1 Legal framework
1.1 Which general legislative provisions have relevance in the private equity context in your jurisdiction?
The United Arab Emirates is a federal state comprising seven emirates: Abu Dhabi, Dubai, Sharjah, Ajman, Umm al Quwain, Ras al Khaimah and Fujairah. It has a federal government and each emirate has its own local government, whose powers are apportioned pursuant to the UAE Constitution. In addition, a number of free zones (or other economic zones) have been established in the United Arab Emirates, which to varying degrees have an independent regulatory regime. The focus of this Q&A is on the onshore environment – that is, jurisdictions in the United Arab Emirates outside of the free zones.
A civil law legal system founded upon Islamic Sharia jurisprudence, and based on codified laws, applies onshore in the United Arab Emirates. The United Arab Emirates was formed in 1971 and its legal environment continues to evolve.
No specific legislation governs private equity investment and related activities in the United Arab Emirates. Many UAE federal, emirate-level or free zone laws or regulations could potentially have relevance to the structure of a private equity investment and to the operations of a portfolio company. Potentially relevant legislation includes:
- the Commercial Companies Law (Federal Law 32/2021);
- the Commercial Transactions Law (Federal Law 18/1993);
- the Civil Code (Federal Law 5/1985);
- the Law on the Regulation of Competition (Federal Law 4/2012); and
- emirate-level local companies law regulations.
Private equity investors should be mindful of:
- the UAE Economic Substance Regulations, which (in respect of relevant activities) impose filing obligations and require the demonstration of substance; and
- the ultimate beneficial ownership requirements of UAE licensing authorities.
As a civil law jurisdiction, there is no doctrine of binding precedent in the United Arab Emirates. UAE law is not always capable of conclusive interpretation, which gives rise to some potential legal uncertainty.
1.2 What specific factors in your jurisdiction have particular relevance for and appeal to the private equity market?
The United Arab Emirates is regarded as a regional centre for doing business in the Middle East, with many organisations establishing their regional headquarters in the jurisdiction.
The Commercial Companies Law introduced a relaxation of foreign ownership restrictions in the UAE onshore environment, laying the foundation for an increased scope for 100% foreign ownership of onshore companies carrying on certain business activities and operating in certain sectors. This easing of foreign ownership restrictions is anticipated to stimulate foreign direct investment into the United Arab Emirates and may reduce or eliminate barriers to private equity investment in the jurisdiction.
Private equity funding structures are significantly more straightforward compared to those in other jurisdictions. For the reasons stated in question 3.3, there is limited use of acquisition finance in the United Arab Emirates. Furthermore, sponsors in other jurisdictions deploy cash-efficient, tax-deductible shareholder loan financing structures. Given the historic and current tax environment, such structures do not offer any material advantages in the United Arab Emirates and therefore simpler structures are favoured. Accordingly, in the absence of a financing structure involving subordination, no 'bidco' group is necessary. This may, however, change in the near future given the anticipated introduction of corporate tax described in question 10.2.
Financial free zones – being the Dubai International Financial Centre and Abu Dhabi Global Market – have been established in Dubai and Abu Dhabi respectively. A common law-based legal framework with enhanced independence from the onshore legal environment and a separate court system apply in each financial free zone. Such jurisdictions are relatively attractive venues for incorporating UAE investment holding vehicles.
2 Regulatory framework
2.1 Which regulatory authorities have relevance in the private equity context in your jurisdiction? What powers do they have?
Limited liability companies, which are the most common form of company through which business activities are performed onshore in the United Arab Emirates, are licensed and regulated by the local economic department of the emirate in which they are established. Local economic departments are responsible for maintaining the Commercial Register and their procedural requirements must be satisfied in order for a person to be registered as a legal shareholder (these requirements can change, so it is important to get up-to-date information as to current processes). Similarly, free zone companies are regulated by the relevant authority of the free zone in which they are established. Such relevant competent authority will almost inevitably have relevance in a private equity transaction in the United Arab Emirates.
