Equity Crowdfunding in Nigeria
The startup space in Nigeria has received a big boost over the past few years. One of the major challenges faced by startups is availability of funds to properly function. Startups are usually registered as private limited liability companies. Hence, they are faced with restrictions in terms of raising funds and must rely on family, personal funds, bank loans, private equity firms or venture capitalist to raise funds. The bureaucracy involved in obtaining capital from the private equity firms and venture capitalists and the high interest rates on loans offered by commercial banks have led a lot of startups in Nigeria and globally to seeking alternative means of funding for their businesses. One of such alternatives is crowdfunding.
The concept has been in existence prior to the advent of the internet. Long before the internet was developed, people took up commitments to provide small amounts of money to support public projects. The Statue of Liberty in New York Harbor is an evidential result of a “crowdfunding” project. The first reported online crowdfunding project is said to have occurred in 1997. Rock band Marillion, were unable to afford to tour after the release of their seventh album. Their American fans used the then emerging internet to raise $60,000 so they could play in the US.
CONCEPT OF CROWDFUNDING VIS-À-VIS THE NEED FOR GROWTH IN THE NIGERIAN ECONOMY
Crowdfunding means raising small amounts of capital from a large number of individuals to finance a business venture through the internet. Raising capital usually involves raising large capital from few sources. The crowdfunding concept provides a twist by availing a large pool of individuals to contribute small capital to fund a business. Using the internet as a veritable tool, crowdfunding connects small business owners with a large pool of investors. Crowdfunding brings about a disruptive change in the financial industry, similar to that which has already impacted other industries belonging to the “Economics of Collaboration”, such as transportation (e.g. Uber, Bolt, PlentyWaka etc.) or agriculture (e.g. Farmcrowdy, Imeela, Pork Money etc.)
The types of Crowdfunding are:
Reward/Donation based: Reward/Donation crowdfunding is seeking small amounts of money from a large group of contributors to fund the completion of a project. In return, contributors receive token rewards such as special recognition in a project label or satisfaction in contributing to a worthy cause.
Debt based: Debt Crowdfunding also known as peer to peer lending connects business owners to large number of lenders at a reduced interest rate. This type of crowdfunding is popular with entrepreneurs who don’t want to give up any equity in their business.
Equity based: Equity Crowdfunding allows large number of individuals to invest in the business by acquiring a small stake of the business without complying with the stringent requirements often attached to the transfer or purchase of securities.
Most of the existing crowdfunding platforms in Nigeria are either reward/debt based. They help to finance businesses majorly in the agricultural sector. They include startups such as Naturfunds Farmcrowdy, Imeela, Pork Money and Thrive Agric. With the existence of these platforms, individuals have been able to invest in farmers’ business by providing loans at a lower and more competitive interest rates than bank loans.
Today, Equity Crowdfunding is an important part of the global financial markets because it provides SMEs with a more cost-effective strategy to raise capital as against the traditional means earlier identified. Premised on the fact that for the nation’s economy to grow, there is need to pay proper attention to the funding, growth and development of startups in the country. The regulator of the Nigerian capital markets, the Securities and Exchange Commission (SEC), deemed it necessary to relax the ban on equity crowd funding and in this stead provided a regulation to control the market. This regulation is borne out of SEC’s determination to maintain investor’s confidence in the capital market.
THE LEGALITY AND VIABILITY OF THE CROWDFUNDING RULES
The concept of Crowdfunding is yet to receive full regulatory acceptance in Nigeria. Recognizing the risk involved in Crowdfunding, the Securities and Exchange Commission (SEC) on August 15, 2016, released a statement imposing a ban on equity crowdfunding activities in Nigeria until the “legal impediments” are removed. The impediments referred to are the extant provisions of Investment and Securities Act and the Companies and Allied Matters Act.
Section 67 (1) of the Investment and Securities Act (ISA) 2007 provides that “no person shall make any invitation to the public to acquire or dispose of any securities of a body corporate…” unless it is a public company or a statutory body empowered to do.
Section 22(3) & (5) of the Companies and Allied Matters Act (CAMA) are both to the effect that unless authorized by law, a private company shall not invite the public to subscribe to its shares or debentures and that the number of members shall not exceed fifty (50).
Section 67(2) of ISA goes further by imposing a fine of N50,000 on a body corporate as well as N100,000 for the officers and directors of any company in contravention of section 67 of ISA.
