Equity Crowdfunding in Nigeria — A Legal and Regulatory Guide
It is no news that access to finance constitutes a major constraint for startups in Nigeria. The exorbitant lending rates from commercial banks-as high as 14% MPR and stringent lending conditions discourage startups and small businesses from approaching the banks for loans. Also, most startups are unable to access venture capital and angel funding because of information asymmetry. Thus, equity crowdfunding presents an excellent opportunity to bridge the funding gaps by introducing an alternative source of financing without the need to observe stringent conditions.
Unfortunately, under Nigerian laws, equity crowdfunding is expressly prohibited. The Securities and Exchange Commission (SEC) on August 15, 2016, released a statement ‘banning’ any equity crowdfunding activities in Nigeria until the legal impediments are removed[i]. However, the SEC is studying other jurisdictions with a view to incorporating equity crowdfunding into the financing structure in Nigeria. This is a welcome development. However, any crowdfunding regulation will need to address the risks associated with equity crowdfunding and investor protection issues.
Crowdfunding in Nigeria
Generally, crowdfunding refers to the raising of funds from the public for a particular purpose or project. Crowdfunding activities are not novel in Nigeria with practices such as Esusu (Igbo); Ajoo (Yoruba), Adashi (Hausa) where a group of people contribute money to be distributed on a need or in a chronological manner. However, crowdfunding activities seem to be mostly reward/donation based. For example, at the 2016 Olympics, Nigerian athletes utilised online funding portals to solicit for funds to finance their trip to the Olympics[ii]. Also, most of the well-known crowdfunding activities are usually to help the sick or the underprivileged.
Nigeria is host to several crowdfunding platforms. There are several rewards-based platforms and peer-to-peer lending platforms in Nigeria such as Imeela, Naturfund, Donate-ng etc. Lending/Debt-based crowdfunding allows the ‘crowd’ to contribute to projects via a loan. The contributors are the lenders and the project owner is the borrower. Examples in Nigeria include Farmcrowdy, Paylater, Ribyfinance, FINT, PorkMoney etc. For Farmcrowdy and PorkMoney, the funders provide financial support to farmers and receive returns in exchange for their contribution once the farm produce is sold. This is like bank loans. However, they offer lower or more competitive interest rates. This type of crowdfunding evolved from peer-to-peer lending.
However, the only known equity crowdfunding platform in Nigeria is Malaik. There is no indication of a successful equity crowdfunding activity in Nigeria.
Equity Crowdfunding in Nigeria
Equity crowdfunding will be a welcome development in Nigeria as it will be an expedient way for startups and small businesses to raise capital. These entities find it difficult to raise capital because they are perceived as high risk by banks due to the fact that they have little or no credit history; inadequate security to use as collateral (the Nigerian government is trying to remedy this situation through the Collateral Registry Regulation but it is still difficult for small companies and startups to raise funds from banks) and poor legal framework regulating them.
As a method of alternative finance, equity crowdfunding will provide startups access to funding from the large pool of investors open to companies listed on the stock exchange. Consequently, the ‘crowd’ (i.e. the investors) not only has a stake in the company’s profits but also bear a portion of the risk for any losses by the company.
The Investment and Securities Act, 2007 and the Companies and Allied Matters Act, Cap C20, LFN 2004 contain provisions that specifically prohibit equity crowdfunding activities in Nigeria.
Section 67(1) of the Investment and Securities Act (ISA)provides that;
No person shall make any invitation to the public to acquire or dispose of any securities of a body corporate or to deposit money with any body corporate for a fixed period or payable at call, whether bearing or not bearing interest unless the body corporate concerned is- (a) a public company, whether quoted or unquoted, and the provisions of sections 73 to 87 of this Act are duly complied with; or (b) a statutory body or bank established by or pursuant to an Act of the National Assembly and is empowered to accept deposits and savings from the public or issue its own securities (as defined under this Act), promissory notes, bills of exchange and other instruments: Provided that nothing in this subsection shall render unlawful the sale of any shares by or under the supervision of any court or tribunal as may be authorised by law.
