LEGAL FOR LEBANESE STARTUPS

LEGAL FRAMEWORK:

How can I register as a merchant?

As a merchant, you should be registered with the Commercial Register and the Ministry of Finance. 

It costs you approximately LBP 1,500,000 (excluding legal fees) to be registered as a merchant, and you should provide the following documents:

  ?  Request (name, nationality, commercial name, object)

  ?  ID

  ?  Address

  ?  Commercial circular

How can I register a sole proprietorship?

Registration as a merchant is a prerequisite to register a sole proprietorship.

It costs you approximately LBP 2,350,000 (excluding legal fees) to register a sole proprietorship and you should provide the following documents:

  ?  Request (name, registration number of the merchant)

  ?  Address

  ?  Social security discharge

What type of company is the most beneficial for my business?

The most common types of companies used in Lebanon are limited liability companies (SARL) and joint stock companies (SAL). In both types of companies, the liability of the partners/shareholders is limited to the extent of their contribution in the capital of the company.

The advantages of forming a SAL over a SARL reside, in 2 main points:

  ?  Benefiting from Circular 331: The Central Bank of Lebanon requires that startup companies be incorporated in the form of a Lebanese joint stock company (SAL); and

  ?  Transfer of shares: A SAL, unlike a SARL facilitates the transfer of shares among shareholders and third parties and therefore attracts investors.

How can I incorporate a SAL?

  ?  Timeline: A SAL can be incorporated on the same day if all the documents are ready and the bank account is opened in the name of the company.

  ?  Fees: It costs approximately LBP 3,000,000 (excluding legal services fees) to incorporate a SAL. Don’t forget that at many law firms offer you deferred fee schemes which allows you to defer payment for legal services until the startup raises funds or starts generating revenue above a certain threshold. 

  ?  Documents:

  ?    By-laws executed by the founders

  ?    Certificate of incorporation 

  ?    Commercial circular 

  ?    Evidence of address

  ?    Request for the opening of a bank account

  ?    Bank certificate confirming subscription of founders (initial capital LBP 30,000,000)

  ?    Constitutive general assembly acknowledging the incorporation and appointing Board of    Directors and auditors

  ?    First Board of Directors electing the Chairman-General Manager and legal counsel

How can I incorporate a SARL?

  ?  Timeline: A SARL can be incorporated on the same day if all the documents are ready and the bank account is opened in the name of the company.

  ?  Fees: It costs approximately LBP 2,600,000 (excluding legal services fees) to incorporate a SAL. Don’t forget that at Ororus Advisors we offer you the deferred fee scheme which allows you to defer the legal services payment until the startup raises funds or starts generating revenue above a certain threshold. 

  ?  Documents:

  ?    By-laws executed by the founders

  ?    Certificate of incorporation 

  ?    Commercial circular 

  ?    Evidence of address

  ?    Request for the opening of a bank account

  ?    Bank certificate confirming subscription of founders (initial capital LBP 5,000,000)

  ?    Constitutive general assembly acknowledging the incorporation and appointing directors and  legal counsel

How can I protect my idea?

First, you can make anyone you work with, including your investors, sign a non-disclosure agreement that commits them to confidentiality. 

From an intellectual property (IP) perspective, you should know that IP doesn’t protect the mere idea per se but the expression of the concept. In other words, your idea should be tangible:

  ?  Copyright: You need to fix the ideas onto a defined medium for copyright to apply

  ?  Trademark: You should register your trademark for your logo to be protected (you can do it by yourself by accessing: www.economy.gov.lb)

  ?  Patent: You should describe and register your invention or invented process for patent to apply

In practice, always remember that your idea may be stolen but the way you implement it is key and can never be copied.

What are the most important types of clauses I should include in the shareholders’ agreements?

While drafting a shareholders’ agreement, don’t forget to discuss clauses relating to: 

  ?  Quorum and majority conditions that should be met in the meetings of ordinary and extraordinary general assemblies of shareholders

  ?  The composition of the board of directors: who will be the first members of the board and the chairman? How will they be appointed? What are the voting requirements (including whether the chairman will have a casting vote)?

  ?  Appointment of a CEO and his/her role

  ?  Transfer of shares (including whether preemption or consent rights apply)

  ?  Events of default and consequences (including put/call options, default sale price, and default exit price…)

  ?  Exit strategy, drag-along, and tag-along, dissolution of the company

  ?  Liability and indemnification

OPERATIONS 

What is required to hire employees?

