Sunday, 22 January 2023

Why some Egyptian startups prefer to set up shop abroad

Why — and how — do Egyptian startups incorporate offshore? Many Egyptian startups, especially those that have raised USD mns in funding, are legally incorporated abroad. Where is no readily available data on the topic, but the trend is one our sources agree has been gaining traction, particularly amid the recent FX shortage. The decision to set up shop abroad is primarily led by investors, rather than startup founders themselves, and typically driven by regulatory and legislative factors, as well as payment facilitation, according to several sources we spoke with.

How does it work? Founders typically set up holding companies in other jurisdictions, with Delaware and the British Virgin Islands among the two most common. The offshore holding company then owns all of the company’s subsidiaries around the world, with each subsidiary paying taxes in its local jurisdiction.

The startups themselves operate in Egypt because operating expenses here are much cheaper, while being domiciled abroad makes it easier for other purposes. The holding company is there for investment and strategic purposes, while the main operations take place in Egypt — until, at least, the company gains traction in other markets.

What makes offshore structuring so attractive?

#1-Alternative investment vehicles: There are a multitude of alternative investment instruments popping up worldwide, but Egypt still lacks the regulatory frameworks for many of them, which makes it necessary for companies seeking these types of investments to have a legal presence in a different jurisdiction. “The option of registering your company in Egypt is fine when you start operating, but if you want to raise funding from international and regional VC investors, the only way to do that is to be a non-Egyptian company to be able to unlock more investment and other financial mechanisms during the funding rounds,” a cofounder of a SaaS startup, who requested to remain anonymous, tells Enterprise. What type of instruments? Our mind immediately goes to convertible notes, for starters.

#2- Shareholder agreements: While Egypt’s Investment Act does cover certain standards such as term sheets (which summarize the terms of a potential investment) and shareholders agreements, its approach to those instruments falls short of global standards.

What does that mean in practical terms? Let’s say all shareholders agree to a drag-along clause in a shareholder’s agreement, for example, which stipulates that majority shareholders can force minority shareholders to join a sale. In other jurisdictions, if a sale place, it would be implemented the way the agreement outlines: The minority shareholders simply must sell. In Egypt, minority shares are considered assets of the minority shareholder, who would need to approve the sale for it to go through, defying the agreement, senior partner at Levari Law Firm Mohamed Raslan notes. The nation’s investment, financial services, and tech regulators have been working since late spring of last year on changes to make SHA provisions including drag- and tag-clauses enforceable here in Egypt (here and here).

And when it comes to a startup’s expansion, the legal aspects get even more difficult. “When I want to expand my holding company internationally and hire people in Europe, Saudi Arabia, and other countries, managing the legal structure of multiple companies from Egypt is very difficult,” founder and CEO of Egyptian loyalty platform Gameball Ahmed Khairy says. “It’s then easier to have the holding company set up abroad.”

#3- Taxation is more efficient abroad, notes Khairy, who says offshore structures make it easier for regional and international investors to minimize capital gains taxes when investors want to exit — they don’t need to pay capital gains tax if the company is registered in Delaware, for instance. But in Egypt, exits are subject to a 22.5% capital gains tax, Raslan tells us.

#4- It’s easier to accept payments, some say: For startups that offer subscription plans with recurring payments, it cab be challenging to collect in Egypt from clients outside this jurisdiction, Khairy says. “I needed a Delaware entity so that I could use [payment processing platform] Stripe to accept recurring payments from clients globally,” he tells us.

#5- Foreign exchange issues: Investors “shy away from foreign exchange volatility,” Khairy says. What’s more, recently imposed limits on international spending using Egyptian credit cards have caused issues for several startups — particularly those whose operations are mostly in Egypt and whose revenues are EGP-denominated. The panoply of tech service providers with which every business must deal — Amazon, Google, Microsoft, Meta, and more — all demand payment in USD. We’ll dive into this issue, and how startups are coping, in part 2 of this story.

Your top stories on future trends for the week:

  • Nine local green startups have been selected to join the UK-backed Climate Finance Accelerator (CFA) Egypt’s inaugural program.
  • Egyptian e-sport platform GBarena is set to acquire Tunisian gaming startup Galactech in a USD 15 mn share swap.
  • Dubai-based BNPL startup Tabby has been valued at USD 660 mn after it raised USD 58 mn in a series C funding round, making it one of the most valuable startups in the region.
  • Talabat MD Hadeer Shalaby shares her Morning Routine.

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