In the present investment climate, few private equity funds operate in Egypt in peculiar models in terms of structures and funding, as recently witnessed in the Egyptian market practice. Hence, fundamentally, the leading participants in the Egyptian private equity market are investment management companies, investment holding companies, and seed investors. Furthermore, the economic reforms implemented by the Egyptian Cabinet to the Egyptian economy are optimising the investment climate for both local and foreign investment.
Devaluation of the Egyptian pound has been counted as a competitive incentive for foreign investors to invest and expand their business in Egypt. However, and similar to the other global and regional markets, since the COVID-19 outbreak has been started, the steady pace of private equity funds in pursuing investment opportunities has been significantly affected – purchasing minority stakes in the high growth business in Egypt.
The Egyptian Capital Market Law (CML) currently authorises the private equity companies –subject to the satisfaction of pre-set legal and regulatory requirements– to be incorporated in the form of a company limited by shares (CLS), which is equivalent to the GP-LP structure in other foreign jurisdictions. However, and from a practice perspective, that structure is still of a less appetite to the most private equity funds.
A state of stability has been witnessed for the sectors dominating the private equity M&A transactions; as the healthcare, education, fintech, renewable energy, oil and gas, and food processing sectors remain highly attractive to the private equity funds in the Egyptian market.
In 2018, significant legislative development was introduced to the CML, where a newly incorporated Egyptian private equity company became obliged to be in the form of CLS structure. This structure ensures a significant advantage for the limited partners, namely confine their liability to their contribution to the company's share capital, provided that they do not engage in the company's management. In contrast, The CLS's manager shall be the general partner in the company, which triggers the illimitation of its liability towards the limited partners.
Accordingly, in June and September 2018, the Financial Regulatory Authority (FRA) issued two executive decrees, whereby a private equity fund shall satisfy certain conditions for establishment and licensing in terms of required legal structure, capital, partners and their respective ownership percentage and qualification, purpose, management, fund’s investment ratios, managers (including the general partner of the fund). It is worth highlighting that a private equity fund’s activity shall be limited to private equity and may apply for a license to undertake venture capital activity.
Another significant legislative change was put in place, where some laws have been amended to require the prior approval in case of direct or indirect acquisition on business. Hence, whenever a private equity fund opts to acquire a stake in the target company, whether directly or indirectly, such acquisition will require the prior approval of the competent local regulator, depending on the activity of the target company.
Generally, the regulatory restrictions in Egypt vary from industry to another. However, for example, there are key restrictions can be highlighted, as follows:
There is no specific level of detail for a due diligence exercise as it varies depending on the acquirer, the target’s activity, compliance with the laws and regulations of its industry. While some acquirers may opt for a limited high-level due diligence with a focus on key red flags, others may prefer carrying out a full detailed due diligence.
A customary legal due diligence usually covers key areas, inter alia, required licensing, full review of the constitutional documents to assess if there are any restrictions and any third-party consents required pertaining to the material agreements concluded by the target company and an assessment of the employees’ rights and general compliance of the target company to the Egyptian laws. However, the buyer, up to its satisfactory level, may require additional/specific due diligence exercise by the advisers. The legal due diligence may be conducted via virtual data room or physical presence of the buyer’s advisers at the target’s premises, but tendency to virtual data room due diligence remains preferable.
Vendor due diligence is not commonly conducted in Egypt. While the buyers do not generally opt to heavily rely on such reports (unless in case of extensive warranties), sellers are generally advised to consider conducting a seller/defensive due diligence in order to ensure an investable vehicle for investors, which should also have an impact on the evaluation process.
While, generally, there is no major difference between a privately negotiated transaction and an auction sale, we witnessed rigid position of the seller in auction sale, as the terms of the acquisition become strictly negotiated and accepted by the seller due to the competition between the bidders to win the sale, which places the seller in a better position to accept the best favourable terms and conditions of the acquisitions in auction sale rather the privately negotiated one.
Typically, most transactions involving a private equity-backed buyer are managed to be indirect acquisitions for ownership restructuring purposes. Hence, the private equity fund usually establishes a special purpose vehicle or more (SPV), depending on the proposed deal structure, to contract with the seller, and thus the partnerships of the private equity fund do not directly enter into and transaction documents with the seller, except for the equity commitment letter with the newly established SPV.