You should be registered with the NSSF (Social Security) within one (1) month from the start of operations. You should also enter into employment agreements with your employees and register them with the NSSF. Social Security contributions are calculated as a percentage of monthly salaries, including overtime, bonuses, and fringe benefits. Note that you should also register foreign employees working in Lebanon (holders of work permits) with the NSSF provided their countries of origin offer equal treatment to Lebanese workers (e.g.: France, Italy, UK, Syria, and Belgium). 

You should declare to the NSSF any termination of employment within 15 days from the date of termination.

What kind of taxes should I pay for my business?

For individual enterprises tax rates apply as follows:

  ?  Net income up to LBP 9M: 4% of profits 

  ?  Net income between LBP 9 M and LBP 24 M: 7% of profits 

  ?  Net income between LBP 24 M and LBP 54 M: 12% of profits 

  ?  Net income between LBP 54 M and LBP 104 M: 16% of profits 

  ?  Net income exceeding LBP 104M: 21% of profits 

For companies tax rates apply as follows:

  ?  15% of profits 

  ?  10% on distribution of dividends 

Note that disposal of shares in SARL are subject to capital gains tax at 10% while sale of shares in SAL companies are exempt

Taxes on salaries and wages are divided as follows:

  ?  Net income up to LBP 6M: 2% of net income

  ?  Net income between LBP 6M and LBP 15M: 4% of net income

  ?  Net income between LBP 15M and LBP 30M: 7% of net income

  ?  Net income between LBP 30M and LBP 60M: 11% of net income

  ?  Net income between LBP 60 and LBP 120M: 15% of net income

  ?  Net income exceeding LBP120M: 20% of net income

Furthermore, you should pay the VAT at the rate of 10% on all goods and services inside Lebanon as long as your turnover over four consecutive quarters exceeds LBP 150M.

RAISING FUNDS:

How can I raise funds?

There are three (3) basic types of investor funding: 

  ?  Equity: Investors invest today in return for a stake in your company. You should set a specific valuation of your company at that point based on which you will determine how much percentage of stock the investor will get in consideration for the amount he/she invests. 

  ?  Loans: A creditor lends you money which you commit to paying back later with an established rate of interest. It is a good option when you need money quickly for a specific reason or when equity is not available.

  ?  Convertible Debt: Basically, it is a hybrid method of funding between debt and equity; you borrow money from investors with the understanding that the loan will either be repaid or turned into a share in the company at some later point in time (e.g., after an additional round of fundraising or once the business reaches a certain valuation).

How does VC management generate income ?

In a nutshell, VCs are paid in two (2) ways:

  ?  Carried interest: commission on gains they produce for the fund (which is usually 20%); and

  ?  Management fees: annual percentage fee to run the business, while they and their investors await a future good payday from investment gains (most commonly fund charges 2% annual management fees on committed capital for ten years).

What are the main terms to negotiate in the term sheet?

Certain clauses are fixed and often imposed by VCs in the term sheet such as:

  ?  the lock-up clause (under which the founders can exit the startups only after the VC);

  ?  the drag-along clause (under which the majority shareholder who wishes to sell his/her shares can force the minority shareholders to join the deal); and

  ?  the tag along clause (which assures that if the majority shareholder sells his/her shares, minority shareholders have the right to join the deal and sell their shares at the same terms and conditions as would apply to the majority shareholder).

Other clauses should be negotiated with the VC to show that the founder stands up for the important issues:

  ?  Valuation/Dilution: valuation refers to the value of your company pre-investment, and determines the price of new money coming in. The lower the value that is placed on your company, the higher the cost of VC money since your ownership of the company will be diluted to a greater extent.

  ?  Liquidation Preference: the liquidation preference determines the profit that an investor gets when the company is sold. It can have an important impact on your return which is why you should make sure to understand the actual dollar differences between the liquidation preference formulas. Keep in mind that terms put in place in the Series A often carry over to the Series B and beyond, so be careful what you agree to here even if it seems relatively harmless at this stage. 

  ?  The composition of the Board of Directors: Usually, early-stage boards should reflect the relative control of the cap table to determine the representation of each of the investors and the common shareholders on the board.

  ?  Protective Provisions: also known as “veto rights” and often in the hand of VCs over specified corporate actions. The protective provisions may not be explicit so make sure you consult your lawyer in this regard.

  ?  Founder Vesting: You may provide that your stock is owned and fully vested upon issuance. However, VCs may want to incentivize you to stay in the company (at least until a milestone is achieved) and therefore, may request that your shares be subject to vesting provisions (e.g., 25% a year over the next four years). Try to negotiate the vesting period, monthly increments and acceleration in the event of a change in control or termination without cause. 

