Although the constant legislative reforms made to the Egyptian economy and the economic reforms undertaken by the Egyptian Cabinet have significantly contributed to boosting the number of transactions involving international and domestic private equity funds, the COVID-19 outbreak is still affecting transactions in both the global and regional markets and, by extension, private equity M&A transactions.
The high demand by SMEs and start-ups for financing has allowed private equity funds to act as an alternative solution for financing and to fill the gap between the available channels of financing and the increased demand on the part of SMEs and start-ups.
In a recent remarkable move, the Board of the Egyptian Sovereign Fund issued Decree No 7 of 2020 promulgating the establishment of a sub-fund, namely, Egypt’s Sub-Fund for Financial Services and Digital Transformation (the “Sub-Fund”). The main purpose of the Sub-Fund is to devote investments to non-banking financial services, digital transformation and financial inclusion, including in insurance and insurance brokerage services, real estate financing, financial leasing, factoring, and microfinancing. This prominent step will likely encourage private equity funds to direct more investments into companies operating in the fintech sector, which underpins the odds of observing further activities in private equity M&A transactions in the Egyptian market in general, and in the fintech sector, in particular.
Certain sectors dominate the private equity M&A transactions scene in Egypt, as the appetite of the healthcare, education, fintech, and renewable energy sectors for private equity funds is steadily increasing and is of paramount importance.
Legislative Development in the CML
In 2018, a significant legislative development was introduced to the CML, when a newly incorporated Egyptian private equity company became obliged to be in the form of a CLS structure (ie, a company limited by shares). This structure ensures a significant advantage for the limited partners, namely, it confines their liability to their contribution to the company's share capital, provided that they do not engage in the company's management. By contrast, the CLS's manager will be the general partner in the company, which triggers the illimitation of its liability towards the limited partners.
Financial Regulatory Authority Decrees
Accordingly, in June and September 2018, the Financial Regulatory Authority (FRA) issued two executive decrees, whereby a private equity fund must satisfy certain conditions for its establishment and licensing in terms of its required legal structure, capital, partners and their respective ownership percentage and qualification, purpose, management, the fund’s investment ratios, and managers (including the general partner of the fund). It is worth highlighting that a private equity fund’s activity will be limited to private equity and it must apply for a licence in order to undertake venture capital activity.
Prior Approval for the Direct or Indirect Acquisition of a Business
Another significant legislative change was put in place, whereby some laws have been amended to require prior approval in the case of direct or indirect acquisition of a business. Hence, whenever a private equity fund opts to acquire stakes 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.
New Decree No 99 of 2021 Regarding Medical Industrial Facilities
Another recent development, in this case with respect to the operation and legal disposal of medical industrial facilities, was the issuing of the New Decree No 99 of 2021, issued on 2 March 2021 (the “Decree”) by the Egyptian Drug Authority (EDA), whereby no medical industrial facility can be established or expanded unless the EDA approves this.
Furthermore, the decree prohibits any sort of legal disposal (eg, sale and purchase) of medical industrial facilities unless prior notification is served to the EDA via certain forms pre-set by the EDA. To this effect, the prior notification will be associated with the necessary undertakings, as determined by the EDA, to ensure the availability of medicine in the market.
In the context of private equity funds M&A transactions, one of the conditions precedent that is likely to be envisaged in future transactions relating to medical industrial facility acquisition, is to notify the EDA. However, the implementation of said decree is to be closely monitored to verify compliance with the new notification requirements.
Generally, the regulatory restrictions in Egypt vary from one industry to another. For example, 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, and compliance with the laws and regulations of the industry. While some acquirers may opt for limited high-level due diligence with a focus on key red flags, others may prefer to carry out full, detailed due diligence.
Customary legal due diligence usually covers key areas, inter alia, required licensing, full review of the constitutional documents to assess if any restrictions and third-party consents are required pertaining to the material agreements concluded by the target company, an assessment of the employees’ rights, and the general compliance of the target company with Egyptian laws. However, the buyer may require additional/specific due diligence to be exercised by its advisers. Legal due diligence may be conducted via a virtual data room or in the physical presence of the buyer’s advisers at the target’s premises, but virtual data room due diligence seems to be preferred.
Vendor due diligence is not commonly conducted in Egypt. However, while buyers do not generally opt to rely on such reports (unless in the 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.
Generally, there is no major difference between a privately negotiated transaction and an auction sale. However, in an auction sale where there is competition between the bidders to win the sale, the terms of the acquisition may be strictly negotiated before being accepted by the seller, as the seller is in a better position to demand the most favourable terms and conditions.
Most transactions involving a private equity-backed buyer are managed as indirect acquisitions for ownership restructuring purposes. Hence, the private equity fund usually establishes a special purpose vehicle (SPV) to contract with the seller, depending on the proposed deal structure, and the partnerships of the private equity fund do not directly enter into any 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 they may be financed by a mixture of both the equity committed to the SPV and the finance provided by the third-party lender (eg, banks). In all cases, the SPV should have sufficient funding to finance the deal, which is usually made available by the private equity fund to the SPV at the time of executing the SPA. Most deals witnessed in the past three years indicate a tendency on the part of key private equity funds in the Egyptian market to acquire a minority rather than a majority stake.
