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Transaction formalities, rules and practical considerations
Types of private equity transactions
What different types of private equity transactions occur in your jurisdiction? What structures are commonly used in private equity investments and acquisitions?
Leveraged buyouts and venture capital investments are the typical type of private equity transactions seen in the Saudi Arabian market. The market is predominantly dominated by local and regional private equity firms, sovereign wealth funds, quasi-governmental entities and family offices. Such transactions could take the form of the investor acquiring a majority stake or a significant minority interest.
Unlike in many other jurisdictions, the general partner and limited partner investment structure is not found in the Saudi market and the form of structures can vary between the following:
- direct investment by the investor into the target; or
- through a fund established by a local asset manager (the investors acquiring units in the fund and the asset manager entering into a custodian arrangement with a local custodian who will establish the vehicle that will acquire the shares of the target).
Where the investment is made by a foreign investor or a non-resident party (excluding a party considered to be 100 per cent Gulf Cooperation Council (GCC)), then foreign ownership restrictions come into play and the investment requires the approval of the Saudi Arabian General Investment Authority (SAGIA).
Corporate governance rules
What are the implications of corporate governance rules for private equity transactions? Are there any advantages to going private in leveraged buyout or similar transactions? What are the effects of corporate governance rules on companies that, following a private equity transaction, remain or later become public companies?
Most private equity investments occur in limited liability companies or closed joint stock companies (CJSC). A private equity investment in a publicly listed company is rare and the impact of applicable corporate governance regulations on such transactions is minimal.
The corporate governance regulations (CGRs) applicable in Saudi Arabia have been issued by the Saudi Capital Market Authority (CMA) and are currently applicable only to listed companies. A copy of these regulations can be found on the CMA website (www.cma.org.sa) under the Implementing Regulations section.
Where the acquisition is being made in a limited liability company, it is normal for a private equity investor to request the legal form of the company to be converted to a CJSC either at the time of closing or as a condition subsequent, as the provisions of the companies law applicable to CJSCs regulate in more detail the framework applicable to the shareholders, the board and their committees, whereas in a limited liability company the framework can be fairly flexible and at the discretion of the parties.
However, an initial public offering is an exit mechanism that private equity investors look to incorporate in their documentation. Therefore, the application of the CGRs would be relevant where the legal form of the target is to be converted to a listed joint stock company to enable the exit. As one of the listing requirements, the company would be required to adopt a code of corporate governance (Code) that is based on the CGRs. This Code would include, but would not be limited to, providing guidance for:
- rights of shareholders;
- rights related to general meetings;
- responsibilities and terms of reference of the board of directors;
- board of directors processes;
- conflicts of interest;
- board committees;
- internal and external auditor; and
- disclosure and transparency.
Issues facing public company boards
What are some of the issues facing boards of directors of public companies considering entering into a going-private or private equity transaction? What procedural safeguards, if any, may boards of directors of public companies use when considering such a transaction? What is the role of a special committee in such a transaction where senior management, members of the board or significant shareholders are participating or have an interest in the transaction?
The entry into of a going-private or a private equity transaction by a listed company would be rare. However the issues likely to be considered by the board of a listed company for such a transaction would include, but would not be limited to, the following:
- ensuring that announcements relating to the transaction are made in a timely manner;
- the requirements of the CMA’s Merger and Acquisition Regulations are followed;
- disclosures relating to any related parties involved in the transaction are made and approved by the general meeting of shareholders; and
- all direct or indirect conflicts of the directors are recorded and approved.
Are there heightened disclosure issues in connection with going-private transactions or other private equity transactions?
As going-private transactions are not common, it is difficult to comment on what sort of disclosures would be required in this scenario. It is likely that procedural requirements of the CMA Merger and Acquisition Regulations would need to be followed, including the requirement to make announcements in relation to any tender offer.
What are the timing considerations for a going-private or other private equity transaction?
The timing considerations (and processes) can vary depending on the legal form of the target entity and also the nationality of the private equity investor or other existing shareholders of the target (for, as mentioned above, if there is any element of a foreign national (excluding a 100 per cent GCC national), a foreign investment license from SAGIA will need to be obtained as part of the regulatory approval for the transaction).