  ?  Anti-dilution Protection: Anti-dilution protects the VC from future sales of preferred stock at a lower valuation. The variations in the types of anti-dilution protection define the extent to which the VC is protected. 

  ?  Exclusivity: VCs may request that you don’t talk with other investors for some period after you sign the term sheet. Be sure the period is not too long (30 to 45 days is enough to finalize a VC investment in almost all cases).

What is a drag-along clause?

A drag-along provision is a clause under which the majority shareholder(s) can require the minority shareholder(s) to join in the sale of a company and sell their shares. This is usually triggered in the event of a company merger or acquisition. It is important to the sale of many companies because buyers are often looking for complete control of a company, and drag-along rights help to eliminate minority owners and sell 100% of a company's securities to a potential buyer.

To protect the minority shareholders, the drag-along provision will usually require the majority shareholder(s) to ensure that the minority shareholder(s) can sell the shares on the same terms and conditions. 

What is a tag-along clause?

A tag-along clause is a clause under which the minority shareholder(s) can require the majority shareholder(s) to join in the sale of the majority shareholder(s)’ stake and sell their minority stake in the company. This is usually triggered by a venture capital deal. It is important for minority shareholders because private equity shares are sometimes hard to sell and large shareholder(s) have greater ability to negotiate and can often facilitate purchases and sales on the secondary market. Tag-along provisions will enable the minority shareholder(s) to tag along with the majority shareholder(s) and sell their shares for the same price and on the same terms and conditions.

What is circular 331?

The Central Bank of Lebanon implemented Circular 331 with the purpose of incentivizing Lebanese commercial banks to invest equity in: 

  ?  startups; 

  ?  incubators or accelerators the object of which is limited to supporting the development, success, and growth of startups in Lebanon; and 

  ?  companies whose object is limited to investing venture capital in startups.

Only SAL with registered shares (not a financial company or offshore company) may benefit from Circular 331. Banks may benefit from interest-free facilities granted for a maximum period of 7 years. The Bank should also invest part of the money obtained from the Central Bank in the beneficiary company and the largest part in treasury bills.

THE EXIT

What are the best practices for exiting the business?

  ?  Keep track of your financials

  ?  Organize your legal archive

  ?  Make sure you negotiate for the business, not for yourself

  ?  Ensure continuity by delegating

  ?  Do not jeopardize the capital structure with the exit

SHAREHOLDERS AGREEMENTS

What formalities must shareholders’ agreements comply with in Lebanon? 

Shareholders’ agreements are not regulated under Lebanese law, and general rules governing agreements, in general, apply to shareholders’ agreements. Paragraph 3 of article 171 of the Lebanese Code of Obligations and Contracts (the “COC”) provides that in principle, agreements are created by the sole and free consent of the parties; no special official form is required unless a text of law requires one, which is not the case regarding shareholders’ agreements. Also there are no registration requirements. 

Can shareholders’ agreements be brought to bear against third parties such as purchasers of shares or successors? 

In principle, shareholders’ agreements are only binding upon their signatory parties. Under the provisions of article 225 of the COC, shareholders’ agreements have a relative value limited to the parties and their residuary legatees. There are, however, contractual ways to ensure that a purchaser will undertake to adhere to a shareholders’ agreement, such as ensuring that at the time of signature of the share purchase agreement, the purchaser signs a deed of adherence whereby he adheres to the shareholders’ agreement and undertakes to abide by its terms and conditions. Also, some of the clauses of the shareholders’ agreement can be incorporated into the bylaws of the company to render them opposable against third parties. 

Can a shareholders’ agreement regulate non-company contents? 

Given that shareholders’ agreements are not expressly regulated under Lebanese law, there are no restrictions relating to the content of such agreements, and there is nothing in principle that prevents shareholders’ agreements from regulating non-company contents, as long as the agreement does not contradict public policy and mandatory applicable laws. 

It is therefore customary to include in shareholders’ agreements, where needed, clauses regarding intellectual property rights, management rights over a specific project, limitations of liability, conflict of interests, policy and strategy issues, and so forth. 

Are there limits on the term of shareholders’ agreements under the law of Lebanon? 

This issue is not expressly addressed under Lebanese law, and one may therefore argue that a shareholders’ agreement’s term may be as long as the term of the company (which customarily is up to 99 years), although in practice various scenarios of events of termination of the shareholders’ agreement will be provided for therein and the term of the shareholders’ agreement will be expressly mentioned in the agreement, and could extend beyond the term of the company if so agreed between the parties that it should also govern issues other than the company, or that it governs more than one company. 