Depending on the nature of the business activities undertaken by a target and other specific characteristics of a particular transaction, various sector regulators may be relevant, such as:
- the UAE Central Bank, in respect of financial institutions and insurance companies;
- the relevant health authority of an emirate, in respect of healthcare organisations; and
- the relevant education authority of an emirate, in respect of school operators.
UAE law may require such an authority to grant its approval in relation to a transaction.
Furthermore, the UAE Competition Authority will be relevant if the transaction triggers a merger control filing. The UAE competition regime is suspensory.
Private equity investors should consider early engagement with the relevant authorities in order to facilitate the smooth implementation of an investment. With the introduction of ultimate beneficial ownership registers in the United Arab Emirates, all regulatory authorities now require clear and detailed information in relation to a corporate group's ultimate shareholding, which may involve requesting passport copies of controlling individuals (at both shareholder and board level).
2.2 What regulatory conditions typically apply to private equity transactions in your jurisdiction?
A transaction involving a UAE business will (where relevant) typically feature relevant competent authority approval of an application in relation to the transfer or issuance of shares, as referred to in question 2.1. This is commonly structured in the definitive transaction documentation as a 'pre-completion obligation' (with a termination right if registration has not been achieved within an agreed timeframe), rather than a condition to completion of the transaction.
As referred to in question 2.2, the approval of a relevant sector regulator may be required; and such an approval will typically be structured in the definitive transaction documentation as a condition to completion of the transaction.
3 Structuring considerations
3.1 How are private equity transactions typically structured in your jurisdiction?
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.
3.2 What are the potential advantages and disadvantages of the available transaction structures?
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.
3.3 What funding structures are typically used for private equity transactions in your jurisdiction? What restrictions and requirements apply in this regard?
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.
3.4 What are the potential advantages and disadvantages of the available funding structures?
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.
3.5 What specific issues should be borne in mind when structuring cross-border private equity transactions?
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.
3.6 What specific issues should be borne in mind when a private equity transaction involves multiple investors?
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:
- 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.
4 Investment process
4.1 How does the investment process typically unfold? What are the key milestones?
Transactions can be categorised as either bilateral or auction sales.
In a bilateral transaction, typical milestones will include the submission of a non-binding offer from the buyer, which if accepted, will lead to at least a legal and financial due diligence process lasting several weeks, depending on:
- the scale of the target business; and
- the quality and completeness of the seller's responses.
Often, a structuring exercise runs concurrently with a due diligence process. Provided that the results of due diligence are satisfactory for the buyer, the parties will negotiate and sign definitive transaction documentation (including a share purchase agreement). If the share purchase agreement is conditional (typically for regulatory and key third-party consents), there will be a period for satisfaction of such conditions prior to closing. Due to the regulatory consents required to effect a share transfer in the United Arab Emirates, a split exchange and completion is normally always required and the use of escrow accounts is common.
Auction sales – which involve a competitive process with a view to maximising the price for the seller – are common in the United Arab Emirates, but have been less successful historically than in other jurisdictions. Such processes typically comprise:
- a first round involving circulation by the seller of a teaser; and
- following the potential bidder entering into a confidentiality agreement, an information memorandum, which is the basis for bidders to submit indicative, non-binding offers.
In the second round, a select group of bidders are given access to a data room and invited to submit binding offers and, commonly, a mark-up of the vendor's draft share purchase agreement. Based on such binding offers, the seller may take forward negotiations with and provide exclusivity to one or more preferred bidders.
4.2 What level of due diligence does the private equity firm typically conduct into the target?
In most UAE transactions sponsored by international private equity houses, relatively comprehensive, financial and technical/commercial due diligence is undertaken in order to understand the applicable risks, which may be unfamiliar given the limited experience of undertaking UAE investments. Depending on the sector in which the target operates and the specifics of the transaction, other specialists (eg, environmental, cyber and corporate risk) may also be engaged to carry out due diligence.
