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Soliman, Hashish & PartnersInsightsBriefingsBanking & FinanceNew FRA Decrees on the Criteria for Securities Trade-offs and Startup Companies

Fatima Amr Associate

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New FRA Decrees on the Criteria for Securities Trade-offs and Startup Companies

Banking & Finance Firm News

On July 26, 2023, the Egyptian Financial Regulatory Authority (the “FRA”) issued Decree No. 151 of 2023 (the “Decree”), on the criteria for trade-offs between applications for a license to practice the activity of evaluation, classification and arrangement of securities.

By virtue of the Decree, the FRA will grant one new license to practice the activity of evaluation, classification and arrangement of securities in light of the capital market’s needs (the “License”). The trade-offs between the applicant companies are made according to the below-stated criteria (the “Criteria”) and the FRA will proceed in granting the License to the company obtaining the highest evaluation score, provided that such evaluation score is no less than fifty percent (50%).

Companies wishing to apply for the License are given a period of three (3) months to submit their application taking into consideration the Criteria, and such period may be extended by the FRA depending on the outcome of the examination of the submitted applications.

The Criteria set by the FRA are the following:

  1. The first criterion is with regard to technical requirements, namely (i) the certification from an international credit rating agency providing that the applicant company will comply with the same standard of the said international credit rating agency, and in the event the certification is not from a major credit rating agency, then such certificate should be accompanied by evidence of a technical partner licensed by the SEC or ESMA and evidence that such technical partner has experience in providing credit ratings of companies listed on a stock exchange upon request, (ii) the presentation of the credit rating methodologies to be followed, and (iii) submitting a report on the availability of the necessary technical and administrative cadres to carry out the activity, namely a working group of credit analysts.
  2. The second criterion is the ownership structure of the applicant company, noting that a minimum of fifty percent (50%) ownership by Egyptian or foreign financial institutions is required and a minimum of twenty-five percent (25%) ownership by an international entity specialized in the practice of credit rating.
  3. The third criterion is independence, objectivity and internal control, namely by submitting evidence of draft policies and procedures to limit conflicts of interest and evidence of envisaged standard operating procedures, governance procedures and regulatory matters.
  4. The fourth criterion is with regard to the capital of the company. The issued and paid up capital is required to be no less than EGP 50,000,000 (fifty million Egyptian Pounds) or its equivalent in a foreign currency.
  5. The fifth and final criterion is with regard to the technical and economic feasibility study of the company.

The FRA also issued Decree No. 150 of 2023 on July 26, 2023 (the “Amendment”) amending Decree No. 1 of 2017 on issuing Egyptian standards for financial evaluation of establishments (the “Old Decree”).

By virtue of the Amendment, new provisions were introduced to the Old Decree and some provisions were altered.

Firstly, the term “Startup Companies” was added to the definitions contained in the Old Decree, to be as follows: companies which have been operating for a short period of time, and often newly-established, in the process of development and undertaking market research. Such companies might be utilizing technology to invent new things. Startup Companies typically begin with low capital and high expenditure, facing many challenges in order to attain the required funding to develop the scale of its operations and expand in the market. The need to evaluate such Startup Companies therefore emerges in order to increase capital depending on their stage of development, so that current or prospective investors may evaluate their investment in light of differences in returns and risks according to each stage of the development of the Startup Company.

Accordingly, the scope of application of the financial evaluation standards in the Old Decree was expanded to include the aforementioned Startup Companies in terms of transactions related to transfer of shares or capital increase or issuance of convertible financing instruments in said Startup Companies in accordance with their shareholder agreements, in the event that companies or authorities practicing capital market activities invest in Startup Companies through convertible financing instruments.

Furthermore, the phrase “customary financial evaluation approaches and methods for established companies that practice the activity” in the sixth criterion, “Methods and Approaches of Financial Evaluation” attached to the Old Decree was amended to be “customary financial evaluation approaches and methods” to include Startup Companies as well.

In the same sixth criterion attached to the Old Decree, the requirement to carry out a preliminary analysis of material and non-material factors when conducting a financial evaluation on a Startup Company was added. Such requirement is due to the difference in relative importance of each factor depending on the sector which the company under evaluation belongs to and its capacity to achieve prospective profits.

It was also added in that same sixth criterion with regard to the phase prior to generating revenue and sales, that the risk capital methodology is the methodology to be used when conducting financial evaluations of Startup Companies in the phase prior to revenue realization. This methodology is based on the assumption of several factors, including the said company’s value upon exit after several years, determining the prospective return on investment, as well as calculating the investor’s stake at exit, and the investor stake given the prospective dilution in their share in light of future capital increase, and consequently evaluating post capital increase or prospective funding and then deducting the investment amount (as per the first increase) in order to evaluate pre-investment.

The aforementioned methodology includes several evaluation methods, including, inter alia, the standard method of capital risk (Standard VC), and the modified method of capital risk (Modified VC).

According to the Amendment, once Startup Companies start generating revenue and sales, they shall be subject to the financial evaluation methods used for established companies that practice the activity.

Annex No. 1 to the Old Decree (“Annex No. 1”) was therefore amended to include the approach to be followed when conducting financial evaluation on Startup Companies (in the phase prior to generating revenue and sales) as stated hereinabove, which stipulates the following:

  • The value of the Startup Company under evaluation is derived from the expected value of the Startup Company at the time of the investor’s prospective exit (Exit Value) based on the expected return on investment.
  • Furthermore, when following the aforementioned approach, several elements shall be considered, which are the exit valuation, target multiple of money, retention percentage and investment recommendation.
  • The same requirement to carry out a preliminary analysis of material and non-material factors when conducting a financial evaluation on a Startup Company which is added under the sixth criterion is elaborated in Annex No. 1. It adds that upon conducting preliminary analysis of the material and non-material factors, the impact of such factors on the Startup Company under evaluation and its capacity to generate future prospective revenue is examined.
  • The factors referred to hereinabove are:
  1. The activity of the Startup Company;
  2. The Startup Company’s current status;
  3. The competency of the management and its experience in the activity it carries out and the team’s competencies;
  4. The market where the Startup Company operates and the technical characteristics and its indicators;
  5. The product’s characteristics, whether it is a good or a service;
  6. The Startup Company’s competitive features;
  7. The utilized technology; and
  8. The Startup Company’s financing stage.

It is stipulated that the analysis of the aforementioned factors enables a comprehensive understanding of the nature and activity of the Startup Company which allows evaluation of the related risks, while taking into consideration that the nature of the factors differ from one industry to another. It is also worth noting that the different financing stages of the Startup Company could lead to the change of the relative importance of some factors over others given that some Startup Companies may be affected by one or more factors to a higher degree than it may be affected by other factors, and therefore it is important to consider the foregoing while conducting the financial evaluation of the Startup Company.

To elaborate further, the Decree provides application examples of the financial evaluation approach of Startup Companies (in the phase prior to generating revenue and sales) in order to ensure correct and comprehensive implementation of the foregoing.

Finally, the FRA also issued Decree No. 160 of 2023 on July 26, 2023, regarding the ratio of instalments to client’s income in the activity of consumer finance (the “Decree No. 2”). By virtue of Decree No. 2, companies licensed to engage in the activity of consumer finance shall ensure that the total monthly finance instalments do not exceed fifty percent (50%) of the client’s total monthly income.

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