United Arab Emirates
Answer ... The private equity market in the United Arab Emirates is still developing and there is not a large volume of precedent.
The structure of private equity investments varies from transaction to transaction, depending on a myriad of factors, including:
- the jurisdiction of incorporation of the target; and
- the location of the underlying asset(s) as between emirate (if onshore) or free zone (if in a free zone).
For example, if a target business is located onshore in the United Arab Emirates, the structure may feature an offshore or free zone ‘holdco’ that holds shares in an onshore ‘opco’.
It is not uncommon for private equity transactions in the United Arab Emirates to involve another investor or shareholder. Typical scenarios where this is the case may include:
- consortium transactions where private equity investors are seeking to pool funds and share risk;
- UAE infrastructure projects where a financial investor is investing alongside a project sponsor;
- UAE infrastructure assets whereby the current owner is seeking partial monetisation of such assets; and
- where a UAE partner is required due to foreign ownership restrictions.
Where there is another investor or shareholder, the shareholding vehicle is often established either in an offshore jurisdiction or in a financial free zone in the United Arab Emirates, owing to enhanced levels of flexibility in terms of financial free zone companies undertaking corporate transactions.
Historically, where foreign ownership was limited as regards onshore entities (generally to 49%), private equity investors often used professional corporate service providers (ultimately owned by UAE nationals) to act as nominees for the equity stake they were not permitted to hold directly. Certain customary arrangements would be put in place to allow the investor to finance, operate and effectively control the onshore entities without the day-to-day participation of the nominee. These arrangements, often referred to as ‘schemes of arrangement’, comprise several different layers of contractual and economic protection in favour of the foreign investor – for example:
- a shareholders’ agreement and memorandum of association conferring a favourable profit split;
- management control and other governance protections on the foreign investor;
- a loan agreement, pursuant to which the foreign investor lends the nominee proceeds for its capital contribution;
- an assignment, as security for such loan, of the nominee’s capital and dividends in favour of the foreign investor; and
- a power of attorney, pursuant to which the nominee grants voting and decision-making powers to the foreign investor.
The legality of such structures has not been definitively decided in all circumstances and specific legal advice should be sought on this issue where relevant. However, such structures are becoming less common given recent legal developments as regards foreign ownership.
As stated in question 1.2, there is typically a simplified funding structure and no ‘bidco’ group.
As elaborated in question 6, there is typically no management equity piece in UAE transactions.
United Arab Emirates
Answer ... Structuring a private equity transaction in the United Arab Emirates involves a number of legal considerations, varies on a case-by-case basis and can be complex. Specific advice should be sought.
Key factors to note include the following:
- In relation to onshore companies, it should be determined whether any foreign ownership restrictions still apply – in which case a ‘nominee’ arrangement (as described above) may still be required, which leads to additional legal and operation risk. In principle, free zone companies are not subject to foreign ownership restrictions.
- Onshore companies offer more limited options in terms of capital structure, as only one class of shares is permitted.
- Financial free zones feature more developed corporate law regimes and greater level of flexibility in terms of undertaking corporate transactions than other UAE jurisdictions. For example, trust law (and beneficial ownership of shares) is recognised in financial free zones.
- Effecting a share transfer/issuance/other change to the share capital or constitutional documents of a UAE onshore company generally requires the cooperation of all shareholders. This can provide leverage to minority shareholders and can lead to difficulties implementing provisions commonly found in a shareholders’ agreement (eg, in the context of an involuntary transfer/drag-along). It is worth noting that remedies of specific performance and injunctive relief are not usually available in the United Arab Emirates.
United Arab Emirates
Answer ... Funding structures vary on a deal-to-deal basis. Shareholder loans in the United Arab Emirates have historically been less attractive from a tax perspective than in other jurisdictions (mainly for lack of interest deductibility).
Multiple classes of shares are available for companies incorporated in some free zones, including the Dubai International Financial Central and the Abu Dhabi Global Market, enabling equity funding structures through shares carrying different rights to distributions and voting rights. Multiple classes of shares are prohibited (or not supported) under the companies law regimes which apply onshore and in other free zones.
There may be challenges with structures involving the issuance of shares for ‘in-kind’ consideration, including a requirement for an auditor’s report and other regulatory hurdles to navigate.
Bank financing is quite difficult to come by in private equity acquisition financings in the United Arab Emirates, mainly due to their size. Acquisition financings are perceived as complex and therefore warrant the involvement of the investment banking teams. Paradoxically, investment banking teams usually require minimum financings of about $100 million in order to get involved. For this reason, most bank-financed acquisitions are for high-value deals, such as the acquisition of Americana or Gargash. That leaves a large amount of transactions outside the remit of banks. One workaround that some of the banks’ commercial teams have implemented – in particular, where no ‘bidco’ group is involved – is to lend directly to the target, with the proceeds then distributed up the shareholding structure in order to pay the purchase price to the seller. This structure allows the commercial teams to classify the loan internally as a corporate loan rather than as acquisition financing.
