The rise and rise of venture capital in the Middle East

Stepping into Hub-71 feels like entering any other collaborative work space for start-ups and venture capital investors. There’s an energy here you don’t find in established corporate or fund management environments – an edge, a sense of pushing boundaries, of youthful urgency to destabilise and disrupt existing industries, markets, and thinking. Disrupt anything. This could be in Silicon Valley, Boston, New York or London. Except it’s not. It’s in the Abu Dhabi Global Market, a financial centre and free zone in the middle of the capital of the United Arab Emirates.

Now home to over 100 start-ups from around the world, Hub-71 is a thriving venture capital environment that is now ranked in the world’s top 10 start-up ecosystems. Opened in 2019, it provides non-equity incentives and support to resident start-ups. The shared space fosters collaboration among start-ups, investors, corporates and government, providing a vital link between innovation and investment. Its success is evident. Earlier this year the first unicorn (a startup valued at more than US$1 billion) joined as part of Hub-71’s Value Creation Programme, which specifically targets later stage start-ups.

Hub-71 is no anomaly. Although the majority of start-ups and venture capital investments originate in the United States, the Middle East is an area of rapidly increasing venture capital activity. A rising number of start-ups and VC fund managers domiciled in the region, increasing inbound investment, and increasing activity from Middle Eastern sovereign wealth funds in the sector, both within the region and overseas, are all testament to this. The actions of governments and certain characteristics of the region itself have contributed to this rise.

Government support

MENA-based start-ups attracted more than US$1.2 billion in funding in the first half of 2021, representing 64% year-on-year growth.¹ A look at the countries in the region receiving the most funding – with 71% invested in the UAE (mainly through the various financial centre free zones, such as the Dubai International Finance Centre, and the ADGM), Saudi Arabia and Egypt – reveals why the region is experiencing a venture capital boom.

Both the UAE and Saudi Arabia have led the way for the oil exporting nations in the Middle East in implementing strategies and initiatives to diversify their economies and reduce their reliance on hydrocarbon resources and related industries. With the world currently experiencing the fastest energy transition in human history, these countries, starkly aware of the implications of this shift on their core revenue-generating assets and ultimately on their long-term wealth, have acted decisively. Both countries have aggressive economic diversity and sustainability goals, together with broader modernisation ambitions, to achieve by 2030. Not surprisingly, other Gulf States such as Qatar and Bahrain have similar strategies for the remainder of the decade.

To achieve these goals both the UAE and Saudi Arabia have implemented fiscal reforms and unleashed large-scale programmes to privatise assets, increase public-private partnerships, unlock value by monetising real assets and infrastructure, improve public benefits and services, develop social and human resources, and optimise government operations. These initiatives, together with complementary legal and regulatory reforms and social changes, ultimately make these countries more attractive destinations for foreign capital with more diverse, efficient and sustainable economies.

In this context, both the UAE and Saudi Arabia have recognised the importance of the venture capital sector to achieve these economic aims. Government-led initiatives have therefore been a key driver of growth in the venture capital sector in the region, evidenced by the development of start-up ecosystems.

Hub-71 for example is a flagship initiative of Abu Dhabi’s US$13.6 billion accelerator programme for business in the city, Ghadan 21. With backing from the likes of Abu Dhabi sovereign wealth fund Mubadala and leading venture capital investors Softbank Vision Fund and Microsoft, it’s no surprise that the initiative is going from strength to strength. Dubai has undertaken similar initiatives, with Dtec (Dubai technology entrepreneur campus) in the tech-focused free zone Dubai Silicon Oasis, and DIFC Fintech Hive, which is a similar hub in the DIFC.

But government support for the sector goes beyond simply providing a desk and Wi-Fi. A taxfree environment has long been an attraction of jurisdictions like the ADGM and DIFC, but this is now complemented by an institutionalised support network aimed at attracting start-ups and giving them the best chance to succeed. The Dubai Future District, for example, has been created to promote innovation and is dedicated to developing the new economy. Within this district, made up of three main financial areas including the DIFC, businesses have access to licensing, visa, legal, funding and housing support – an environment designed to attract start-ups and give them the best chance to succeed.

Middle Eastern governments are also increasingly providing regulatory support to start-ups. All of the Gulf States for example either have or are proposing regulatory sandboxes for Fintech, which provide a protected environment for innovators to test Fintech products with oversight by regulators. Following the first Fintech sandbox in the region launched by the ADGM in 2016, ADGM RegLab, both the Dubai Financial Services Authority in the DIFC and the Central Bank of Bahrain followed suit in 2017. The Central Banks of Saudi Arabia and Kuwait launched their sandboxes the following year, and recently Oman and Qatar announced their intention to do the same as part of broader efforts to encourage Fintech investment and innovation in the banking sector.

There is also regulatory support for venture capital funds. The ADGM for example has created a specific regulatory framework for venture capital fund managers. Some of the benefits of this framework are reduced governance and control requirements, eg no requirement to appoint an internal auditor, separate custodian or independent fund administrator, and no minimum capital requirements. Certain requirements must however be met: the fund must invest in equity of unlisted early stage companies and have a closed-end structure, the offering must be made by private placement to professional investors, and fund size is limited to US$100 million, unless otherwise agreed with the regulator, the Financial Services Regulatory Authority.

