The Financial Regulatory Authority (FRA) issued decision No. 150 for 2023 to amend the Authority’s decision No. 1 for 2017 regarding the standards for financial evaluation of enterprises, by developing some methodologies and models that suit the nature of start-ups to help them access the necessary funding for growth, expansion, and business development.
The resolution defines startups as companies with a short operating history and often newly established and in the process of growth and search for markets, some of which depend on technology to innovate new solutions, and often start with low capital and high costs with the establishment stage and face many challenges at its inception to obtain The necessary financing to develop the size of its operations and expand its presence in the market.
The need to evaluate emerging companies in order to increase capital appears according to the stage of growth that the company is going through, as the main investors, whether current or prospective, need to evaluate their investments in light of the different returns and risks according to each stage of the growth of the startup.
The decision stipulated the addition of a new method for evaluating startups during the pre-revenue and pre-sales phase within the approaches and methods of financial evaluation, which is the risk capital method, which includes the basic method of risk capital and the modified method, which is based on the assumption of a number of factors, including the value of the company at exiting after several years and determining the expected return on investment, and calculating the percentage of the investor upon exiting and the percentage that he will get, taking into account the expected reduction of his share after the future capital increase, and through that he reaches an evaluation after the capital increase, then deducts the amount of investment collected in the first increase to reach a pre-investment evaluation.
The decision also stipulated that a number of key elements should be taken into account when using this method, namely the exit value, the investment multiplier and the retention ratio, and the investment recommendation, provided that the exit value is considered as the future and expected value of the emerging company at the time of exit, whether by offering the company’s shares on the stock exchange or by selling them for one of the strategic investors, provided that the value of the exit is determined using the income approach or the market approach. The decision also stipulates that the target investment multiplier is estimated using the direct form method, or by calculating the target return upon exit.
The decision also stipulated a number of general considerations for evaluating startups before the stage of revenue realization, including taking into account a preliminary analysis of all material and non-material factors in the company being evaluated according to the nature of the company’s activity and the sector to which it belongs, and studying the impact of those factors on it, as well as the company’s ability to achieve profits. Among these factors are the company’s purpose, the company’s current status, the management’s efficiency and experience in the activity, the qualifications of the work team, the market in which the company operates and its technical characteristics and indicators, the characteristics of the product, whether it is a commodity or a service, the competitive advantages of the company, the technology used, the financing stage that it is going through. In the company, where the analysis of these factors and the study of their impact leads to a good understanding of the nature and activity of the company as well as the possibility of evaluating the associated risks, taking into account the difference in the relative importance of these factors according to the nature and activity of the company.
The decision also required that the evaluation include an analysis of the strengths and weaknesses of the entity being evaluated, and a review of the opportunities and challenges that the company may face during the forecast periods, as well as the extent of its commitment to the principles of governance and its ability to fulfill its obligations.
Chairperson of FRA Mohamed Farid emphasized that the development of Egyptian standards for the financial evaluation of enterprises takes into account, in the first place, the nature and business models of emerging companies that enjoy great growth opportunities and need different methods of evaluation to obtain the necessary funding for expansion and entering new markets and adding new activities, products and solutions, for the corporate sector in emerging economies are of growing importance and impact on international economies in general and the Egyptian economy in particular, in connection with their support for productive capacities, driving economic growth, and providing more jobs.
Farid added that the process of developing standards comes in light of the Authority’s management’s keenness to complete efforts to provide an enabling environment for economic entities to explore opportunities for growth and business development through the services provided by non-banking financial markets and the entities operating in them.