Private equity deals are normally financed through equity commitment provided by the fund to the SPV or may be financed by a mixture of both the equity committed to the SPV and debt provided by third-party lender (eg, banks). In all cases, the SPV should have the sufficient funding to finance the deal, which is usually availed by the private equity fund to the SPV at the time of executing the SPA. Most deals witnessed in the past three years, indicates a tendency of the key private equity funds in the Egyptian market to acquire minority stake rather a majority stake.
While a private equity consortium is observed in a few transactions in the market, it is not yet common in Egypt. Indeed, the private equity fund holds majority equity on the offshore SPV level. Meanwhile, a minimal ratio (minority) will be held by the management in the neighbourhood of (10%) in most cases. However, the significant part of equity funding is often secured via preferred equity instrument, which has preferred return under the fund management agreement, as the common equity will not suffice to secure the equity funding of the transaction, due to its minimal ratio of the total equity funding.
While the co-investment right can be a right granted to the investor under the management agreement, the investor may not show the interest in co-investing alongside the private equity fund, especially at the very beginning of the transaction up to its closing for cost-efficiency and uncertainty of the transaction. However, the investors may opt to their co-investment right at a later stage following the closing, on a higher-level structure of the SPV and management team. These are the passive stakes/investments managed by the private equity manager, which ultimately aim to enlarge the financial interest of such investors in such investment.
Having said that, in the case of acquiring larger stake the co-investors may engage together with the private equity fund at the same level as the management team, and hence minority protection will be given to the co-investor (eg, access to information right).
While the completion accounts mechanism can be generally witnessed in a few cases in the market, the locked-box mechanism remains the dominant form of consideration structure in Egypt, which is particularly suited to transactions where the parties require economic certainty in case, for example, private equity exits. Hence, the price payable for the target is based on a balance sheet prepared at an agreed date prior to completion providing for a fixed equity price. Usually the most common locked-box date used is the target’s last financial year end.
In this respect, and although the locked-box is protected by the restrictions on "Leakage" and "Permitted Leakage" under the SPA, the buyer, for certainty purposes, may require the audited financial position of the target company for a specific period preceding the completion, as well as the management accounts covering the gap between the audited financials and completion, especially the completion date usually falls after the locked-box date in a relatively long period of time.
Unlike the foregoing, the earn-outs mechanism can be observed in the transactions, where the private equity fund is not involved. Furthermore, the involvement of a private equity fund will definitely affect the transactions structure, but not the type of consideration mechanism, as we have witnessed a repeated pattern of the used consideration mechanism in the most transactions involving a private equity buyer.
The SPA usually provides for a level of protection, which is commonly given by the seller not the buyer (eg, restrictions on "Leakage" and "Permitted Leakage" and business warranties in relation to accounting and the financial position of the target). Said level of protection does not usually differ irrespective of the nature of the seller, whether a private equity seller or corporate seller.
While the parties agree to a specific indemnity for the leakage, which, for example, can be on an Egyptian pound for Egyptian pound basis, the interest charge on leakage is rarely adopted in the market. However, the buyer may recourse to the general rules of interest charge under the Egyptian law.
Allocating a specific dispute resolution mechanism for the consideration structure is not common in Egypt. The parties usually agree to a dispute resolution mechanism for the entire share purchase agreement, especially the parties agree to specific indemnity (eg, Egyptian pound for Egyptian pound indemnity for leakage in case of locked-box mechanism), which is, in most cases, identified and settled before completion of the transaction.
The level of conditionality depends on the outcome of the due diligence exercise, which likely to identify certain mandatory and suspensory regulatory conditions (eg, FRA approval and GAFI approval), along with other conditions such as third-party consents or shareholder approval. The material adverse change/effect is one of the key elements of the SPA and is heavily negotiated between the parties, which may trigger the termination right of the buyer. Indeed, one of the common conditions observed in the SPA is the third-party consent if it is provided under a material contract to which the target is a party.
From our experience, the buyers are usually conservative, so they are not willing to accept “hell or high water” approach undertaking, especially, that said approach may conflict the fiduciary obligation of the private equity fund towards its investors. Further, the said approach will trigger several implications affecting the consummation of the transaction, as well as contingent liability that will likely be incurred by the fund. Hence, the hell or high water is not usually adopted by the private equity funds in the Egyptian market.
Although the break fees nor the reverse break fees are not mandated or regulated under the Egyptian law, in private M&A the break fees are commonly incorporated under the SPA, in favour of the buyer not the seller since the likelihood of incurring significant expenses is to the buy-side not the sell-side. Although break-up fees for public transactions are not prohibited by law, they are not common or customary.
