Venture Financing

This inBrief highlights the different aspects of venture capital, an important source of raising money for start-up companies which do not have access to capital markets. We discuss the different types of venture financing through which start-ups can raise money and which are taken into account when assessing valuations.


Types of Venture Financing


Although there are different forms of venture financings that can be utilised by start-ups depending on their needs and goals, it should be noted that generally a start-up can only raise financing through issuing equity or debt. Therefore, venture financing is fundamentally provided as a form of debt or equity. When deciding which form of equity or debt to pursue, it is important to bear in mind ‘maturity’, ‘valuation’ and any other ‘preferences’ awarded to investors.


Below we set out the common types of structures for venture financings and the typical terms which may apply.


1 – Convertible Promissory Notes 


This form of venture financing is a debt security convertible into equity upon the occurrence of a certain conversion event. Such conversion event could encompass a financing round, a liquidation event or even an initial public offering. This is an effective method for start-ups to raise capital without the cost, time, and complexity of a preferred stock financing as it involves minimal negotiations with investors and significantly less volume of documentation. As these notes are a debt security, the start-up does not require to conduct a company valuation. While these convertible promissory notes are considered as debt, investors could benefit from accrued interest payable to the note holder upon maturity as stipulated in the terms of issuance of these promissory notes.


Upon the occurrence of a financing event, the notes often convert at a price that is lower than the price paid by the investors purchasing shares in a qualified financing round. This is because the conversion price is often determined and calculated based on either a discount rate (which is typically a percentage of the qualified financing’s issue price) or a valuation cap (a cap on the pre-money valuation at which such notes may convert).


2 – Simple Agreement for Future Equity (SAFE)


A SAFE is similar to the process of issuing a convertible promissory note. A start-up could issue a SAFE to the investor as a promise of repayment. This typically means that the SAFE converts in the same manner as a convertible promissory note, but because a SAFE is not considered a debt instrument, it does not accrue any interest and it does not have a maturity date. Consequently, a SAFE is left outstanding until a qualified financing or corporate transaction triggers conversion of or payment on the SAFE. Upon conversion, the SAFE coverts into a number of shares of preferred stock, determined by dividing the purchase price of the SAFE by the applicable conversion price, which is normally calculated based on either a discount rate (which is typically a percentage of the qualified financing’s issue price), or a post-money valuation cap at which the SAFE may convert. The terms of the SAFE often stipulate that the choice of calculation would be the calculation which results in the greater number of shares.


3 – Preferred Stock Financings


This type of equity financing involves issuing preferred stock to venture investors at a substantial premium over the price charged to the founders or the seed investors. As a justification to the premium paid for the shares, investors are given preferential treatment. This could take form of a liquidation preference and other preferential rights over holders of common stock as well as certain voting rights. This helps startups classify shares according to the investment rounds and also justifies a lower price (lower than is paid by preferred investors) for common stock to its employees.


Assessing Valuations


Pre-money valuations of a start-up are provided as an indication in a given financing round which investors take into consideration when determining the company’s development stage and assess their investment potential prior to investing.


The pre-money valuation is carried out based on the price per share that the investors are offering to pay the start-up company multiplied by the total number of shares outstanding (including options, other convertible securities and shares reserved for employee stock options).


The standard position for start-ups to determine valuation is by contrasting the company’s position in the future with the desired rate of return by the investors for the near future. However, in practice venture capitalists tend to estimate the amount of cash required to achieve some development milestone and equate that amount to a certain percentage of the company. It is often the case that a start-up company in the UAE is likely to be valued on a similar scale at what valuations venture capitalists have been giving to other companies with a similar business model. Following a financing round, the start-up company’s post-money valuation can be determined by adding the amount of money invested in the financing to the pre-money valuation. ■

Video inBrief: SAFEs startup company financing

In this video inBrief, Shahram Safai, partner, discusses SAFEs (Simple Agreements for Future Equity) and its advantages and disadvantages as a method of funding between start-ups and investors.






Disclaimer: Afridi & Angell’s video inBriefs provide a brief overview and commentary on recent legal announcements and developments. Comments and opinions contained in the video and description are general information only. They should not be regarded or relied upon as legal advice.


SAFEs-Start-up Company Financing

The UAE has seen a significant increase in investments and entrepreneurship over the last decade.  The Dubai International Finance Centre (DIFC) reported record growth driven by ‘a robust ecosystem, global partnerships and investment in FinTech and Innovation’. This exceptional growth in investments has acted as a catalyst for the increased usage of Simple Agreements for Future Equity (SAFEs) in start-up company financings.


SAFEs are a method of funding directly between start-ups and investors used in the seed financing rounds of a company’s start-up phase to raise capital in return for future equity. They have been an increasingly popular form of funding within the start-up ecosystem since their establishment in 2013, and even more so since their modification in 2018.