Acquisition of shares in a limited liability company
The acquisition of shares in a limited liability company will entail:
(i) preparing an amendment to the articles of association (Amendment) of the target company to reflect the name of the investor and exit (if applicable) of any shareholder, including identifying in the capital provision, the relevant shares and percentage to be owned by each party. Current Ministry of Commerce & Investment (MOCI) practice is to restate the articles of association;
(ii) seeking the approval of MOCI on the Amendment;
(iii) executing the Amendment before a competent notary in Saudi Arabia, either in person or through representation;
(iv) publication of the Amendment on the MOCI website; and
(v) updating the commercial registration of the target.
If a foreign investment licence is required to be obtained from SAGIA or amended as part of the process, then the same will be processed prior to commencing with the MOCI steps identified in (i) to (v) above.
Share transfers in a limited liability company are subject to rights of pre-emption in favour of the existing shareholders, and these will need to be waived as part of the process (such waiver usually obtained in the form of the Amendment).
The parties are required to provide documents in Arabic, attested (and legalised if coming from abroad) and the process to transfer shares in a limited liability company can take from three to eight weeks if the SAGIA process is also involved. The timelines mentioned here are exclusive of the time taken to complete any conditions precedent.
Acquisition of shares in a CJSC
To the extent that a foreign investment licence is not required or does not need to be updated as part of the process, closing a transaction in a CJSC is a much simpler process and requires the preparation and execution of the share transfer instrument, and updating the share register of the target to register the transfer of shares.
If an amendment to the by-laws is required as part of the closing of the acquisition, then a shareholders’ general meeting will be required to approve the amendments to the by-laws, and a minimum of 10 days’ notice is required for such meeting. The general meeting approvals must be obtained prior to effecting the share transfer and once obtained, the share transfers can be completed in one business day. Post-completion the commercial registration of the target will need to be updated to reflect any amendments to the target’s board of directors.
The founding shareholders of a CJSC are restricted by the Companies Law from transferring their shares to a third party for a period of two fiscal years of not less than 12 months, commencing from the date of incorporation of the company or from the date of conversion from a limited liability company to a CJSC. This restriction is important to note from an exit perspective, if at the time of entry, the investor had required the legal form of the company to be converted from an limited liability company to a CJSC.
Dissenting shareholders’ rights
What rights do shareholders have to dissent or object to a going-private transaction? How do acquirers address the risks associated with shareholder dissent?
Dissenting shareholder rights in a limited liability company
Pursuant to the provisions of the Companies Law, all shareholders in a limited liability company enjoy rights of pre-emption in the case of a proposed share transfer by a shareholder or issuance of new shares by the company. These pre-emption rights need to be waived (such waiver usually obtained in the Amendment). Additionally, each shareholder is required to be present in person or represented by attorney before a notary for the signing of the Amendment and therefore a dissenting shareholder has the ability to frustrate the closing of a transaction.
Dissenting shareholder rights in a CJSC
Shareholders in a CJSC, unless subject to a contractual agreement, are not subject to any pre-emption rights on a share transfer and therefore, while legally there is no requirement for all shareholders to agree to the deal, from a commercial perspective and to avoid any issues around closing it would be recommended to inform the other shareholders. However, if the investor is acquiring shares in the CJSC through a share subscription, then the capital increase (and the corresponding change in the by-laws) would need to be approved by an extraordinary general assembly of the shareholders and the existing shareholders would also need to waive their rights of pre-emption over the issuance of the new shares by the company.
What notable purchase agreement provisions are specific to private equity transactions?
A purchase agreement in Saudi Arabia will contain all the usual provisions found in similar agreements in other jurisdictions. The buyer will insert a list of conditions precedent reflecting items arising from its due diligence; private equity investors will look to incorporate additional conditions relating to the raising of funds, which in certain instances a seller will look to resist; the seller will be required to provide a full suite of representations and warranties, covering authority, ownership of the shares and over all business items; the claims’ provision will contain a de minimis amount, a basket of claims and a cap on liability (usually linked to the business representations and warranties); and it is usual to find private equity investors imposing restrictive covenants on a seller.
It is common for private investors to push for purchase price adjustments, and it is becoming a common feature of purchase agreements in Saudi Arabia to find either the locked box approach or the post-completion accounts mechanism.
Participation of target company management
How can management of the target company participate in a going-private transaction? What are the principal executive compensation issues? Are there timing considerations for when a private equity buyer should discuss management participation following the completion of a going-private transaction?