While a private equity consortium is observed in a few transactions in the market, this is not yet common in Egypt. Indeed, the private equity fund holds majority equity on the offshore SPV level. Meanwhile, a minimal ratio (minority) of around 10% will be held by the management in most cases. However, a significant part of equity funding is often secured via a preferred equity instrument, which has a preferred return under the fund management agreement, as common equity will not suffice to secure the equity funding of the transaction, due to its minimal ratio to 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 an interest in co-investing alongside the private equity fund, especially at the very beginning of the transaction up to its closing, based on cost-efficiency and the uncertainty of the transaction. However, investors may opt to use 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 aims to enlarge the financial interest of its investors in such investment.
Having said that, in the case of acquiring a larger stake, the co-investors may engage together with the private equity fund at the same level as the management team, in which case, minority protection will be given to the co-investor (eg, the right to access information).
While the completion accounts mechanism is used in a few cases in the market, the locked-box mechanism remains the dominant form of consideration structure in Egypt, as it is particularly suited to transactions where the parties require economic certainty in case of, 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. Generally, 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 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. The buyer may also require the management accounts covering the gap between the audited financials and completion, especially when the completion date falls some time after the locked-box date.
Unlike the foregoing, the earn-out mechanism can be observed in transactions where a 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 the same consideration mechanism tends to be used in most transactions involving a private equity buyer.
The SPA usually provides 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 usually remains the same, 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-pound basis, the interest charge on leakage is rarely adopted in the market. However, the buyer has recourse to the general rules of interest charged under 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 and, in particular, the parties usually agree to specific indemnity (eg, Egyptian pound-for-pound indemnity for leakage in the case of a locked-box mechanism), which, in most cases, is identified and settled before completion of the transaction.
The level of conditionality depends on the outcome of the due diligence exercise, which is 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 most common conditions observed in the SPA is third-party consent, if it is provided under a material contract to which the target is a party.
In Egypt, the buyers are usually conservative, so they are not willing to accept hell or high water undertakings, especially where this approach conflicts with the fiduciary obligation of the private equity fund towards its investors. Furthermore, the hell or high water 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 approach is not usually adopted by private equity funds in the Egyptian market.
Although break fees and reverse break fees are not mandated or regulated under Egyptian law, in private M&A 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.
As with any other acquisition transaction, termination rights are vested in both parties on the occurrence of certain events specified under the acquisition documentation. Material adverse change/effect and non-satisfaction of conditions precedent (eg, obtaining the prior approval of the regulator or third-party consents) are key events that can trigger termination of the transaction, unless waived by the aggravated party.
Generally, private equity sellers will attempt to limit their liability arising from the sale of the portfolio company, in order to return the proceeds to the investors in a timely manner, and maximise their return on investment, knowing that any unreasonable extension of the return time will affect the fund’s performance. Therefore, private equity sellers tend to assume 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 rise to any liability. Thus, typical warranties given by the private equity seller under the SPA will be limited to the fundamental obligations and warranties (ie, to transfer the shares free of encumbrance, the fund’s ownership of the shares, the power and authority to enter into the SPA, permission of leakage, and running the portfolio company in the ordinary course of business until completion).
Furthermore, the private equity seller will opt to negotiate the shortest possible perception period of the warranties given under the SPA, which in most cases ranges between six and 24 months. In the event that 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.
Private equity sellers typically provide fundamental business and core warranties (eg, legal title to the shares, the power and authority to enter into the SPA, accounting, litigation, solvency, insurance, etc).
In Egypt, the management team does not usually participate in shareholding at the target level. Furthermore, in most transaction documentation, whether or not the management team is involved in the board of the target, the customary business warranties will be provided by the seller (eg, accounting, tax, employment, insurance, litigation, compliance with law, accuracy of the disclosed document/information, etc).
Warranties are typically capped under the SPA in terms of limitation of time and quantity as the time limitation of most 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, core warranties (eg, title of the shares and power and authority) are typically capped at 100% of the transaction consideration, while business warranties (eg, employment, litigation, compliance, etc) are capped at 25% of the transaction consideration.
Warranty and indemnity 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 resort to indemnity claims covering potential liabilities.
Litigation is not common in M&A transactions or private equity transactions in Egypt, as the parties usually agree to institutional arbitration as a way to solve disputes. The most commonly disputed clauses may be, for instance, MAC, breach of warranties (ie, core warranties and business warranties), and price adjustment. However, the potential rise in disputes when a private equity fund is involved is minimal, as private equity funds usually tend to undertake comprehensive due diligence on the target company before execution of the transaction documents, so that they can eliminate the possibility of post-closing disputes as much as possible.
Public-to-private transactions are not common in private equity transactions in Egypt.