Similar to any other acquisition transaction, the termination rights are vested in both parties upon occurrence of certain events specified under the acquisition documentation. Material adverse change/effect, dissatisfaction of conditions precedents (which for example includes the prior approval of the regulator or obtaining third-party consents) are key events to trigger termination of the transaction, unless waived by the aggravated party.
Generally, the private equity sellers will always attempt to limit their liability arisen from the sale of the portfolio company, in order to return the proceeds to the investors in a timely manner, and hence maximising their return on investment, knowing that any unreasonable extension of the return time will affect the fund’s performance. Therefore, the private equity sellers tend to assume a minimal liability under the SPA of the transaction.
Where liability is assumed by a private equity seller, the private equity seller needs to make sure that warranties given under the SPA will not give a rise to any liability. Thus, typical warranties given by the private equity seller under the SPA will limited to the fundamental obligations and warranties (ie, transfer the shares free of encumbrance, the fund’s ownership of the shares, powers and authority to enter into the SPA, permission of leakage, running the portfolio company in the ordinary course of business until completion).
Further, the private equity seller will opt to negotiate the possible minimal perception period of the warranties given under the SPA, which in most cases ranges between six to 24 months. In the event the private equity fund is a buyer, the fund expects to receive a list of warranties (ie, business and core warranties), subject to the outcome of the due diligence.
The private equity sellers typically provide fundamental business and core warranties (eg, legal title of the shares, powers and authority to enter into the SPA, accounting, litigation, solvency, insurance, etc).
From our experience, the management team does not participate in the shareholding at the target level. Further, in the most transaction documentation the seller, whether the management team is involved in the board of the target, the customary business warranties will be provided (eg, accounting, tax, employment, insurance, litigation, compliance with law, accuracy of the disclosed document/information, etc).
Generally, the warranties are typically capped under the SPA in terms of the limitation of time and quantity; as the time limitation of the warranties ranges from six to 24 months, except for the tax warranty which is typically tied to the elapse of the statute limitation (ie, five years). As for the quantity, the core warranties (eg, title of the shares and power and authority) are typically capped to 100% of the transaction consideration, while the business warranties (eg, employment, litigation, compliance, etc) are capped to 25% of the transaction consideration.
The W&I insurance is not common in Egypt. The private equity seller does not provide any further protections, other than the ordinary core and business warranties. Nonetheless, the parties may agree to cover certain risks post-closing through financial adjustments.
For example, tax-related risks are a common concern among businesses in Egypt. Thus, one common approach to safeguard the purchaser is to retain a portion of the consideration for an agreed period to cover any potential tax exposure. Purchasers tend to make deferred payments, pricing adjustments and escrow arrangements rather than to resort to indemnity claims covering potential liabilities.
Generally, litigation is not common in the M&A transactions nor the private equity transactions in Egypt, the parties usually agree to institutional arbitration as a way to solve disputes. From our experience, most commonly disputed clauses can be, for instance, MAC, breach of warranties (ie, core warranties and business warranties), and price adjustment. However, we see the potential rise of disputes when a private equity fund involved is minimal, as the private equity funds usually tend to undertake a comprehensive due diligence on the target company before execution of the transaction documents, so that they eliminate the possibility of post-closing disputes as much as possible.
Public-to-privates is not common in private equity transactions in Egypt.
Any corporate entity established in Egypt or investment project carried out in Egypt involving a minimum of (10%) foreign shareholding for non-listed companies or (2.5%) for listed companies (excluding any company operating locally by virtue of a concession agreement) is now required to submit disclosure/reporting forms to GAFI on a quarterly and annual basis or in the event that certain articles of a company’s statutes are amended. Further, according to the FRA’s listing rules, shareholders are obliged to notify their shareholding, voting rights, subscription percentage (directly or indirectly) reaches or falls below (5%) and its multiples. This also applies to the employees and board members and their related parties, whose respective shareholding, voting rights, subscription percentage (directly or indirectly) reaches or falls below (3%) and its multiples.
Mandatory offer thresholds are present in Egypt, as the CML provides for a one third percentage to subject the acquirer for a mandatory tender offer when the minority requires so. However, it is worth highlighting that there are a few exception cases, subject to the FRA’s technical discretion, on case by case basis.
Depending on the target’s shares; as for the unlisted shares, the consideration may be in cash and/or in-kind, while for the listed shares, the consideration for a mandatory tender offer may be all in cash, or a mixture of cash or shares.