In Saudi Arabia the most common means of incentivising the management would be through entering into new employment contracts with the key personnel. Equity-based incentives are not common and consideration would have to be given to their structure and enforceability. For example, a limited liability company does not issue shares, and therefore any equity incentive award would require the name of the employee to be registered in the articles of association of the company as a shareholder (which may create practical difficulty given the regulatory approval process for the articles of association) and any change in such would require the employee to attend before a notary or be represented thereat.
Shares are issued in a CJSC and it may be possible to provide share incentive schemes in this type of company.
What are some of the basic tax issues involved in private equity transactions? Give details regarding the tax status of a target, deductibility of interest based on the form of financing and tax issues related to executive compensation. Can share acquisitions be classified as asset acquisitions for tax purposes?
The impact of tax is an important element that needs to be dealt with upfront in the structuring of a transaction.
In Saudi Arabia, a Saudi or a GCC national pays 2.5 per cent zakat on its investment and any income generated on a sale of shares would also be subject to 2.5 per cent zakat. However if the investment by the Saudi investor or GCC investor is made through an offshore vehicle (ie, non-resident in Saudi Arabia), then a 5 per cent withholding tax will be applied on any dividend distribution and the sale of shares would trigger a 20 per cent capital gains tax on the capital gain arising from such sale.
The investment of a foreign investor would be subject to a 20 per cent income tax and withholding tax on dividend distribution and capital gains tax on the sale of shares would apply as mentioned above.
At times, private equity firms look to structure their investment through a vehicle established in the Dubai International Financial Centre. The tax implications of such structures should always be considered before implementation.
Debt financing structures
What types of debt are typically used to finance going-private or private equity transactions? What issues are raised by existing indebtedness of a potential target of a private equity transaction? Are there any financial assistance, margin loan or other restrictions in your jurisdiction on the use of debt financing or granting of security interests?
There are no restrictions on a purchaser arranging debt finance to fund the purchase price paid for the shares of the target. It is then usual for the purchaser to settle the existing debt. To the extent any indebtedness remains, then consents from the existing lenders or notice to the existing lenders will need to be obtained prior to closing (usually catered for in the conditions precedent).
Debt and equity financing provisions
What provisions relating to debt and equity financing are typically found in going-private transaction purchase agreements? What other documents typically set out the financing arrangements?
A purchaser will seek to incorporate in the purchase agreement a condition precedent around arranging acquisition finance for the purchase. However, the documentation to be entered into with the lender will be recorded in a separate arrangement, through typical financing and security documentation.
Fraudulent conveyance and other bankruptcy issues
Do private equity transactions involving leverage raise ‘fraudulent conveyance’ or other bankruptcy issues? How are these issues typically handled in a going-private transaction?
While it is common for a purchaser to include detailed ownership and title issues through the warranties in the purchase agreement, fraudulent conveyance transfers have not been common in the Saudi market. Ownership and title warranties are treated as fundamental warranties, and usually covered in the purchase agreement with a right for the purchaser to rescind the contract, in the event of breach. As a measure of good practice it is recommended to obtain a print-out from MOCI, as such print-out will show the names of the shareholders of the company (as registered with MOCI).
Shareholders’ agreements and shareholder rights
What are the key provisions in shareholders’ agreements entered into in connection with minority investments or investments made by two or more private equity firms? Are there any statutory or other legal protections for minority shareholders?
A minority shareholder will seek to include the following protections in a shareholders agreement:
- board representation (including quorum for a board meeting to be achieved only when the board member representing the minority shareholder attends the board meeting);
- reserved matters both at the shareholder and board level to ensure that the minority shareholder has a right to approve or reject matters considered critical to its investment;
- share transfer restrictions including a right of pre-emption or tag-along by the minority investor; and
- access to company information, books and records.
It is recommended to try to reflect the above shareholder rights in the constitutional documents of the company, but this requires discussion with MOCI. Practice shows that there may be more flexibility to reflect some if not all the rights mentioned above in the articles of association of a limited liability company, while for a CJSC current MOCI preference is to adopt their standard form and therefore it may difficult to entrench some of these rights in the by-laws of a CJSC.
Additionally, a private equity investor will look to capture various exit mechanisms in the shareholders’ agreement. Exit mechanisms could include:
- sale of shares in an initial public offering or a priority right to sell shares in an initial public offering;
- sale of shares to a strategic investor; or
- a put option requiring the other shareholders to purchase its shares.
Under Saudi law, call and put options are unlikely to be unenforceable as they are deemed promises to buy and sell something in violation of shariah principles as applied in Saudi Arabia. However, it is common to include these items, as a party may honour its contractual obligations.