Any corporate entity established in Egypt and any 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) are 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. Furthermore, according to the FRA’s listing rules, shareholders are obliged to notify the FRA if their shareholding, voting rights, subscription percentage (directly or indirectly) reaches or falls below 5% and multiples of 5%. This also applies to employees, board members and their related parties, whose respective shareholding, voting rights, subscription percentage (directly or indirectly) reaches or falls below 3% and multiples of 3%.
A recent amendment has been introduced to the CML with respect to the thresholds requiring submission of a mandatory offer to the minority. The new amendment introduced certain thresholds that can be summarised, as follows:
Consideration is dependent on the target’s shares. For unlisted shares, the consideration may be in cash and/or in kind, while for listed shares, the consideration for a mandatory tender offer may be all in cash, or a mixture of cash and shares.
The CML requires a mandatory tender offer to be final and not subject to conditions. In exceptional cases, and subject to the FRA’s approval, an offeror can make a mandatory tender offer conditional on the acquisition of a minimum stake in 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. Furthermore, 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.
Furthermore, 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 can be granted to the bidder under 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. However, the CML has allowed minority shareholders to request and oblige majority shareholders to acquire their stake.
While conceptually, irrevocable commitments can be agreed in the case of an unlisted target company, irrevocable commitments are rare in the case of listed target companies to minimise the level of disclosure, especially since 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, which illustrates the impracticability of irrevocable commitments in tender offer transactions.
Hostile takeovers are not common in Egypt but there have been a few of them in the market. Where a hostile takeover occurs, 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.
Equity incentivisation is a cornerstone feature of the private equity market in Egypt. However, as stated previously, the level of equity is minimal and it is usually dependent on the adopted structure and the agreement between the relevant parties. It is generally about 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, managers can be incentivised under management incentive schemes, where incentive shares can be acquired by managers concurrently with the private equity fund at the time of closing the transaction. The main purpose of vesting provisions is to incentivise managers to maintain 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 “good leavers” and “bad leavers”.
The principal management agreement entered into by the general partner and the limited partners usually provides for certain restrictions on the limited partners in relation to specific matters (eg, the operation and management of the private equity fund), which is emphasised by Egyptian law as well as under the CLS structure. As a result, it is common that the 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 the length of the restrictive period.
Management and Voting Rights
As a general concept, minority shareholders are protected by the applicable law, and manager shareholders owe a fiduciary duty to the other shareholders (ie, the limited partners). As a further protection for limited partners under the CLS structure, the general partner(s) is not allowed to dispose of its allotment unless the extraordinary general assembly approves this. 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. On the other hand, the liability of the general partner(s) for the debt of the private equity fund is unlimited, since the general partner(s) is responsible for the daily management of the limited partnership and is therefore liable for the private equity fund’s financial obligations, including debts and litigation.
Anti-dilution protection is generally granted to shareholders (including manager shareholders) under the law, but it is always subject to exercising a subscription right in the event of any capital increase of the fund. However, in the case of a joint stock company structure, exercising a subscription right remains optional, and this can be further protected contractually between the manager shareholder and other shareholders. However, in a CLS structure, the general partner’s allotment is 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 specifies provisions with respect to management and voting rights under the CLS structure, the management agreement may entail further technical details with respect to management of certain matters involving the business and holding structure (eg, multi-vehicle adjustments and related investment vehicles of a 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 exit from the private equity fund. However, 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 a certain number of board seats, in addition to certain reserved matters, requiring the approval of 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 programme; 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 and any material deviation from this; approval of 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 Egyptian companies’ law. In this respect, the shareholders of capital corporate entities (ie, limited liability companies and joint stock companies) are only liable for the acts of the company to the extent of their contribution to said company’s capital, unless such act implies criminal liability or grants a favourable advantage to specific shareholder(s) without regard for the interests of other shareholder(s) or the company. Therefore, one of the key priorities of private equity funds is to apply a proper governance regime in their portfolio companies to minimise the level of exposure, which is perfectly accomplished by 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, private equity funds associate several governance rights with compliance policies, including the appointment of board representatives to the portfolio companies’ board of directors, and veto rights with respect to diversified strategic matters.
The holding period for private equity transactions is usually tied to two main elements, namely, the life cycle of the principal 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, this is still subject to several factors and market conditions.
While private equity funds can consider other exit strategies, the “dual track” is not common in the market. Reinvestment upon exit is unusual in private equity practice, however, the fund remains fixable to reinvest, depending on its investment strategy.
Drag rights are typically provided under transaction documents. Although the drag right is commonly granted to the majority shareholder, 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, manager shareholder and private equity fund) are aligned under one vehicle (ie, the offshore SPV). The tag rights are therefore granted to the offshore SPV under the shareholders’ agreement entered into with the other shareholders of the target company, according to which, the offshore SPV can exercise the said right, at its sole discretion, and co-sell the minority shares to a third-party buyer on the same terms and conditions.
Other than a statutory lock-up period for a main shareholder in the case of an IPO (ie, two fiscal years), the lock-up period between the private equity seller and the other shareholders is generally agreed for three years. The IPO arrangement can be conducted gradually in 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. Meanwhile, relationship agreements may be put in place between the private equity seller and the target company, subject to disclosure requirements and corporate approvals.