Today, the global venture capital ecosystem is more reliant than ever on free-flowing Middle Eastern money, but what happens when one of the region’s biggest sovereign wealth funds tightens the taps?
Public Investment Fund—Saudi Arabia’s $925 billion sovereign investment vehicle—is now prioritizing domestic projects, the Financial Times reported this month. Up until this shift, the Kingdom’s fund had been on a decade-long global investment spree—under the direction of Crown Prince Mohammed bin Salman—and VCs have been a major beneficiary.
In recent times, PIF has been leading the charge among many Middle Eastern investors, such as those in the UAE, who have turned to VC as falling oil production and languishing prices have diminished their traditional sources of wealth.
This has come either through huge fund commitments, such as PIF’s promise in 2016 to invest up to $45 billion in SoftBank’s Vision Fund, or via direct investments. PIF has backed companies like Uber and augmented reality company Magic Leap as well as making numerous investments via its VC arm Sanabil.
Given how entrenched PIF, and indeed the broader region, are in the global VC market, any retreat by the fund will be deeply felt—particularly if other oil-rich countries facing similar headwinds follow suit.
A Middle Eastern love affair
Middle Eastern investor participation in non-domestic VC deals has swelled over the past decade as the region seeks to diversify economically and reduce dependence on oil for revenue.
This year, 4.6% of rounds—excluding those from the region—featured Middle Eastern investors, according to PitchBook data, up from 2.9% in 2014. Their percentage of deal value currently stands at 12.6%—the second-highest figure over the last decade.
Then there are fund commitments. Sovereign wealth funds like the Abu Dhabi Investment Authority and its sister fund Mubadala are a key source of LP capital for VC funds, which have actively worked to attract investors in the region.
The intensifying love affair between Middle East and foreign VCs has come amid a bleak backdrop for fundraising. In 2022, capital available from institutional investors in the West dried up as LPs found themselves overweight in private assets with the collapse of public valuations.
Capital raised by VC funds in the US and Europe was at the lowest level since 2019 last year, according to PitchBook data. The cash crunch pushed investors, including some of the biggest names in VC such as Andreessen Horowitz and Founders Fund, to travel to the desert in search of investors with deeper pockets.
And it isn’t just Western VCs reaching out to the Middle East. Chinese investors have been establishing stronger ties with the Middle East as tension rose with the US. Washington’s crackdown on technology investments in China spurred the Asian nation’s investors to look elsewhere for their capital as US LPs retreated. With such geopolitical relations still tense and no signs of a recovery for VC fundraising, capital commitments from the Middle East will remain important.
As a result, a withdrawal, or even a reduction, of capital from Middle Eastern sources could exacerbate an already difficult fundraising market for VCs, likely leading to fewer and smaller funds. Competition for alternative pools of capital would intensify and more established firms would likely dominate the attention of the limited partner, leaving less capital available for smaller VCs.
Family offices and high-net-worths in the West and in Asia are gravitating more toward VC and to some extent could make up for a pullback by Middle Eastern LPs. The question is whether these new sources of capital will even begin to address the gap left behind by the likes of PIF.
Startups would face the same challenge. Their fundraising environment isn’t much better than that of venture firms—particularly in the later stages. Sovereign funds have historically played a big role in funding large late-stage or pre-IPO rounds. A scarcity of capital could delay exit plans, making an additional impact on investors.
Go local or go home
If a wider pullback were to happen, the key to getting access to Middle Eastern capital could lie in the region itself. Officials from PIF are reportedly putting in place more conditions on managers to invest in Saudi Arabia in exchange for commitments.
Sovereign wealth funds from other countries are also emphasizing the need for local support.
The Qatar Investment Authority, for example, launched its first fund-of-funds this year to invest more than $1 billion in international and regional VC funds. A key objective for the vehicle is to attract international VC funds to Qatar and the wider Gulf region to develop the local startup ecosystem.
Startups in the region have faced a similar dealmaking environment as those in the West, with deal count and value falling significantly from their peak in 2022. This year, €3.7 billion has been invested across 614 deals, according to PitchBook data.
An influx of cash from foreign VCs would lead to increased opportunities for local startups, increasing access to global networks and expertise. Although this could pose a challenge for VCs without prior investment experience in the region, it would be an opportunity to diversify their portfolios and gain exposure to a growing market.
Even with PIF’s shifting its focus to the domestic market, the Middle Eastern well of capital is far from drying up. But foreign VCs would be wise to pay attention to regional dynamics and perhaps prepare to work harder for their checks going forward.
Featured image by Mara Potter/PitchBook News
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