The key differences between US, UK and MENA venture funding documents
When conducting cross-border venture financing transactions, knowing the key differences in documentation and terms can help ensure you have a smooth transaction. To help you navigate transactions in the US, UK and the Middle East, below we've laid out the key differences in documents and terms in US, UK, and Middle East and North Africa (MENA) priced equity transactions.
Form of documentation
Investments in the United States are typically implemented through five core documents:
- The Stock Purchase Agreement (SPA), which is generally intended to be specific to the sale of the shares to the investors and is between the issuer and the purchasing investors of that specific priced equity round only. The SPA is the equivalent to the share subscription agreement used in UK and MENA transactions.
- The Certificate of Incorporation (COI), which is usually publicly available in most US states. It establishes the rights of the shares, including the preferred shares (but not necessarily that of individual holders of the shares).
- The Investors’ Rights Agreement (IRA), which is among the issuer, the new investors and sometimes prior investors or key shareholders providing for rights and benefits specific to the investors that aren’t inherent in the underlying shares, which includes a right of first offer on new issues of shares as well as board governance provisions and information rights.
- The Right of First Refusal and Co-Sale Agreement, which is among the issuer, key holders and founders of the issuer with material holdings of the issuer’s equity and the investors.
- The Voting Agreement (VA), which is among the issuer, the investors and founders, and various ordinary shareholders (referred to as common stockholders in the US).
The division of these documents is a function of requirements of law and also the expected survival of such documents following certain events later in the life of the company.
UK venture financing documents are usually condensed into one combined subscription and shareholders agreement - often referred to as an investment agreement - and a separate set of articles of association, although there are times when the investment agreement is split into two separate agreements (the subscription agreement and the shareholders agreement). The core documents are therefore:
- The Subscription and Shareholders’ Agreement (or a standalone Subscription Agreement and a separate Shareholders’ Agreement), which sets out key provisions relating to the issue of the shares as well as (i) restrictive covenants on the founders; (ii) the right of one or more shareholders to nominate directors to the board; (iii) reserved matters requiring an investor director approval; and (iv) information rights in favour of the investors.
- The Articles of Association, which include all class rights attached to the shares, including (i) conversion rights; (ii) anti-dilution rights; (iii) liquidation preferences; (iv) preferred shareholder rights; (v) rights of first refusal; and (vi) drag along and tag along rights.
Middle East and North Africa
VC investments in the Middle East are typically implemented through the following three core documents:
- The Share Subscription Agreement (SSA), which is intended to be specific to the issue of shares and is between the issuer, the purchasing investors, the holders of outstanding convertible securities converting in the specific round and, in some cases, the founders (particularly in earlier stage funding rounds).
- The Shareholders’ Agreement (SHA), which is entered into between the company, the founders, holders of ordinary (voting) shares and the investors (holding preferred shares), which sets out all rights attaching to all classes of shares, information rights, governance rights (board and shareholder voting provisions), rights of first refusal, drag-along and tag-along rights, conversion rights, liquidation preferences and anti-dilution rights.
- The Articles of Association (Articles), which are typically tailored to enshrine the shareholder and class rights agreed in the SHA.
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Differences in market practices
If you're used to conducting venture financing transactions in other parts of the world, we've listed five key differences in market practices between the Middle East, the US and the UK to watch out for. While each transaction may have its unique features, including a combination of US or UK terms, we’ve set out below the most common approach in each jurisdiction.
Rights of first refusal and pre-emption rights
VC transactions in the US, UK and the Middle East all include a right of first refusal (ROFR) on transfers of shares by the shareholders. The common approach to ROFRs in US transactions is for ROFR rights to apply only to transfers of shares by the founders and other key holders of shares (and in some cases very early-stage investors), and the shares are offered to investors or major investors only.
The approach is similar with respect to pre-emption rights on the issue of new shares by a company, where new shares are also offered to investors or major investors in US transactions, while typically being offered to all shareholders in UK transactions.
The approach to ROFRs on secondary transfers and pre-emption rights on a new issue of shares in Middle East transactions is mixed. Both the UK and the US approaches are used, and it’s not uncommon to find a mix of both US-style and UK-style provisions in the underlying transaction documents.
Ultimately, the agreement on how ROFR and pre-emption rights will apply largely depends on negotiations between the founders and their investors, as well as the identity and domicile of the lead investor and their lead counsel. We have, however, been witnessing an increase in the adoption of a more US-style approach to these rights in the Middle East, with investors (or major investors only) benefiting from a ROFR right on a transfer of shares by the founders and key holders of ordinary shares, and pre-emption rights being offered to investors (preferred shareholders) or major investors only.
Anti-dilution rights in US venture transactions are structured using a conversion price adjustment formula, which is also commonly used in the Middle East. In the event of a down round, an adjustment (a reduction) is made to the price per share at which the investor had made its original investment. With a conversion price adjustment, there’s no immediate issue of shares to the investor after a down round, but rather a synthetic issue of shares based on an adjusted conversion rate of preferred shares to ordinary shares.
In the UK, however, the common approach is an immediate bonus issue of shares that occurs at the closing of the down round. While the result is largely the same, it’s the mechanics and formulae that vary.
In the US, founders are often not party to the stock purchase agreement and no indemnification or warranties are typically given by the founders.
In the UK, however, founders are often party to the Subscription and Shareholders’ Agreement, and are expected to stand behind the warranties, albeit with a lower limit to their liability for claims. The position in the Middle East hasn’t been standardised, where certain investors expect founders to stand behind core and business warranties, while others are comfortable excluding the founders from the Subscription Agreement altogether.
Investors in MENA transactions may insist on founder warranties at least during early-stage funding rounds (series seed and series A), although there’s a slow movement away from this approach.
Disclosures against representations and warranties in US transactions are made by way of a schedule of exceptions, which sets out specific disclosures and exceptions to the representations and warranties given by the company in the stock purchase agreement. In the UK and the Middle East, disclosures against warranties are made pursuant to a disclosure letter, which also includes specific disclosures against the warranties given in the subscription agreement.
Typically, a UK-style disclosure letter will often include certain general disclosures, as well as a disclosure of the contents of the data room shared with the investors during the due diligence process, although data room disclosures are subject to negotiations. In contrast, disclosures made in a schedule of exceptions in a US venture transaction wouldn’t include general disclosures or a disclosure of the contents of the data room. In the Middle East, both approaches are used.
Founder vesting and leaver provisions
Founder vesting and leaver provisions in the Middle East are typically documented in the Shareholders’ Agreement and the Articles of Association, which is similar to the approach used in UK venture transactions, where vesting and leaver provisions are incorporated into the Articles of Association. This is distinct from the approach in the US, where founder vesting and leaver provisions are contained in a separate agreement between the company and the founder.
Furthermore, both the Middle East and the UK define ‘good leaver’ and ‘bad leaver’ circumstances to determine whether and at what price founder shares (whether vested or unvested) may be bought back, while in US transactions founders and employees are typically at will to leave their employment and would therefore forfeit any unvested shares.