What is a SAFE?

SAFEs were established to create a quick and easy way for investors to invest in start-ups using a simplistic legal document that is entrepreneur friendly and easily understandable. Under a SAFE, investors can provide funding for start-up companies during the initial phase of funding of a company and in return, the SAFE will convert into ownership of shares during the next equity investment round of funding at a predetermined rate. The major difference between SAFEs and other forms of start-up financing such as convertible notes, is that SAFEs have no interest rate or maturity date.


SAFEs were established to create a quick and easy way for investors to invest in start-ups using a simplistic legal document that is entrepreneur friendly and easily understandable. Under a SAFE, investors can provide funding for start-up companies during the initial phase of funding of a company and in return, the SAFE will convert into ownership of shares during the next equity investment round of funding at a predetermined rate. The major difference between SAFEs and other forms of start-up financing such as convertible notes, is that SAFEs have no interest rate or maturity date.


Pre-money SAFEs vs Post-money SAFEs

When introduced in 2013, SAFEs were formed based on pre-money valuations which are based on the initial value of the company before taking into account the investment contributions made by the SAFE investors (pre-money SAFEs), however, complications resulted as SAFEs became increasingly popular and of higher value making it difficult for start-ups to know their share capital dilution and for investors to know their relative ownership percentage. In light of this difficulty, SAFEs were revised and adapted in 2018 (post-money SAFEs).


The key difference between pre and post money SAFEs is that the investor’s ownership percentage using a post money SAFE is fixed and calculated based on a fixed post SAFE valuation. This makes it much more transparent and guarantees the investor a minimum percentage of ownership after the SAFE round.


Pro Rata Rights

Initially, pro rata rights were compulsory in SAFEs meaning SAFE holders were required to participate in subsequent equity rounds in order to maintain their percentage of ownership without dilution. However, upon adaptation in 2018, this was changed and pro rata rights became optional for investors.


Advantages and Disadvantages of SAFEs

The advantages and disadvantages of SAFEs are:



– No interest rates (unlike convertible notes) meaning the costs of financing are lower.


– No maturity date which means theoretically the SAFE could be everlasting, except in the following circumstances, which would terminate a SAFE: the following equity round, acquisition of the business, IPO or if the company shuts down.


– Instant transactions directly between the start-up and the investor meaning no co-ordination with other shareholders is needed.


– Simplicity makes it a cost effective and time effective option.



The disadvantages of SAFEs are dependent on the type of SAFE acquired.


– The disadvantages of a pre-money SAFE is that it lacks transparency between the start-up company and investor as tracking dilution and stock ownership is difficult.


– The most significant drawback of pre-money and post-money SAFEs is the inevitable dilution effect on existing investors, which is amplified even more in post-money SAFEs because a guaranteed minimum percentage of ownership is given to investors.



SAFEs have proven to be an increasingly popular method of start-up company financing, and we anticipate this trend to continue, especially in the Middle East. The upcoming EXPO 2020, beginning in October 2021, which aims to attract more investors into the Middle East will further accelerate the growth of the start-up/venture capital ecosystem and the use of SAFEs. In addition, the successful handling by the UAE government of the COVID-19 crisis continues to bolster the attraction of the UAE as an investment destination. ■

Cram Down Financings in the Era of Covid-19

We are in unprecedented times. The Covid-19 pandemic has swept the globe like a tsunami and it continues to wreak havoc on countries, people and economies. The effects of the pandemic are evident now. For example, the US unemployment rate is presently at 14.7%. In the peak of the financial crisis of 2008, the unemployment rate was 10%. This rate is predicted to rise to 25% at the peak of the Covid-19 pandemic – equivalent to the unemployment rate of the US Depression of the 1930s!


Given the backdrop of the cataclysmic economic effects of the Covid-19 pandemic, it has also become increasingly harder to find willing investors for startup companies. Such a scenario will give rise to “cram down” financings. In such a cram down financing, only one or a few investors are willing to put any new money into a company. However, such money usually comes with a much lower valuation for the company (down round) and forced conversions from luxurious preferred shares to plain vanilla common shares which generally punish non-participating shareholders who end up ‘crammed down’ to a small ownership stake of the company in common shares.


Generally, such a cram down financing involves a few controlling venture capital investors increasing their control and ownership stake at the expense of the crammed down remaining investors who did not participate in the financing. In such circumstances, courts have held that controlling venture capital investors must satisfy the “entire fairness test” by proving that the transaction was fair to the minority crammed down shareholders. This means that a controlling venture capital shareholder may have a fiduciary duty to minority shareholders.


In such circumstances, controlling venture capital investors should insist on a broadly worded indemnity from the company to protect them against potential claims by the minority shareholders based on the entire fairness test and breaches of fiduciary duty.


