July 24, 2016

Legal Corner: Capital Raising

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You have registered your company, obtained a DMCC licence and have been successfully carrying on business in the DMCC Free Zone, but now you need a capital injection. Whether for meeting regular costs and expenses – payroll, rent, paying suppliers, or for taking the next strategic step for your business, companies often need to raise capital.

 

Capital Raising – What are your Options?

You may choose to fund the company yourself, obtain finance from a bank or to raise capital from external investors. This article focuses on raising capital from external investors.

The identity of external investors can vary. It might be friends and family, wealthy individuals who invest in SMEs, venture capitalists or private equity investors.

External investors often bring with them a wealth of knowledge and experience, in addition to the capital that your company needs. External investors can therefore be a valuable source of advice and guidance on the management and growth of your company. Below, we look at some of the key points to consider when seeking capital from external investors.

 

Equity or Debt?

If the investors take equity, they will become shareholders in your company and may request some of the rights and protections discussed below. As a shareholder, the investor would be entitled to a pro rata share of any dividends paid by the company and, looking further along the life cycle of your company, proceeds from the sale of all shares in the company.

If the investors loan money to the company, it may be on the basis that in the future they have the right to convert the loan into shares in your company.

 

Rights of the Investors

The rights that you grant your investors will depend on the stage in the life cycle of your business and the percentage shareholding the investors are taking. Typically the larger the shareholding, the more rights and protections the investors will request.

The rights and protections requested by the investors may include:

  • The investor being or appointing a director to the board of your company. This enables the investor to be involved with management of the company, which may have a direct effect on the value of their investment.
  • Restrictions on the issue of new shares and on the transfer of shares by giving the investor the right of first refusal to buy more shares. This protects the investor against their shareholding in the company being diluted and therefore their proportion of dividends or sale proceeds being reduced.
  • A right to take part in any sale of shares if you, as the founder of the business, plan to sell the company. The investor may not wish to continue with their investment in your company if you are no longer involved in the business.
  • To receive regular financial information, such as management accounts.

 

Is any Documentation Needed?

An external investor will expect their investment to be documented. If the investor is putting in debt, this would be recorded in a loan document and would set out any rights of the investor, such as the right for the loan to be converted into shares or the right to receive financial information.

If the investor will have shares in your company, typically a shareholders’ agreement will be put in place. This agreement would record the investment being made and all rights of the investor.

 

What are the next steps?

If you are thinking about raising capital, there are numerous resources available, but in the first instance you may wish to speak to your lawyers, accountants or your bank. These advisers who know you and your business will be well placed to help you in considering which option is most suitable for your company.

Topics: Legal Corner

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