Why are startups in the Middle East opting for credit?

Startups across the Middle East are increasingly seeking private credit as an alternative to traditional banks and public debt markets to meet their funding needs. This form of financing, provided by non-bank institutions such as private equity firms, credit funds, and alternative asset managers, has seen rapid global expansion, with assets under management (AUM) more than doubling to over $2 trillion since 2019.

In the region, private credit has attracted interest from major sovereign wealth funds, including Saudi Arabia’s Public Investment Fund (PIF), Abu Dhabi Investment Authority (ADIA), Abu Dhabi Developmental Holding Company (ADQ), and Mubadala. These entities have partnered with leading global credit firms to tap into lucrative, risk-adjusted returns, signaling a shift in regional investment strategies.

DRIVERS OF PRIVATE CREDIT

Nathan Kwon, Head of Credit Practice at investment firm Shorooq, says private credit is thriving in the region due to the challenges startups face in securing financing through traditional banks, which have “stringent lending criteria that many tech companies struggle to meet.”

Kwon highlights this conservatism with data, citing a joint survey by the Union of Arab Banks and the World Bank. The survey found that only 8% of bank lending in the MENA region goes to small and medium enterprises (SMEs)—a figure that drops to just 2% in GCC countries.

“Such limitations make private credit an attractive alternative, offering more flexible and tailored financing solutions that better align with the unique needs of tech companies and SMEs,” he adds.

Confidentiality is also a major concern for many businesses, which often pushes them toward private credit.

“Private credit typically involves direct negotiations between the lender and the borrower, without the need for public disclosure. This contrasts with traditional banking, where loan approvals may require broader internal reviews and adherence to regulatory reporting standards that could compromise confidentiality.”

“For startups aiming to maintain a competitive edge by keeping strategic plans or financial conditions private, this discretion is particularly valuable,” Kwon adds.

Expanding on the appeal of private credit for startups, Sara Aiello, Startup Ecosystem Manager and ESG Lead at the UAE International Free Zone Authority, says the approval process is faster, with fewer bureaucratic hurdles, reducing wait times significantly. “It also has less stringent eligibility criteria, provides access to larger funding pools, and offers more customized terms than standard loans.”

For startups, speed and accessibility are crucial. Traditional banks require extensive documentation, a strong credit history, and a well-established business track record—barriers that many young startups struggle to overcome. Traditional banks offer standardized financing with little flexibility, while private lenders tailor loan agreements to startups’ needs.

In contrast, private credit offers adjustable repayment schedules, flexible interest rates, and innovative options like revenue-based financing or equity-for-credit deals. This streamlined and adaptable approach makes it a preferred funding source for emerging businesses.

Nada Shahen, Project Senior Officer at GB Ventures, highlights additional benefits of private credit, such as relationship-based lending. Startups often prefer private lenders who understand their unique business models and are willing to build long-term relationships, unlike traditional banks, which take a more impersonal approach.

Another advantage, Shahen explains, is the availability of creative financing solutions. “Private credit often includes innovative financial structures tailored to startups’ needs, helping to ease cash constraints that typical banking products might not address.”

POSSIBLE RISKS

While private credit provides flexibility, it also comes with risks. For startups, Kwon says, these include higher interest rates and cash flow burdens that may restrict operational flexibility. Investors, meanwhile, face repayment risks, particularly when lending to fast-growing tech companies.

“To mitigate these risks, we lend against cash flow-generating assets rather than at the company level,” he explains. “Through asset-backed financing, lenders can ring-fence the cash flow owed to them from the company’s other costs and expenses, significantly reducing repayment risk.”

Similarly, Aiello highlights the risk of high costs that startups often face with private credit, including strict repayment schedules and hefty penalties for missed payments—challenges for businesses with unpredictable cash flow.

“An important aspect is that startups may need to give up equity in the business in exchange for the investment. This can dilute the ownership of the business and can lead to a potential loss of control over business decisions. Another aspect to consider is a misalignment in interest between investors and founders, which can create friction.”

For investors, the high failure rate is a major risk—while one in five startups fail within the first year, nearly 90% eventually shut down. Limited transparency is another challenge, making it difficult to accurately assess a startup’s potential due to incomplete or unavailable information.

Legal and regulatory risks also pose concerns for both parties. Differences in local laws and contract enforceability in the Middle East can be especially challenging for international investors unfamiliar with the region’s legal framework.

“To mitigate these risks, startups need to develop realistic cash flow projections and contingency plans to maintain a financial cushion. Also, having a strong CFO or financial advisor to manage finances effectively is crucial for every new business,” Aiello says.

She advises investors to thoroughly assess a startup’s business model, market potential, scalability, and leadership. Private credit deals rely on personal relationships, leading to limited due diligence as trust is granted upfront.

FUTURE OUTLOOK

Private credit in the region, which has grown over the years, is likely to continue.

“The shift towards private credit is likely to continue as startups seek alternative financing sources that can cater to their specific needs,” says Shahen, adding that the rising interest from both local and international investors in high-risk, high-reward opportunities, which could further drive the expansion of the private credit market.

The global trend towards private credit, driven by banks’ reduced risk appetites post-financial crisis, is expected to influence the Middle Eastern market positively, according to Kwon. “However, factors such as geopolitical stability, regulatory changes, and the overall economic climate will play crucial roles in shaping the trajectory of private credit in the region.​””

And as national ambitions, such as the UAE’s goal of becoming a global hub for innovation and entrepreneurship and Saudi Vision 2030, fuel demand for private credit, Aiello emphasizes the importance of regulatory frameworks that protect private lenders and facilitate smooth transactions, further enhancing the sector’s appeal.

“While countries like the UAE and Saudi Arabia provide a stable, supportive environment for startups, other parts of the Middle East may face challenges due to geopolitical tensions or slower economic growth,” Aiello adds.