The Rise of Saudi Arabia and the MENA Region in Venture Capital
Palo Alto Partners Perspective:
The Middle East and North Africa (MENA) region is becoming a focal point for venture capital (VC) investment, with Saudi Arabia emerging as a key player. As the ecosystem matures, there are increasing opportunities for international collaboration, particularly for U.S. venture firms. However, the region’s nascent VC landscape requires a nuanced approach. Fund managers must understand that relationship building, grounded in local culture, is critical. Success in the Middle East often depends on building long-term trust with investors like family offices and sovereign wealth funds, as well as adapting to unique market dynamics. Emerging managers who take the time to establish meaningful connections can benefit from the region’s growing entrepreneurial ecosystem and untapped potential.
For emerging managers, the MENA region presents both challenges and unique opportunities. The region’s growing sophistication in venture capital and its focus on fostering innovation make it an attractive destination for diversification. Saudi Arabia, in particular, has witnessed increased allocations to venture capital, driven by government initiatives and private-sector funding. By aligning with local investment preferences and demonstrating a commitment to mutual growth, emerging managers can position themselves as valuable partners. Moreover, the focus on backing emerging managers with smaller ticket sizes aligns with the region’s investment strategies, offering a chance to become part of the next wave of standout VC firms. This underscores the importance of a patient, relationship-driven approach to capitalizing on the region’s untapped growth potential.
- The Middle East and the MENA region are becoming increasingly important for venture capital investment, with the region being the number one new net geographical area for venture capital investment in 2023 01:11.
- This episode’s guest is Ramzi Samara, the co-head of private funds at MASIC, a single-family office based in Riyadh, Saudi Arabia 01:15.
- The episode will discuss the number one mistake US managers make when coming to the Middle East, whether the region is in early stages, and what timelines US managers should expect when raising in the MENA region 01:24.
- Ramzi Samara is welcomed to the podcast, and he thanks the host, David Weisberg, for having him 01:43.
How does VC view the market dynamics in Saudi Arabia? 01:45
- Many venture capitalists, including Mark Andreessen and Ben Horowitz, have been visiting the Middle East and North Africa (MENA) region, specifically Saudi Arabia, indicating a positive market sentiment towards US venture capitalists, with the ecosystem validation, potential for portfolio companies to benefit from a different market, and collaboration between sharing deals and know-how being key factors 02:03.
- There have been examples of successful collaborations between US venture firms and local startups in the region, such as fintech companies receiving funding from US venture firms, which brings in know-how and lessons learned from the growth of fintech companies in the US 03:06.
- The Saudi startup ecosystem is still in its nascent stages, with a lot of strong startups, positivity, and funding from government and the private sector, but it has not yet reached the levels of attracting all VC firms to invest in multiple companies 03:33.
- Exits in the secondary market, stock exchange, and acquisitions, such as Kareem’s acquisition by Uber and sub.com’s acquisition by Amazon, are setting the tone for future entrepreneurs and sending positive signals to global VC firms 04:07.
- US venture capital firms coming to the region often expect to return with significant investments, but this is not how it works, and successful case studies have shown that relationship building is key, taking time to build relationships with sophisticated investors, such as family offices, institutions, and sovereign wealth funds 04:46.
- Fund managers who have been successful in the region have understood the importance of relationship building, which is core to the culture in Saudi Arabia, and have avoided mistakes such as expecting easy money and not taking the time to build relationships 05:17.
- Managers need to understand that different institutions and individuals have various mandates, and listening first is key to finding potential ways to collaborate in the venture capital environment 05:38.
- Relationship building in the Middle East involves taking the time to get to know potential LPs, understanding their mandates, histories, and long-term goals, which are key components for fund managers 05:58.
- Knowing the individuals involved and being familiar with them can go a long way in building relationships, and meeting face-to-face can take the relationship to a whole new level 06:35.
- In the Middle Eastern culture, particularly in Saudi Arabia, it is still important to discuss things outside of business and build personal relationships, as solely focusing on quick fundraising does not work 06:57.
- Fund managers need to come to terms with the importance of understanding and adapting to the local culture and way of doing business in the region 06:32.
- The traditional approach of quickly fundraising and looking for LPs does not work in Saudi Arabia, and a more personalized and relationship-driven approach is necessary 07:14.
How should Venture Capitalists think about navigating MENA? How does Saudia Arabia differ from the UAE, Bahrain, Qatar, etc. 07:16
- Saudi Arabia is a relatively new player in the venture capital (VC) game compared to other areas like the UAE, Qatar, and Kuwait, which have been investing in VC for longer, making it easier to raise funds from those regions due to a better understanding of the asset class 07:29.
- The local VC ecosystem in Saudi Arabia started to form around 2014-2015, although entrepreneurship has been present since the country’s founding, and international VC involvement is a relatively recent development, with larger institutions and sophisticated family offices getting into venture capital in the past four or five years 08:06.
