Venture capital financing in Nigeria

Nigeria’s burgeoning tech start-up ecosystem

Nigeria’s tech start-up ecosystem has become “chart-topping” in recent times, attracting venture capital from Silicon Valley, China, and all around the world. It is perhaps the resilience and creativity of youngsters enabled by technology and rising unemployment rates that have brought Nigeria such fortune. Starting from the early 2010s, the entrepreneurial and technology ecosystems began attracting foreign funding and cooperation. The “tech” sector, (including telecommunications, information and information services, publishing, motion pictures, sound recording and music production, and broadcasting, today accounts for about 17.92% of Nigeria’s GDP. In 2012, it accounted for only about 7.70% of the nation’s GDP.

The visit of Facebook’s CEO to Nigeria in August 2016, and the partnerships and programmes established during that visit, foretold the current rally of start-up funding in these ecosystems. In August 2021, the Financial Times acknowledged that, despite Nigeria’s struggling economy, its fintech groups had attracted more than USD1 billion in venture capital in the previous two years. On the Global Startup Ecosystem Index 2021 released by StartupBlink, Nigeria, having overtaken Nairobi (Kenya), is now Africa’s top start-up ecosystem.

As of November 2021, the top five beneficiaries of venture capital investments in Nigeria are Opay, Andela, Flutterwave, Kuda Bank, and Decagon. Opay, a financial services company, secured USD400 million in August 2021 in a funding round led by SoftBank Vision Fund, the venture capital arm of Japanese conglomerate SoftBank Group Corp. It is the single largest inflow in an investment round secured by an African-based start-up. In September 2021, Andela announced that it raised USD200 million from investors led by the SoftBank Group as well.

In March 2021, Flutterwave raised USD170 million in a Series C round, and in August 2021, Kuda Bank raised USD55 million in a Series B round coming on the heels of an earlier Series A USD25 million financing in March 2021. Decagon, an IT start-up, raised a total of USD26.5 million in 2021. It raised USD1.5 million in August, led by Kepple Africa and Timon Capital and backed by Tokyo-based UNITED Inc, and USD25 million loan from Sterling Bank Plc and the Central Bank of Nigeria (CBN).

Other investments include USD17 million seed and Series A funding for Mono, a financial data start-up, in October 2021 led by Tiger Global; the USD13.1 million seed funding of Autochek, an auto-tech start-up, co-led by TLcom Capital and 4DX Ventures; USD10.5 million in Series A financing for Alerzo, an e-commerce retail start-up, in August 2021 led by London-based Nosara Capital. There are at least ten other Nigerian start-ups that have been able to access foreign venture monies in the year 2021 alone.

Clearly, there is an increasing number of fintech-related entrepreneurial activities in Nigeria with a very fertile environment for the growth of tech start-ups. Healthtech in Nigeria is also attracting venture money. In September 2021, a US and Nigeria-based genomics start-up, 54gene, raised USD25 million in a Series B round led by Cathay AfricInvest Innovation Fund to expand its capabilities in precision medicine. In May 2020, Helium Health, a healthtech start-up also raised a USD10 million Series A fund co-led by Global Ventures and Africa Healthcare Masterfund. There are several other smaller venture capital investments in healthtech and fintech in Nigeria.

Venture funding is, by its nature, not permanent capital funding. Venture capital investors plan to exit sooner or later. The goal for investors, typically, is only to finance a start-up’s innovation and business infrastructure towards a significant scale-up with a multiplier effect on profitability ahead of a bigger private or public offering of its investment units. The increase in venture monies inflow into Nigeria’s tech space portends the success of Nigerian tech products and services. These venture capitalists have foreseen the directional success of these start-ups.

