Saudi’s Vision 2030 to drive up foreign investment through more joint ventures

Setting up a joint venture is an attractive option for entering a new market, but foreign investors need to pay attention to certain key factors in deciding the most suitable legal structure.

Saudi Arabia has set ambitious objectives to transform its economic landscape, including attracting foreign direct investment and increasing foreign direct investment’s contribution to its GDP. This is part of the kingdom’s ‘Vision 2030’ policy, that aims to diversify its economy and create new job opportunities.

Having stated that the kingdom is “open for business”, the Saudi government plans to improve the business environment, restructure economic cities, create special zones, and deregulate the energy market to make it more competitive in the Middle East region. More sectors are earmarked to open up to private investment, driven by an ambitious government privatisation programme.

In many instances, businesses will need to establish a presence in Saudi Arabia in order to conduct business there or to contract with local entities, including government entities. It is important to differentiate between the different legal structures that are available, and which may be most suitable for each economic activity.

Advantages of joint ventures

There are numerous benefits of setting up a joint venture in Saudi Arabia compared to an independent enterprise or a wholly owned subsidiary. These benefits include easier and wider access to certain economic activities, pooling of assets and expertise, and access to established local know-how and reputation. As part of that know-how, the company may gain valuable insights into consumer behaviour, cultural and industry-specific nuances and business practices that may not otherwise be apparent.

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In Saudi Arabia, certain activities can only be carried out through an entity which has a certain level of local ownership. These include activities related to oil exploration; drilling and production, subject to certain exceptions; and real estate investment in Mecca and Medina. However, even if there are no such requirements for the chosen activity, it may still be prudent to partner with an established local enterprise to gain a competitive edge over other businesses that may not have the same level of market knowledge and established networks.

In general, using a joint venture structure can help international companies mitigate some of the risks associated with entering a new market, such as reducing financial liability, avoiding market uncertainty and ensuring regulatory compliance.

However, there are certain pitfalls that foreign enterprises must be aware of prior to entering into a joint venture in Saudi Arabia and there are steps companies should take before finalising an arrangement.

Due diligence on joint venture partner

Before entering into a joint venture, investors must conduct thorough research on the market and the regulatory environment in Saudi Arabia.  A vital part of this research is selecting a local partner whose expertise, resources and networks align with the objectives of the joint venture.

Investors need to ensure that the local partner has a strong reputation and experience in the industry they are looking to invest in. It is important to check whether the partner is a politically exposed person (PEP) and, if so, the implications of doing business with them.

It is prudent to assess the potential joint venture partner’s financial stability and business track record, and to make sure they have a good understanding of local market dynamics and regulatory requirements. The cultural fit with the potential partner, and the alignment of their business practices and values should also be considered.

Legal structures

Once the right partner has been found and a decision is made to enter into a joint venture, foreign investors need to carefully consider the various legal structures available in Saudi Arabia. Getting the structure correct from the outset is important to ensure the business can be carried out as needed.

Different legal structures will have different implications on liability, risk protection, financing, tax and other procedural formalities. Depending on the activities of the joint venture, it may be more advantageous to establish the entity in one of the special economic zones instead of on the mainland.

In Saudi Arabia, foreign direct investment is governed by the Foreign Investment Law and overseen and enforced by the Ministry of Investment (MISA). Foreign investors are required to obtain a foreign investment licence (MISA licence). The requirement for a specific type of MISA licence is triggered by a foreign investor’s choice of activities carried out in the Kingdom.

A common practice is to incorporate a holding joint venture company in which the foreign and local partners will have an interest. This holding company will in turn own the operating subsidiaries. This may be especially beneficial where separate licences are required by the Saudi regulatory authorities for each activity that the joint venture company is intended to carry out. This structure will help simplify governance and other regulatory procedures going forward.

Minimum capital requirements

In addition to foreign shareholding restrictions, MISA may also impose certain capital requirements that would need to be invested into the joint venture over a certain period. These capital requirements vary depending on the chosen economic activity and the percentage of the Saudi partner’s ownership. Where there is a minimum capital requirement, the amount to be invested will be shared between the joint venture partners in proportion to the percentage of their share ownership.

Unenforceable contractual terms

The Saudi legal framework is complex and constantly evolving. During the process of setting up the joint venture and drafting the joint venture documents, foreign investors must ensure that all constitutional documents, particularly those that confer decision-making powers, comply with Saudi companies law.

The Saudi companies law and associated implementing regulations now recognise joint venture and shareholders’ agreements (SHAs). This means that joint venture agreements will be considered binding by the Saudi courts and can be incorporated into the articles of association or bylaws of a Saudi company.

However, some of the terms common to joint venture agreements in other jurisdictions could be unenforceable in Saudi Arabia. The so-called ‘call options’ clause is one example. Joint venture agreements typically include a ‘call option’ as a consequence of material default. This would give the non-defaulting shareholder the right, but not the obligation, to purchase the defaulting shareholder’s shares at a discount.

In Saudi Arabia, enforcing this may be challenging in practice as any transfer of shares would require all shareholders to physically attend a notary to sign the relevant transfer documents and the updated constitutional documents. There are ways to mitigate these enforceability risks, although the risks cannot be entirely eliminated.

Co-written by Alexandra Aikman, Nathalia Elhage and Suzan Shaban of Pinsent Masons.