The scope of legal due diligence is determined on a transaction-by-transaction basis, taking into account:
- the scale of the investment;
- the nature of the target's business;
- the specific business drivers of the target;
- the risks which are generally applicable to the sector in which the target business operates; and
- the risk tolerances and institutional requirements of the sponsor.
Typically, legal due diligence is generally in line with other markets and, subject to an agreed materiality threshold, involves a review of:
- corporate structure;
- material acquisitions and disposals;
- financing arrangements;
- material contracts;
- material assets;
- real estate;
- information technology;
- data protection;
- intellectual property;
- compliance; and
- litigation and disputes.
The due diligence culminates in a by-exceptions, red-flag issues report.
In some scenarios, sponsors are willing to take a less comprehensive approach to due diligence – for example, in the context of a distressed or fire sale, where the price is perceived to justify such an approach.
Investors often choose to carry out reputational, intelligence, risk advisory and investigative due diligence in relation to regional counterparties.
4.3 What disclosure requirements and restrictions may apply throughout the investment process, for both the private equity firm and the target?
The parties will be subject to confidentiality obligations contained in a non-disclosure agreement (NDA). The central purpose of an NDA is to protect confidential information relating to the target business; however, NDAs tend also to restrict disclosure of the fact of the transaction and related negotiations.
If one or more of the parties is listed, there may be applicable regulatory disclosure requirements and confidentiality restrictions. For listed entities, disclosure of a potential transaction is generally required upon the execution of a memorandum of understanding or equivalent document.
In addition, in certain emirates (eg, Abu Dhabi), advertisement of the summary details of any proposed share transfer is a required step in the share transfer process and cannot be avoided. However, such advertisement is usually in the public Gazette, which is not widely read or reported on.
4.4 What advisers and other stakeholders are involved in the investment process?
Both parties usually appoint legal advisers and corporate financial advisers throughout the transaction in order to:
- provide advice;
- assist in negotiations;
- prepare transaction documentation; and
- otherwise facilitate implementation of the transaction.
Other specialist advisers may also contribute to structuring and the due diligence workstreams.
Regulators, finance providers and important customers/suppliers of the target business may also be relevant in the investment process in terms of satisfying conditions precedent.
In certain sectors, regulators can also be heavily involved in a transaction process (eg, health authorities or education authorities), and need to be comfortable with an incoming investor's knowledge, expertise and financial standing.
5 Investment terms
5.1 What closing mechanisms are typically used for private equity transactions in your jurisdiction (eg, locked box; closing accounts) and what factors influence the choice of mechanism?
On a buy-side transaction, private equity sponsors will typically seek a closing accounts purchase price adjustment mechanism. However, UAE private equity buy-side transactions are often in the context of competitive auction sales involving a locked-box mechanism.
On an exit, a locked-box purchase price mechanism will typically be sought in order to achieve price certainty and facilitate a prompt return of proceeds to the fund, rather than having to wait for a potential adjustment. However, to date, the number of private equity exit precedents in the United Arab Emirates is limited and therefore market practice is still evolving.
Counterparties in buy-side and sell-side transactions are often regional trade sellers or buyers (private equity secondary market sales in the United Arab Emirates are not common). Such counterparties may lack experience in using locked-box purchase price mechanics. For this reason and others (eg, lower quality of earnings/accounting when compared to other jurisdictions) locked-box mechanisms are not as prevalent in the United Arab Emirates.
5.2 Are break fees permitted in your jurisdiction? If so, under what conditions will they generally be payable? What restrictions or other considerations should be addressed in formulating break fees?
There is no general restriction on break fees under UAE law; however, they are rare in private M&A deals other than in very competitive auction processes.
Under the UAE Securities & Commodities Authority (SCA) Resolution 18/RM of 2017 Merger & Acquisition Rules (which are generally applicable to public M&A deals), break fees:
- require the approval of SCA;
- must be disclosed in the offer document; and
- are subject to a cap of 2% of the value of the offer.