The Covid-19 pandemic has resulted in a significant shortage of venture capital financing for companies. Such shortage can result in unique investment opportunities for those venture capital investors who are willing to invest in such uncertain times. However, such opportunities can result in potential liabilities that may be so significant as to wholly undermine such investment unless specific investor protections are negotiated. ■

Venture Capital Investment in the UAE: Market and Regulatory Overview

A Q&A guide to venture capital law in the United Arab Emirates.


The Q&A gives a high level overview of the venture capital market; tax incentives; fund structures; fund formation and regulation; investor protection; founder and employee incentivization and exits.

The private equity, venture capital, and start-up ecosystem in the UAE: recent developments

In the lead up to the Expo 2020, the UAE government has taken a number of measures to promote economic diversification, foster growth, and stimulate the region’s innovation environment. The government’s push to develop the private equity, venture capital, and start-up eco-system is a central component of this agenda. In this inBrief we summarize the recent developments implemented in the UAE that enhance the ease of doing business for private equity and venture capital funds as well as start-up companies.


New Regime for Fund Establishment and Management


Over the last three years, the UAE Securities and Commodities Authority (SCA) has issued two important laws concerning the regulation of private equity and venture capital funds in the UAE. They are, (1) SCA Board of Directors’ Chairman Decision No. (9/R.M) of 2016 and (2) SCA Administrative Decision No. (3/R.T) of 2017. Some of the key provisions of these laws include:


  • establishing local mutual funds and marketing and promoting of foreign funds to investors in the UAE;
  • conferring corporate personality on the fund and limitation of investor liability; and
  • defining “Venture Capital Fund” as well as the conditions for venture capital funds to satisfy.


Despite these positive laws, onshore funds tend to be uncommon in the UAE due to foreign ownership restrictions and regulatory requirements imposed by the SCA. Consequently, many private equity and venture capital funds are established in the economic free zones of the Dubai International Financial Centre (DIFC) and Abu Dhabi  Global Market (ADGM) (collectively, the Financial Free Zones), which are regulated respectively by the Dubai Financial Services Authority (DFSA) and the Financial Services Regulatory Authority (FSRA) (collectively the Offshore Regulators).


The Financial Free Zones permit fund managers located both within and outside the Financial Free Zones to establish funds within the Financial Free Zones through a range of fund vehicles that include investment companies, investment partnerships, and investment trust structures. The fund managers based in the Financial Free Zones also have the flexibility to establish and manage funds outside the Financial Free Zones. Firms authorised or licensed by the respective Offshore Regulators can also promote and sell both domestic and foreign funds in or from the Financial Free Zones. In addition, the SCA and the Financial Free Zones have recently begun implementing a passporting regime that will allow for the mutual promotion and oversight of domestic funds established in these respective jurisdictions.


Also, the Financial Free Zones have taken several steps to create a favourable regulatory environment for private equity and venture capital funds. For example, they apply a risk-based regulatory approach for their funds regime that includes exempt funds (which are funds available for professional clients) and qualified investor funds, which have less stringent requirements than exempt funds and are specifically targeted at sophisticated investors such as high net worth individuals and family offices. In addition, the FSRA has introduced a risk-proportionate regulatory framework for managers of venture capital funds, which among other things, exempts venture capital fund managers from base capital or expenditure-based capital requirements.


New Trends 


Several recent legislative developments have also collectively provided more opportunities for funds and regulators have sought to stimulate disruptive industries. For example, each of the DIFC and the ADGM established a FinTech regulatory sandbox to create a progressive regulatory environment for the growth of the FinTech industry in the UAE.


In addition, the new pledge law enables pledgees to perfect their security interest over movable assets. This law will substantially enhance and create certainty in commercial lending. As a result, start-ups lacking immovable property will find it easier to avail bank financing by pledging movable assets such as their receivables, raw materials, or future assets.


Finally, the UAE’s new bankruptcy law introduces a regime that allows for protection and reorganisation of distressed businesses. It offers some protection for issuers of dishonoured cheques for the duration of any preventive composition or restructuring procedure. In addition, the new law provides debtors with the ability to raise new finance during the preventive composition or restructuring process, with court approval. Together, these changes provide entrepreneurs with further confidence to take calculated risks and comfort banks/investors with exposure to such investments.


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The above positive changes will result in the establishment of new funds and attract more entrepreneurs and investors to the UAE. Ultimately, such policy reforms will cement the UAE’s position as the private equity, venture capital, and the start-up hub of the Middle East. ■

Making Monetary Sense: Understand Your VC Term Sheet, Entrepreneur Middle East

During the course of startup maturation, founders seek financing alternatives outside of banking, family, and friends. As a result, venture capital funding has been on the rise in the Middle East as trips in this region pursue greater and more sophisticated sources of capital, with Dubai thus far serving as the funding epicenter. This publication reveals everything you need to know.