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Thursday, 7 April 2022

Egypt wants VCs to invest here directly — and is looking at regulatory changes to make it possible

A cooperation protocol signed yesterday could be a first step toward making it more attractive for VC firms to directly invest in Egypt, if our read on a cabinet statement is right.

What’s the news? Three key regulators have agreed to work together to make it easier for both local and international VCs to invest in Egyptian startups. On board are the General Authority for Investment and Freezones (GAFI), the Financial Regulatory Authority (FRA), and the Information Technology Industry Development Agency (ITIDA), according to a cabinet statement.

Why does it matter? VCs and private equity investors — local and international alike — have long invested in Egyptian companies via offshore structures that see them structuring funds as special purpose vehicles (SPVs) domiciled in other countries. They do this for tax efficiency (allowing each party to pay taxes in its own jurisdiction), but they are also very much driven by the unique terms in shareholder agreements they’ve negotiated with the company in which they’re investing.

Uh, Enterprise — what do you mean, shareholder agreements? VC and PE investors alike demand minority rights protections, whether those are rights to invest in future rounds, the right to ride along on any future transaction (a “tag along” option), guaranteed board seats, etc. And company founders will often want rights including, for example, the ability to control a company long after they stop owning 50% plus one share.

The problem is that those types of arrangements are either (a) untested in Egyptian law or (b) flat-out impossible. A study (pdf) a few years back by the EBRD, PwC and the Egyptian Private Equity association noted that as matters stand today, the enforceability of “tag-along rights, drag-along rights, call options and put options is untested … In Egypt, minority shareholders generally lack rights and cannot affect the day-to-day activities of a company. They are often unable to influence the strategic direction of a firm, unless they act as a voting bloc.” All of this is anathema to venture investors, PE types and company founders alike.

What’s next? Lots of consultations with VCs (and PE firms), we hope. GAFI has been tapped to prepare a “standard shareholder agreement” for startups (we hope this is a model agreement and not a one-size-fits-all prescription). Minority rights will be at the center of that contract. Meanwhile, the FRA is working on regulations that will allow the use of convertible notes to invest in startups. (A convertible is a debt instrument that converts into equity at some point in the future based on pre-agreed triggers.)

Wait, wait — there’s more. The memorandum also sets the stage for the regulators to explore ideas including:

  • Founder claw-back clauses
  • Preferred shares
  • Reserved matters
  • Employee stock options
  • And looking at valuation methods (and funding instruments) that are common globally, but not yet provided for in Egyptian law.

Smart lawyering and good policymaking are responsible for this: Our friends at Shahid Law Firm’s Venture by Shahid worked with a team at ITIDA headed by Amr Mahfouz that helped lead a process that brought things to this point, the firm said in a statement (pdf).

Enterprise is a daily publication of Enterprise Ventures LLC, an Egyptian limited liability company (commercial register 83594), and a subsidiary of Inktank Communications. Summaries are intended for guidance only and are provided on an as-is basis; kindly refer to the source article in its original language prior to undertaking any action. Neither Enterprise Ventures nor its staff assume any responsibility or liability for the accuracy of the information contained in this publication, whether in the form of summaries or analysis. © 2022 Enterprise Ventures LLC.

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