Ahmed Elnaggar, founder and managing partner of Elnaggar & Partners
The United Arab Emirates (UAE) has emerged as a leading hub for startup entrepreneurs and investors, driven by favorable regulations and connectivity to global markets. However, many newcomers find themselves negotiating with seasoned investors who are adept at structuring deals to their advantage.
As the founder and managing partner of Elnaggar & Partners, a legal consulting and corporate services firm, and as the creator of the Emirates Legal Network Association, I observe this dynamic in the thriving startup landscape of the UAE on a daily basis. Numerous founders enter into agreements—be it shareholder contracts, employment agreements, convertible notes, or acquisition terms—without fully comprehending the potential legal ramifications hidden in intricate clauses.
If you are about to sign a shareholder agreement, an employment contract, a convertible note, or an acquisition deal, here are five essential clauses that every startup founder must understand before finalizing any agreement.
1. Planning Your Exit Strategy: Know Your Way Out Before You Need It
Every business relationship commences with a commitment, much like the first bite of a meal. While startup founders often concentrate on potential gains, they tend to overlook the crucial question: what happens when the partnership concludes?
A poorly drafted exit clause can keep you locked in unfavorable agreements, force a loss-making sale, or even lead to legal disputes. In the fast-paced startup environment of the UAE, this scenario is not merely hypothetical.
In mergers and acquisitions, exit stipulations dictate whether you exit on a high note or with regrets. Drag-along rights, tag-along rights, and put/call options define who governs the process and under what conditions. If these concepts are unfamiliar to you, it is advisable to seek expert advice.
The fundamental principle: be aware of your exit options from the very beginning. As Ahmed Tarek mentioned on Shark Tank Egypt: “You don’t have to use it, but you must have it.” Clearly outline how partnerships will terminate, how disputes are resolved, how shares may be sold, and what actions occur if investors choose to exit before you do.
2. Ownership Valuation and Dilution: Guarding Against Loss
Experienced investors frequently craft agreements that initially appear appealing but gradually diminish founders’ ownership and control. First-time entrepreneurs are often the easiest targets.
Convertible notes are a prime example. Unseen terms, including valuation caps, discounts, or equity triggers, can discreetly tip the scales in favor of investors. Anti-dilution clauses add another layer of risk, safeguarding investors at the expense of founders during subsequent funding rounds.
A historical example serves as a cautionary tale. Eduardo Saverin, an early co-founder of Facebook, saw his ownership plummet from over 30% to under 10% after signing agreements that forfeited his preemptive rights, allowing Zuckerberg and others to issue new shares without his consent.
The takeaway is clear: never sign incorporation or shareholder agreements without securing robust preemptive rights and modeling the repercussions of future share issuances. Every detail counts. Understand how terms will function in various scenarios before making any commitments.
3. Control and Voting Rights: Understanding Real Power
Founders often enter agreements only to realize they have relinquished control over their companies. The hard truth is, majority ownership does not automatically confer actual power.
Investors and their legal teams regularly incorporate protective measures that grant them veto power over significant decisions, such as recruiting executives, budget approvals, fundraising efforts, and product strategy. You may hold a majority stake in your company but still find yourself unable to rebrand, expand, or pivot as necessary. Acquisition agreements may also bind you to restrictive obligations long after the deal is finalized.
Steve Jobs experienced this firsthand. Despite being one of Apple’s creators and visionaries, he was pushed aside when the board supported CEO John Sculley. Lacking protective voting rights, Jobs was effectively stripped of influence.
Bear this vital lesson in mind: holding a majority stake does not equate to control. Without protective governance rights, even founders may find themselves sidelined by their boards. Ensure that you thoroughly understand whether you are selling shares of your company, seeking investment, or relinquishing any degree of decision-making authority, and preserve strategic control to align with your vision.
4. Non-Compete and Restrictive Clauses: Risks to Future Opportunities
This area often contains some of the most dangerous yet overlooked contractual stipulations. While you may think you’re merely signing an investment agreement, hidden within could be clauses that bar you from pursuing your next entrepreneurial venture. Non-compete clauses can be drafted so broadly that they effectively prevent you from working in your entire industry for years.
If these stipulations aren’t crafted judiciously, you could end up in a restrictive partnership where your partner thrives while you face legal limitations. The same applies to employees who sign employment contracts without sufficient non-compete clauses to safeguard your company when they leave, potentially taking invaluable knowledge, ideas, and contacts with them.
Non-solicitation terms could also inhibit your ability to collaborate with your own team or clients if relationships break down and you are forced to exit the business. Imagine dedicating years to building networks and relationships, only to sign a document that imposes legal constraints on your professional and personal connections.
Always negotiate clear timelines, specific geographical limits, and carefully define what constitutes “competition.” Otherwise, you risk forfeiting your future innovations.
5. Dispute Resolution: Selecting Your Preferred Legal Forum
No one enters a deal with the intention of facing disputes. As Fatima BalFaqeeh remarked on The Jurist Podcast: “It’s wonderful to witness the beginning of a venture, but imagining worst-case scenarios early on is essential. Engaging a legal professional simplifies the process and alleviates discomfort.”
I wholeheartedly agree. Addressing challenging topics upfront is far wiser than dealing with costly conflicts later. This is where the dispute resolution clause becomes pivotal, as it dictates where, how, and under which legal framework conflicts will be settled.
Being compelled to engage in litigation in a foreign jurisdiction can be burdensome, consuming time and financial resources. Fortunately, the UAE presents robust options, including advanced civil law courts, common law free zone courts, internationally recognized arbitration centers, and established mediation practices. While each has its own advocates, the essential factor is that your clause should be enforceable and align with best practices.
Ultimately, select a dispute resolution forum that is both feasible and trustworthy for all parties involved.
A Necessary Reality Check for Founders
The UAE is brimming with opportunities for startup entrepreneurs, but one poorly constructed clause or agreement can jeopardize years of hard work. While investors are not always adversaries, they typically possess more experience than first-time founders. As many have learned—some the hard way—business is business.
Before finalizing any contract, ask yourself these five pivotal questions: What is my exit strategy? How will this influence my future ownership? Who maintains control after signing? Am I jeopardizing future opportunities? If challenges arise, where and how will disputes be addressed?
If you can confidently answer these questions, you are well-positioned for success. If not, consider obtaining expert legal counsel before proceeding with any agreements.