Circular 33 is a potential catalyst to the rise of private equity in Lebanon, which is taking on an ever greater role in the economy, as explains Souraya Machnouk.

The Central Bank of Lebanon (BDL) has always acted as a driver for investments in Lebanon, most recently by announcing several Economic Stimulus Packages in the past three years, but its Circular 331 remains its boldest move to date. Issued on August 22 in 2013 with the main objective of stimulating the creation of startups and facilitating finance to companies at their earliest stages, it was hailed by Lebanese private equity investors (PEs) and venture capital firms (VCs) as a great success for the Lebanese SMEs' ecosystem in general.

The banking industry in Lebanon is generally of a conservative nature, primarily reliant on risk-aversion and capital hoarding, which has reflected unfavorably on the development of business startups that are in desperate need of capital. Aware of this distortion, BDL, who cannot directly invest in equities according to Lebanese law, implemented through Circular 331 a creative mechanism to advance $400 million to Lebanese commercial banks, which are required to invest these funds either directly in startups, or indirectly in startup funds, through the acquisition of equity participations in these entities.

The mechanism consists of the bank receiving a seven-year interest-free loan from BDL, then using this loan to buy treasury bills bearing a 7% interest rate, and finally selling the latter to BDL at a discounted rate, thus increasing the current value from which the bank derives a profit amounting to 75% of its investment in startups.

To ensure that banks reduce their investment risks, and continue to diversify their investment portfolios in startups, Circular 331 stipulates that BDL will guarantee 75% of the banks' investment in startups, and prohibits that a bank's total participation exceeds 3% of its capital without BDL's approval. BDL receives 50% of the profits accrued to the investing bank through the startups' distribution of dividends or the sale of the bank's shares in the startup

VCs and PEs, diffident at first, started in 2014 garnering investment that they would otherwise have trouble finding especially with the current unstable political and security situation that is hindering demand for long-term investments such as equities.

To incentivize the investments under Circular 331 even further, BDL ambitiously launched in November 2014 the “Accelerate 2014" program, and organized Lebanon's first international startup conference bringing together over 500 top entrepreneurs, investors, and knowledge-economy stakeholders from around the world to lay the foundation for establishing Lebanon as a premier international startup hub, and for providing startup support activities and relevant startup investment opportunities to a high caliber international audience. Consequently, this year saw existing VCs and PEs fundraising amounts much higher than their previous funds.

Nevertheless, and despite the BDL's efforts to encourage banks to offer private equity financing to companies, rushing to invest in startups poses certain challenges to commercial banks that have long been accustomed to dealing with SMEs in a lending capacity, and have demonstrated a historical preference towards name-based lending as opposed to business model, collateral, and cash-flow based lending. These banks have neither the knowledge nor the background in investing in startups. Moreover, another challenge is the general hostility of the family-owned and owner-manager enterprises in Lebanon, which constitute 98.2% of all Lebanese companies, towards ceding partial corporate control, even in exchange for capital injection.

The Lebanese banking sector is in a dire need of a cultural shift from conservative lending to best investment practices. There's also a growing awareness, especially with the change of generations in family businesses, that institutional investors and equity funds bring financial boosts, management know-how, and better corporate governance to companies. Only time will tell if Circular 331 will lead to the renaissance of private equity in Lebanon.