The United Arab Emirates (the UAE) continues to attract an increasing amount of foreign direct investment (FDI) across a range of sectors, none more so than the technology sector with investment into medium and high tech projects accounting for over 60 per cent. of the total foreign direct investment into Dubai in 2017 (as reported by the Dubai FDI Monitor). The Ruler of Dubai, His Highness Sheikh Mohammed bin Rashid Al Maktoum, has made clear his intention for Dubai to become a leading technology hub and is keen for Dubai to lead the field worldwide in attracting investments into innovative technologies like Artificial Intelligence and robotics.
“Onshore” companies in the UAE are generally required to have at least 51% of their share capital registered in the name of a UAE national (or a corporate entity wholly owned by the same) and so investors are often attracted to incorporating companies in economic Free Zone areas within the UAE, which permit 100 per cent. foreign ownership. Certain Free Zones in Dubai such as the Dubai Creative Cluster are focussed on promoting technology companies. Together with the Dubai International Financial Centre (DIFC) and the Abu Dhabi Global Market (ADGM), they are at the forefront of the UAE’s enthusiasm for FDI in this sector. However, Free Zone companies are only technically allowed to operate within the border of the Free Zone they are licensed in and if they want to undertake business in onshore UAE they need to be appropriately licensed to do so by the onshore authorities.
It is therefore eagerly awaited to see whether, as has been reported in the local press, the UAE government will relax foreign ownership restrictions on UAE onshore companies in Q1 2019. The recent rumoured exemptions granted to Apple and Tesla allowing them 100 per cent. foreign ownership for their onshore operations in the UAE have only increased hope that the technology sector will be one of the sectors that the foreign ownership rules will be relaxed in respect of. We believe any relaxation to the rules will be beneficial for the UAE as a whole and its attractiveness as a hub for technology businesses.
Nevertheless, there are a number of considerations which investors should be aware of prior to making investment in technology companies in the UAE, in order to protect not only their investment and returns, but also the assets of the company (including its people) in which they are investing.
This article focuses on some of the key legal issues that arise when making investments into UAE technology businesses.
Protecting the investment
Shareholder rights are usually contained in the constitutional documents of a company (e.g. its Articles of Association or other bye-laws) and any contractual agreements between the shareholders of the company.
A shareholders agreement is often the contractual mechanism regulating the relationship between any investor and the founders / original shareholders of a technology company. This will often set out the detailed rights and obligations of the parties, as opposed to the constitutional documents, which generally tend to be less extensive in the UAE. A balance has to be achieved in a shareholders agreement between an investor that wants an element of control and the desire of founders / entrepreneurs to get on with doing what they are / have been doing well. Investors are often concerned in seeing provisions dealing with the following matters in any shareholders agreement: (i) the level of control they will have over the management and financial decisions of the company (including information rights); (ii) restrictions over the transfer of their shares; (iii) exit rights; and (iv) pre-emptive rights over the issue of future shares to new investors in order to prevent dilution of their initial shareholding. Founders of a technology company will be keen to ensure a majority stake in the business (at least in early funding rounds) although they will need to balance this with the need to give away equity to new investors who may provide funding to grow the business and also having a pool of equity to ensure there is equity to incentivise the existing and additional members of the management team going forward.
Due to the fast moving pace of start-ups (and specifically in the technology space), investors may often feel pressurised to provide funds quickly, and often before advisers and the shareholders have had time to fully negotiate the commercial investment terms of a medium to long term investment. Sometimes, there simply is not enough time to draft a shareholders agreement, change the constitution of a company, negotiate a share subscription agreement with warranties, as this can (and often does) take many weeks. We are therefore increasingly seeing the use of shorter / different investment agreements being used in this market, which have their history in markets such as the Silicon Valley in the United States of America. For instance we are seeing Simple Agreements for Future Equity (SAFE) and Keep It Simple Security (KISS) arrangements, which often assist with the initial funding stage of technology companies in a timely and cost-effective manner.
SAFE documents only include limited heads of term in relation to an investment and enable an investor to provide funding in exchange for the right to convert its investment to equity on the occurrence of a future event, for example on a future fundraising round. Standard SAFE documents do not contain express references to a repayment date or interest and allow all decisions regarding the company's valuation and terms of conversion to equity or otherwise to be deferred without holding up the initial investment. SAFE arrangements do not come without uncertainty as reliance is placed on a future transaction(s) / event. Investors should ensure that their rights under SAFE documents are protected by including terms that require the company to re-pay the investor’s investment in the event of change of control or liquidity event. Ultimately, our experience suggests that SAFE arrangements work best where there is confidence that the start-up has a clear path to an equity financing transaction in the future. i.e. a clear timetable exist for an investment round.