5.3 How is risk typically allocated between the parties?
On balance, UAE transactions involving international private equity investors tend to be on more buyer-friendly terms. That said, risk allocation is always a matter of particular negotiation and is deal specific, particularly in the context of a competitive bid process.
On a locked-box transaction, a buyer assumes economic risk from the locked-box date (subject to leakage protection). Private equity buyers seek to manage risk through conducting due diligence and negotiating warranty protection from the seller. It is customary for the contents of the data room to qualify the warranties, to the extent that matters are fairly disclosed. Tax covenants, pursuant to which a seller agrees to be responsible for all pre-completion tax liabilities of the target group, are increasingly common in UAE deals.
Although there are limited private equity exit precedents in the UAE M&A market, we would expect private equity sellers to refuse to give warranties to a buyer beyond customary title to the sale shares and the capacity to enter into definitive transaction documentation. Warranty and indemnity insurance is commonly used to bridge any gap between these limited warranties and those required by the buyer.
Earn-outs are relatively common in the United Arab Emirates, particularly in relation to founder-owned businesses, which helps to balance the risk for an incoming investor.
5.4 What representations and warranties will typically be made and what are the consequences of breach? Is warranty and indemnity insurance commonly used?
M&A transactions in the United Arab Emirates are often conducted on a UK-style basis (with English or Dubai International Financial Centre law governing the terms of the definitive transaction documentation). Accordingly, it is rare for warranties to be given as representations and/or on an indemnity basis.
Private equity buyers will typically seek comprehensive warranties from a seller, subject to tactical considerations in competitive auction processes which tend to result in a more focused warranty package.
Although there are limited private equity exit precedents in the UAE M&A market, we would expect private equity sellers to refuse to give warranties to a buyer beyond customary title to the sale shares and the capacity to enter into definitive transaction documentation.
Historically, there was limited use of warranty and indemnity insurance in UAE transactions, although it is now more prevalent. It is fairly common in transactions involving an international privative equity sponsor or other sophisticated buyer. For a private equity seller in the United Arab Emirates, the use of warranty and indemnity insurance is the preferred option.
6 Management considerations
6.1 How are management incentive schemes typically structured in your jurisdiction? What are the potential advantages and disadvantages of these different structures?
Management incentive schemes involving the issuance of 'hard' equity to members of the management team are less common in the United Arab Emirates than in many other jurisdictions. The main driver behind this is that – given the current tax landscape in the United Arab Emirates, with no income or capital gains tax payable by individuals – there is no tax advantage for management in holding shares. Consequently, considerations around equity appreciation being taxed at capital gains tax rates (rather than employment income tax rates) is not applicable in the United Arab Emirates. No change to the tax regime applying to individuals is currently envisaged and so we do not expect the general approach to 'hard' equity changing in the near future.
In addition, in circumstances where an investment structure does not include a Dubai International Financial Centre (DIFC) or Abu Dhabi Global Market (ADGM) 'holdco', there are practical considerations that render the establishment of 'hard' equity management incentive schemes challenging:
- Share classes: 'Onshore' companies cannot issue different classes of shares with bespoke rights attached to each class. As a result, it is very difficult to have a 'management' class of shares.
- Share transfers and other corporate actions: In order to effect an 'onshore' share transfer or undertake certain other corporate actions (eg, amending the constitutional documents), all shareholders must attend a notary public in order to sign and have the relevant documentation and an updated memorandum of association notarised before they are submitted to the relevant authorities. The reliance on all shareholders being present or agreeing to the relevant action increases the risk that an exiting manager may frustrate certain actions, including the transfer to the company or another shareholder of any shares issued as part of a management incentive plan.
The combination of the tax considerations and practical difficulties set out above means that contractual 'phantom' equity, option or profit-sharing schemes are more common in the United Arab Emirates, particularly outside of the financial free zones.
Due to inheritance issues and Islamic Sharia jurisprudence, it is recommended that shares be held through corporate vehicles rather than directly by individual shareholders.