The availability of capital

Start-ups obviously need funding. The abundance of local capital for this purpose has attracted start-ups to the Middle East and provided the financial firepower to animate the VC ecosystems.

Most of this capital has been provided by the sovereign wealth funds of the Gulf States. These SWFs have become global venture capitalist powerhouses, rivalling the leading private equity firms. Their deep pockets, long investment horizons and gravitas make them the ideal partner. Mubadala alone poured nearly US$3.5 billion into venture capital investments in the first nine months of 2021.²

SWF investment in start-ups has mainly been in offshore markets; the US, China and India in particular, and typically in later stage funding rounds where bigger ticket sizes fit better with their traditional investment strategies. Mubadala’s US$1.2 billion investment in 2020 in Jio Platforms, an Indian telco and data services company, is an extreme example of that. But now, with experienced in-house VC investment capability, earlier stage investing by the SWFs is becoming commonplace.

Mubadala in particular is becoming more nimble and is shifting towards investment in earlier stage rounds, having launched a $400 million European tech fund in 2018 for that purpose. Just after the UAE and the UK signed a £10 billion sovereign investment partnership earlier this year, its global ventures platform led a £60 million Series B funding investment in Huboo, a UK-based e-commerce fulfilment provider that is expanding in Europe. This was the largest ever Series B raise in the UK.

Middle Eastern SWFs are also now increasingly looking in their own backyard. Armed with learnings from the implementation of their US and European venture strategies, they have recognised that funding high-growth businesses in the region is an important part not only of their investment strategies but also their broader role in achieving their respective state’s transformative economic aims. And the VC investment capability and knowhow they have developed, and the profile of their investment activity, particularly in unicorns, have provided a welcome boost to the region’s start-up sector.

Saudi Arabia’s Public Investment Fund has been aggressive on this front, particularly through its VC-focused investment vehicles, the most notable being Softbank Vision Fund. Created five years ago (specifically for technology investment) with Japan’s Softbank, other sovereign wealth funds such as Mubadala and corporates such as Apple, its two funds now reportedly have assets under management of around US$150 billion. The firepower it brings to the local start-up scene was evident in July 2021 when Softbank Vision Fund 2 led the US$415 million Series C raise by Kitopi, a Dubai-based cloud kitchen platform and now the region’s third homegrown unicorn.

PIF’s support of fund managers has also formed a key aspect of its strategy. For the sole purpose of promoting the development of a venture capital ecosystem, two years ago PIF established Jada, a fund of funds company. By funding venture capital funds and private equity focused on the Saudi market, Jada’s mandate is to create a selfsustaining growth platform for local SMEs. Look deeper into the funds it has invested in and its ecosystem development strategy becomes clearer. One such fund, VentureSouq, is an ADGM VC fund focusing on MENA Fintech opportunities. Its base? Hub-71.

Fund managers like VentureSouq are also critical for tapping into another prevalent deep pool of capital for regional start-ups – family offices and high-net-worth individuals. Family offices have traditionally played an important role in the economies of Middle Eastern states, and this is now extending to the digital economy. Historically underinvested in technology and generally slow to embrace change, leaders of Middle Eastern family offices are realising that the current pace of change and the extent of digital disruption now leaves their businesses exposed. 75% of those leaders now say that technology, digital and innovation initiatives are a top priority for the next two years.³ With 58% of family offices intending to expand into new markets or client segments, tech-based start-ups, alongside real estate and private equity, now form one of the main asset classes where these investors are eager to find returns.⁴ That’s overwhelmingly positive news for start-ups in the region.

Regional characteristics

The drive for economic diversification and ensuing government financial and other support for start-ups is, however, only part of the story. The rise of venture capital in the Middle East is not limited to the Gulf States and their start-up cultivating approach. Why has Egypt for example developed a thriving venture capital ecosystem, becoming a regional start-up powerhouse? Although it too has benefitted from aggressive government policies to support start-ups, the answer also lies in some of the characteristics of the region itself.

The Middle East is an increasingly attractive emerging market. There is both large scope for the development of new goods and services and significant room for new businesses across a wide variety of sectors to grow, and grow rapidly, given the utilisation of technology. And the aggressive reform programmes and diversification initiatives referred to above only enhance the broader economic environment in which new businesses can thrive. For start-ups, it’s even more attractive given the start-up sector in the region is still relatively immature.

The financial services sector provides a good example. A high percentage of the adult population in the Middle East is unbanked. It’s estimated that 70% of the region’s adults lack access to a bank account (up to 80% in the region’s developing nations) despite many being active economic citizens.⁵ The region, and even the developed nations within it, still rely heavily on cash, and cash on delivery, as a payment method. Fintech, and its application throughout all aspects of the financial services value chain – from payment systems, to digital delivery models and micro banking – has the potential to completely change that.