Shareholders in a limited liability company enjoy various protections given that any matter that affects the articles of association of a company (such as the name and details of the shareholders of the company, the objects of the company, the capital structure, the governance structure, dividend distribution) are all reflected in the articles, and if any such item were to be changed, then this would require an amendment to the articles that would need to be signed by, or on behalf of, all shareholders before a competent notary.
In a CJSC, there are certain items that require unanimous shareholder approval and these relate to:
- changing the company’s nationality;
- moving the company’s head office to a location outside Saudi Arabia;
- increasing the financial burden of the shareholders; and
- depriving a shareholder or amending its fundamental rights as a shareholder in the company.
Other matters (including amendments to by-laws) require extraordinary general meeting approval.
Acquisition and exit
Acquisitions of controlling stakes
Are there any legal requirements that may impact the ability of a private equity firm to acquire control of a public or private company?
If a private equity investor is seeking to acquire control of a limited liability company or a CJSC, then subject to any foreign ownership restrictions applicable to the industry in which the target operates, there are no impediments or requirements for the proposed acquisition.
However, an acquisition of a controlling stake in a public company will trigger the CMA Mergers and Acquisitions Regulations, which set out in detail the specific rules relating to mandatory and permitted tender offers.
What are the key limitations on the ability of a private equity firm to sell its stake in a portfolio company or conduct an IPO of a portfolio company? In connection with a sale of a portfolio company, how do private equity firms typically address any post-closing recourse for the benefit of a strategic or private equity buyer?
If the private equity investor is looking to sell its shares in a limited liability company, then it needs all shareholders of the company to approve the deal, as, for the reasons mentioned earlier, the process will require an amendment to the articles of association of the company, and in practice, all shareholders must attend and sign the amendment before a competent notary.
It is usual that a shareholders’ agreement would be in place in a CJSC between the private equity investor and all other shareholders and such shareholders’ agreement would usually contain restrictions on the transfer of shares (including rights of first refusal, pre-emption rights, drag-along, tag-along, etc). Therefore, while there is no regulatory impediment to a transfer of shares in a CJSC (assuming that the lock-in period imposed by law has expired), there may be contractual limitations that need to be considered prior to proceeding with a sale.
A listing of the company requires various corporate authorisations including resolutions and declarations signed by all directors. Accordingly, a private equity investor on its own could not manage a listing of a company and will require the support of all shareholders and their representative directors.
As regards post-closing recourse against a private equity seller, the concept of indemnity and warranty insurance is still novel for the Saudi market and the norm remains for the buyer and the seller to agree a claim’s liability period and cap on liability. Private equity sellers push for a claim period surviving not longer than one audit cycle and the cap on liability will be linked to a percentage of the purchase price. However, in certain limited cases where the private equity investor is selling shares along with another seller who was the controlling shareholder (such seller not being a private equity firm), private equity investors have resisted taking the obligation for any liability for any post-closing recourse. It is not common for a private equity seller to agree to hold a certain amount of the purchase price in escrow until the end of the claims liability period (and the escrow arrangement in such instances would be more common when the private equity firm is the purchaser).
Portfolio company IPOs
What governance rights and other shareholders’ rights and restrictions typically survive an IPO? What types of lock-up restrictions typically apply in connection with an IPO? What are common methods for private equity sponsors to dispose of their stock in a portfolio company following its IPO?
It is rare for a shareholders’ agreement between the shareholders in a CJSC to survive upon the listing of the company and upon listing all governance matters and rights of shareholders would be subject to the by-laws of the company and the CMA Corporate Governance Regulations. A listed company must comply with the CGRs, some of which include:
- appointment of a prescribed number of independent and non-executive directors to the board;
- appointment of an audit committee and its composition;
- appointment of a remuneration committee and its composition;
- appointment of a nomination committee and its composition; and
- adoption of a corporate governance code for the company that does not contradict the provisions of the Corporate Governance Regulations.
The CMA requires that all founding shareholders of a company listing on the main market be subject to a lock-up period. In the past, the lock-up period was generally six months from the date that the shares of the issuer commenced trading on Tadawul (ie, the Saudi stock exchange). However, in some cases, the CMA had requested that the restrictions on founding shareholders remain for five years (as was the case with telecommunications companies). The CMA now considers each issuer on a case-by-case basis and determines a suitable lock-up period for the founders.