6.2 What are the tax implications of these different structures? What strategies are available to mitigate tax exposure?
As there is presently no income tax or capital gains tax payable in the United Arab Emirates, there is no tax advantage for management in holding shares given there is no advantage for equity appreciation to be taxed at capital gains tax rates (rather than employment income tax rates), as is the case in other jurisdictions.
6.3 What rights are typically granted and what restrictions typically apply to manager shareholders?
For the reasons mentioned in question 6.1, it is relatively uncommon in the United Arab Emirates for manager shareholders to have direct equity interests, so it is difficult to give a sense of a typical set of rights and restrictions applicable to manager shareholders. Where there are manager shareholders, it is more common in the United Arab Emirates that this is a result of them being a founder and, accordingly, they have more substantial minority interests, with the rights and restrictions being dictated by the level of their shareholding. The types of restrictions typically included in these scenarios are:
- leaver provisions – although these provisions are usually based on shares being transferred or bought back at a discount to fair market value rather than for a nominal amount;
- restrictions on transfers without consent;
- investor reserved matters;
- provisions relating to manager shareholders providing reasonable cooperation in an exit scenario; and
- depending on the shareholder composition, manager covenants.
It is also relatively common in the United Arab Emirates to have a delegation of authority or an authority matrix setting out the delegated powers of the management team.
6.4 What leaver provisions typically apply to manager shareholders and how are 'good' and 'bad' leavers typically defined?
Leaver provisions are uncommon in respect of entities in the mainland United Arab Emirates and free zones other than the DIFC and the ADGM due to the procedural challenges set out above.
In the DIFC and ADGM, leaver provisions typically track those in the United Kingdom, such as the following:
- 'Good leaver':
- Death or incapacity;
- Retirement at normal retirement age; or
- As determined by the board of directors with investor consent.
- 'Bad leaver':
- Voluntary resignation;
- Termination of employment for cause; or
- Breach of restrictive covenants.
A key difference is that, since manager shareholders, as founders, often tend to be more significant shareholders, the price paid for a compulsory transfer of manager shareholders' shares in a leaver scenario is usually either:
- at fair market value in a good leaver scenario; or
- at a discount to fair market value in a bad leaver scenario as opposed to a nominal amount (as is sometimes the case in bad leaver scenarios in other jurisdictions).
In the more common contractual 'phantom' equity, option or profit-sharing schemes, these are often conditional upon the relevant manager remaining employed by the target business and so there is no good leaver/bad leaver concept included.
7 Governance and oversight
7.1 What are the typical governance arrangements of private equity portfolio companies?
In the United Arab Emirates, governance provisions are typical of those in other jurisdictions and usually include the following:
- Board representation: Investors will nearly always have a right to appoint a number of investor directors with at least one investor director required to be present for a quorum to exist at any board meeting.
- Reserved matters; Investors (and other significant shareholders) will nearly always have a list of reserved matters requiring their consent.
- Business plan and annual budget: In most investments, the management team is typically expected to prepare an annual business plan and budget for the portfolio company for approval by the board with the consent of the investor. Management teams are often required to report to the investor on progress as against the business plan and budget on a quarterly or six-monthly basis.
- Delegation of authority/authority matrix: It is common in the region for there to be a delegation of authority or authority matrix established at the outset of an investment setting out the matters that the management team can carry out without the consent of the investor or the board.
- Reporting requirements: Customary reporting requirements are usually included in the transaction documents to ensure that the management team provides the investor with copies of relevant financial information, such as management accounts, quarterly reports and audited accounts, within a specified timeframe. In line with global trends, there has also been a rise in interest and requirements for non-financial environmental, social and governance reporting to private equity investors.
7.2 What considerations should a private equity firm take into account when putting forward nominees to the board of the portfolio company?
In several sectors in the United Arab Emirates, personal relationships are still heavily influential and a critical facet of doing business. As such, the appointment of a locally based chairman with key contacts and knowledge of the relevant sector is often viewed as an important consideration for private equity investors when considering potential appointees to the board of a portfolio company. In addition, where a portfolio company operates in a regulated sector, it can be helpful for a portfolio company to have board appointees who are familiar with and have experience of navigating the processes and regulations of the relevant regulators.