The Fintech sector in the Middle East has steadily grown over the past years at a compounded annual growth rate of over 30%, up an impressive 49% on a year-on-year basis for H1 2021.⁶ Most of this growth is in payments, transfers and remittances, with 85% of Fintech firms in the region operating in this space.⁷ This is not surprising given the historical high prevalence of cash transactions, the rapid recent growth of e-commerce, and large expat workforces. In 2017 in the UAE alone, expat remittances (mostly to India, Pakistan and the Philippines) totalled US$44.5 billion.⁸

Facilitating this Fintech rise is the fact that the MENA region is one of the most digitally connected in the world. Smartphone usage is widespread – currently constituting over 60% of all connections and forecast to be 80% by 2025.⁹ Internet usage is also high, with over 88% of the population going online daily.

Demographics also play a big part. Home to 7.5% of the world’s population, the MENA region has a predominantly young population. Of the nearly 600 million people in the region, more than 50% are under 25 years old. This translates to a customer base unencumbered by traditional service delivery methods and engagement with providers, and a growing culture of entrepreneurship.

Historically, the Middle East has also benefitted from its geographical location, as a gateway to both Africa and Asia. Given that one-third of the world’s population lives within a four-hour flight of Dubai (and two-thirds within either hours), the region’s proximity to Africa and Asia is an attractive attribute for start-ups looking to capitalise on those vast emerging markets.

New regional cooperation between Israel, the UAE and Bahrain under the Abraham Accords should only further enhance the growth of the venture capital sector in the Middle East. Israel has traditionally been the region’s technology and innovation capital, forging close links with Silicon Valley and being a world leader in security, AI and enterprise software development. With the signing of the Abraham Accords in August 2021, the pathway for collaboration, particularly for cross-border investment in tech and other sectors, has become clearer. Indeed, the commercialisation of the Accords from a venture capital perspective has already commenced. In November 2021, Israel’s most active VC fund, OurCrowd, became the first Israeli fund manager to be licensed in the ADGM, targeting tech start-ups in the UAE and the broader region.

These factors all make the region a place of opportunity, attractive for start-ups looking for markets, global private equity firms looking for high returns, and corporates hungry for acquisitive growth. In H1 2021, 31% of MENAbased venture capital transactions involved investment from outside the region.¹⁰ Some of the larger acquisitions in the Middle East by foreign investors in recent years have grabbed the headlines and shown the extent of opportunities that exist there. These include Uber’s acquisition of MENA ride-hailing business Careem in 2020 for US$3.1 billion, and Amazon’s acquisition of MENA online retailer Souk.com in 2017 for US$650 million.

While these high-profile deals catch the eye, they’re also indicative of an increasing strength in the underlying M&A market in the Middle East, creating more exit opportunities for both founders and investors alike. The challenge for the region is for local equity markets to mature to the point that listings on local exchanges such as the ADX or DFM become a viable, and commonplace, exit strategy. IPO exits have generally been challenging for regional start-ups – Middle East companies accounted for less than 1% of all IPOs globally in the first half of 2021, and many of those IPOs were of large state-owned enterprises.¹¹

The current popularity of “SPACs” – special purpose acquisition companies, which are listed with the sole purpose of making acquisitions within a certain time period – should increase the number of IPO exits for regional start-ups.¹² The imminent listing on NASDAQ of Anghami, the Arab world’s leading music streaming business, through its merger with a SPAC, Vista Media Acquisition Company, has led the way, showing the benefit of this structure for startups by de-risking the IPO process. The NASDAQ listing of Swvl, a bus ride sharing business that started in Cairo, should soon follow, with Swvl having agreed a merger with a SPAC, Queen’s Gambit Growth Capital, in July 2021. And while these transactions stand out as they’ll be the Middle East’s first tech companies to be listed on NASDAQ, a more impressive story will be regular listings of companies like Anghami and Swvl on Middle Eastern exchanges, either through SPACs or by the traditional listing route.

Conclusion

The rapid rise of venture capital in the Middle East has not happened by accident. Facilitating the development of sustainable venture capital ecosystems, backed by their powerful sovereign wealth funds, has been a key pillar of the economic diversification strategies of the region’s oil exporting nations as they discard their historic petrodollar dependency. And the culture of transformation and innovation that this is creating, combined with the Middle East’s young, digitally connected population, who are ideally located between two other large emerging markets, looks set to ensure that this rapid rise continues.

1. MENA H1 2021 Venture Investment Report, MAGNiTT
2. SWF Global, 7 October 2021
3. PwC Middle East Family Business Survey 2021
4. PwC Middle East Family Business Survey 2021
5. To the Future and Back: Financial Inclusion in the Arab World by Nadine Shehade, CGAP
6 MENA H1 2021 Venture Investment Report, MAGNiTT
7. Ibid
8. Ibid
9. Statista Research, 25 March 2021
10. MENA H1 2021 Venture Investment Report, MAGNiTT
11. The Many Paths to Exit by Noor Sweid, General Partner, Global Ventures
12. There were 305 SPAC IPOs globally in the first half of 2021, raising a total of US$98 billion. MENA H1 2021 Venture Investment Report, MAGNiTT