The law regulating the activities of businesses and investments in Nigeria is evolving, as expected, to accommodate the current trends in the market. This is clear from the recent introduction into federal law of the limited partnership and limited liability partnerships entity forms under Nigeria’s Companies and Allied Matters Act, 2020, as well as the enactments of the Finance Acts of 2019 and 2020. Under the Finance Acts, the rate of company income tax, which was generally 30% for all companies, now applies only to companies with an annual turnover of over NGN100 million. Medium-sized companies with an annual turnover of at least NGN25 million but less than NGN100 million now pay income tax at the rate of 20%, and small companies with annual turnover of less than NGN25 million are totally exempted from income tax.

Venture capital investing in Nigeria: what to keep in mind

Setting up the fund in Nigeria

A venture fund in Nigeria may be structured in different ways, such as a partnership, a company, a co-operative society or a trust. The chosen structure impacts the returns, tax liabilities, asset protection and operational costs of the fund. The classic structure for funds is a limited partnership structure where only a limited number of a closed group of investors purchase a participatory interest in the fund. Venture funds may also be structured as a limited liability partnership (LLP), limited partnership (LLP) or limited liability company (LLC). The LP and LLP entity forms are more attractive to venture funds than the LLC because of their flexibility and tax efficiency advantages. Funds registered as LPs and LLPs are not subject to corporate income tax at the vehicle level, rather the vehicle’s income, gains, losses, deductions and credits are passed through to the partners and taxed as personal income tax rates for individual partners and at companies income tax rate for corporate partners. The dividends received by a fund structured as a limited partnership are, however, subject to withholding tax at 10% and are assessed as part of the partners’ income to determine the assessable profit to each partner.

Like a general partnership, but unlike an LLP, an LP is not a body corporate but is a relationship between its partners. The only disparity between a general partnership and a limited partnership is that there are limited partners whose liability is limited to such partners’ capital contribution or commitment. Thus, an LP has no independent corporate existence and the partnership issued in the name of the partners. The LP option also requires at least one general partner, whose liabilities are unlimited and who manages the partnership business. LPs cannot have more than 20 partners but there is no maximum number of partners in an LLP. An LLP has juristic personality different from the individual partners that constitute it. Like an LLC, an LLP has perpetual succession and any change in the partners of the LLP does not affect the existence, rights or liabilities of the LLP. In Nigeria, an LP/LLP may be registered under federal law (ie, the Companies and Allied Matters Act (CAMA)) or under state laws (eg, the Partnership Law of Lagos State, 2009).

A preferred structure to consider is the trust structure, other than the unit trust structure; ie, the typical collective investment scheme in which the public is invited to purchase units of the fund. A trust is generally a structure whereby the settlor, through a trust agreement or deed sets up a trust and appoints a trustee who holds and manages the trust assets for the beneficiaries. In the case of a venture fund, the settlors are the investors who pool funds together to invest in target entities and the appointed trustee(s) manage(s) the investment for the venture (trust) fund.

The trustee(s) is/are also responsible for the management and distribution of the investment proceeds to the investors as beneficiaries of the venture fund. The trust deed would establish the trust, appoint the trustees, identify the beneficiaries, spell out the duties and obligations of the trustees, and specify the contribution ratio and profit/asset sharing ratio.

Regulatory considerations

One reason to set up a venture fund in Nigeria is access to investments/commitments from Nigerian institutional investors such as pension fund administrators. Not all venture funds managed by managers resident in Nigeria are required by law to be registered with Nigeria’s Securities and Exchange Commission (SEC). Only venture funds with investors’ funds commitment of at least NGN1billion (approximately USD2.4 million).

Additionally, pension funds may be invested only in funds or securities registered with the SEC. According to the National Pension Commission, Nigeria’s total pension funds asset value closed at NGN12.78 trillion (approximately USD31.1 billion) as of September 2021. The registration process with the SEC entails the preparation and submission of several documents including a partnership agreement (where applicable) and a technical/management agreement between the venture fund and the beneficiary. A private fund is not permitted to solicit funds from the public. Private funds are funds whose units are not offered to the public or traded on public exchanges. On the other hand, public funds are funds open to investments from the public. 

