundle in the pursuit of shared capital gains

• PE funds offer SMEs – equity funding , – a broader capital base, – financial and technology networks,– corporate governance;– Management professionalization

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A PE Investment supports the corporatization of an SME and its ability to compete and grow

MENA PE Sector has Grown and Diversified Without Focusing on SMEs

Sector DiversificationSector focus of PE Investments 1998-2007

GrowthPE Investments (1998-2007)

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SMEs Require Specialized PE Funds Managers

• MENA has few SME specialists: few regional managers have an SMEs track record and focused skills to deal with SMEs/family businesses

• Traditionally MENA FUNDS made opportunistic investments in SMEs; now in fashion, SMEs attract PE managers with past opportunistic SMEs investment experience

• Disciplined strategy, specialized teams, strategy adapted deal flows, proximity and exit markets: critical factors for successful SME PE investments

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Disciplined Investment Strategy

• LPs are Restricted Investment Depositors (RID); A fund (Mudarib) offers to LPs (Rab ul Mal investors) a financial product that is essentially a RI Deposit

• LPs invest their deposits in a defined strategy; This RID is defined by its maturity, expected duration, the type of investment targets (e.g. size, early stage, equity growth), the targeted types of economic activities; a promising investment proposal defined by GP, and refined to suit LPs

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Successful SMEs PE Investments Require Specialized Teams

• Each fund’s management team is a core critical factor of credibility and success

• The team needs to have PE SME experience, i.e. having practiced the business

• There should be a matching of the team’s skills profile with the investment strategy (e.g. sector focus)

• LP should not fall in a “capture trap” by investing only with few established PE GPs, undermining PE competition, stifling SMEs opportunities

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Deal Flows Need to Match Investment Strategies, but Catch 22

• Need for organized information and networks to build up a deal flow; 5 investments may occur for a review of a hundred cases

• The Deal Flow proposal needs to be consistent with the strategy and target size of fund

• The catch 22 between availability of funds and shaping a robust deal flow

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Paradox: Egypt’s annual SME PE gap is USD 500mn, but building a deal flow is a challenge (info access and retrieval)

SMEs PE Investments: Need Proximity, Disciplined Implementation Capability

• Proximity: In the SMEs PE market, a Musharaka cannot be managed from a distance; the partnership with the SME requires constant presence and contact; technical and interpersonal skills

• Implementation: The PE manager’s corporate governance and management systems need to be transparent and robust

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Exits Are Risky But Options Are Developing

IPOIPO

Management buyoutManagement buyout

Owner buy-backOwner buy-back

Trade saleTrade sale

To foreign strategic investors looking to expand regionally or found a local champion or to local strategic investor looking to consolidate production or to expand through backward or forward integration;

When management does not hold stock option plans and desires an ownership stake in the value they create or management and ownership are split; helpful in generational transmission of SMEs’ ownership;

Business remains in owner’s control; may use put options at pre-determined valuation; PE provides long-term financing to owners interested in achieving desired growth, accessing business intelligence and network

Through notably Nilex, CASE SMEs’ window for companies with issued capital in the range from EGP 500 k to 25 mn; Nilex remains relatively inactive but flexible regulations should boost activity;

Stylized SME PE Fund’s Portfolio Portfolio Amount Entry Exit Exit Proceeds Multiple

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•CO 1 4.4 2010 2015 8.79 2.01 •CO2 5.4 2010 2015 17.90 3.30 •CO3 5.4 2010 2015 13.48 2.49

•CO4 5.4 2011 2016 17.90 3.30 •CO5 4.4 2011 2016 0.00 0.00 •CO6 4.4 2011 2016 8.79 2.01 •CO7 4.4 2011 2016 11.81 2.70

•CO12 5.4 2013 2018 41.14 7.59 •CO13 4.4 2013 2018 8.79 2.01

•CO8 5.4 2012 2017 13.48 2.49 •CO9 5.4 2012 2017 41.14 7.59 •CO10 4.4 2012 2017 8.79 2.01 •CO11 4.4 2012 2017 11.81 2.70

Total (USD mn) 63.0 203.80 3.23

Needed: SME PE Funds Investors with SME PE Risk-Return Appetite

• Institutional Investors: pension funds, insurance companies, Wakf organizations

• International DFIs: Arab Fund for Social and Economic Development, ICD, IFC, EIB, SIFEM, PROPARCO, FMO, BIO, OPIC,

• Banks• Wealth managers• High net worth individuals

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Regional LPs/Investors need to become more familiar with the PE industry, calibrate their return expectations and investment horizons

THANK YOU

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