Looking to raise capital for your startup through investment-based crowdfunding in Nigeria? Nigeria ’s Security and Exchange Commission has put in place a new regulation on crowdfunding which will allow businesses and startups in the country to raise money from the public. The practice is similar to what South Africa already has. Intergreatme, a South African startup, as an instance, recently succeeded in raising over R32.7 million ($2.2 million) by simply putting up an online request for funding in return for shares on Uprise.Africa and getting overwhelmed by public contributions.
Below is what Nigeria’s new regulation on crowdfunding is all about.
What Categories Of Businesses Can Raise Funds Through Crowdfunding Under The New Rules?
- Under the regulation, only MSMEs (Micro, small and medium enterprises, generally referred to as “startups”, for convenience, under this article) registered as a company in Nigeria with a minimum of two years operating track record are eligible to raise funds through a Crowdfunding Portal registered by the Securities and Exchange Commission. However, if the startup has been less than 2 years in operation, but has a strong technical partner who has been in operation for at least 2 years, the startup will qualify. The startup will also qualify if it has a core investor on ground.
- However, some startups are prohibited from raising funds through a crowdfunding portal, and they include those with (i) complex structures (that is, a startup without adequate clarity about its ownership or control which make it difficult to immediately ascertain the beneficial owners of the entity) ; (ii) public listed companies and their subsidiaries; (iii ) startups with no specific business plan; (iv) startups that propose to use the funds raised to provide loans or invest in other entities.
- Also, if a crowdfunding portal or any of its officers, directors, shareholders or related persons own or control more than 5% of the shares of the fundraising startup, the startup will be barred from raising funds on the portal. However, the funds may still be raised if approval of the SEC is first sought before the startup is granted access to the portal.
Who Regulates The Fundraising Startups, SEC Or The Portal?
- Under the rules, SEC does not directly interface with the fundraising startups. Indirectly, SEC vets the fundraising startups’ crowdfunding applications through the submissions made by the crowdfunding portals on behalf of the fundraising startups. This leaves SEC with far-reaching powers to approve or reject. No procedure was, however, stated in the regulation for appeal against rejection.
How Much Can A Startup Raise Through The Crowdfunding Portal?
- Startups are only allowed to raise a maximum of the following amounts within a 12-month period: i) The maximum amount which may be raised by a Medium enterprise shall not exceed N100Million ($260k); ii. The maximum amount which may be raised by a Small enterprise shall not exceed N70Million ($182); iii. The maximum amount which may be raised by a Micro enterprise shall not exceed N50Million ($130k).
- For startups that run digital platforms that connect investors to specific agricultural or commodities projects for the purpose of sponsoring such projects in exchange for a return (such as FarmCrowdy, the maximum amount they may raise through the portal within a 12-month period is N1bn ($2.6m), which may be increased if the startup obtains approval from SEC.
How Can Startups Crowdfund Under The Regulation?
For startups in Nigeria desiring to raise funds under the crowdfunding regulation, the following steps must be followed:
- The startup must fall under the categories of businesses allowed above.
- Application for registration as a fundraiser to a crowdfunding portal (similar to Uprise.Africa in South Africa) is then made. A Crowdfunding Portal is a Nigerian company which must maintain capitalization to the tune of N100 million. The portal must also run a website, portal, application, or other similar module that facilitates interaction between fundraisers and the investing public.
- Due Diligence is then conducted on the startup by the crowdfunding portal. The due diligence exercise will, cover, among other things, (i) background checks on the startup to ensure fit and properness of their board of directors, officers and controlling shareholder(s); (ii) the business proposition of the startup.
- Once the application has been accepted by the Crowdfunding Portal, the startup will then proceed to raise funds from the public, in return for corresponding shares in the business.
- However before raising the funds, every fundraising startup shall issue an offering document, which must contain information such as (i) warnings to investors (ii) the name and address of the startup, directors and officers; (iii)holders of more than 5% of the startup’s shares; (iv)description of the business of the startup; (v) principal risks facing the business of the startup; (vi)use of proceeds; (vii) target offering amount (and a deadline to reach the target offering amount); (viii) risk factors; (ix) related party transactions (x) exit options for investors, etc.
- The offering document must be published to the investors through the crowfunding portal.
- For now, only plain vanilla bonds/debentures, ordinary shares and other investment instruments can be issued in return for the investors’ funds by the startups.
