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The Middle East: Venture capitalists’ port of call

Over a dozen Silicon Valley VCs are indulging in a new love affair with Middle East cash

Published: Fri 14 Apr 2023, 1:31 PM

  • By
  • Ehtesham Shahid

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From a venture capital perspective, the region becomes an attractive destination due to several underlying factors. - KT file

From a venture capital perspective, the region becomes an attractive destination due to several underlying factors. - KT file

“If you build it, he will come.” In the 1989 film Field of Dreams, a mysterious voice says these words to a farmer invoking him to build a baseball field to lure a famous player’s ghost. Strangely enough, “build and they will come” later became the mantra for attracting capital, tourists, and talent to this part of the world. The implication was that creating a good enough product or service would naturally attract people.

What seems to be happening with venture capital (VC) funds – investment firms that fund early-stage startups in exchange for equity – is perhaps not so strange a phenomenon, definitely not communicated via a mysterious voice. The trend of VC funds making a beeline to engage with the region for funding has been growing. A recent Financial Times report says over a dozen Silicon Valley VCs, controlling tens of billions of dollars, are indulging in a new love affair with Middle East cash.

One statement in the report is especially worth mentioning. “We came to San Francisco looking for them in 2017. Now ... everyone is coming to [us],” FT quoted Ibrahim Ajami, head of ventures at Mubadala Capital, as saying. With things getting difficult in their backyard due to the economic downturn, the region appears more than just greener pastures. Economies diversifying away from oil and significant investments into the tier-one tech sector encourage them.

Challenges in the backyard

Europe has struggled with challenges such as sluggish productivity growth, ageing populations, and rising government debt levels for some time. Across the Atlantic, a politically volatile United States is locked in a battle of attrition with China. Amid these circumstances, described as the “worst funding crunch for VC firms in almost a decade,” they spot opportunities elsewhere – especially in the Middle East.

The challenges for these funds in Europe and the US come at many levels. As their number rises, the competition for deals becomes more intense, making it difficult for funds to identify and invest in promising startups. Another challenge is startup valuations, which have risen significantly in recent years, making it more difficult for them to generate investment returns.

Another factor influencing decision-making is regulatory requirements. Significantly varying regulations from country to country make it difficult for VC funds to navigate and comply with the legal landscape. Economic uncertainty adds another layer of complexity, making it more difficult for VC funds to raise capital from limited partners, impacting their ability to invest in startups.

A market saturation element is also playing out, making it difficult for new startups to gain a foothold in the e-commerce and digital media sectors. This combination of factors limits the investment opportunities available to VC funds. Despite remaining a crucial driver of innovation and growth in the West, these funds face numerous challenges impacting their ability to invest in and support startups.

Why the Middle East?

From a venture capital perspective, the region becomes an attractive destination due to several underlying factors. In a way, it is about space, appetite, and anticipation. The September 2021 Preqin data put the number of VC funds active in North America (primarily the US and Canada) at 2,514 and 3,187 in Europe. In comparison, only 130 VC funds were active in the Middle East and North Africa (Mena).

Ehtesham Shahid is an editor and researcher based in the UAE. - KT file

Ehtesham Shahid is an editor and researcher based in the UAE. - KT file

The same data shows that the total amount of capital under management by VC funds in Mena was $7.3 billion as of September 2021. In comparison, VC funds in North America had $875.9 billion under management, and funds in Asia (primarily China) had $412.8 billion under management. So, there is space for growth and appetite in this part of the world, explaining the interest.

A serial entrepreneur and investment banker in his previous avatar, Omar Farooqui calls this trend part of a strategic move eying the “Middle East as well as South Asia,” looking at both opportunities and capital. “VC funds is a newer phenomenon here, but they have been around in the West for a long time,” says Farooqui. According to him, as the capital in the West is not as abundant, VC firms have started to come to the Middle East. “A lot of them are setting up shops here,” he confirms.

That brings us to the elephant in the room, the tech startup failures, which have grabbed headlines recently, significantly impacting VC funds in the West. When such startups collapse, the fund invested in it loses some or all of its investment, which affects overall performance and reputation. Even if it is not a complete failure, it may not meet the expected growth targets or exit at the expected valuation.

The increased competition for these funds from other regions, especially in emerging markets – with significant potential for growth and innovation – also appears to be behind this thrust. Maybe the mantra at play is, “If you cannot beat them, join them.”

Ehtesham Shahid is an editor and researcher based in the UAE.



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