According to experts, the start of the interest rate reverse cycle is making equity investment more alluring and lucrative for investors, which is why the UAE and the larger GCC region are expected to experience a huge spike in startup funding in the last quarter of this year and continue through 2025.

Compared to the forecast $638 million in 2023 funding for tech startups, venture capital (VC) and private equity (PE) funding in the United Arab Emirates is expected to more than quadruple to reach $2 billion by the end of 2024. Next year, they are expected to reach $2.5 billion.

Due to the region’s favorable policies, growing tech sector, and development potential, more international investors are expected to join the UAE and GCC.

Nonetheless, investment experts predict a significant change in the funding structure as investors who have been burned in the past choose safer options like the contractual return of capital, strong cash coupons, and exposure to the borrower’s equity growth through warrants and other comparable instruments.

Khaled Talhouni, Managing Partner at Nuwa Capital, a prominent investment firm specializing in early and growth-stage start-ups with its headquarters in Dubai, told Arabian Business, “We expect funding to stabilize around the $2 billion mark in 2024 and then potentially accelerate in 2025 up to $2.5 billion.”

According to Khaled Talhouni, “national budgets and oil prices are two factors that would impact this [the anticipated funding surge], which will affect the pace of deployment and the availability of dry powder.”

According to Sharaf Sharaf, Fund Head at Amplify Growth Partnership, the end of the cheap capital era will also bring about a significant change in the funding landscape, as investors will place greater value on companies that can produce consistent revenue streams than on growth metrics.

According to Tracxn‘s “Geo Annual Report,” tech startup investment saw a sharp decline in 2023, falling to $638 million, a 65 percent decrease from the year before.

However, since the third quarter of this year, venture capital has been showing indications of resurgence, with some companies raising double-digit money, up to $30 million.

In the first nine months of 2024, UAE startups are expected to have raised over $690 million.

UAE, GCC funding landscape to see major shifts

According to industry experts, entrepreneurs will emerge as winners in each area as a result of the change in investment strategy, capturing a disproportionate share of the capital in their respective categories.

They added that the UAE and the region’s relative wealth and young, tech-savvy population position startups well for expansion in the innovation economy and will help them draw in more capital in the upcoming quarters.

According to them, expected waves of interest rate cuts will substantially boost the region’s startup funding opportunities this year and in the future.

“In general, lower interest rates should encourage capital to move from debt to stocks, particularly in private markets or alternatives for investors and allocators seeking higher alpha,” Talhouni stated.

He said VCs and PEs would be betting on more equity capital for startups, especially those with high growth and profit-making potentials, given the present acceleration of companies going towards IPOs and exits following the opening of the possibility to go public.

However, Sharaf thought that since fintech business models usually produce steady revenue, they are good candidates for debt financing, and the trend of fintech raising debt rounds is probably here to stay.

“Debt gives fintechs a means to grow effectively without dilution as equity financing becomes more costly.

Furthermore, Sharaf told Arabian Business, “We expect a stronger focus on debt solutions as an effective way to fuel their expansion, especially for scaling digital payments, SME lending, and financial services models, as regulatory support for fintechs grows in the MENA region.”

In pursuit of this extra return, he added, “This will also help investors adjust their risk-reward trade-off.”

According to the CEO of the Amplify Growth Partnership fund, interest rates have decreased, but only a little.

Even though 3-month SOFR (Secured Overnight Financing Rate) rates have decreased from a peak of 5.4% in late 2023, the decline has only been 10%, as rates are at 4.8%.

“Looking back, rates have gone up by about 400% since the beginning of 2022,” he stated.

According to Sharaf, investors value the mix of strong cash coupons, contractual return of capital, and exposure to the borrower’s equity growth through equity participation instruments like warrants or other comparable instruments, especially in light of the current interest rate environment.

He added that this is a safer method to obtain exposure to intriguing, rapidly expanding businesses in the UAE and the GCC. “This enables us to give our investors access to expanding technology-driven businesses without their initial investment being dependent on an exit to realize their gains,” he said.

Region to see more acquisitions, consolidation drive among startups

Notwithstanding the forecasts of a spike in funding, there will likely be some significant failures in the UAE and the surrounding area, which will lead to a wave of purchase deals—the takeover of startups for their human capital—and a market consolidation drive.

“There will probably be some significant failures in all areas; this is a normal development of the ecosystem; as more and more businesses are founded and subsequently funded, more will definitely fail,” the top executive at Nuwa Capital stated.

According to Sharaf, as the ecosystem develops, more and more businesses will need specialized capital solutions that are based on their needs and maturity stage. As a result, the region will also witness the rise of specialized stage funds like growth funds and debt funds.

According to Talhouni and Sharaf, more international investment firms will eventually enter and grow in the UAE.

“Yes, there is no doubt that more companies like TPG and General Atlantic will keep growing in the area, and other new international players will begin to consider the area,” Talhouni stated.

Sharaf claimed that the UAE and GCC are emerging as major international investment destinations because of their strategic location, ambitious national objectives, and solid economic foundations.

“We anticipate a rise in engagement from international investors drawn to the area by its favorable rules, growing innovation sector, and growth potential.