We’re looking to raise one million dollars at a valuation of five million.” This is a common line with which entrepreneurs conclude their raising pitches. But a closer attention to the applicable company regimes in the GCC will reveal that executing these terms is not very straight forward. Limiting our focus for now to the two largest SME hubs the region (KSA and UAE), the applicable laws of both jurisdictions employ a structural obstacle by mandating a unified share price for LLCs.Such legal requirement prevents founders from causing the issuance of shares to investors at a higher valuation, because it mandates that the per-share value must be equal among all shareholders. The investors in our example will not be able to pay one million for 20% of the company if the entrepreneurs did not pay four million for the remaining 80%. And while such obstacle, from a legislative perspective, is addressed through the availability of joint stock companies (JSCs), which allow the issuance of stock at premium and the issuance of different classes of stock, the administrative costs associated with forming and maintaining JSCs remain prohibitive for most SMEs. So how do entrepreneurs and venture capitalists overcome such obstacle and recognize the value of early stage work without fronting hundreds of thousands in costs to convert into a JSC?
The common solution deployed by regional SMEs is to hold the local operating LLC through an offshore SPV that houses both investor and founder shares. The SPV would allow for investment amounts to be raised via different classes of shares at different share prices, and authorize surplus to be paid on top of share par value. The higher valuation will translate into shares issued for a premium to par value, thus lowering the number of shares issued to the investors versus the founders. The valuation can also be translated into preferred shares with minimal input into company management but senior distribution preferences.
BVI and Cayman Islands are commonly used for the jurisdiction of the SPV, with a possible second-tier SPV registered at a UAE offshore jurisdiction for localization purposes. See Chart 1 for common holding structures. While we agree that such structures do add administrative costs to SMEs, they remain much cheaper than the cost of meeting and maintaining the administrative requirements of JSCs.
We recognize that facilitating capital inflows into SMEs through lowering obstacles such as this one has the attention of many MENA jurisdictions, and Saudi Arabia’s recent lowering of the minimum capital requirement for JSCs to SAR 500,000 is a leading example of that. It remains, however, that the structures outlined here offer cheaper, more flexible, and more commonly used processes for founders and investors to set valuations of rounds in growth companies.