There are, however, matters that may be included in the clauses of a shareholders’ agreement regarding which courts may impose a limited term. 

Are shareholders’ agreements related to actions by directors valid in Lebanon? 

The mandatory prerogatives of the Chairman-General Manager and the board are provided for by law; shareholders may after that adapt the non-mandatory prerogatives and decision-making powers as they wish in the by-laws or shareholders’ agreements provided that they do not prejudice a mandatory prerogative. Also, it is possible in shareholders’ agreements to change the modalities of the decision-making process of the content of a specific decision, provided that this decision is, in the end, adopted or taken by the adequate corporate body and provided that the change does not violate Lebanese public policy issues of company law. 

Does the law permit restrictions on the transfer of shares? 

Article 118 of the COC provides among other things that, subject to the restrictions relating to contribution shares and guarantee shares of directors; any shareholder may freely assign his share to a purchaser who will succeed to his rights and undertakings as shareholder. 

However, a preferential right may be provided for in the bylaws, for the benefit of all shareholders or the benefit of some of them, or for the benefit of the company, provided that such a right is exercised in a period and at the conditions of the price determined by the bylaws. Moreover, it is possible to restrict transfers of shares for a limited duration of time. The exercise of the rights mentioned in this paragraph must however not lead to abuse, either by practically eliminating the transferability of the shares or by causing a serious prejudice to the shareholder. 

The principle is therefore that shares are freely assigned, unless exceptions are provided by law (for example regarding contribution shares or guarantee shares) or by the bylaws (for example any preferential right or consent rights (not expressly provided for by law but accepted in practice under certain conditions)). 

Regarding bearers’ shares, however, there is in practice no way to ensure a restriction on their transfer, and new rules and regulations ban the issuance of bearer shares in Lebanon. 

What mechanisms does the law permit for regulating share transfers? 

As aforementioned, aside from restrictions relating to contribution shares and guarantee shares, article 118 of the COC recognizes expressly the preferential right. 

However, the bylaws may provide for other mechanisms such as consent rights for example (by virtue of which the transfer of shares to a third party is subject to the approval of the appointed organ of the company (such as the board of directors of the company)), or preemption rights, or put and call options, or drag along and tag along options, all provided that there is no abuse and that this does not lead in practice to a prohibition of the transferability of shares. 

Do bylaws tend to be tailor-drafted, or do they tend to use standard formats? 

There are NO standard by-laws promulgated by law. However, most practitioners have elaborated their own standard formats, which they adapt as need be, and which usually provide for roughly the same content. 

What are the motives in Lebanon for executing shareholders’ agreements? 

The motives for executing shareholders’ agreements are very diverse. It may be to fill out gaps in the law; to agree on specific matters between shareholders but in a private way; to complete the law and bylaws; to agree on more complex issues that shareholders do not wish to include in the bylaws, such as governance between two or more groups of shareholders and constitution of boards and committees, granting of rights to minority shareholders over reserved matters, agreeing on strategic and managerial policies for the company, dividend policies for the company, transfers of shares, and on termination in the event of default of either party. There have also been cases where the contract initially drafted was a joint venture agreement, i.e. pre-incorporation, which also provided however for the content usually seen in shareholders’ agreement and an express mention that the joint venture agreement would become a shareholders’ agreement following the company’s incorporation.

What contents tend to be included in shareholders’ agreements? 

The contents included in shareholders’ agreements in Lebanon will vary depending on the matter at hand. In general, it will cover issues relating to quorum and majority at general assemblies and board meetings including how to deal with dead-lock situations, election of board members and chairman, mechanisms for the appointment of a CEO or assistant general manager, management, reserved rights, transfer of shares restrictions, financing obligations and decision-making, corporate governance issues, anti-dilution provisions, strategy of the company and business plan, admittance of new shareholders, confidentiality, breach and termination, events of default and their consequences, dissolution of the company; it could also include dividends policies, intellectual property issues, specific obligations of management or technical assistance by one party with indemnification and conflict of interest clauses in this respect, non-compete clauses. 

What determines the content included in shareholders’ agreements? 

The factors that determine the content included in shareholders’ agreements will be the client’s wishes; the specific nature of the company and/or its project(s); the need for specific protections to be granted to the client; the need to provide for specific measures that are not provided by law or to go over and above the ones that are; the need for some matters to remain confidential; whether the matters provided therein should be binding upon all shareholders or only some of them (who would, therefore, be the parties to the shareholders’ agreement); the need to have the agreement applicable to any new shareholders or purchasers (via a deed of adherence that must be signed as a condition precedent to any sale), and so forth. 