Furthermore, depending on the structure of the investment, venture capital investments may trigger antitrust regulation and compliance. This would happen where an investment or a set of investments involves an acquisition of direct or indirect control over a business or where the investor’s rights over the business amount to “material influence”. Control may be established in many ways including majority shareholding, control over votes at general meetings, majority representation on the board, and veto powers.

Such investments are notifiable to, and must be approved by, the Federal Competition and Consumer Protection Commission (FCCPC) if the combined turnover of the venture capital fund and the target company in, into or from Nigeria equals or exceeds NGN1 billion (approximately USD2.5million) or the annual turnover of the target company in, into or from Nigeria equals or exceeds NGN500million (approximately USD1.3 million). Where, for any reason, it is not clear whether the transaction is notifiable or not, parties may engage the FCCPC by way of a pre-notification consultation or a negative clearance. The pre-notification consultation is intended to assist transaction parties in the preparation of necessary documents and requirements for the merger notification process while the negative clearance helps parties to ascertain whether or not the transaction is in fact, notifiable. The regular timeline for the FCCPC’s review is 60 business days, after satisfaction of notification requirements, and 45 business days for expedited reviews. These timelines may be extended by the FCCPC.

Nigeria’s antitrust regulations apply to transactions within and outside Nigeria. Recently, the FCCPC issued the Foreign Merger Guidelines which regulate the acquisition of shares or other assets outside Nigeria resulting in a change of control of a business, part of a business or any asset of a business in Nigeria. For such transactions, the approval of the FCCPC is required. Notifications must be done prior to transaction implementation.

Finally, where, a venture capital investment involves the import of foreign currency into Nigeria, it is beneficial to obtain a certificate of capital importation (CCI) from an authorised dealer. A CCI facilitates the unconditional and unrestricted repatriation, through an authorised dealer in freely convertible currency, of dividends or profits (net of taxes) attributable to the investment, payments in respect of loan servicing where a foreign loan has been obtained, and the remittance of proceeds (net of all taxes) and other obligations in the event of sale or liquidation of the enterprise or any interest attributable to the investment. (Section 15, Foreign Exchange (Monitoring and Miscellaneous Provisions) Act). A CCI grants access to the CBN-regulated foreign exchange markets which are clearly legal and offer rates more favourable than those in the parallel unregulated markets.

Tax incentives

Nigerian law seeks to encourage investments in Nigeria through tax reliefs and incentives to further motivate investment in particular sectors of the economy. Some of these incentives are also available for venture capitalists investing in Nigerian companies. They include the following.

Capital Gains Tax Act (CGTA) and Value Added Tax Act, 1993 (as amended)

Capital gains tax (CGT) at 10 per cent is payable on the disposal of shares issued by Nigerian companies. However, CGT is not payable in three instances thus: (A) in respect of any portion of the disposal proceeds that are reinvested within the same year of assessment in the acquisition of shares issued by any company incorporated under CAMA; (B) where the total proceeds of disposal are below N100,000,000.00 (approximately U$200,000) in any consecutive period of twelve (12) months; or (C) where the shares are transferred between an approved borrower or lender in a regulated securities lending transaction as defined in CAMA. Similarly, shares are explicitly exempted from value-added tax (VAT). If a venture capital fund intends to dispose of its equity investments in a business, such divestment will not attract CGT where any of (A)-(C) above is the case and VAT. 

The erstwhile Venture Capital (Incentives) Act (VCA) 1993 made provisions for tax reliefs and other incentives for the benefit of venture capital funds and venture capital projects. However, the Investment and Securities Act 1999 repealed a large part of the VCA, including Section 4 of the VCA which provided extensive incentives for venture capital.