Target companies and industries
What types of companies or industries have typically been the targets of going-private transactions? Has there been any change in focus in recent years? Do industry-specific regulatory schemes limit the potential targets of private equity firms?
As mentioned above, going-private transactions are not common and therefore it is difficult to comment on industry trends.
Subject to any foreign ownership restrictions (discussed below), there is no restriction on the potential targets of private equity firms. Recent transactions involving private equity firms have been seen in the fast-service restaurant business, healthcare and education sectors.
What are the issues unique to structuring and financing a cross-border going-private or private equity transaction?
A foreign investor (excluding a 100 per cent GCC national) will be required to obtain a foreign investment licence from SAGIA prior to completing the acquisition. Obtaining this licence requires the submission of various documents on behalf of the investor (including the provision of audited financial statements, board or shareholder resolutions, and other corporate documents). All documents coming from abroad need to be notarised and legalised by the Saudi embassy or consulate in the jurisdiction and thereafter translated into Arabic before submission. Preparing these documents requires some lead time.
A 100 per cent foreign investment is possible in the industrial and service sectors. However, if a foreign investor were considering acquiring shares in a trading entity in Saudi Arabia, then as a general rule such investment would be subject to a maximum shareholding of 75 per cent of the share capital and a minimum capital contribution of 20 million Saudi riyals by the foreign shareholder. Pursuant to a recent change in law, while it is possible to establish or acquire a 100 per cent ownership in trading entities, the conditions relating to such investment are stringent.
Additionally, there is a negative list prescribed by SAGIA that lists activities in which foreign participation is not permitted in Saudi Arabia. A potential investor must consider this list before considering the investment.
Club and group deals
What are some of the key considerations when more than one private equity firm, or one or more private equity firms and a strategic partner or other equity co-investor is participating in a deal?
For such transactions, we are seeing parties enter into co-investment arrangements pursuant to which the private equity firm controls the investment, including the exit options, and prefers that the strategic investor play a silent role. The strategic investor is mostly concerned about board representation and reserved rights for critical items. Given the practical difficulty in enforcing call and put options under Saudi law and the enforcement of security (such as pledge of shares), it is common to see the parties structuring the investment through an offshore jurisdiction (such as setting up the investment vehicle in the Dubai International Financial Centre). The implications of tax on such structures need to be considered.
Issues related to certainty of closing
What are the key issues that arise between a seller and a private equity buyer related to certainty of closing? How are these issues typically resolved?
There is usually a degree of time involved between the signing of a purchase agreement and completion of the transfer and this creates the biggest concern around deal closing. The timeline is usually driven by the time required to satisfy the number of conditions precedent incorporated in the purchase agreement by the investor. These would include obtaining relevant government approvals, which may include approvals from the competition authority, SAGIA and MOCI, and operational matters such as obtaining consents under finance facilities and third-party agreements and obtaining or renewing licences and permits.
Private equity firms also look to incorporate funding conditions in the purchase agreement and, if successful, reserve the right to walk away if they are not able to raise the funds from their investors.
It is not uncommon for a private equity investor to seek compensation for a pre-mature termination of the purchase agreement on account of a failure by the seller to satisfy its conditions precedent or a breach of warranty occurring before closing, and in some agreements the parties have agreed a fixed amount to cover the costs incurred. However, even if the parties have agreed to a termination fee, if contested, such a provision may not be enforceable under Saudi law, as the general rule is that in order to be recoverable, damages for breach of contract or tort must be actual, direct and quantifiable. What constitutes actual and direct damage in a given case is a matter as to which a Saudi court will have a degree of discretion, but in principle there must be a high degree of certainty that a quantifiable, monetary loss has resulted or (rarely) will inevitably result from the breach in question without regard to other factors not attributable to the party in breach. The emphasis on certainty, however, makes it quite difficult to recover compensation for most kinds of losses that are classified as consequential, such as loss of anticipated profits, loss of production and the like because (except in rare cases) their occurrence is considered to be inherently uncertain or to depend on events or contingencies not directly related to the breach.
Ultimately, the points raised depend on the outcome of the negotiations between the parties, and a well-represented seller will push back on the number of conditions incorporated in the purchase agreement and also the obligation to pay any termination fees.
Update and trends
Update and trends
Have there been any recent developments or interesting trends relating to private equity transactions in your jurisdiction in the past year?
A buyer obtaining insurance coverage for representations and warranties for deals in the Saudi market would still be considered novel, and we expect this to be an area of practice that will develop in the coming years.