With the introduction of the UAE Economic Substance Regulations in 2020, it is often important for UAE entities to be able to demonstrate that they have adequate economic substance in the jurisdiction where the regulations apply to the activities of the entity. A key component of this is that an adequate number of board meetings should be held in the United Arab Emirates, with a quorum of directors being physically present in the United Arab Emirates. As such, it is an important consideration for portfolio companies to whom the regulations apply that board nominees have the ability to attend board meetings within the United Arab Emirates. The definition of 'adequate' is considered on a case-by-case basis, depending on the nature and level of activities carried out by the relevant entity.
From a practical perspective, it is always important for an investor to be mindful of any potential conflicts of interest that could arise by virtue of a proposed appointee's other appointments to the boards of other portfolio companies and/or entities within the investor's group, as the appointee may potentially owe duties to more than one entity. In most circumstances, the interests of the investor and the portfolio company will usually align. However, there may be situations where a conflict of interest arises and results in the relevant director having to be recused from participating in discussions and voting on certain matters, which should be borne in mind by the investor when proposing its appointees to try to minimise the occurrence of such situations.
For public and private joint stock companies (generally listed entities or entities carrying out specific activities, such as banking/insurance), the chairman and the majority of directors of the board must be UAE nationals and directors may not:
- be a member of the board of more than five joint stock companies based in the United Arab Emirates;
- act as chairman or vice chairman of more than two companies based in the United Arab Emirates; or
- act as a managing director of more than one company in the United Arab Emirates.
7.3 Can the private equity firm and/or its nominated directors typically veto significant corporate decisions of the portfolio company?
Typically, private equity investors have a veto over a defined list of investor reserved matters which the company cannot take without the investor's consent irrespective of whether it is a majority or minority investment. The number and nature of reserved matters are typically dictated by:
- the stage and size of the investment; and
- the level of the investor's shareholding.
The ability to veto at a board level is dependent on the level of bargaining power of the investor and the level of investment. At times, most commonly in majority transactions, investors do manage to negotiate provisions where board resolutions cannot be passed without an investor director voting in favour or insist on having board control via the number of investor directors that they are able to appoint. These rights are less common in minority investments.
There is typically a single general manager named on a company licence and thought should be given to whether this individual is an investor representative. The practical reality is that this individual should be someone on the ground in the United Arab Emirates who can execute transactions on behalf of the business with ease and efficiency; but equally, this individual will have day-to-day operational control of the company. There are certain controls that investors can put in place to restrict the activities of this individual, whether through limiting his or her powers in the constitutional documentation and/or putting in place a restrictive power of attorney.
7.4 What other tools and strategies are available to the private equity firm to monitor and influence the performance of the portfolio company?
As alluded to in question 7.1, the key tool for investors in the United Arab Emirates in terms of monitoring a portfolio company's performance are the reporting requirements that are typically included in the transaction documents to ensure that the portfolio company's management team provides the investor with the relevant financial information at agreed intervals to ensure the company's performance can be appropriately monitored.
In addition to the rights and tools already discussed in question 7, in terms of influencing the performance of a portfolio company, in certain investments private equity investors also seek to include 'step-in' or 'swamping' rights in the investment documentation, whereby the investor receives enhanced voting rights at a board and shareholder level in underperformance situations. These rights allow the investor to take control of the relevant portfolio company and make decisions that it sees fit in order to turn around the performance of the company. These enhanced rights are typically triggered where a company:
- is, or is in danger of becoming, insolvent;
- is in breach of any obligation to repay debt owed to the investor; or
- is in breach of its obligations to a third-party lender.
Default provisions are also usually included in the shareholders' or investment agreement that trigger compulsory sale provisions where a shareholder:
- is in material breach of its obligations under the relevant agreement; or
- is subject to an insolvency event.