In Nigeria, inviting the general public to provide financing in exchange for shares in the company, without authorization from the SEC, is considered illegal and opens the company to fines. Section 67(2) of the ISA imposes a fine of N5,000,000 (for corporate bodies) and N100,000 (for the officers and directors of the company).
The Companies and Allied Matters Act (‘CAMA’) regulates the formation and operation of companies in Nigeria. The CAMA contains some restrictive provisions dealing with the transfer of shares, invitations to the public to subscribe for shares etc.
Specifically, Sections 22 (3) & (5) requires a private company to have no more than fifty members. The CAMA also prohibits public invitation for the subscription for shares or debentures or to deposit money for fixed periods or payable at call.
Thus, equity crowdfunding arrangements that require the ‘crowd’ to contribute funds to a company in exchange for shares is prohibited in Nigeria. Accordingly, any equity crowdfunding regulation will need to provide exemptions or exclusions to the above provisions in addition to other investor protection provisions.
Equity Crowdfunding Regulation in Nigeria-Lessons for the SEC
Once the necessary amendments and exemptions are incorporated in the CAMA and ISA allowing equity crowdfunding in Nigeria, the next step will be for the SEC to determine the policy considerations and regulatory environment for equity crowdfunding in Nigeria.
· Policy Consideration
The starting place for the SEC is to determine the policy objective of any equity crowdfunding regulation vis-à-vis efficiency and inclusivity. Inclusive in the sense that all entrepreneurs are given a chance to pitch their idea to the ‘crowd’. If the SEC decides on ‘efficiency’, an efficient way to channel funds from public investors to promising startup companies will be emphasized as against inclusivity.
To help in choosing its policy goals, the SEC must decide whether Nigeria needs equity crowdfunding as a substitute for Venture Capital (VC) and angel investment or if Nigeria can afford to have crowdfunding as a complement to existing VC and angel financing. This is because countries that possess enough pools of entrepreneurial capital can afford to undermine efficiency by trying to make the crowdfunding regime inclusive. But countries that lack satisfactory levels of startup finance cannot afford that luxury.
The tension between the policy goals makes it necessary for any regulator to make a choice based on the above parameters. This is because the policy goals determine the regulations to be imposed by the SEC. For example, gatekeeping function (Gatekeeping implies setting parameters for companies to be included and/or excluded) for the crowdfunding platform seems to be vital for an efficient system while inclusivity implies a free for all and unmediated access to the crowd.
It is pertinent to point out that the USA as a policy objective settled on inclusivity and efficiency, while New Zealand settled on efficiency. Undoubtedly, the USA has a large pool of VC and angel financing being the home of Silicon Valley.
From a regulatory perspective, an efficient regime imposes fewer restrictions and adopts a more liberal approach than an inclusive one. For example, New Zealand imposes fewer restrictions on crowdfunding as against the USA. Instead, New Zealand deputized the crowdfunding platforms and depends on private actors to act as gatekeepers to protect investors from investing in fraudulent companies or companies that are likely to fail.
· Regulatory Environment
Having decided on the policy goals, the SEC needs to decide how to achieve whichever goal it settles on. Examples of issues that can be considered include-
Ø Financial Intermediaries
One of the primary functions of the SEC is to protect investors. Equity crowdfunding allows non- professional investors who might lack the capacity to adequately assess and monitor a company to invest in such companies. To address this risk, regulators in other countries have introduced a financial intermediary between the crowd and the company. This intermediary, usually known as a funding ‘portal’ or ‘platform’, must be registered with the SEC and regulated by the SEC. Thus, the SEC can decide what additional requirements to impose on the portal.
The USA securities crowdfunding regulation, the Jumpstart Our Business Startups (‘JOBS Act’), prohibits intermediaries from offering investment advice or recommendations; soliciting purchases, sales or offers to buy securities offered or displayed on its website or portal; hold, manage, possess or otherwise handle investor’s funds or securities etc. The Act also requires the portal to ensure that each investor reviews investor education information and positively affirms that they are risking the loss of their entire investment[iii]. The Act also requires intermediaries to ‘meet such other requirements as the SEC may by rule prescribe for the protection of investors and in the public interest[iv].