The CML requires a mandatory tender offer to be final and not to be subject to conditions. Exceptionally, and subject to the FRA’s approval, an offeror can make a mandatory tender offer conditional on the acquisition of a minimum stake of the voting rights or the capital of the target company. Offers can be conditional on acquiring at least 51% with the purpose of controlling the company or 75% if the acquisition is for the purpose of a merger.
If, however, the shares offered for sale do not meet the specified minimum stake – 51% or 75% (as the case may be) – the offeror may not acquire the offered lower stake without obtaining the FRA’s prior approval. Further, if the tender offer is through a swap of shares that will be issued through a capital increase, the offer must be conditional on the company’s approval of the issuance of the shares.
Financing as a Condition
With regard to financing as a condition, the offer proposal submitted to the FRA must include a confirmation from a licensed bank in Egypt evidencing the availability of the financial resources to fund and cover the offer. Accordingly, unless there is confirmation of financial solvency, the FRA should not accept the offer proposal.
Neither break-up fees nor reverse break-up fees are mandated or regulated by Egyptian law. In private M&A, it is common that parties agree on break-up fees. Although break-up fees for public transactions are not prohibited by law, they are not common or customary.
Further, the FRA is entitled during the offer’s validity period and up to five days before the lapse of this period to accept a competitive offer, hence the impracticability of break-up fees in tender offer transactions.
Generally, and despite the parties’ agreement on break-up fees or liquidated damages, or both, Egyptian law allows a party to claim reduction of agreed damages, to the extent that the agreed amount is deemed excessive compared to the resulting damages.
If a private equity bidder acquires less than 100%, the bidder can enter into a shareholders’ agreement, where additional governance rights to be granted to the bidder under the said agreement, but this would trigger a disclosure obligation. In fact, the squeeze-out mechanism is not recognised under Egyptian law, thus, there is no mechanism available to compel minority shareholders to sell their stakes. In fact, the CML has allowed minority shareholders to request and oblige majority shareholders to acquire their stake.
While conceptually the irrevocable commitments can be agreed in case of the unlisted target company, the irrevocable commitments are rare in case of listed target companies to minimise the level of disclosure, especially that the FRA is entitled during the offer’s validity period and up to five days before the lapse of this period to accept a competitive offer, hence the impracticability of ICs in tender offer transactions.
The hostile takeovers are not common in Egypt as we have witnessed a few of them in the market. However, in case of a hostile takeover takes place, the FRA has the power to mandate the acquirer to submit a fair market value report carried out by an independent financial adviser admitted before the FRA.
From our experience, the equity incentivisation is a cornerstone feature in the private equity market in Egypt, and hence is common. However, as we stated above the level of equity is minimal and it is usually depending on the adopted structure and the agreement between the relevant parties, however, generally, it falls in the average of a neighbourhood of 10%.
The institutional strip structure dominates the private equity transactions scene in the Egyptian market. In fact, most private equity transactions are indirect, being carried out by an offshore investable arm “SPV” of the private equity fund.
Typically, the managers can be incentivised under the management incentive schemes, where the incentive shares can be acquired by the managers concurrently with the private equity fund at the time of closing the transaction. The main purpose of the vesting provisions is to incentivise the managers to keep their high performance with the private equity fund and to retain the “right” deal executives until the end of the private equity fund’s investment period. Normally, the vesting provisions, including the respective calculation, may be identified under the constitutional documents of the offshore SPV, which typically categorise the “good leaver” and “bad leaver”.
Generally, the principle management agreement entered into by the general partner and the limited partners provides for certain restrictions on the limited partners in relation to specific matters (eg, operation, and management of the private equity fund), which is emphasised by the Egyptian law as well under the CLS structure. As a result, it is common that supplementary agreement entered into with the managers of the private equity fund, provides for certain restrictive covenants (eg, non-compete, non-solicitation). However, Such covenants should not be excessive in terms of restrictive period.
Management and Voting Rights
As a general concept, the minority shareholders are protected by the applicable law, and manager shareholders owe a fiduciary duty to the other shareholders (ie, limited partner). As a further protection for limited partners under the CLS structure, the general partner(s) is not allowed to dispose its allotment unless the extra ordinary general assembly approves so. Moreover, in the CLS structure, limited partners’ liability is confined to their contribution as they provide capital but cannot make managerial decisions and are not responsible for any debts beyond their initial investment, unlike the general partner(s), who’s liability is unlimited for the debt of the private equity fund since the general partner(s) is responsible for the daily management of the limited partnership and hence is liable for the private equity fund’s financial obligations, including debts and litigation.
