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Reserved Matters is a term that is used in the corporate management world that refers to a particular set of situations or decision points that are reserved for the approval of a certain person or group of persons. In the private equity and venture capital worlds, such certain person or persons tend to be the investors or minority shareholders.

The existence of these Reserved Matters gives the approving persons a veto right over the company proceeding with actions involving the particular set of situations or decision points identified as Reserved Matters. Shareholders therefore tend to use Reserved Matters to address points of particular risk to them where they feel that the decision making body (board or shareholders meeting), who would otherwise have authority to decide on the situations or points in question, may decide in a manner that is against their interest if it were to proceed on standard (majority) basis. This, in turn, enhances the governance of the company and ensures that its various stakeholders are well represented and catered for.

Reserved Matters are customarily addressed in shareholders’ agreements and negotiated prior to consummating an acquisition or investment. In certain jurisdictions, including ADGM and Saudi Arabia, it is also recommended to reflect the reserved matters in the relevant entity’s constitutional documents to avoid lack of clarity on the enforceability of the provisions.

Protecting Minority Shareholders

Companies laws tend to favor majorities in decision making in relation to companies. A majority of board members is the base for approving decisions before the board, and a majority of shareholders customarily form the base for approving most shareholder decisions. Because of this standard tendency, incoming minority shareholders, especially investors, will wish to protect their interests where they may conflict with those of the majority of the shareholders, or where they may steer the company in a direction that is contrary to their investment purpose.

With the foregoing in mind, it important to remember the timing and agility impact Reserved Matters introduce into the decision-making process, and how requiring the approval of a specific sub-set of decision makers may slowdown company progress and growth. Therefore, where Reserved Matters are established to protect minority interests, it is advisable to also consider quorum and deadlock provisions that can enable the company to push forward without significant delays.

Not Back-Seat Control

It is vital that minority directors or representatives of shareholders entitled to veto rights in respect of Reserved Matters keep in mind that they may owe certain legal obligations to the company, which legal obligations may influence their vote. As such, the abuse of such power to approve Reserved Matters may, at time, subject the shareholders to legal challenges. In general, it is also not advisable that minority shareholders or investors attempt to exert back seat control over a company by deadlocking its decision making through Reserved Matters. Industry best practices is to use Reserved Matters as a shield to protect investors, rather than a sword to exert their influence.

Where the protected minority is a group of persons rather a single shareholder or investor, it is best practice that Reserved Matters are approved by a majority of the protected persons, being shareholders or directors. This reduces the likelihood of having to cater to holdout individual positions, or subject the company to lockups resulting from a very small number of shares.

Types of Reserved Matters 

Customarily, Reserved Matters fall into 3 categories: preferred shares or investor reserved matters, board reserved matters, and statutory reserved matters. Let’s take a closer look at each category and what it means for companies and shareholders.

Preferred Shares / Investor Reserved Matters

This type of Reserved Matters is customarily structured to protect preferred shareholders or investors. By invoking such reserved matters, certain decisions that impact the preferred shareholders or investors cannot be made without receiving a “yes” vote from a majority of the shares that includes a majority of the preferred shares or the investors. Decisions that are typically included in Preferred Shares / Investor Reserved Matters include decisions that will:

• Change the terms of the shares in any way at all, no matter how small,
• Create a new class or series of shares, or digital coins or tokens,
• Increase the number of shares available to employees, outside consultants, or investors,
• Cause shares to get repurchased,
• Result in shares becoming listed on an organized exchange platform,
• Cause a subsequent liquidation event,
• Alter the size of the board of directors or managing body and its authorities,
• Result in the dissolution of the company, and
• Permit borrowing above a certain debt ceiling.

Board Reserved Matters

Board Reserved Matters are decisions structured to protect minority shareholders by subjecting certain board decisions to the approval of the minority-elected board members. This typically includes decisions pertaining to:

• Approving the business’s annual budget,
• Giving the green light to a proposed business plan,
• Appointing auditors or changing them,
• Altering the company’s accounting policies,
• Acquiring, redeeming, or issuing shares and equity securities,
• Borrowing or guaranteeing debt, usually above a certain ceiling,
• Agreeing to a settlement including litigation or arbitration for disputes on the company’s behalf, usually above a value threshold.
• Licensing, selling, or transferring company property, whether it be physical, digital, or intellectual,
• Altering the company’s business or entering new business lines,
• Making impactful changes to the company at any level,
• Approving expenditure requests above a certain percentage of the already approved budget,
• Entering into or terminating any contracts with shareholders or other conflicted parties,
• Changing compensation policies as it relates to benefits, retirement plans, healthcare, leave, and salaries, and
• Filing for bankruptcy.

Statutory Reserved Matters

Statutory laws pertaining to companies also customarily provide for certain Reserved Matters, which may or may not be varied. Saudi Arabia’s Companies Law, by way of example, provides for certain situations to be approved by a certain level of share votes, which may or may not be varied by shareholders.

As an example, in limited liability companies, matters requiring a 100% affirmative vote are:

• Deciding to change the company’s nationality
• Making shareholders responsible for debts that exceed half of the business’s share capital
• Financially increasing the liability of the company’s shareholders

and matters requiring a 75% affirmative vote are:

• Agreeing to proposed amendments to the company’s Articles of Association (AoA).

Corporate Advisors

We highly recommend that you consult your lawyers when negotiating or considering your compliance with reserved matters. As you may have gleaned from the above, many of the typical reserved matters are key decision points in the life of the company, and should be weighed expertly.

The attorneys at Hammad & Al-Mehdar represent over 35 years of experience in providing corporate law services in Saudi Arabia and the UAE. Contact us today to discuss how we may be able to support your corporate legal requirements.