These provisions can be a useful tool for investors in incentivising manager shareholders to comply with their obligations in respect of how a portfolio company is managed. The compulsory sale provisions will typically trigger a compulsory sale of a shareholder's shares at a discount to fair market value. The level of discount is dictated by the type of event that triggers the compulsory sale.
8.1 What exit strategies are typically negotiated by private equity firms in your jurisdiction?
As in other jurisdictions, a fundamental pillar of private equity investment is that the investor typically receives its minimum level of returns in priority to other shareholders in an exit or liquidity scenario. The minimum level of investor returns is often the higher of a fixed multiple of the amount(s) invested by the investor or a percentage of the investor's internal rate of return over the lifetime of the investment. To this end, it is becoming more common for private equity investors to invest through a convertible loan or preference share instrument which ranks in priority to the equity of other shareholders.
In order to achieve an exit, private equity investors will usually seek to include provisions in the investment documentation to allow them to propose and compel the other shareholders to pursue an exit after a certain period. These provisions will typically oblige the other shareholders to cooperate and assist with an exit process that is proposed by an investor. In addition, taking any steps in relation to an exit will usually be an investor consent matter, so that an exit cannot be pursued by the other shareholders without the consent of the investor. Private equity investors will also typically expect to have control over transfers by the other shareholders to third parties either for a defined 'lock-up' period or for as long as they remain a shareholder to prevent other shareholders from exiting the business before them.
'Drag' provisions are commonly included in the investment documentation to compel the other shareholders to sell their shares where shareholders (including the investor) holding shares over a certain percentage threshold propose to sell their shares to a third-party investor. Depending on the type of investment, investors at times do also seek the ability to be able to transfer their shareholding to other qualifying financial investors before an exit so that they can exit an investment with another similar investor stepping into their shoes. These provisions are most common in long-term project infrastructure investments.
Unlike in other jurisdictions, 'secondary' transactions (ie, sales between a private equity seller and private equity buyer) are not particularly common in the United Arab Emirates, so this should not be assumed as a likely exit route for private equity investors in the region.
8.2 What specific legal and regulatory considerations (if any) must be borne in mind when pursuing each of these different strategies in your jurisdiction?
When determining the initial investment structure, the practical challenges that can exist when trying to achieve an exit should be a key consideration for the investor. It is important that advice is sought at this stage so that exit strategies can be implemented as effectively as possible. Depending on the location of the relevant entity within the United Arab Emirates and the legal framework that applies, there can be significant procedural challenges when it comes to effecting share transfers in 'drag' or other involuntary sale scenarios where a shareholder may not be willing to cooperate, particularly outside of the financial free zones.
With the above in mind, it is particularly worth noting that where the 'onshore' UAE courts have jurisdiction, the ability to obtain specific performance (or other similar equitable remedies) to compel a party to comply with its obligations under an agreement is generally not available where damages are deemed to be an adequate remedy. Therefore, enforcement of the relevant provisions in the investment documentation should be considered when deciding how an investment should be structured and, in particular, where the 'holdco' should be established.
For these reasons, it is most common for private equity investments to have a 'holdco' established either offshore or in the Dubai International Financial Centre or the Abu Dhabi Global Market.
9 Tax considerations
9.1 What are the key tax considerations for private equity transactions in your jurisdiction?
As the United Arab Emirates is currently a predominantly tax-free jurisdiction, the impact of tax and the structural considerations relating to it are a lot less relevant than in other jurisdictions, as at this time no corporate tax is payable by companies within the United Arab Emirates, except in the case of specific businesses such as:
- oil and gas companies (at a rate of up to 55%); and
- branches of foreign banks (at a rate of 20%).
In addition, there is currently no personal income or capital gains taxes levied by UAE authorities upon individuals in the United Arab Emirates.
However, the United Arab Emirates is preparing to introduce corporate tax at a federal level in June 2023, which is explored in further detail in question 10.2.