Withholding Tax (WHT)

WHT is payable on debt interest and dividends, whether received by a Nigerian company or a non-resident company, at the rate of 10%. If the investor(s) is/are from a country with which Nigeria has a double taxation treaty, the WHT is at a reduced rate of 7.5% instead of 10%. Countries with double taxation treaties with Nigeria include Belgium, Canada, China, Czech Republic, France, Netherlands, Pakistan, Philippines, Romania, Singapore, Slovakia, South Africa, Spain and the United Kingdom.

Dividend paid out after WHT has been deducted from it qualifies as “franked investment income” and is not liable to further income tax in the hands of the recipient, irrespective of whether they are Nigerian or foreign. Similarly, WHT deducted on dividends or debt interest payments received by foreign investors does not attract any further income tax burden in Nigeria.

Key documentation in venture capital investment

The Simple Agreement for Future Equity (SAFE)

The SAFE standard form was introduced by Y Combinator in late 2013. The SAFE form was introduced to replace convertible notes for early-stage financing. The original SAFE was based on pre-money valuation only. However, in 2018, Y Combinator amended its draft SAFE agreement to be based on a post-money valuation. The SAFE is an investment agreement between a company and an investor where the investor provides the company money which will be debt initially but converted into the common equity of the company on certain triggering events like future equity financing or the sale of the company.

Though the SAFE form is similar to convertible notes, in that it can be converted to equity eventually, it is not a debt instrument and there is no interest accruing and no maturity date. The standard terms in a SAFE include discounts for the investor on future shares purchases, valuation caps, most-favoured-nation provisions and pro rata rights.

The SAFE form despite being well-understood and helping to limit time and money spent by start-ups and investors on negotiation and advice is perhaps not as widely used in Nigeria as it deserves to be. Considering the benefits of SAFEs at this important time in Nigeria’s venture financing history and the fact that Y Combinator’s SAFEs are based on American law, we at G. Elias & Co. have developed a Nigerian version of the SAFE documents, taking into consideration the Nigerian law and its particular tech and entrepreneurial ecosystem.

Other typical investment agreement types

Where venture monies are being invested in the US holding or parent company of a Nigerian start-up or business, the equity series rounds are typically documented in a suite of documents typical and standard for US-based venture capital investment transactions. These comprise a stock purchase agreement, a voting agreement, an amended and restated investors’ rights agreement, an amended and restated certificate of incorporation, and a right of first refusal and co-sale agreement. The right of first refusal and co-sale agreement ensures that investors obtain liquidity before or at the same time as the founders. The stock purchase agreement contains terms of the sale including representations, warranties and undertakings, minimal conditions precedent provisions, and boilerplate provisions. Where any representations turn out to be accurate, investors may pursue recission rights and other legal remedies against fraud. The restated certificate of incorporation sets out standard provisions on rights of common and preferred stockholders including dividend rights, voting, and priority in payments on liquidation or sale. Liquidation preference over common shares provides downside protection to preferred shareholders. Key provisions in these documents are provisions on early exit, pre-emption rights, board representation, inspection, board observer and information rights, and tag and drag rights.

Where the strategy is to purchase shares immediately, rather than make a future purchase, the share subscription agreement and shareholders’ agreement are typical venture financing agreements. The share subscription agreement sets out the terms of the investment, specifically the number of shares purchased, the price of each share, use by the company of proceeds of the sale, any additional investments, completion formalities, representations, warranties, and indemnities.

The shareholders’ agreement (SHA) spells out the relationship between the investor, the target and its existing shareholders, and includes a list of items requiring key investors’ consent, exit mechanisms, protection of minority interests, and pre-emptive rights. Debt investments may also be structured as convertible debts or outright loans documented in a loan agreement or a convertible loan agreement or convertible note purchase agreement.

As part of the transaction, the investor may need internal legal reorganisation including clear employment agreements with founders, termination of existing agreements, the appointment of investor nominees in internal audit and other financial positions, and the creation of employee stock option plans to align the interests of the investor with those of the management to the extent possible.

