With the M&A market in the Middle East gaining momentum, particularly in the UAE, share acquisitions have become a favored method for investors tapping into the region's growth. Foreign investors strategic buyers and local investors are increasingly acquiring stakes in UAE companies, attracted by the country's economic diversification, the numerous opportunities, and investor-friendly regulations.
What is a Share Acquisition?
A share acquisition involves purchasing shares of a company, which can vary in intent. Sometimes, the acquisition is for a small stake, offering an opportunity for someone to be a silent partner without influencing management. In other cases, even a small share purchase might include a request for a board seat, which the seller may agree to. Companies might also seek acquisitions when an expert in the field is valuable to have on their board. On another hand, the acquisition may aim to gain ownership and/or control. Additionally, some acquisitions are strategically driven to absorb competition, allowing the acquiring company to strengthen its market position by reducing the number of competitors or gaining access to new technology, talent, or customer bases.
From the seller's perspective, the motivation is often to generate income, but there can be other reasons as well. Sellers may be looking to exit an industry to pursue new ventures, or simply cash in on years of profits.
In any share acquisition, it is essential to carefully evaluate the objectives behind the purchase and the implications for both parties. As previously outlined, the structure, terms, and potential outcomes of the acquisition can vary significantly depending on the intent. Understanding the legal, financial, and operational impacts is crucial to ensure that the acquisition aligns with the long-term goals of the parties.
Key Considerations
- Due Diligence: Conducting thorough due diligence is crucial in any acquisition. This involves reviewing the target company's financial, legal, operational, and tax position. The objective is to identify any risks or liabilities that the buyer will inherit, such as debts, ongoing litigation, tax implications, or regulatory issues. Comprehensive due diligence helps buyers make informed decisions and structure appropriate protections in the transaction documents. Additionally, it significantly impacts the valuation of the company, ensuring that the buyer understands the true worth and potential risks associated with the acquisition.
- Valuation: A proper valuation exerciseconducted by financial advisors or valuation experts ensures that the purchase price is as close as possible to the actual value of the target company. It is important to note that appraisers typically use different valuation methods, each of which may lead to a different result.
- Tax Considerations: It is crucial to assess, via tax advisors, the tax impact of the acquisition, both in the UAE (including VAT, capital gains, and other applicable taxes) and in the buyer's home country in cross-border transactions. Tax-efficient structuring can reduce costs, minimize financial burdens and sometimes minimize liabilities.
- Control and Management Post-Acquisition: Buyers acquiring a majority stake must carefully evaluate their approach to managing the organization's strategic direction. This includes the critical responsibility of appointing directors who will align with the buyers' vision and objectives and will implement the shareholders resolutions. In the case of minority acquisitions, it is essential to negotiate protective rights that safeguard the interests of the minority buyers. Such protective measures may include establishing veto powers over specific key decisions, typically outlined in a reserved matters list, or securing representation through board seats or stipulating a minimum minority presence in the quorum can further protect their interests. In other instances, it may be beneficial to include provisions requiring a qualified majority for specific resolutions, ensuring that a high voting percentage is necessary for approval and implementation. These provisions are vital to ensuring that minority stakeholders have a meaningful voice in significant corporate matters, while avoiding any obstruction to the company's day-to-day operations, growth and progress.
- Share Transfer Restrictions: Such restrictions can limit both the buyer and existing shareholders. Common restrictions to consider include:
- Lock-in periods: Prohibiting the sale of shares for a set time.
- Right of first refusal: Allowing existing shareholders the first right to purchase shares before they are offered to a third party.
- Consent requirements: Requiring approval from the board or other shareholders before selling shares.
- Call and put options: Call options allow a buyer to purchase shares at a set price and under agreed conditions, while put options give shareholders the right to sell shares under agreed conditions.
- Exit Mechanisms: It is critical for private equity and venture capital investors to consider clear exit strategies. These could include:
- Qualified IPO (QIPO): Selling shares through an IPO under agreed terms.
- Tag-along rights: Allowing investors to sell their shares alongside the founders or other investors in the company, preferably based on a predetermined method of valuation.
- Drag-along rights: Enabling investors to compel founders or other investors to sell with them.
- Share buy-back: Obligating the company to repurchase shares from the investor.
It is important to note that while tag-along rights grant holders the option to exercise their rights based on the agreed valuation, drag-along rights and share buy-back mechanisms impose an obligation on their subject. When the drag-along clause is activated, concerned shareholders are required to sell their shares in accordance with the predetermined method of valuation, leaving them with no choice in the matter.
- Warranties and Indemnities: Warranties and indemnities protect the buyer from undisclosed liabilities or hidden risks. Sellers typically provide warranties on the company's financial health, legal compliance, and ownership of key assets. Indemnities allow the buyer to claim compensation if these warranties prove inaccurate or if liabilities arise post-acquisition.
In turn, the buyer may also provide warranties, such as confirming their entitlement to enter into the share purchase agreement and demonstrating that they possess the financial capability to complete the acquisition. Should any of these warranties be breached, the buyer may be subject to remedies or indemnities, all in accordance with the clauses and provisions outlined in the agreement.
- Protective or negative covenants: One of the most critical articles and clauses of a shares sale and purchase agreement is the protective and negative covenants. These provisions must be carefully reviewed and meticulously drafted, as they play a vital role in safeguarding the buyer's interests post-acquisition. One common form of these covenants is non-compete clauses, which prevent the seller or key shareholders from engaging in competing businesses for a defined period and within a specified geographic area. These clauses are critical in ensuring that the seller does not leverage sensitive information or client relationships to undermine the newly acquired entity.
In addition to non-compete clauses, other protective measures can be implemented, such as non-solicitation clauses. These clauses specifically prohibit the seller from soliciting the target's employees, clients, or suppliers for a certain duration, thereby protecting the company's workforce and customer base from being drawn away post-acquisition.
Negative covenants may also extend to financial and operational activities. For example, the seller may be restricted from undertaking significant business changes, incurring additional debt, or engaging in transactions that could adversely affect the company's value without the buyer's consent. These provisions are vital for maintaining the stability and integrity of the business during the transition period, ensuring that the buyer can operate the acquired entity effectively and without undue competition or disruption.
Conclusion
Given the above considerations, carefully drafting and negotiating key transaction documents, such as the Share Purchase Agreement and Shareholders Agreement, is essential to protect thebuyer and the seller; the various components of these documents play a crucial role in safeguarding the interests of the parties and ensuring a smooth transition post-acquisition. Each provision must be carefully reviewed and meticulously drafted to address potential risks and liabilities effectively. By engaging in thorough negotiation and clear articulation of these elements, both parties can protect their interests, promote transparency, and support long-term stability within the newly acquired business.
Equally important is ensuring compliance with UAE laws, whether it involves adhering to the UAE Commercial Companies Law for mainland entities or following the specific regulations applicable to free zone companies. This includes completing all necessary legal formalities for share transfer, such as submitting the required filings with the Dubai Economy and Tourism for mainland companies in Dubai or the relevant free zone authority.
Click here to view previous article in this series
Click here to view next article in this series
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.