The Importance of Management Fees

Management fees play a crucial role in private equity funds in that they permit the fund manager or general partner (GP) to generate an income stream from the fund to cover its costs for operating and managing the fund. At their core, management fees are designed to provide fund managers with the ability to pay salaries and cover overhead expenses such as office space associated with running the fund or funds. This directly translates into the fund’s health (recall funds’ reliance on attracting and retaining key persons) and consequently returns for the limited partners (LPs). Just as important from a fairness standpoint is the management fee offset, which credits back to the fund, and therefore the LPs, external streams of income generated by the GP and that are related to fund. This article discusses in detail the management fees and offsets in private equity funds and best practices in fund management that provide for fairness to managers and LPs.

The Purpose Drives the Fees

As noted earlier, the core function of management fees is to provide fund managers with income streams that permit them to pay salaries, retain advisors, and cover costs related to managing the fund, be it direct costs such as travel or overhead such as office rent (more on this below). It is important to establish a premise at the outset, which is that to align the financial interests between the fund managers and investors, it is universally accepted that fund management salaries are decent, but not handsomely rewarding, pushing fund managers therefore to rely on carried interest and fund returns for rewarding paydays. With that premise in mind, because the costs associated with running a fund change over the course the fund’s life cycle, it is only logical that the management fees charged by the fund manager to the fund also change overtime. The typical private equity fund has 3 life stages:

• Investment period – During the investment phase of a fund’s life, the GP will be occupied with sourcing and making investments. For this reason, the management fee is at its highest and paid in advance every quarter. Market standards are at 1.8% to 2% during this period, but can fall outside this range for single asset funds (lower) and highly diversified or EM funds (higher).
• Harvesting period – After the investment period, the fund is no longer able to make new investments. Therefore, the GP’s role is reduced to support existing investments, review and report on them, and sell or liquidate the positions. Due to the reduced role, GPs should expect that management fees will stepped down. We customarily see reduction of 0.25% quarterly to a minimum of 1%. At this point, however, the GP and key persons should also be able to raise or close on a subsequent fund, permitting them a new stream of management fees.
• Extension period – By standard, private equity funds have a term of 10 years. However, the GP can choose to extend the fund by 1 or 2 years to allow it additional time to liquidate some final fund assets and distribute proceeds. Because this is elective to the GP, who is holding on to the assets to maximize their value (and its carried interest), and because the costs are very limited to liquidating final assets, standard market practices provide that the fund will not pay to the GP a management fee during extension periods unless the LPs agree otherwise.

The management fees and stepdown structure are customarily set out in a very clear manner in the limited partnership agreement (LPA) or fund terms and conditions to allow the investors to understand them and examine them clearly.

Inclusions in Management Fees

Management fees are directly related to the reasonable costs of operating the fund. How management fees are derived should be transparent to LPs and investors just as they are to the GP to prevent conflicts of interest and a negative feel of being overcharged. Costs that GPs should expect to be covered by the management fee include:

• Conferences, research and information services, and computers and software;
• Consultants and advisors retained in relation to fund investments;
• Travel and entertainment;
• GP regulatory compliance costs, licensing costs, and cost for maintaining books and records; and
• Office space, furniture, facilities, and communications costs.

Management Fee Offsets

Private equity fund managers or GPs can generate income streams outside of management fees in connection with the fund. Examples of these streams include board membership fees received from fund portfolio companies, monitoring fees or transaction or broken deal fees from fund investments, and advisory fees from portfolio companies or in connection therewith. Because the fund manager is receiving the management fee to manage the fund, fairness and alignment of financial interests dictate that it should not also receive fees from fund portfolio companies or investments. As such, it is a standard practice that the types of income streams noted above, if received, would be offset against the management fees. Market practice in this regard is that 100% of such other fees would be offset against management fees payable by the fund. That said, we do see at times offset provisions that provide for a lower offset percentage, or that permit the GP to charge management or other fees in connection with co-investments along the fund. The provisions relating to the offset are usually reflected in the fund terms and conditions or LPA.

The GP Series

The GP Series is a series of practical guidance notes prepared by Hammad & Al-Mehdar’s PE and VC team that are designed to guide GPs and practitioners on best practices relating to private equity fund management.

The attorneys at Hammad & Al-Mehdar represent over 35 years of experience in providing legal services in Saudi Arabia and the UAE at international standards. Contact us today to discuss how we are able to support the legal demands of your private equity fund.

A cross-discipline Hammad & Al-Mehdar team advised Tarabut Gateway on its $13 million series seed financing, led by Berlin-based venture capital firm Target Global, and joined by Kingsway Capital, Entrée Capital and regional investors: Al-Zamil Investment Group, Global Ventures, Almoayed Technologies and Mad’a Investment.

The round is the largest fintech seed round in MENA, and a promising 2021 start for the ecosystem and the fintech industry.

Tarabut Gateway is MENA’s largest regulated open banking platform, licensed by the Central Bank of Bahrain. The platform enables the collaboration between financial institutions by accessing financial data of the partner bank’s customers and allowing them to build new apps and services. Currently, Tarabut has offices in UAE, London, Manama, and is planning to expand regionally.

The HMCo team was led by partner Abdulrahman Hammad, and included Samy Elsheikh, Tarek Bilani, and Layla Tatwany.

Hammad & Al-Mehdar partner Abdulrahman Hammad and senior associate Samy Elsheikh author the Saudi Arabia chapter of The Mergers & Acquisitions Review, 14th edition, published by Law Business Research.

The chapter provides a deep dive into the relevant laws and regulations relating to the Saudi Arabia’s M&A sphere, and is an important comparative reading for counsel and managers looking acquisitions or divestitures in the Kingdom.

The chapter is available for download here.