Protection provisions for venture capital investors

It is common for venture capital investors to require that certain contractual protections are set out in investment agreements. These are usually in the form of representations and warranties in relation to the shares to be acquired as well as to the business. There are also certain provisions of laws in Nigeria aimed at protecting foreign investments into Nigeria. These include the following.

Prohibition of expropriation or nationalisation of a business or assets by the government unless the acquisition is in the national interest of for a public purpose. In such instances, investors are entitled to fair compensation and legal redress (Section 25, National Investment Promotion Commission (NIPC) Act; Section 44, 1999 Constitution of the Federal Republic of Nigeria (as amended)).

Provision for the settlement of disputes between investors and the government using international commercial methods (such as arbitration) rather than strictly Nigerian public sector methods (such as the courts and tribunals).

Arbitration is the main alternative resolution mechanism. Nigeria’s Arbitration and Conciliation Act avails foreign investors of the opportunity to choose and use arbitration. It also makes applicable the Convention on the Recognition of Foreign Awards to any award made in Nigeria in any contracting state arising out of international commercial arbitration, provided that the contracting state also has reciprocal legislation recognising the enforcement of arbitral awards made in Nigeria. (Section 54, Arbitration and Conciliation Act, Chapter A18, Laws of the Federation of Nigeria 2004 (ACA)). An arbitral award is binding and enforceable in Nigeria irrespective of the country in which it is made (Section 51, ACA).

Nigeria is a signatory to the International Centre for Settlement of Investment Disputes (ICSID) Convention. The ICSID (Enforcement of Awards) Act, Chapter I20, Laws of the Federation of Nigeria 2004 (ICSID Act). The ICSID Act provides for the enforcement of awards made by ICSID in Nigeria. The party seeking the recognition of the award in Nigeria is to file the duly certified copy of the award at the Supreme Court of Nigeria (Nigeria’s apex and final court of appeal). The award shall thereafter have effect as if it were an award contained in the final judgment of the Supreme Court (Section 1(1) ICSID Act).

Monetary judgments obtained in the High Courts of England, Ireland, Scotland, Ghana, Sierra Leonne, Barbados, Bermuda, British Guiana, Jamaica, or any other territory under the protection of the British Crown can be enforced pursuant to the Reciprocal Enforcement of Judgment Ordinance 1922. A judgment creditor may bring an application for leave to register such foreign judgment within 12 months from the date of delivery of the judgment. A registered foreign judgment will be treated as if it is a judgment of the registering court.

Nigeria is a signatory to the African Continental Free Trade Agreement (AfCFTA). The AfCFTA aims at boosting intra-African trade and investment by establishing a single market for goods and services across the 54 countries in Africa. It also allows for the free movement of business travellers and investments within Africa. 

Nigeria has bilateral investment agreements with 31 countries, 15 of which are in force. Nigeria also has double taxation treaties with 14 countries and is a signatory to 21 investment-related instruments.

Conclusion

Nigeria’s tech and entrepreneur ecosystems are attracting millions of dollars in venture monies – and for good reasons too. However, the usual risks inherent in venture capital investments are present as returns depend on the successful growth of the investee. Some of the key legal considerations are good starting points for guidance on venture capital investment and structuring decisions.

Nigerian law continues to evolve to deliver the framework necessary to facilitate, promote, and even propel a lot more venture capital investments into Nigeria. However, to attract greater venture monies, a great many more amendments are necessary, particularly to the rules and regulations of the SEC. These amendments should at the very least include an increase in the fund size of funds requiring registration with the SEC. Considering that the SEC no longer doubles as the competition regulator, it is difficult to justify why private venture funds domiciled in Nigeria should require authorisation from the SEC. Also, registration requirements should be amended to reflect current realities. In general, further legislative reform is needed to harmonise the provisions of extant investment laws to adequately regulate and expand venture capital financing in the light of increasing entrepreneurial activities necessary for greater GDP growth and national development.