Key Considerations for Foreign Investors in UAE Companies

The United Arab Emirates has rapidly emerged as a global hotspot for foreign investment and venture capital activity. With a strategic location, robust infrastructure, and business-friendly reforms, the UAE has been successful in attracting startups, founders, and investors from around the world. However, investing in UAE companies is not without its complexities.

Below, we explore the legal, structural, and transactional considerations that investors and business owners must bear in mind.

Choosing the Right Jurisdiction

Onshore vs Free Zone Incorporation

One of the most immediate and important decisions for any investor is determining where the company is incorporated:

Mainland (Onshore) Companies:

Incorporated and managed within the mainland jurisdiction of the relevant Emirate, these businesses have unrestricted access to the local market but are fully subject to UAE law.

Mainland (Onshore) Companies:

Set up within special economic zones, free zone companies often enjoy regulatory independence, tax advantages, and operational flexibility. However, pending the implementation of new legal reforms, they are usually restricted from trading directly with the UAE mainland and remain subject to various federal laws.

The DIFC and ADGM

Many foreign investors gravitate towards companies established in the financial free zones of the Dubai International Financial Centre (DIFC) and Abu Dhabi Global Market (ADGM). This preference is driven by several advantages:

• The ability to issue multiple share classes and create bespoke articles of association.

• Independent common law legal systems.

• Efficient, transparent legal processes managed in English-language courts, familiar to international investors.

• Enhanced enforceability of complex contractual rights, including 'drag and tag', leaver provisions, and put and call options.

Challenges with Mainland Companies

For many foreign investors, mainland companies are less attractive due to:

• Restrictions on creating more than one class of shares.

• Limitations on altering standard articles of association.

• Uncertainty over enforcement of specific contractual provisions, with UAE courts often favouring damages over specific performance.

• Restrictions on foreign ownership in certain sectors (albeit, recent changes to UAE law have significantly relaxed the restrictions on foreign ownership of mainland companies).

Note: These reservations often extend to the non-financial free zones that do not follow a common law system, so thorough due diligence is essential.

Subsidiaries, Branches, and Foreign Ownership

Subsidiary Jurisdiction

Investors must consider where any subsidiary of the target business is incorporated. Some sectors in the mainland UAE still pose foreign ownership restrictions, despite reforms allowing up to 100% foreign ownership in many industries. If required by law, investors must arrange for a local nominee shareholder and ensure robust legal agreements are in place to protect their interests.

Branches in the UAE

A branch differs from a subsidiary in that it is not legally separate from its parent company. While it enables commercial operations in another jurisdiction (i.e., the UAE mainland), a branch exposes the parent company to direct liability for its obligations. This lack of ‘ringfencing’ can increase risk for investors.

Common Types of Investments

SAFEs (Simple Agreements for Future Equity)

SAFEs are gaining ground in the MENA region, allowing early-stage funding without setting a firm valuation. Their attributes:

• Facilitate conversion to equity upon trigger events, typically with discounts or valuation caps.

• Not a debt instrument (unlike CLNs) and do not accrue interest.

• Caution: Because SAFEs convert only in future equity rounds or liquidity events, there is less certainty regarding conversion timing or repayment.

Convertible Loan Notes (CLNs)

CLNs are frequently used for interim funding or when a startup's valuation is not yet established. Key features include:

• Valuation caps and conversion discounts: Allow conversion to equity at favourable rates.

• Interest accrual: Often rolled into the equity on conversion.

• Flexibility on sale: On a sale event, holders can choose to convert or reclaim their loan.

Share Subscriptions

Many investments continue to be structured as straightforward share subscriptions, with negotiated terms captured in investment and shareholder agreements. These typically cover:

• Class and number of shares acquired.

• Board and observer rights.

• Minority protections and lock-up periods.

• Share transfer rights and restrictions.

• Comprehensive investor information rights.

It is vital to enshrine these protections not just in contracts, but in the company's constitutional documents, taking into account jurisdictional restrictions.

Final Thoughts

The UAE’s ecosystem for startups and foreign investors continues to deepen and mature. However, its nuanced legal landscape demands careful, well-informed structuring of investments. By understanding the local options for incorporation, safeguard mechanisms, funding structures, and exit planning, investors can capture the exceptional opportunities this thriving region offers while effectively managing their risks.

For venture capitalists, private equity firms, funds, and other types of investors exploring opportunities in the UAE, strategic legal and financial guidance is crucial. Understanding and mitigating the legal and commercial risks associated with investing in a UAE company is essential to making informed and risk adjusted decisions.

To discuss this further contact Jamie Tredgold

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This material is provided for general information only. It should not be relied upon for the provision of or as a substitute for legal or other professional advice.