Generally, the anti-dilution protection is granted to shareholders (including the manager shareholder) under the law, but always subject to exercising the subscription right in the event of any capital increase of the fund. However, in case of JSC structure, the exercising of subscription right remains optional, which can be further protected contractually between the manager shareholder and other shareholders. Unlike said case, in CLS structure, the general partner’s allotment shall be always a half percent of the other limited partners’ share in the fund, which is an obligatory requirement for a private equity fund to retain its licence.
Business and Holding Structures
While the law provides for specific provisions with respect to the management and voting rights under the CLS structure, the management agreement may entail further technical details with respect to the management over certain matters involving the business and holding structure (eg, multi-vehicle adjustments and related investment vehicles of the private equity fund).
Under the CLS structure, the law grants the entire management to the general partner (including managers), and hence the right to control the exit of the private equity fund. However, from our experience, the management agreement usually organises the exit right to entitle the partners (general and limited) to vote for the exit.
From a governance standpoint, it is typical for a private equity fund shareholder to have control over the target’s business. This is usually achieved under the shareholders’ agreement, where the private equity shareholder is entitled to certain number of board seats, in addition to certain reserved matters, requiring the approval the private equity shareholder to pass (eg, capital increase, issuance of any shares or equity-linked securities, reduction in capital, redemption of shares, granting of options including the performance incentives program, changes to class rights or rights issue, approval of the annual financial statements, balance sheet, profit and loss statement and cash flow statement of the target, permitting any material change in the accounting policies and principles adopted by the target company, approval of the target’s business plan and annual budget any material deviation of which, approval on the target’s related-party transactions, declaration, distribution and/or payment of dividends by the target company to its shareholders or their direct parent companies, investment or participation by the target in any entity, etc).
In principle, the liability of shareholders is fundamentally organised under the Egyptian companies’ law. In this respect, the shareholders of capital corporate entities (ie, LLC and JSC) are only liable for the acts of the company to the extent of their contribution in the said company’s capital, unless such act implies a criminal liability or grants a favourable advantage to specific shareholder(s) without regard for the interest of the other shareholder(s) or the company. Therefore, one of key priorities of the private equity funds is to apply a proper governance regime in their portfolio companies to minimise the level of exposure, which perfectly accomplished upon imposing a compliance policy in the said portfolio companies.
It is typical for a private equity fund to impose a comprehensive compliance code in their portfolio companies. The implementation of such compliance code by the private equity fund ensures proper oversight of the portfolio companies’ activities. For the purpose of efficiency, the private equity funds associate with compliance policies several governance rights, being appointment of board representatives on the portfolio companies’ board of directors, and veto rights with respect to diversified strategic matters.
The holding period for private equity transactions are usually tied to two main elements, namely the life cycle of the principle fund and the achievement of the business plan to ensure greater “RoI” on the portfolio companies. This would normally take up to five years. Commonly, the private equity funds place the IPO as a strategic way of exit. However, it is yet subject to several factors and market conditions.
While the private equity funds can consider other exit strategies, the “dual track” is not common in the market. The reinvestment upon exit is unusual in the private equity practice, however, the fund remains fixable to reinvest, depending on its investment strategy.
The drag rights are typically provided under the transaction documents. Although the drag right is commonly granted to the majority shareholder, we witness a private equity minority shareholder can stipulate this right under the shareholders’ agreement to force the majority shareholders to co-sell their shares to a third-party buyer on the same terms and conditions. The drag right is commonly exercised on the entire shares of the majority shareholders of the target company.
As the private equity funds adopts the institutional strip approach, the “institutional co-investor” scenario does not occur in practice at the shareholding level of the target company.
Based on the institutional strip model, the private equity investors (ie, management shareholder and private equity fund) are aligned under one vehicle (ie, the offshore SPV), and hence the tag rights are granted to the offshore SPV under the shareholders’ agreement entered into with the other shareholders of the target company, whereby the offshore SPV can exercise the said right, at its sole discretion, and co-sells the minority shares to third-party buyer on the same terms and conditions.
Other than statutory lock-up period for a main shareholder in case of an IPO (ie, two fiscal years), agreeable lock-up period between the private equity seller and the other shareholders generally for average of three years is put. The IPO arrangement can be conducted gradually into several phases, which may have a positive impact on the value of the remaining equity held by a private equity seller, until the full exit. While the relationship agreements may be put in place between the private equity seller and the target company, subject to the disclosure requirements and corporate approvals.