In addition to banks, we see private debt and mezzanine funds as well as investment banking firms filling in the gap left by the banks – in particular, for lower-value but complex leveraged acquisitions. Private debt or mezzanine fund will disburse funds already committed by limited partners, while other firms will act as arrangers, putting together a financing which can be sold down to investors, often via private placements. Unlike in other jurisdictions, where access to public markets in order to finance acquisitions is not uncommon, in the United Arab Emirates, for the most part, we see privately placed instruments. These instruments are often Sharia compliant and may contain some mezzanine features such as payment in kind or warranties.
United Arab Emirates
Answer ... While not advantageous from a tax perspective, shareholder loan funding may be more straightforward to implement compared to straight equity funding by way of share issuances. This is because issuing shares in UAE companies can be an administratively burdensome and time-consuming process, which requires liaising with the relevant competent authority and the participation of all the shareholders to effect a share issuance.
Bank financings usually have the advantage of being the cheapest available. While banks have large balance sheets and may be able to take on the entire debt financing, they often diversify the risk through a syndication process or otherwise upon distribution; this has the disadvantage that the borrower may have to deal with many banks rather than a single relationship bank. Further, as mentioned in question 3.3, unless the financing is large enough, investment banking teams might be precluded from acting on the financing. The use of a financing directly to the target instead of a financing to ‘bidco’ is one solution; however, this does entail some complex closing mechanics to ensure that the proceeds of the financing can be used to pay the seller.
Private debt and mezzanine funds are extremely sophisticated and more flexible when it comes to structure and security package. They are usually faster at obtaining credit approvals (or approval by the investment committee) and can usually close transactions much quicker than banks. They are also more flexible when it comes to deal size and can take on smaller financings. On the other hand, they tend to be more expensive and may require an equity kicker in order to reach the desired internal rates of return. Investment firms acting as arrangers enjoy the same flexibility as funds, but they do not take the debt on balance sheet, meaning that the deal will depend on the arranger’s ability to arrange credit. If the credit fails to generate interest from investors or if market conditions change, the deal might fall through.
Whether the financing is provided by a bank or a fund, or is otherwise privately placed through a capital markets instrument, such financings are often structured to be Sharia compliant. Sharia-compliant instruments have the advantage of attracting a larger pool of investors, especially in the Middle East. They do tend, however, to be slightly more complex than conventional products – not least because all Sharia financings require an asset base underpinning the Sharia transaction. Depending on the target, it might be difficult to commit an asset to be used for purposes of the Sharia structure for the tenor of the facility. As a result, many financings are structured as ‘commodity murabaha’, which does not require the use of an asset owned by the target. However, commodity murabaha structures have been under scrutiny in recent years, hampering their use – in particular by UAE Central Bank licensed institutions.
United Arab Emirates
Answer ... It is important for non-UAE based sponsors to obtain early legal, accounting and tax advice on structuring an investment into the United Arab Emirates.
A common cross-border consideration in the United Arab Emirates is foreign ownership restrictions. The Commercial Companies Law relaxed foreign ownership restrictions in the UAE onshore environment effective from March 2021. Emirate-level economic departments therefore have discretion to determine the sectors and business activities where up to 100% foreign ownership is permitted (subject to a strategic impact list where foreign ownership is still restricted as referred to in the Commercial Companies Law). Where a UAE local partner is required, a sponsor should consider putting in place certain customary ‘nominee’ arrangements that effectively vest legal and economic control over the business with the sponsor.
Sponsors should be prepared to encounter bottlenecks and hurdles in terms of setting up a cross-border corporate structure. For example, the relevant authorities tend to require onerous documentary formalities on supporting documentation pertaining to non-UAE persons that may take weeks to obtain; and such documents may need to be legalised, notarised, translated and apostilled and so on. In addition, the introduction of ultimate beneficial ownership registers means that the regulatory authorities in the United Arab Emirates are focused on understanding the ultimate shareholding and how controlling shareholders hold their shares. Corporate structures which involve complex nominee and/or trust arrangements can cause delays if the regulatory authorities cannot get comfortable with them.
Identifying an appropriate governing law under the transaction documentation is an important consideration (noting that UAE courts outside of the Dubai International Financial Centre and Abu Dhabi Global Market are unlikely to apply English law). There are also enforceability considerations; and an effective dispute resolution forum which facilitates enforcement in light of the location of the relevant parties (and their assets) should be identified at an early stage.
Subject to any overriding tax, accounting, financial and other structuring drivers, sponsors may wish to consider structuring a UAE investment so as to benefit from international investment agreement protection.
United Arab Emirates
Answer ... As per a transaction involving multiple investors in any other jurisdiction, the terms of the ongoing relationship between the parties will be an important consideration. Central to that will be whether there is alignment on an exit strategy. Other topics may include:
- governance;
- decision making;
- deadlock resolution;
- share transfer restrictions/exit rights;
- further funding obligations;
- information/reporting rights;
- events of default; and
- restrictive covenants.
The relative percentage of each investor’s investment may influence bargaining power.
Practical considerations around executing a consortium deal should be borne in mind – in particular, the potential for protracted intra-consortium negotiations. Investors may need to recalibrate their usual requirements in order to accommodate agreement with each other investor.
Also, see question 3.2 in relation to the requirement for all shareholders to cooperate for certain actions to be taken as regards onshore entities. This consideration, together with a lack of flexibility generally for onshore entities, generally leads to an overseas or free zone entity being used as the consortium vehicle.