Introduction
Early-stage fundraising is a critical milestone for startups, and selecting the right investment instrument can significantly impact a company’s legal structure and future financing rounds. One such instrument gaining popularity among startups and investors is the Simple Agreement for Future Equity (“SAFE”). Originally developed in Silicon Valley, the SAFE is now commonly used in international startup ecosystems. However, its legal treatment in the United Arab Emirates (UAE) requires careful analysis, particularly due to the country’s dual legal framework encompassing both mainland UAE and financial free zones like the Abu Dhabi Global Market (ADGM) and the Dubai International Financial Centre (DIFC).
What is a SAFE?
A SAFE is a contractual agreement under which an investor provides capital to a startup today in exchange for the right to receive shares in a future equity financing round, typically at a discount or subject to a valuation cap. Unlike convertible notes, SAFEs are not debt instruments as they do not carry interest, have no maturity date, and do not impose repayment obligations on the company. This simplicity makes SAFEs attractive but also creates uncertainty in jurisdictions where they are not explicitly recognized by corporate law, such as in mainland UAE.
This blog is a part of our Choosing the Right Investment Instrument for Startups: Legal Analysis of SAFEs, Convertible Notes, and Equity Rounds Blogpost.
SAFEs in Mainland UAE: Legal Gaps and Risks
Under Federal Decree-Law No. 32 of 2021 on Commercial Companies, there is no legal provision for SAFEs. Consequently, SAFEs are not formally recognized in mainland UAE and do not fall neatly within the established categories of shares or debt. This raises questions about enforceability, treatment in company filings, and the ability to convert SAFEs into equity at a later date. Moreover, UAE mainland companies are generally not allowed to issue different classes of shares, such as non-voting or preferred share, without special regulatory approval. Given these challenges, mainland-incorporated startups are advised to consider more conventional instruments, such as convertible notes or compulsorily convertible preference shares (CCPS), which align better with existing company law and can be structured with regulatory compliance in mind.
SAFEs in ADGM and DIFC: Contractual Flexibility
In contrast, ADGM and DIFC, which operate under common law systems, provide significantly greater flexibility for structuring SAFEs. Both jurisdictions allow companies to enter into contracts and issue multiple classes of shares including non-voting or preferred shares subject to the provisions of their Articles of Association. In ADGM, for example, the Companies Regulations 2020 permit private companies to structure forward-looking investment instruments like SAFEs, provided they are clearly documented and compliant with corporate governance requirements. Similarly, in DIFC, SAFEs can be drafted and enforced under the DIFC Contract Law, giving startups and investors the contractual certainty needed for early-stage investments.
Drafting Considerations and Shareholder Rights
Despite this flexibility, it is important for both founders and investors to ensure that SAFEs are carefully drafted. Key elements include the conversion trigger (e.g., a future priced round or liquidity event), valuation cap, discount rate, and treatment on dissolution or acquisition. Additionally, companies must ensure that their Articles of Association authorize the issuance of shares upon conversion and that the share capital is appropriately structured to reflect the rights of incoming equity holders. In free zone contexts, SAFEs can also be structured to align with post-money or pre-money valuation methodologies, but this requires precise modelling of the company’s capitalization table to avoid unintended dilution.
Tax and Regulatory Implications
From a regulatory and tax standpoint, the recent introduction of UAE Corporate Tax under Federal Decree-Law No. 47 of 2022 adds new dimensions to the use of SAFEs. While SAFEs are not considered debt or equity at the time of issuance, their conversion into shares could have tax implications, especially where cross-border investments or related-party transactions are involved. Moreover, while SAFEs are contractual instruments, their use may attract attention from the Securities and Commodities Authority (SCA) in mainland UAE if marketed broadly or issued to multiple investors, as they may fall within the scope of securities offerings depending on the facts.
Founder and Investor Perspectives
For founders, the primary benefit of a SAFE is the speed and simplicity it offers in closing early-stage capital without the complexity of priced equity rounds. However, this should not come at the cost of legal clarity. Poorly drafted SAFEs can lead to disputes regarding conversion terms, valuation, or investor rights. Investors, on the other hand, must understand that SAFEs typically do not grant governance, voting, or liquidation rights until they are converted into equity, and therefore offer limited protections compared to traditional shareholding.
Conclusion
While SAFEs are a useful tool in startup financing, their legal enforceability and practical use in the UAE depends significantly on where the company is incorporated. For companies in ADGM or DIFC, SAFEs can be used effectively with proper structuring and legal oversight. For mainland entities, caution is warranted due to the lack of formal legal recognition and regulatory ambiguity.
