Why the UAE's New Venture Capital Regulation Will Help The Ecosystem
At the beginning of the year, the UAE government announced new regulations for venture capital funds operating in the country. And while the actual wording of the new regulations hasn’t been released –even lawyer friends of mine haven’t been able to get their hands on the document– the announcement contains plenty for entrepreneurs and venture capitalists to sink their teeth in to.
What will the new regulations mean for the local ecosystem? Well, we’ll get into the finer details of the announcement in a minute, but let’s start by providing an overview. Essentially, the regulations result in more checks and balances being imposed on venture capital firms operating in the UAE. So are the new regulations a bane, creating extra paperwork when what we need is more dynamism? Or are they a boon, bringing the UAE venture capital scene up to international standards?
I’ll say from the outset that I believe the regulations are a positive development, and should achieve their stated aim of attracting venture capital funds to the country. And I’m not alone in that belief– plenty of investors, lawyers and entrepreneurs I’ve spoken to share the same optimism about the new legal system.
So what does the system entail? Well, for starters, it imposes reporting obligations on venture capital firms. If the value of the assets under your management exceeds AED180 million, you’ll have to issue an annual report according to IFRS standards, appoint a risk management officer, and ensure that your risk exposure is equal to or less than the fund’s net asset value. And if the value of the assets under your management is less than AED180 million, you won’t have to worry about a lot of that stuff, but you’ll still need to draft an annual financial report, as well as stick to the rule regarding risk exposure.
So, if you’re a really large firm, you’ll have to conduct proper, world-standard financial reporting, and even if you’re not that large, you’ll still have to manage your risk exposure. That’s a key point to take away– the UAE government is encouraging venture capital firms to be responsible with their investments with these regulations.
Now, you could argue that this might create a climate in which venture capital firms become more risk-averse, thereby impacting investment for startups that need funding. But, to me, that shouldn’t be a worry. Venture capital firms, by their very nature, assume a certain amount of risk when they invest in startups. Bringing their accounting practices up to international standards won’t change their hunger for buying into exciting new businesses.
As the owner of a startup, then, getting investment will simply require that your business plan be backed up by solid financials. If you have enough startups doing that, before you know it, the good practice bar for accounting will have been raised across the ecosystem.
This is crucial if we’re to attract international venture capital firms to the region. Not to take anything away from the ones already operating here, but we want more. More investors means more competition, and that means better valuations and a more diverse ecosystem. At Series B, for example, where serious money is needed, there are only a very small number of players that can actually take part in the rounds. Attracting international investors should help to plug that gap.
The new regulations also deal with how funds should be allocated. The headline here is that at least 70% of a venture capital firm’s assets should be invested in one of more of a few domains. That includes new or troubled projects (though they’ll only be able to invest 30% of their assets into these sorts of businesses), and equity instruments issued by unlisted companies (read: most SMEs looking for funding). Venture capital firms can also choose to invest in units of other venture capital firms, though only up to 10% of their total assets.
There’s quite a lot to unpack there, but the long and short of it is that the regulations are encouraging venture capital firms to not only ensure that their funds are actually being used to invest in UAE businesses, but also that the funds are distributed fairly across a range of business types.
We don’t yet know how the new regulations will play out, but as they’re imposed on the market, I reckon that we’ll begin to see a more dynamic investment landscape that encourages and rewards innovative startups with solid financials. This doesn’t mean that you’ll have to be raking in serious cash in order to receive investment; it simply means that, if you can demonstrate an ability to turn a profit with your business plan, you’ll be more attractive to investors. That much should be obvious to any business owner anyway, but that obligation is now being written into the legal framework.
I look at these new regulations with a sense of optimism – anything that encourages venture capital firms coming to the Middle East and investing more money has to be a positive thing. The ecosystem needs to continue to grow. We’ve seen some great results with the likes of Souq.com, Careem and Propertyfinder raising serious money. And as some of these guys start to exit –whether that’s listing or actually M&A activity, or whether they exit to bigger, international players– there’ll be even more of a reason for international firms to invest in this region. And that’ll pave the way for newer startups to get funding.