Ahmed Elnaggar, the founder and managing partner at Elnaggar & Partners.
The UAE has emerged as a leading hub for startup founders and investors, attributed to its favorable regulations, robust infrastructure, and access to international markets. However, burgeoning entrepreneurs frequently find themselves negotiating with seasoned investors who expertly craft deals to their advantage.
As the founder and managing partner of Elnaggar & Partners, along with my role in the Emirates Legal Network Association, I witness this trend regularly within the UAE’s vibrant startup atmosphere. It’s common for new founders to rush into agreements—be it shareholder contracts, employment terms, convertible notes, or acquisition arrangements—without fully grasping the legal complexities that may be hidden within the fine print.
Here are five essential clauses every startup founder should understand before signing any legal documents or, as is increasingly common, clicking the e-signature option.
1. Your exit strategy: Be prepared before the time comes
Every business partnership commences with a commitment, akin to the first taste of a meal. Startup founders often center on immediate prospects, overlooking the question: how does it all end?
A poorly-structured exit clause can ensnare you in an unfavorable deal, compel a loss-making sale, or even lead to disputes. In the UAE’s dynamic startup realm, this scenario is all too real.
In the context of mergers and acquisitions, exit stipulations dictate whether you depart with satisfaction or disappointment. Provisions like drag-along rights, tag-along rights, and put/call options influence who governs the exit process and the conditions surrounding it. If these terms are unfamiliar, seeking expert advice is essential.
A fundamental principle: you must outline your exit strategy right from the start. As articulated by Ahmed Tarek on Shark Tank Egypt: “You don’t have to act on it, but you must establish it.” Clearly define the process for ending collaborations, managing disputes, the sale of shares, and scenarios where investors withdraw funds before you do.
2. Valuation and ownership dilution: Recognizing when you lose control
Experienced investors often craft deals that seem valuable initially but eventually shift control away from founders. Newcomers are particularly vulnerable.
Convertible notes exemplify this issue. Hidden provisions, valuation caps, discounts, or equity triggers can quietly pivot the ownership scales. Anti-dilution provisions pose another challenge, enabling investors to shield themselves at your expense during subsequent funding rounds.
A historical cautionary tale is that of Eduardo Saverin, an early Facebook co-founder, whose share dropped from over 30% to less than 10% after signing agreements that revoked his pre-emptive rights, allowing others to issue new shares without his consent.
The takeaway is straightforward: never finalize incorporation or shareholder agreements without ensuring robust pre-emptive rights and assessing the implications of potential future share issuances. Every detail counts. Understand how terms might manifest in both favorable and unfavorable situations before committing.
3. Control and voting rights: The illusion of majority ownership
Founders frequently enter agreements only to discover they’ve forfeited control over their companies. The stark reality is that holding a majority stake doesn’t necessarily confer genuine authority.
Investors and their legal teams often incorporate protective measures granting them veto power over crucial decisions, including executive hires, budgets, fundraising, and product direction. You could possess the largest share but remain powerless to change branding, expand, or adapt strategies. Additionally, acquisition contracts might bind you to stringent commitments even after the agreement finalizes.
Steve Jobs experienced this firsthand. Despite his role as co-founder and visionary at Apple, he was sidelined when the board supported CEO John Sculley. Lacking protective voting rights, Jobs found himself stripped of his influence.
Internalize this vital lesson: majority ownership does not inherently equate to actual control. Without governance rights that safeguard your interests, founders can be pushed aside by their own boards. Ensure you fully understand the implications of selling shares, accepting investments, or relinquishing decision-making authority. Maintain alignment of strategic controls with your foundational vision.
4. Non-compete and restrictive clauses: Potential career stoppers
This is one of the most frequently neglected yet perilous contractual components. You may think you are merely finalizing an investment agreement, yet hidden within could be a clause that bars you from launching your next venture. Non-compete clauses can be so broadly defined that you find yourself effectively shut out of your entire industry for extended periods.
If these clauses are not crafted fairly, you might end up in a partnership where your partner capitalizes on opportunities while you are legally restricted. A similar risk applies to your employees who sign contracts without adequate non-compete provisions to shield your business when they leave, taking along valuable insights and connections you’ve cultivated.
Non-solicitation terms can hinder your ability to work with your established team or clientele if relationships deteriorate and you’re compelled to exit. Imagine investing years in building networks and relationships while promoting your entrepreneurial vision, only to find yourself hindered by a contract that imposes legal constraints on your professional and personal associations.
Always negotiate specific durations, geographical limitations, and clearly defined concepts of competition when favorable. Otherwise, you might unwittingly forfeit your future projects and innovations.
5. Dispute resolution: Selecting your legal battleground
No one enters a contract envisioning conflict. Fatima BalFaqeeh stated on The Jurist Podcast: “Witnessing the inception of a business is marvelous, but considering worst-case scenarios from the outset is crucial. Involving a legal advisor simplifies processes for everyone and alleviates discomfort.”
I wholeheartedly agree. It is far more prudent to engage in difficult discussions beforehand rather than facing expensive disputes afterward. This is why the dispute resolution clause is vital; it specifies where, how, and according to which laws disagreements will be settled.
Being compelled into litigation in another jurisdiction can be detrimental, consuming time and resources. Fortunately, the UAE presents robust options, including advanced civil law courts, common law free zone courts, world-class arbitration venues, and structured mediation systems. Each has its pros and cons, but the important factor is ensuring that your clause is enforceable and aligns with best practices.
In summary: select a dispute forum that is both affordable and trustworthy.
A reality check for every founder
The UAE presents vast opportunities for startup founders, but a single poorly constructed clause can detract from years of hard work. Investors aren’t always adversaries, yet they usually possess more experience than founders, particularly those just starting out. The lessons of experience teach us, or some learn the hard way, that business is, ultimately, business.
Before entering into any agreement, consider these five essential questions: What is my exit plan? How will this impact my ownership? Who will have control after signing? Am I sacrificing future opportunities? How and where will I manage disputes if issues arise?
If you can confidently address these inquiries, you are on a path to success. If not, it is wise to consult with seasoned legal professionals before proceeding with your signature.