Laws Governing Venture Capital

The venture capital sector is the most dynamic industry in today’s financial market. Venture capital is the money offered by professionals who invest in new, fast-expanding businesses that have the potential to become major economic contributors. For start-up companies, venture capital is a significant source of equity. Venture capital can be seen as the philosophy of business development as “your ideas and our money.” Venture capitalists not only provide monetary resources but also help the entrepreneur with guidance in formalizing his ideas into a viable business venture. The venture capital in recent years has really taken off in the UAE. The UAE government has taken several steps to encourage economic diversification, promote development, and stimulate the region’s innovation environment in the run-up to Expo 2020. A vital component of this agenda is the government’s drive to develop private equity, venture capital, and start-up eco-systems. Additionally, venture capital is given to companies who meet the following criteria:

1. Newly floated companies that do not have access to equity capital or any related instruments.
2. Firms that provide goods or services with much room for growth potential.
3. Firms with a higher-than-average profit margin.
4. New products that are in the early stages of growth.
5. Projects with a higher-than-average level of risk.

 

Brief History

The history of venture capital is similar to that of humankind. At the time of the fifteenth century, Christopher Columbus wanted to travel westwards from Europe instead of eastwards, and so he planned to reach India. His far-fetched plan was rejected by the King of Portugal, who declined to finance him. Finally, Queen Isabella of Spain agreed to finance him, and Christopher Columbus’ voyages are now inscribed in history. As a result, the concept of venture capital was born. After World War II, the modern venture capital industry started to take its shape. People are often told that they chose to become entrepreneurs because they see role models of other successful entrepreneurs. Venture capitalists fall under the same category, and the earliest members of the organized venture capital industry had many role models, including the following three:

American Research and Development Corporation

Digital Equipment was the biggest success which was founded in 1946. General Georges Doroit, a French-born military man who is known as “the father of venture capital,” founded ARD. He was a professor who taught the subject of Industrial Management at Harvard Business School in the 1950s. The rest of the faculty, which focused on conventional corporate management, thought his lectures on the importance of risk capital were quirky and strange.

J.H. Whitney & Co J

.H. Whitney & Company was created in 1946 by partners John Hay Whitney and Benno Schmidt as a venture capital firm in the United States wherein Minute Maid orange juice was one of their early hits. Minute Maid juice was created as a result of the company’s innovative method of delivering nutrients to American soldiers.

The Rockefeller Family

 The Rockefeller family holds one of the world’s most enormous fortunes and is an American industrial, political, and banking family. One of L S Rockefeller’s early interests was in Eastern Airlines, which is no longer in operation but was one of the earliest commercial airlines.

Laws Governing Venture Capital in the UAE

Venture capital funds are mainly aimed at businesses that enable technology in the UAE. Historically, local iterations of world e-commerce, urban mobility firms, and digital content players that provide Arabic-language content have been highly focused. During the last few years, the interest in HealthTech (with Covid-19 attracting a lot of the interest), FinTech, FoodTech, and logistics has been increasing. In the onshore area of UAE, financial operations are usually supervised and controlled by the central bank and the Securities and Commodities Authority (SCA). However, in the DIFC and the ADGM, the responsibility of the financial regulatory is of the Financial Services Regulatory Authority (FSRA) and the Dubai Financial Services Authority (DFSA). Over the recent years, two significant laws on private equity and venture capital funds in the UAE have been issued by the UAE Securities and Commodities Authority (SCA). They are

1. SCA Board of Directors’ Chairman Decision Number (9/R.M) of 2016 and
2. SCA Administrative Decision Number (3/R.T) of 2017 Some of the key provisions of these legislations include:

• Establishment of local mutual funds and promotion and marketing of international funds to UAE investors;
• Granting corporate identity to the investment fund and restriction of investor liability; and
• Defining and identifying ‘Venture Capital Fund’ as well as the requirement for venture capital funds to satisfy

The financial free zones enable fund managers both within and outside the financial free zones to establish funds across a variety of fund vehicles, including investment firms, investment trusts, and trust partnerships. The fund managers based in the area of financial free zones have the flexibility to establish and manage funds outside zones. Firms approved or licensed under their respective offshore regulators can, in or from financial free zones, also promote and sell domestic and foreign funds. The fund managers located in the financial free zones can also establish and manage funds outside the financial free zones. Companies approved or licensed by the respective offshore regulators can also promote and sell both domestic and foreign funds in or from the financial-free zones. Moreover, some measures have been taken by financial free zones to establish a favorable regulatory framework for private equity and venture capital funds. For instance, they apply a risk-based regulatory approach to their funds’ system, which incorporates exempt (funds available for professional clients) and eligible investor funds that have fewer conditions than exempt funds that primarily target sophisticated investors such as persons with a high net worth and family offices.

Furthermore, the FSRA has developed a risk-based regulatory system for managers of the risk capital funds that exempt venture capital fund managers from the base capital or expenditure-based capital requirements. Recent Trends Several recent legislative advancements have also provided immense opportunities for funds, and regulators have settled to stimulate disruptive industries. For example, to develop a progressive regulatory environment for the development of the FinTech industry in the UAE, each of DIFC and ADGM established a FinTech regulatory sandbox. Moreover, the new pledge law allows pledgees to increase their security interest in movable assets. This legislation would significantly improve and provide continuity in commercial lending. This would facilitate access to bank financing by pledging movable assets such as receivables, future assets, or raw materials. Lastly, a regime for the protection and reorganization of distressed businesses is introduced under the current UAE bankruptcy law. For issuers of dishonored checks, it provides protection for the duration of any preventive composition or restructuring process. In the course of the preventive composition or restructuring process, with the help of financial lawyers, the current legislation also allows debtors to raise new funds with the permission or approval of the Court. Together, this move gives entrepreneurs more confidence to take calculated risks and comfort banks and investors exposed to such investments.