Pursuant to the powers conferred on it by Section 313 of the ISA, The Securities and Exchange Commission released a document in March 2020 titled “Exposure of Proposed New Rules to the Rules and Regulations of the Commission” (The rules) which is among other things aimed at providing an insight into SEC’s plans to make the Crowdfunding market a safe, conducive and profitable space for all stakeholders. The rules define Crowdfunding as “the process of raising funds to finance a project or business from the public through an online platform”. The provisions of the rules would be analysed in line with; The Relevant Enterprise, Investors, the Operator of a Crowdfunding Portal and the Issuers.
MSMES AND THEIR EXTENT OF RAISING CAPITAL
In the rules, only Micro, Small and Medium Enterprises (MSMEs) incorporated in Nigeria with a minimum of two years’ operating track record can raise funds through a crowdfunding portal registered with the SEC. This presupposes that a public company can also raise funds using Crowdfunding. This provision differs from the requirement under the Jumpstart Our Business Startups (‘JOBS Act’) which regulates Crowdfunding in the United States of America where only private companies are eligible to raise funds using a crowdfunding intermediary. The rules also stipulate that Micro, small and medium enterprises can only raise a maximum of ₦50 million, ₦70 million ₦100 million respectively within a 12-month period. The essence of this provision is to prevent Issuers from raising surplus funds for projects that are impossible to achieve. These limits do not apply to MSMEs operating as a digital commodities investment Platform. The rule defines a digital commodity investment platform as “a digital platform that connects investors to specific agricultural or commodities projects for the purpose of sponsoring such projects in exchange for a return”. Existing platforms such as Pork money or Farmcrowdy fall under this definition. These platforms are required to apply to SEC for a “No objection” to continue operating as a digital commodities platform. Interestingly, the rules prohibit these platforms from hosting commodities investment projects on their platform or any other platform under control. They can only host projects on other Crowdfunding platforms not under their direct or indirect control.
The overriding reason for the regulation of the capital market by SEC is to protect investors by creating an atmosphere that is devoid of sharp practices of any kind. The epicentre of the rules is the protection of investors’ money and thus major parts of the rules are centered on mitigating the risks the investor is faced with. Retail investors are not allowed to invest more than 10% of their annual income in a calendar year while no limit is set for sophisticated high net worth individuals and institutional investors. The Jobs Act permits an investor whose annual income is below $100,000 to invest the greater of 5% of his annual income or $2,000. Where the investor’s annual income is more than $100,000, he can invest 10% of his salary but such must not exceed $100,000 in a year.
THE OPERATORS OF A CROWDFUNDING PORTAL
The rules require a Crowdfunding portal to register with SEC and such portal can only be operated by a crowdfunding intermediary. Only registered entities as Exchange, Dealer, Broker, or Alternative Trading Facility may be registered as a crowdfunding intermediary. The rules provides that: “a dealer registered by the Commission for the purpose of crowdfunding will be considered a ‘Restricted Dealer’ and can only carry out activities covered under this rule. A Crowdfunding portal located outside the country will be considered as operating in Nigeria if it targets Nigerian investors.
The rules also provide that SEC can revoke the registration of any Crowdfunding portal where it fails to meet up with the requirements of the rules, fails to operate or maintain the crowd funding portal for a period of 6 consecutive months or fails to pay the prescribed fees. These registration requirement do not apply to; (i) a technology service provider providing the infrastructure; (ii) software or the system to an operator; (iii) an operator of a communication infrastructure that enables orders to be routed to an approved stock market and; (iv) an operator of a financial portal that aggregates content and provides links to financial sites of service and information provider.
Non-professional investors who lack the capacity to adequately assess and monitor a company are protected under the rules. The rules laid out certain obligations of the crowdfunding portal to include:
• Adequate disclosure of relevant information relating to the issuers, general risk warning, complaints and dispute resolution and fees charged on an issuer.
• Carry out investor education programmes
• Inform investors of any material adverse change to an issuer’s proposal etc.
The Rules also require the crowd funding portals to carry out due diligence on issuers using the scope provided under the rules.
To be continued
Ayokunle Olowogboyega and Idris Edalere are both associates at Tayo Oyetibo LP, a foremost multi service Law firm in Nigeria. Ayokunle is a member of the firm’s Regulatory compliance and Business Advisory group as well as the Commercial law practice group and Idris is one of the Founding Members of Commercially Aware NG. They can be reached at email@example.com and firstname.lastname@example.org.