The United Arab Emirates introduced value added tax (VAT) in 2018. Under the VAT regime, VAT is generally applicable at a standard rate of 5% on the domestic supply of most goods and services.
9.2 What indirect tax risks and opportunities can arise from private equity transactions in your jurisdiction?
As the United Arab Emirates is currently a predominantly tax-free jurisdiction, indirect tax risks and opportunities are not relevant. However, while not strictly taxes, several indirect costs are associated with operating a company in the region, such as:
- trade licence renewal fees;
- visa renewal fees for employees;
- a mandatory requirement to maintain a lease; and
- social security contributions for qualifying UAE or Gulf Cooperation Council nationals.
9.3 What preferred tax strategies are typically adopted in private equity transactions in your jurisdiction?
10 Trends and predictions
10.1 How would you describe the current private equity landscape and prevailing trends in your jurisdiction? What are regarded as the key opportunities and main challenges for the coming 12 months?
Overall, private equity activity in the United Arab Emirates is relatively limited with, on average, only a handful of private equity transactions completing each year. The limited levels of activity were even more pronounced:
- in the period following the collapse of Abraaj Group in 2018, which may have somewhat tarnished investor opinions; and
- during the height of the COVID-19 pandemic, which made it difficult to practically consummate transactions for a period.
Since then, there has been increased deal flow, with record levels of 'dry powder' enabling the deployment of capital with more regularity; the relaxation of foreign ownership restrictions further supports this trend. Provided that the potentially challenging global macro-economic conditions on the horizon do not worsen, we expect this trend to continue.
In particular, there has been an increased focus on the privatisation or flotation of state-owned infrastructure assets. This has seen government-owned entities such as Abu Dhabi National Oil Company take on foreign investment and the Dubai Electricity and Water Authority list approximately 18% of its shares on the Dubai Financial Market. These types of assets are generally attractive to investors seeking long-term, stable returns. In Dubai, there are plans to continue this trend with the prospect of the sale of stakes in up to 10 state-owned businesses having been floated.
The recent growth of locally based securities exchanges such as the Abu Dhabi Securities Exchange and the Dubai Financial Market has seen an increase in local initial public offerings (IPOs). If this trend continues, it could see private equity investors begin to view local IPOs as a more viable exit strategy from certain investments.
10.2 Are any developments anticipated in the next 12 months, including any proposed legislative reforms in the legal or tax framework?
The main anticipated development likely to impact on private equity investors in the region will probably be the introduction of the corporate tax framework which was announced by the Ministry of Finance earlier this year. It is proposed that a federal corporate tax which will be introduced and be effective from 1 June 2023. The proposed corporate tax legislation and system are currently at the consultation phase but it is expected that corporate tax will be levied on 'onshore' UAE entities on their business profits in a particular accounting period at a rate of 9%; and that, while free zone entities will fall within the scope of the corporate tax system, they will be subject to a 0% corporate tax rate, provided that they comply with the relevant regulatory requirements and do not conduct business in the mainland United Arab Emirates.
However, despite the introduction of corporate tax, the proposed tax rate of 9% and the 0% rate for free zone entities will mean that the region should remain attractive from a tax perspective when compared to other jurisdictions.
11 Tips and traps
11.1 What are your tips to maximise the opportunities that private equity presents in your jurisdiction, for both investors and targets, and what potential issues or limitations would you highlight?
In comparison with other jurisdictions, the private equity market in the Middle East is still developing and there is less familiarity and experience of private equity transactions than in other parts of the world. Although the United Arab Emirates is regarded as the most active private equity jurisdiction in the region, when compared with jurisdictions in Europe and the United States, there is less traditional private equity activity in the market.
As a result, there is generally a lack of experience and familiarity among most target entities as to how private equity transactions are typically structured and the types of controls that are often required by private equity investors. Equally, advisers in the region may lack experience in private equity transactions. In order to navigate several of the issues flagged above, it is key to appoint advisers with appropriate experience of private equity transactions in the region at an early stage.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.