December 13, 2012
Finding a fair price – Elie Habib
Development (RED), a member of Abraaj Capital
Finding a fair price
Conflicts in valuation hinder investment in entrepreneurs
Private equity (PE) financing for small and medium enterprises (SMEs) is a fairly nascent industry in the Middle East and North Africa (MENA) region, but it is increasingly being accepted as SMEs seek financing to grow and expand. In Lebanon, awareness in the business community of PE financing, with an emphasis on providing value-added services as well as capital, has been increasing in 2011 and 2012, promising a deep and exciting deal flow in 2013.
PE firms tend to invest in companies that have validated their value propositions, acquired a customer base, identified target markets and are ready for accelerated growth and expansion. While PE firms have extensive expertise in various sectors, they approach every deal as a unique opportunity and agreeing on a “fair price” for each target company is one of the key challenges. While the metrics and methods used in valuing companies are relatively standardized globally, Lebanese and MENA companies have their own unique regional characteristics, limited target markets and challenges with efficiencies that make the valuation and investment process more complicated and open the door for lengthy negotiations. As new deals are being completed in Lebanon, they become benchmark references, creating a localized valuable deal model for upcoming opportunities.
In the family
In the MENA region, around 75 percent of the companies operating in the private sector are family businesses whose owners tend to place higher sentimental values and have greater attachment to their firms, which often results in a prolonged decision-making process related to relinquishing full control of their companies. Historically, small and medium family businesses are characterized by their high reliance on loans, weak management structure and being under-leveraged, which usually hinders them from achieving their full potential. As these companies seek faster growth, they could approach PE firms to invest in them and provide access to growth capital and various value-creation services, such as institutionalizing their businesses, formulating strategies, bringing exposure to foreign markets, developing financial plans, etcetera. In these cases, the founder’s own valuation of the company can be subjective and emotionally driven, seeking to be compensated for past struggles or to secure the future livelihood of the family.
As for companies established and run by individual entrepreneurs, they tend to be more flexible, as their founders realize the necessity of bringing in seasoned partners to support their growth in a competitive environment. However, we have noticed that despite their strong entrepreneurial skills and knowledge of the business environment, they face the same difficulties as family businesses, placing a high value on ‘sentimental’ factors that cannot be priced while still having a hard time accepting the proposed fair price. For instance, during the negotiations that took place to acquire a minority stake in a promising company that operates in Lebanon and has regional exposure, we were unable to agree on a price for no rational reason: the founders believed that their company will outperform some of the perceived competitors being launched in the United States and written about in digital trade press such as TechCrunch and GigaOM undefined and as result, they demanded price parity for their company.
Country and business environments, as well as local realities factor substantially into lowering the fair price of a company relative to international ones. However, regardless of methods used, good faith negotiations have to take place to reach a specific price that satisfies all parties and to establish good grounds for a strong relationship to take place in the future.
In almost every country in the MENA region, several funds running tens of millions of dollars of capital are ready to be deployed, opportunities are waiting to be tapped and business professionals are available to provide their support; however, investment barriers still exist, mostly due to valuation conflicts. During negotiations, founders should be more flexible and minimize the sentimental factors arising from selling equity in their company that, otherwise, would have potentially never reached its optimal growth.