KISS agreements aim to improve certain aspects of SAFE (more specifically the lack of interest rate and investor protections) although will require increased negotiation between parties upfront. KISSes can be structured on an equity basis (which do not accrue interest) or a debt basis which, in order to protect the investor, should refer to accrued interest at a standard rate and to a maturity date after which the holder may convert the investment amount plus any accrued interest into equity of the company. KISSes have the ability to provide additional rights to succeeding investors by including the right to participate in future financing rounds.
Technology companies, of which their brand and intellectual property (IP) assets are often at the heart of the value of the business, should also explore the advantages of entering into separate non-disclosure and confidentiality agreements with investors to protect the ‘trade secrets’ of the company. This is often important where institutional investors may be investing in a number of companies which may be or are likely to become competitors in the future.
Protecting the brand
Investors should ensure that IP assets are properly protected so as to guarantee their ongoing value, which often, for tech companies in particular, is a key element of the business. Investors should note that IP law in the UAE is structured around a number of specific laws, each protecting individual rights such as Trademarks, Copyright and Patents. The UAE is also a member of the World Trade Organization, a signatory to both the Berne Convention and the Paris Convention, and a Patent Cooperation Treaty member, meaning that the UAE is obliged to comply with certain minimum international standards for the protection of intellectual property.
The Ministry of Economy (MOE) is in charge of regulating and supervising all matters relating to IP and a formal registration of each IP right with the MOE, in accordance with the relevant law, is often the best method of ensuring protection. Registration can however be a complex and lengthy process, therefore investors should take steps immediately on securing an investment to ensure the relevant target has registered and protected its IP portfolio, or otherwise is taking steps to do so.
Incentivising management / employees
Once investors are confident the value of the company and their investment are sufficiently protected, they should also look at the employee arrangements within the company to ensure that the key management / business team remain motivated and are incentivised to further develop the business. Generally share option schemes are not put in place directly at UAE company level. Instead, it is more common to establish a management incentive scheme through a specific cash arrangement, whereby employees would receive a bonus calculated as a certain percentage of net profit of the company or through shares to be issued to employees in a non-UAE holding. Often such non-UAE holding companies are based in jurisdictions such as the Cayman Islands or the British Virgin Islands.
In the case of onshore technology companies, all employees must have a registered employment agreement with the UAE entity, which is filed with the UAE authorities, in order to obtain a working visa and the UAE labour law will apply. Such contracts should include, amongst other things: (i) appropriate IP protections to ensure any IP rights developed during employment are registered in the name of the company (and not the employee); (ii) appropriate notice periods; and (iii) restrictive covenants to prevent employees sharing trade secrets with new employers, although investors should be aware that these contracts would only be enforceable in the UAE to the extent their terms comply with the UAE labour law.
Following a number of legislative steps that involved various regulations establishing the components of what is now recognised as UAE Competition Law, two recent updates have firmly established a Competition Law regime in the UAE. The first was the enactment of the 2016 Regulations (these finally established relevant market share thresholds for the purposes of Competition assessment) while the second was the establishment of the UAE’s Competition Authority (Authority) by the MOE. Investors will therefore need to consider UAE competition law requirements in relation to investment or M&A transactions involving tech enterprises which either conduct their business or hold IP rights here in the UAE.
For investors, they key elements of the new regime to be aware of include the fact that any activity that will result in what might be considered an economic concentration (such as a merger or acquisition) under the Regulations, must first obtain prior approval from the Authority. The Authority itself has helpfully issued a filing form for notifications of these types of transaction however, confirmation will still need to be sought from the Authority regarding the proposed content to be provided and the timing for any public disclosures, this will be an important consideration if sensitive information such as the purchase / investment price is to be disclosed. If investors need to file for Authority approval of any M&A deal, consideration will need to be given as to how this will impact the deal timetable.
Penalties for non-compliance, on paper, can appear to be quite severe (fine representing between 2% and 5% of the annual revenues of the business that is the subject of the violation) although it is fair to say that as far as we are aware the Authority has undertaken very few major investigations or imposed any large fines. There are also a number of key exclusions from the Competition Law itself, so investors should also take note as to whether the profile of the transaction they are engaging in may fit within one of these exclusions.
It will therefore be important to keep in mind the importance of both assessment and compliance with Competition Law in the UAE in relation to any investment or M&A transaction.
It is an exciting time for technology companies in the UAE and an increased number of opportunities are likely to become available for foreign investors looking to invest in this space if the UAE government does formally conclude any relaxation of ownership restrictions for onshore companies. Investors will be in a strong position prior to making FDI into technology companies if they first ensure that the key technology and IP of the company are sufficiently protected and consideration is given to the structure and return of their investment.