Ø Limits for issuers and investors
The SEC can reduce the crowd by limiting the investment to either a restricted group of people, possibly only sophisticated investors, each contributing more capital than the average crowd or imposing monetary limitations for both investors and issuers.
In the USA, issuers may not raise more than $1000000 annually via crowdfunding[v] while for investors, the maximum annual aggregate amount that one investor may purchase is based on a sliding scale. If the investor’s net worth or annual income is under $100000, he can invest the greater of $2000, or 5% of his annual income in crowdfunded securities each year[vi]. If his net worth or annual income is over $100000, he can invest 10% of his annual salary, capped at $100000 per year[vii].
In New Zealand, no investment or investor caps are imposed. People are free to invest as much as they want in as many companies. However, the regulator trusts ‘gatekeepers’ or ‘syndication (Here, a crowd invests alongside a large and sophisticated ‘lead’ investor, usually professional investors like a VC or an angel investor)’ to impose this limit. Thus, the portal self-regulates by determining the investment limits and criteria for investment. For example, PledgeMe in New Zealand and Seedrs and Crowdcube in the UK require crowd investors to pass a test before investing in a company to certify that they are sufficiently aware of the investment risk.
Ø Disclosure Requirements for Issuers
To protect investors, the SEC may require certain disclosure requirement from issuers.
In the USA and in Canada, certain disclosures such as information about the offering and the issuer’s business, directors, officers and major shareholders; related party transactions ; planned use of proceeds; risk factors and financial statements, which may need to be reviewed or audited, depending on the offering amount, are required. After the crowdfunding, certain ongoing disclosures are also required such as an annual report providing financial statements and information like the information in the offering documents.
Ø Eligible Companies
The SEC will need to decide what types of companies can raise equity via the portal. In the USA, only private companies are eligible to raise funds via an intermediary. Public and foreign companies are excluded. Canada allows public and private companies but excludes foreign companies.
Ø Advertising
The SEC will need to decide as to whether to restrict or encourage advertising Again, this decision will depend on the policy objective of the SEC.
In the USA, basic advertising about the issuers business is permitted in addition to referring potential investors to the information available on the funding portal. In Canada, no advertising or solicitation is permitted beyond referring potential investors to the information available on the funding portal. Conversely, New Zealand does not prohibit or limit advertising but allows an issuer to advertise, promote and market its offerings as it sees fit[viii].
This list is by no means complete; they are just mere indicators of potential areas the SEC should consider in developing a bespoke regulation which could serve in protecting the investment of the public and reduce the incidence of fraud.
Conclusion
Undoubtedly, the challenge here will be for the SEC to design an appropriate equity crowdfunding structure for Nigeria by benchmarking global best practices. However, before this can be done, the SEC will have to adopt rules and propose amendments to the CAMA and the ISA that will permit companies to raise funds through crowdfunding. With the proper framework in place, equity crowdfunding is an idea whose time has come.
Disclaimer: This article is only intended to provide general information on the subject matter and does not itself create a client /attorney relationship between the r
[i] ThisDay Article, ‘SEC Rules Out Crowdfunding in Nigeria for Now’ August 15, 2016 accessed via https://www.thisdaylive.com/index.php/2016/08/15/sec-rules-out-crowdfunding-in-nigeria-for-now/ on November 02, 2018.
[ii] Shame of a nation: More Nigerian athletes solicit for fund on social media, accessed via http://www.vanguardngr.com/2016/07/shame-nation-nigerian-athletes-solicit-fund-social-media/
[iii] Section 77d-1(a) (3)-(5) of the JOBS Act
[iv] Section 77d-1(a) (12) of the JOBS Act
[v] Section 77d(a)(6)(A) JOBS Act
[vi] Section 77d(a)(6)(B)(I) JOBS Act
[vii] Section 77d (a) (6) (B) (ii) JOBS Act.
[viii] Section 89–94 Financial market Conduct Act, 2013.