- Venture capital is still a new asset class in Saudi Arabia, with some families having invested in it for over 10 years, but they are few in number, and the larger landscape is still developing, with U.S. fund managers recently adding Saudi Arabia to their itinerary 08:45.
- Investors in Saudi Arabia are becoming more sophisticated, and it’s just a matter of time before different family offices and institutions become comfortable with VC, with some strong players already allocating to venture capital 09:10.
- MASIC is a family-owned investment company established in 2009, which recently added venture capital as an asset class to its portfolio, with a focus on global VC, specifically in the US, to gain exposure to software-driven businesses and achieve outsized returns 09:32.
Ramzi’s investing thesis at MASIC 10:27
- Emerging managers are key to the ecosystem, and committing smaller ticket sizes to more emerging managers is part of the investment thesis, as statistics show that first-time and second-time fund managers outperformed more established fund managers over a 10-year cycle 10:47.
- Investing in emerging fund managers is risky, but committing to a larger number of emerging managers on an annual basis with smaller ticket sizes and tracking their performance against peers can help mitigate this risk 11:21.
- The goal is to be part of the next wave of emerging managers that become the next benchmarks, such as Union Square Ventures, and several emerging managers have been looked at this year despite the challenging fundraising environment 11:37.
- An emerging manager is defined as a fund manager with a fund one up to fund three, around $150 million or less in fund size, and may have a new team, strategy, or thesis focus, even if they have a strong track record 12:18.
- Co-invest opportunities are not currently part of the mandate, and the focus is on being patient and long-term investors in fund managers, with co-investments potentially being considered in the future 13:04.
- Diversification is achieved by looking at the US and being opportunistic in Europe, with a focus on more mature markets, and sector-focused investments are considered, but generalist firms are preferred 13:35.
- The investment approach is driven by a strategic asset allocation point of view, with a focus on diversification from a geographic and stage perspective 13:59.
Ramzi’s portfolio strategy 14:15
- The portfolio strategy involves making specific bets in the range of $20-150 million, with a bias towards generalist firms due to the risk of sector-focused firms requiring a deep understanding of the sector itself 14:21.
- The generalist approach is preferred, especially in the early days, as it allows for a diversified portfolio construction by investing in several types of sectors 14:41.
- As the portfolio grows, there are plans to consider more focused funds that look at specific sectors such as healthcare or fintech, which could serve as good diversifiers to the overall portfolio 14:50.
- The generalist approach is currently the most comfortable strategy, but as the portfolio expands, there will be a deeper exploration of different sectors to determine the best additions 15:02.
- Assessing sector-focused funds, such as AI funds, can be challenging due to the fast-paced nature of the space and the various layers involved, from the application layer to LLMs 15:18.
- Despite the challenges, there is a recognition of the potential for strong returns in industries before they are well-established, as seen in the cases of Uber and Airbnb, which later became part of the sharing space 15:41.
- The trade-off is that some of the best investment opportunities may arise before a sector is formally named or recognized, making it essential to continue educating oneself about sector-focused fund managers 15:55.
Criteria for evaluating a fund 19:12
- When evaluating emerging managers in venture capital, the assessment process is more qualitative than quantitative due to the lack of a track record, and it involves lighter due diligence compared to more established managers 19:37.
- The team is at the heart of the evaluation, focusing on whether they have the right hunger, connections, sourcing strategies, and the ability to pick out winners in a power law dynamics environment 19:47.
- Evaluating the team’s ability to identify potential unicorns and top market leaders is crucial, as well as their capacity to return the fund over time 20:12.
- Assessing the team’s strategy is important, including the sectors they focus on, to ensure alignment with the investor’s preferences and restrictions, such as avoiding investments in adult entertainment, wine, or gambling 20:41.
- The evaluation process also considers whether the emerging manager is operating in a crowded space, their ability to win deals, and the potential impact of a concentrated or large portfolio 21:06.
- The goal is to gain conviction that the fund manager has the potential to be a top-performing fund in the future, based on their justification, thought process, and overall strategy 21:34.
Looking at passive vs. active fund managers 21:41
- Venture capitalists can be categorized into two types: those who pick winners and those who get winners to pick them, with the distinction often depending on the stage of investment and the level of involvement with portfolio companies 21:44.
- Early-stage managers may be more hands-on, while later-stage managers may be more passive, with some firms focusing on adding value to their portfolio companies through services like recruiting and securing funding 22:01.
- The role of lead investors is evolving, with some firms growing significantly in terms of assets under management (AUM), which can be a concern for investors, but also presents opportunities for diversification and maximizing returns 22:48.
- The growth of AUM can be a sign of a successful investment strategy, but it’s essential to assess whether the firm is focused on returns or just gathering assets, with some firms increasing their fund size by 50% or 100% year-over-year 23:22.
