The UAE is on track to have one million SMEs by 2030, thanks to its progressive regulatory framework, streamlined visa processes and approximately 40 free zones. This makes the UAE a prime destination for start-ups and SMEs in the technology, healthcare, and agriculture sectors.
As these businesses seek to optimise, scale and expand, they will require access to financing. While bank lending remains a dominant force in the UAE, we see an increase in alternative financing solutions from private credit funds targeting these start-ups and SMEs. But what are the factors driving this trend, and will it continue?
Accommodating regulatory landscape
Regulatory frameworks across the region are evolving. The Dubai International Financial Centre (DIFC) and the Abu Dhabi Global Market (ADGM), key free zones essential to the development of financial services in the UAE, have been at the forefront of adopting regulatory changes to attract private credit funds to establish a presence in the UAE and originate transactions. In 2022, the Dubai Financial Services Authority (DFSA), being the independent financial services regulator of DIFC, introduced a private credit fund regime designed explicitly for funds located in the DIFC. Following this, in 2023, ADGM’s Financial Services Regulatory Authority (FSRA) implemented its own private credit regulation. The aim of the regulators remains clear: to usher in new credit funds to facilitate alternative financing options for SMEs. This has also presented Gulf state-owned investors seeking attractive returns with a lucrative alternative asset class, making them a prevalent force in 2023 private credit transactions.
Asset class that fills the market gap
Domestic banks still dominate the UAE lending scene for some of the largest companies. However, for fast-growing mid-market companies with relatively limited credit history, options for raising financing that suits their business model are limited. These companies are a focus for many of the domestic credit funds in the UAE. Many of these businesses with good cash flow have a high cash burn rate in their initial years as they ramp up their business. They need flexibility, which traditional banks are unlikely to provide. Some of the flexible features that we have seen private credit funds offer these businesses are:
- Maintenance covenants based on forecasted receivables or recurring revenue (similar to ARR structures in Europe) instead of EBITDA;
- Flexible interest payment terms with PIK toggles (part cash, part Payment-In-Kind);
- Limited amortisation requirements with a larger bullet payment at the end;
- Agility to provide tailored “permitted” definitions that meet specific business needs;
- Tolerance for higher leverage with flexible pricing with discounts for meeting certain ESG parameters and
- Speedy execution
Private credit as an asset class has proved its consistent resilience by successfully navigating through myriad macroeconomic factors over the last few years. They have a robust investment philosophy that focuses on the quality of credit and generally favour sectors with relatively stable income streams that are not cyclical. Their regulatory burden is limited compared to the banks, which allows them to be more creative when structuring a transaction and offer more bespoke solutions to fast-growing mid-market businesses.
Country (de)risk
Over the last few years, through a raft of legislative reforms, the UAE has matured in terms of providing an environment with enhanced investor protection. Private credit lenders new to the UAE can take comfort from the fact that security and guarantees granted by SMEs and growth companies usually include a comprehensive package of corporate guarantees and security, which is often more extensive than in Europe. For example, all asset security over a broad range of movables assets (including bank accounts and receivables) can be taken relatively quickly, without much complexity, and enforcement is now possible through self-help remedies.
In 2016, the UAE introduced its first comprehensive federal bankruptcy law applicable to onshore companies. It marked a significant step toward modernising its commercial legal framework, enhancing investor confidence, and providing clear mechanisms for managing financial distress. This framework was recently updated with the introduction of Federal Law No. 51 of 2023. The new bankruptcy law, which came into force in May 2024, along with solutions available under DIFC and ADGM, provides a more predictable and transparent framework for creditors, further boosting the UAE’s attractiveness for private credit lenders.
Whether private credit lenders will achieve the same success in the UAE, where businesses have traditionally relied on long-term relationships with their banks, remains to be seen. For the above reasons, we predict a continuing shift towards private credit by mid-market companies that want to access capital in the UAE, irrespective of the broader market environment.