The State of Qatar and the Qatar Financial Centre have undergone rapid development in the world of venture capital and technology startups. As of this writing, there are no fewer than 8 leading regional and global VC firms with a presence in the QFC, including: Alchemist, B Capital, Builders VC, Deerfield, Human Capital, Utopia, Golden Gate and Rasmal. (Most of these firms are part of the Qatar Investment Authority’s “Fund of Funds” program.) As the VC ecosystem continues to take shape in Qatar, local stakeholders may wonder if the legal system provides an adequate framework. In this article, we discuss one of the most important legal documents in the world of VC—the ubiquitous SAFE—and whether local startups can use them reliably.

Background

The world of VC and startups is distinct from more traditional investments like private equity and M&A, where investment targets are typically larger and more established companies. As startups rarely take on debt financing, most startups rely on equity financing from early investors and VC firms. This means fewer share purchase agreements and more share subscription agreements or Simple Agreements for Future Equity (better known as “SAFEs”).

VCs typically invest in technology startups in their immediate and extended markets. But when VCs operate in unfamiliar markets, they understandably prefer to incorporate familiar elements. One important element is the use of holding companies established in jurisdictions with no direct connection to the target startups, but with considerable history as destinations for VC investment. Those jurisdictions are limited to just a few names: Delaware, Cayman Islands, Singapore, and arguably a few others.

One of the many reasons for the concentration of startup holding companies and VC investments in a handful of jurisdictions is the predictability of how the legal systems in those jurisdictions will enforce the rights of parties involved in startups—from founders to employees to all levels of investors (pre-seed, seed, Series A, etc.) to the startup companies themselves.

The Simple Agreement for Future Equity (SAFE)

One of the core documents in the world of startups is the Simple Agreement for Future Equity (SAFE). Since startup companies often raise capital before they have begun to generate consistent profits (or even revenue), it is very difficult for early-stage investors and founders to agree on valuation. When parties cannot agree on valuation, they cannot agree on what a certain investment (e.g. 1 million USD) is worth in terms of an ownership percentage in the company. Hence, the popularity of SAFEs in which one contractual term is agreed at the outset (the cash value of the investment) and another key term (percentage of ownership) is determined at a future date based on certain events.

The use of SAFEs has become commonplace all over the world, so much so that even the wording of these contracts has become relatively standardized (even more so than FIDIC agreements or LMAs). Initially, the wording of popular SAFEs was made to fit target companies incorporated in Delaware. But as SAFEs became increasingly popular in other jurisdictions (Cayman, Singapore, etc.) new SAFEs emerged with localized language for those places.

Are SAFEs Sharia-compliant?

But SAFEs have not gained similar adoption in the Muslim world, for some obvious reasons. First, many experts consider SAFEs to be unacceptably “speculative”, thus rendering them inconsistent with Sharia principles due to the concept of ‘gharar’. In most SAFEs, the investment amount is clear, but the other half of the equation is not. Investors are not entitled to a certain percentage of the company they are investing in, and it is very possible that those investors could ultimately end up with a percentage of the company that does not accurately reflect its value at the time of investment or at the time of vesting.

Another issue affecting SAFEs and other startup investment practices in the region is the common use of multiple classes of shares—Ordinary, Preferred, Series A preferred, Redeemable, Convertible, etc. Traditional corporate rules in Islamic jurisdictions require that all shareholders hold identical rights, thereby limiting the ability to issue preferred shares or provide other negotiated rights that startup investors have come to expect. In those environments, even basic VC concepts such as liquidation preferences, conversion discounts, or valuation caps can be viewed as incompatible with local law.

The QFC – a viable alternative

Consequently, founders and investors often default to more familiar jurisdictions such as Delaware, the Cayman Islands, or Singapore. In some cases, they go so far as to establish a new holding company with no operational nexus to the underlying business, accepting the costs and administrative friction of a cross-border structure simply to gain confidence that their transaction documents will be enforced as intended.

But startups in Qatar—whether incorporated under the Ministry of Commerce and Industry (MOCI), the Qatar Free Zone Authority (QFZA) or other licensing authorities—may not need to resort to such measures in order to facilitate future VC investment, because the QFC offers many of the same advantages as these other jurisdictions, namely:

  • Respect for the principle of Freedom of Contract
  • A common law system based on English law
  • A transparent court system which publishes its judgments
  • A panel of highly respected and experienced judges hailing from many of the most advanced legal systems around the world
  • Application of agreed governing law, including QFC law
  • No unilateral application of Sharia, which typically conflicts with SAFE notes and related legal concepts like preference shares vs ordinary shares
  • An “Onshore court system” with minimal friction between QFC court substantive decisions and execution of judgments against assets in Qatar
  • No tax on foreign-sourced profits
  • No capital controls
  • Use of English language in proceedings (no mandatory use of Arabic for proceedings or translations of English language documents)
  • Adequate remedies for investors, including:
    • Specific Performance: the QFC courts can compel the company to issue the investor the number of shares to which he/she is entitled under the SAFE
    • Monetary Damages: under QFC contract law, an aggrieved party is entitled to compensation from a breaching party that would put the aggrieved party “in the position he would have been in if the contract had been properly performed.” This is key, because in the event of a dispute between SAFE holders and companies, only “expectation damages” can properly compensate investors. Other types of damages like “reliance damages” (which restore the aggrieved party to the position it was in before the contract) do not adequately compensate startup investors for the risks they take for investing in early-stage companies.

Conclusion – Your SAFE is safe in the QFC

As more startups and VCs continue to set up shop in Qatar, they will consider how—and where—to structure their investments, including SAFEs.

Even startups that already operate in mainland Qatar through the Ministry of Commerce and Industry may find it beneficial to set up a QFC holding company and then engage in capital raising through that entity, rather than raising directly through their MOCI entity (for the reasons discussed above in ‘Are SAFEs Sharia-compliant?’) or by setting up a foreign holding company.

For the reasons set out above, both startups and VCs operating in Qatar may conclude that there is no need to interpose unrelated jurisdictions (like Delaware or Singapore) in order to facilitate investment, and the Qatar Financial Centre may be the most appropriate choice for all stakeholders in the ecosystem.

In conclusion, your SAFE is safe in the QFC.

Authors: Dean Jaloudi, Partner