What are the most common types of clauses in shareholders’ agreements? 

The most common types of clauses in shareholders’ agreements in Lebanon, other than boilerplate clauses (confidentiality, term, and termination; governing law and jurisdiction; notices; assignment; severability; and so forth), are clauses relating to: 

  ?  Quorum and majority conditions that shall be met in the meetings of ordinary and extraordinary general assemblies of shareholders in general, and for any specific issues in particular (if any). 

  ?  The composition of the board of directors (the identity of the first members and the chairman, and the mechanism of their appointment), and voting at its meeting (notably whether the chairman will have a casting vote). 

  ?  Appointment of a CEO or assistant general manager and the role of the CEO. 

  ?  Transfer of shares: preferential or consent rights and the conditions of their application (if such clauses are not provided for in the bylaws of the company). 

  ?  Events of default and consequences (including put and call options, default sale price and default exit price, and so forth). 

  ?  Exit strategy, drag-along, and tag-along, dissolution of the company. 

  ?  Liability and indemnification. 

What mechanisms does the law permit to ensure participation of minorities on the board of directors and its control? 

The Law does not expressly provide for any such mechanisms, as members of the board of directors are elected by the ordinary general assembly of shareholders. It is, however, not unusual to see in shareholders’ agreements clauses to the effect that the board of directors shall be composed at all times of x members nominated by each shareholder (i.e. even if a shareholder were a minority shareholder, it would be agreed in the shareholders’ agreement that he/she would appoint at least x board members) although this would actually imply that the shareholders would have to vote in a specific manner, which, if contested, may be considered as null and void under Lebanese law with respect to its opposability against the company but would be considered valid between the parties, noting that in such case the indemnities and sanctions under the shareholders’ agreement play an important role. It is also possible to ensure that no board meetings shall be held without the presence of x board members nominated by minority shareholders, by determining that the quorum for board meetings is at least x directors, with at least y board members appointed by the minority shareholder being present or represented. 

Is it possible in Lebanon to ensure minority shareholder control using a shareholders’ agreement? 

It is not entirely possible to ensure minority shareholder control by means of a shareholders’ agreement, although it is possible however to provide therein for example that any board of directors’ meetings will not be held without the presence of at least x board members, one of which for example should be from the members appointed by a minority shareholder. It is also possible to increase the quorum required for general assemblies in order to ensure that no assemblies will be held without the presence of a minority shareholder; it is however not possible to increase the majority required for voting at such assemblies in a way that would grant one shareholder or group of related shareholders the right unilaterally to block decisions at the assemblies. 

What are the usual valuation mechanisms in connection with rights of first refusal or share transfer regulations? 

There are various mechanisms of share valuation. 

  1  These could be based on book value or net worth value as evaluated by the company’s auditor, or if a party disagrees on such valuation, it could be the average of the book value as evaluated by each of the auditors chosen by each party. 

  2  It could also be a multiple or a divider of the book value as evaluated according to the mechanisms set forth above, respectively for the default sale price and default purchase price. 

  3  It could also be based on the best price offered, although in such a case it may be mitigated with the fact that such best price should reasonably be in the same range as the book value for example (evaluated according to one of the means above or otherwise). 

Is it admissible for a shareholders’ agreement clause to refer dispute resolution to the courts other than those of Lebanon and under a law other than that of Lebanon? 

It would be admissible in theory for a shareholders’ agreement to include a clause referring dispute resolution to the courts other than those of Lebanon; however, when choosing a law other than that of Lebanon, it is important to consider exequatur (= executing the judgment) if, for example, the judgment violates public policy; hence a foreign law could be applied provided that Lebanese public policy provisions are considered for exequatur purposes. In light of the above, it would make sense to choose Lebanese courts if courts are the dispute resolution procedure adopted or foreign courts that would take into consideration Lebanese public policy. However, arbitration proceedings are also recommended, noting that the arbitration court should also take into consideration Lebanese public policy law if a foreign law applies to the shareholders’ agreement. 

Can a shareholders’ agreement to include an arbitration clause with seat outside Lebanon and under a law other than that of Lebanon? 

It is admissible for a shareholders’ agreement to include an arbitration clause (provided that the matters provided for in a given shareholders’ agreement can be arbitrated and do

not fall under one of the issues that are of the exclusive jurisdiction of Lebanese courts) with seat outside Lebanon; however, as aforementioned, when choosing a law other than that of Lebanon, it is important to consider executing the judgment. 

Written: Rami Alame

Date: 08/10/2017