When it comes to entering into a joint venture, acquiring a business or selling yours (either a part or all of it) or restructuring your current corporate structure, you want to do it right. The options for structures, risk management and future thinking are wide and it can be a complicated area to get your head around.
In this article we share a few of the areas that you might like to consider when it comes to your next joint venture or a major purchase or sale, and some of the pros and cons of each.
Importantly though, every deal is unique – what’s best for the business next door might be terrible for you. Getting specific and targeted advice that weighs up the pros and cons of your situation and your desired outcomes is important to ensure that you don’t just go with the easiest sounding solution, or perhaps get into a more complicated transaction that you need to.
Joint ventures are commercial arrangements where two or more entities collaborate in order to
- undertake a business activity or achieve a common goal;
- share in the profits and risks of the relevant activity; and
- contribute, whether in equal proportion or otherwise, to the assets and expertise required to drive the venture forward.
The benefits of entering into a joint venture include:
- complementary contributions to the venture;
- sharing resources, costs and risks; and
- accessing opportunities for new markets, new customers, new products, new technology, leverage or a gradual sale/purchase of a business
A joint venture is particularly useful where the joint venture partner is familiar with the local market and has existing business relationships. It is also often used in scenarios where there are foreign ownership restrictions prevalent in the relevant jurisdiction. In such jurisdictions, the foreign investor and the local partner sometimes operate on the basis of schemes of arrangement which set out how profits are to be divided between the partners and how the company is to be run.
However, they aren’t always a good idea in certain situations, for example where:
- the underling chemistry between the parties is not aligned;
- the strategy for the joint venture and the joint venture entity has not been agreed at the outset;
- there is no real sharing of roles and responsibilities between the partners, leading to disagreements; or
- the manner in which business is conducted by the joint venture partners is markedly different.
In the UAE (and the Middle East generally), we see a number of joint ventures, as a result of the foreign ownership restrictions that apply. While this may change in the future, joint ventures are still a very popular way for a new entrant to access and assess the market.
While a joint venture may be contractual in nature (for example, for specific construction projects), in most sectors in the UAE, there would be an incorporated joint venture entity that carries on the relevant business activity. Where the entity is incorporated would depend on a number of factors, including:
- where the clients/customers are based;
- the nature of the business activity to be carried out;
- the identities and needs of the shareholders;
- applicable ownership restrictions; and
- time/cost involved in establishing the entity.
There are numerous options as to where to establish a joint venture entity in the UAE, ranging from ‘onshore’ (i.e. not in a ‘free zone’) to one of 45+ free zones. Costs vary to a considerable extent; it is therefore necessary to narrow down the options using the factors set out above.
Once the jurisdiction has been identified, the joint venture partners need to consider the documentation that will set out details of their relationship and, ultimately, protect them if disaster strikes. This would include:
- a term sheet (ideally);
- a joint venture or shareholders agreement (that covers both, the pre-incorporation and post-incorporation periods);
- the constitutive documents of the joint venture entity (i.e. the memorandum and articles of association); and
- ancillary documents (such as employment/service/management agreements) that may be put in place between the joint venture partners or between a joint venture partner and the joint venture entity.
You can pick up the main points that would need to be covered in a joint venture agreement, from our handy JV issues checklist.
An example of a typical joint venture structure that is used in the UAE, primarily as a result of the foreign ownership and succession/inheritance-related issues, is set out in the diagram below.First diagram
The benefits of this structure, from a foreign shareholder perspective, include:
- ability to structure and enforce arrangements with other/national shareholder offshore/in a common law jurisdiction (if, for example, the DIFC or ADGM are selected as the free zones in which to incorporate the joint venture company);
- a level of certainty in respect of succession issues in the event that the other/national shareholder is an individual – the individual’s (in)ability to act as a shareholder should not affect the underlying operations of the joint venture;
- any disputes/issues affecting the joint venture company are ‘ring-fenced’ from the operating entity; and
- the structure can be made simple or more complicated, depending on the risk appetite of the shareholders, for example, to make the structure more simple, the individual shareholders could hold shares in the joint venture entity directly or, to make it more complicated, the foreign individual shareholder could build in an offshore trust to hold his shares in the joint venture company.
This process generally entails a shareholder of a business selling the shares/assets owned by him/her/it in the business to a third party or to another shareholder, the buyer of those shares or assets. For the purposes of this article, we will only be looking at private acquisitions and sales.
Like any other asset, a business owner may choose to ‘cash in’ and sell the shares/asset once a sufficient gain has been made and he/she has an operating, profitable item for sale, that is an attractive proposition to third parties.
From the buyer’s perspective, acquiring shares or assets in a business could, among other things, be for the purpose of acquiring market share, entering a new market or as a strategic bolt-on to an existing venture.
The benefits and drawbacks of the option of selling shares or assets depends very much on individual circumstances and objectives. Having said that, in the UAE, share sales are more common than asset sales.
The main advantage of a share sale is that the underlying entity is not affected, and control transfers from one shareholder to the new buyer. The process can be relatively straightforward, assuming that requisite third party and regulatory approvals are sought and obtained.
The main disadvantage of a share sale is that all assets and liabilities remain with the business. The buyer must therefore rely on its due diligence process and on contractual provisions, such as warranties and indemnities.
The main advantage of an asset sale is that a buyer is able to select the relevant assets and liabilities that it wishes to purchase.
The main disadvantage of an asset sale is that assets would need to be transferred individually. For example, real estate, commercial contracts, loans and employees would all need to be transferred on an individual basis.
There are a number of ways in which to complete a potential sale/acquisition of shares or assets of a business.
The main documents in an acquisition/sale include:
- sale and purchase agreement.
- disclosure letter prepared by the seller and the seller’s team.
- board or shareholders’ resolutions or other corporate approvals
- a shareholders’ agreement in the event that the seller will remain in the business.
- service or employment agreements for key employees.
- ancillary documents in the event of an asset sale, such as employee and customer/supplier contracts.
There are also a number of UAE-specific issues to consider, which you can read more about in our article on 5 key legal issues to consider when selling your business in the UAE.
We recently completed a share sale for an expat owner in the UAE, who held shares in an entity in a free zone company. Read more about that transaction, the challenges faced and our successes.
There is no ‘one size fits all’ option when it comes to structuring a sale or acquisition; every deal is different and the needs and commercial objectives of each party are also different. It is therefore imperative that the parties discuss and agree on a structure that works for both, from a commercial, regulatory, legal and tax perspective.
Here is an example of a basic structure for a sale of shares (not necessarily jurisdiction-specific).Second Diagram
A couple of advantages from the perspective of both parties, of this structure, are:
- by transferring the shares of the holding company (HoldCo), the target company is not being impacted and the shareholder(s) of the target company remains the same; and
- if HoldCo is incorporated offshore, the process of transferring shares in it can be relatively straightforward and time efficient.
A couple of advantages, from the buyer’s perspective, of this structure, are:
- the buyer has a special purpose vehicle (SPV) that purchases the shares, thereby separating the buyer from the underlying asset (shares in the target company) and any liabilities that may arise as a result of being a shareholder of the target company; and
- when it comes time for the buyer to sell the shares in the target, it can do so easily, by selling the SPV itself.
As you will have noted from the issues highlighted above, it is imperative to obtain legal advice at the outset, in respect of the structure and implementation of any joint venture or acquisition/sale transaction in order to avoid uncertainties, delays and unnecessary costs.
If you have questions, book a legal consultation now. We are here to help!