Businesses in the UAE often turn towards free zones. The free zones offer greater flexibility and full-fledged ownership. It also streamlines the licensing procedure. It would not be wrong to say that many investors also seek regulatory guidance from professional lawyers to choose the right free zone for their business setup.
What are Convertible Loan Notes?
Convertible loan notes (CLNs) are gaining momentum worldwide. In the UAE, the investors are relying on CLNs for capital. Under Convertible Loan Notes, the capital is converted into equity later on.
However, in many cases, the discount is also provided. To know how you should consult professional lawyers. The law firms’ legal experts can tell you about the CLN’s structure and rules set by the government.
CLN is a famous way to raise funds and finances across the globe. It is a way to meet capital requirements for startups and SME. This meets short-term capital specifications. It does not require immediate valuation, which benefits the startups. Lawyers in the UAE recommend CLNs for early fundraising stages because of their flexible structure.
Benefits of Convertible Loan Notes CLN
A convertible loan note is a hybrid instrument popularly known all over the world for investment. It initiates as a loan, which is later converted into shares. The investors prefer this structure because it does not require prompt valuation. However, for future fundraising, the valuation becomes necessary.
The startups lack a solid financial history. CLNs are most suited for them because they offer flexibility. It is a lucrative way to support growth. It does not compel premature or hasty equity decisions. It is seen that startups in the UAE often consult law firms for their CLN contract legally.
Normally, a discount is issued to the investor. CLN contains the maturity date, valuation cap, and the conversion discount rate. It offers founders and investors to easily conduct their business operations without worrying about finances.
Use of Convertible Loan Notes CLN in UAE Free Zones
The UAE Free Zones often make the use of CLN very complex. The free zones are known to be business-friendly. They have lenient laws and regulations that are often easier to comply with. However, the fact is that CLN conversion is not always easy in every free zone, and getting consultation
Moreover, the Free zones in the UAE usually adhere to company laws rather than common international standards. They require shareholders to follow the strict legal procedures and laws.
UAE Free zones do not treat convertible debts as treated in other parts of the world. In the UK and Delaware Jurisdiction, the recognition of CLN differs from UAE free zones.
In the UAE free zones, the conversion of a loan note into equity is daunting. There are several legal barriers in the way.
In some of the free zones, it is tough to issue new shares in the corporate structure. There are certain approvals that are mandatory for it. These hurdles often prevent conversion.
It also creates an atmosphere of uncertainty for investors and founders. Overall, these obstacles reduce the attractiveness of CLN in the UAE free zones.
The free zones and UAE legal Structures
A great number of free zones are successfully operating within the UAE. Numerous companies prefer to register under company regulations rather than federal UAE laws. Some of the examples are as follows:
- DMCC
- JAFZA
- DAFZA
Conversely, the other free zones like DIFC and ADGM adopt common law principles. The majority of the free zones use the civil style of legislature. In this, the emphasis is upon documentation procedures and approvals. Many companies Hire lawyers to manage all these.
UAE free zones strictly control share transfers and capital amendments. They are also active in corporate documents.
On the other hand, CLN needs automatic conversions in the future. The fee zone contradicts the future conversions. This is the flexibility provided by CLNs. The investors should wisely choose free zones where CLN are recognized.
How Valuation Caps and Discounts Restrict CLN
Almost all of the CLNs are based on valuation caps. It is part of it because it favors the investors for early conversions. This is an international standard. This allows the investors to get the favorable conversion terms in the future.
The discount for conversions is also supported under free zone regulations. Therefore, the majority of the UAE free zones do not explicitly support the concept. These terms contradict the share issuance law. In case the authorities need the share price for matching the declared capital value, the problem arises.
This makes it difficult to permit share issuance at discounted values. This is a barrier in the way of enforcing CLNs in Free zones.
This may create problems for fundraisers and investors. They may waste their time in negotiations rather than fundraising.
Smooth CLN normally facilitates fundraising in the long term. However, the delayed or challenging conversion usually creates panic and chaos for start-ups. They will face difficulties in closing future investment rounds. In delays, Experienced Dubai lawyers discuss practical solutions and direct approvals.
Therefore, in Free zones, the investors may be reluctant to enter a deal with ambiguous share structures. The startups mainly depend on CLN in the initial years. The delays are not good for them.
Moreover, the free zones need pre-approvals for share changes. This also slows down the entire process. Additionally, it increases the paperwork, and lengthy documentation is needed.
The startups need agility, which is completely missing in it. The flexibility clashes with the free zones’ specifications. Besides, it creates operational problems that cause a halt and also cause inconvenience.
DIFC and ADGM Support CLNs
The free zones, such as DIFC and ADGM, operate under common law. They would rather facilitate the CLN in an effective manner. These free zones in the UAE recognize the convertible debts.
They also allow automatic conversion clauses. As a result, it provides clarity in corporate procedure needed for CLN. The issue of new shares is relatively easier under DIFC and ADGM.
The international investors are familiar with these jurisdictions. It is more aligned with the best international practices. This eases out the procedure and also makes it swift.
The startup that intends to use CLN should choose DIFC and ADGM rather than other free zones. They offer greater flexibility and stability to startups. Moreover, the investors will enjoy predictability that supports future planning.
Take professional Assistance
The free zones in the UAE keep evolving over time. The investors and founders of startups must be vigilant in selection. The legal guidance from law firms in Dubai will help in navigating crucial matters.
They offer useful insights about company law, share issuance regulations, and financial legislation. Before signing CLN, it is advised to perform due diligence who aid in the evaluation.
Intelligent Lawyers in Dubai will analyze the fundraising and share structures to choose the most suitable option. This overall reduces the risks. Besides, it allows stability and certainty in the future.