- The correlation between fund size and returns is a crucial consideration, with larger funds potentially being more late-stage and having different dynamics than smaller, early-stage funds 23:34.
- LPs should be cautious of “AUM gatherers” who prioritize collecting management fees over carry, with leading indicators including high management fees, large fund sizes, and rapid growth that may not be justified by market conditions 24:19.
- To identify AUM gatherers, LPs should look for signs such as high management fees, large fund sizes, and rapid growth that may not be justified by market conditions, as well as a focus on deploying capital quickly rather than prioritizing returns 24:40.
- The objectives of the firm and the LP’s portfolio construction goals should guide investment decisions, with a focus on maximizing returns and achieving a diversified portfolio 24:01.
- AUM growth can be a strong signal, but it’s essential to understand the justification behind it, as sometimes fund managers get too large, and it’s crucial to assess whether they are the right fit for a portfolio mix 25:21.
- A counterargument to AUM growth is that some fund managers need to increase their core fund to reduce SPVs or co-investments, allowing them to have enough capital for follow-on investments or increase ownership and lead deals 26:16.
- Opportunity funds have a mixed reputation in the industry, with some LPs loving them as a way to double down on winners, especially if the strategy is to follow on from the core fund, while others dislike them, feeling forced into certain opportunities 26:51.
- Opportunity funds can make sense for some fund managers, especially those with smaller core funds, as they provide a way for LPs to get into follow-on investments rather than doing SPVs, which can be time-consuming 27:20.
- The key is to ensure that the fund manager is focused on investing, and LPs should carefully evaluate the fund manager’s strategy and justification for AUM growth or opportunity funds 27:37.
Risks and downsides of investing in micro VCs 27:41
- Investing in micro VCs poses similar risks to investing in larger managers, primarily revolving around the strategy and experience of the General Partner (GP) in finding and winning deals, and securing ownership in top-performing companies 28:06.
- A key concern is concentration risk, where a large investment in a small fund can result in a significant portion of the fund being anchored by a single Limited Partner (LP), which may not be desirable from a risk-return perspective 28:35.
- To mitigate this risk, it is essential to assess whether investing in a smaller fund manager makes sense, considering factors such as the number of other LPs involved and the potential for concentration risk 28:54.
- One approach to addressing concentration risk is to allocate smaller ticket sizes, which can help alleviate this risk and make investing in smaller fund managers more viable 29:05.
- To facilitate investments in emerging managers with smaller fund sizes, a dedicated emerging manager bucket can be established, allowing for smaller investment sizes and more flexibility in portfolio allocation 29:03.
How Ramzi thinks about concentration risk 29:12
- Concentration risk is a concern from a diligent standpoint, as it is generally not a good sign to be the only one in a fund 29:16.
- Concentration risks are related to diversification, and managing these risks involves spreading investments across different fund managers to minimize exposure 29:24.
- Diversification can be achieved by allocating a portion of the fund to multiple managers, such as putting $1 million in five different fund managers, allowing for a spread of risk and potential returns 29:32.
- If a large portion of the fund is invested in a single underperforming manager, the money could be used more efficiently elsewhere, highlighting the importance of assessing risk-adjusted returns 29:49.
- Effective portfolio management involves diversifying the portfolio and assessing risk-adjusted returns from a concentration risk perspective to ensure efficient use of funds 30:00.
What VCs should know about MASIC as one of the earliest adopters of the venture capital asset system in Saudi Arabia 30:05
- MASIC is one of the few family-owned investment firms in Saudi Arabia with a dedicated country capital program, and they are interested in meeting and speaking to different fund managers to learn from their strategies and gain market insights 30:25.
- Despite having a strong pipeline, MASIC values the opportunity to connect with fund managers and learn from their experiences, especially since being in Saudi Arabia can make them feel somewhat removed from different ecosystems 30:37.
- MASIC makes an effort to travel to the US a few times a year to spend quality time with existing and new portfolio fund managers, demonstrating their commitment to building relationships and staying informed 30:59.
- Saudi Arabia is going through a transformative period, driven by Vision 2030, and has a vibrant startup ecosystem that is growing rapidly, with a few IPOs from startups in the region in the past two years 31:29.
- The country has a lot of talent, with 70% of the population being younger than 35, and a strong digital adoption rate, which was accelerated by the COVID-19 pandemic 31:59.
- Saudi Arabia has a strong e-government system, allowing citizens to complete most tasks through mobile apps, and a growing service industry, including ride-hailing and food delivery 32:33.
- There are still many opportunities for disruption and growth in the region, including in the field of AI, with Saudi companies working on large language models for the Arabic language 32:53.
- MASIC is open to collaborating with others and forming partnerships, and they encourage those who are skeptical about Saudi Arabia to visit and see the changes happening firsthand 33:19.
