Building a startup ecosystem requires primarily 4 key building blocks: Smart capital, proper education platform, legal framework and setting the appropriate entrepreneurial mindset. Despite the Kuwaiti culture being very entrepreneurial in nature ever since the founding of this nation, 2013 witnessed the birth/amendments of 2 important laws which are crucial to redefining the entrepreneurial ecosystem in Kuwait: The new Companies Law No. 97 of 2013 and the Kuwait National Fund for SMEs Development law No. 98 of 2013.
My focus today will be on highlighting important articles of the new Companies Law that relate to building a more venture-friendly legal framework for entrepreneurs and investors to transact. The amendments relating to startups include: 1) recognizing shareholders agreements; 2) the introduction of share classes for the first time in the Arab World for any investor and finally, 3) enabling the issuance of shares below a minimum nominal par value.
Once your startup is ready to be legally registered, you will have to choose one of the following legal forms to be registered: General partnership company, limited partnership company, partnership limited by shares, joint venture company, shareholding company, limited liability company and single person company. To attract smart money, minority shareholders (venture capital) will require to have a front seat when you drive your startup. With limited common shareholders rights, minority shareholders would typically require you to form a closed shareholding company to insure that share classes and shareholders agreements protect their equity position. Shareholding companies in Kuwait require a minimum 51% Kuwaiti shareholding pattern and a minimum of five shareholders; they are regulated by the Ministry of Commerce and the Capital Markets Authority.
A Shareholders Agreement is an important document that gives minority shareholders (venture capital) specified rights to define how your company will be governed going forward. When your company is formed, its shareholders may decide on a set of ground rules over above the basic articles of association laws that will govern their relationship with the founders. Some examples may include how do you handle a shareholder who wants to sell their shares? Should it be possible to force out shareholders in the event of a buyout (tag-along/drag-along rights)? Here is a list of common terms that are highlighted in shareholders agreements:
- How does your capital structure look like? Clearly define your pre-money and post-money capital table
- Should the agreement involve all shareholders? Or is there a minimum percentage required?
- Are there vesting provisions? On who and for how long?
- Who will sit on the board? Are there any board advisors? How will they be compensated?
- Key man clause
- Are there any anti-dilution rights?
- Drag-along and tag-along rights
- How do you resolve shareholders disputes? Arbitration clarity
- First right of refusal guidelines
- Shareholders rights: IP, information, financial statements, reports…etc
- What happens in the event of death/incapacity? And how do vested shares get treated in this case?
- Financial and non-financial authority matrix that govern operations (budget approvals, banking spending limits, contractual limits…etc)
- What decisions require unanimous board and/or unanimous shareholders approval?
- Compensation: Incentive scheme and remuneration of teams, board members
- Non-compete clause: Should there be any restrictions on shareholders with respect to competing interests?
- Preferred shares: Types of shares and rights attached to them
- What would trigger the dissolution of the business?
You can get as creative as you want in drafting your shareholders agreement as long as it does not conflict with any laws of your jurisdiction. Unfortunately, unaccounted for conflicts still pop up along the way which might change the destiny of your company, so make sure you provide for all the scenarios you can think of.
There are a number of incidents in the Arab world where share classes were introduced for specific foreign investors but no legislation has yet been put forward for all investors to benefit from before law No. 97 2013; The introduction of share classes is the first of its kind not only in Kuwait but in the whole Arab world.
As you start validating your idea and traction is seen with customers of your startup, it’s important to evaluate different equity funding options you may seek from Venture Capital firms which is why we need to highlight the difference between a common stock and preferred stock. Preferred stock is a share class that has a specified yield on the assets and profits (dividend payout) and is senior to common stock in the event of a company’s liquidation or bankruptcy but is subordinate to ordinary debt and typically has no voting rights attached to it.
At later stages of your startup’s cycle, it is quite common for your company to issue different share classes of common stock especially when your company goes public. When issuing a new share class of common stock, more voting rights will be assigned to one class of stock over the other. Beyond voting rights, different share classes are typically indifferent and are entitled to the same economical rights/benefits, i.e. to profits and company ownership.
Rights Issue Below Par Value
In an asset class where failure rate is high, having the flexibility of a rights issue to buy additional security below par value can be vital to the survival of a startup. For example, if you’re a shareholding company in Kuwait and you are in the process of completing a capital increase at a price per share below par value, the previous law did not allow for this. Rebalancing the shares allocation was previously a way around the law to reflect the discounted rights issue however with today’s amended law, the capital table is cleaner and changes are easier to reflect.
All in all, the fact remains that this is a law and without it being executed, it’s worthless. The recent amendments to the Companies Law in Kuwait positions Kuwait to be legally a more venture-friendly environment. With more dynamic individuals participating in senior roles in Kuwait’s government, the recent changes reflect the country’s willingness to further align its business environment with international practices. In the next StartupQ8 event, we’ll be shedding some more light on the new Companies Law so please join us if you have further queries or comments.