- Throughout the fundraising period, startups will be rigorously monitored by the crowdfunding portal.
- Accordingly, the monitoring will extend to the conduct of the startups, and the portal is empowered to take action against any misconduct of the startups. The portal will also monitor fundraising startups to ensure that the fundraising limits imposed on the fundraiser are not breached. Furthermore, the portal will monitor investors to ensure that the investment limits imposed on the investors are not breached.
- To this effect, the portal is required to file regular reports about the fundraising startups and their conducts throughout the fundraising period with SEC.
What Happens When Investors Invest In A Startup Through The Crowdfunding Portal?
- Under the regulation, investors may be allowed to invest in startups hosted on the crowdfunding portal as long as they comply with the investment limits specified by SEC. For now, retail investors may not invest more than 10% of their annual income in a calendar year; and (ii) Sophisticated, High Net worth and Qualified Institutional Investors are not subject to any limits.
- While fundraising, it forbidden for a startup to hold a fundraise on different crowdfunding portals at the same time.
- At the end of the fundraise, investors will be allowed a period of 48 hours during which they may withdraw their investment.
- If there is a big change which will affect the fundraiser, the investors will be given the option to withdraw their investment if they choose to do so within 7 days after they have been properly notified.
- Should the investor decide to cancel his/her participation in the fundraise, all funds which may have been debited from or blocked in their account shall be refunded or released within 48 hours of the request to cancel.
- However, once the investors have invested, their investment funds become locked in after they have been allotted shares or other investment by the startup. This remains so until after one year, except under some exceptional circumstances such as where the investors transfer their shares to other retail investors, family members, the startup itself, a high net-worth individual or an institutional investor.
- In any case, retail investors are entitled to withdraw from the startup or to sell their shares, whenever controlling shareholders transfer control of the startup to third parties within three years from the conclusion of the offer.
How Are Funds Invested Through The Crowdfunding Platform Treated?
- Under the new crowdfunding regulation, every crowdfunding portal shall appoint a custodian who shall establish and maintain a separate trust account for each funding round on its platform. The custodian must be a financial institution registered by SEC as a Custodian.
- Funds invested will be maintained by the Custodian in a trust account and will only be released to the startups after certain conditions are met.
- To begin with, funds raised would only be handed over to the startups if the target amount or the lowest threshold of funds to be raised is met.
- Where the lowest threshold is not reached at the end of an offer, the crowdfunding portal shall effect a refund to all investors within 48 hours.
- Investors shall have the right to withdraw any offer or agreement to purchase the securities or investments instruments 48 hours after the closing date stated in the startup’s offering documents.
- Thereafter, an investor is only able to cancel in the event of a material change to the offering.
- Where the funding target is reached, the crowdfunding portal shall make funds available to the startup within 24 hours provided that where the fundraiser is a public startup or a public startup by default, the portal shall require evidence of registration of the securities with the SEC prior to transferring the funds to the fundraiser (where applicable).
- Where the amount raised meets the minimum amount but falls short of the target amount, the fundraiser shall provide a revised plan for the proposed use of funds to the investors and the portal, provided that the underlying project(s) to the proposed use of funds can be downscaled and executed independently without negatively impacting operations of the startup.
- A crowdfunding portal shall take all reasonable steps and establish measures by which it is able to verify that the proceeds raised from its platform are utilized for the stated purpose.
- For an offer to be successfully completed, the minimum amount indicated in the offering document which must be sufficient to accomplish the business objectives of the fundraiser must have been subscribed for.
How Long Does Each Crowdfunding Campaign On The Portal Run?
- A funding project will run on a crowdfunding portal for not more than (60 days), although the period may be extended for a further period of not more than 30 days upon such conditions as may be specified by the portal.
As An Investor, How Are Personal Data Treated Under The Rules?
- The rules make extensive provisions for the protection of personal data. Among other things, it provides that the crowdfunding portal must ensure security and confidentiality of information collected from investors. They are also required to keep all a copy of all relevant documents used on the portal for a period of at least 7 years. The fundraising startups are, themselves, required to maintain an accurate list and details of all investors after the fundraising.
Are Startups Required To Pay Any Fees Under The Rules?
- Yes. Startups fundraising through the crowdfunding portals are required to pay fees only to parties involved in each crowdfunding campaign, such as the crowdfunding portal or the startups’ solicitors or accountants, provided that the total fees paid do not exceed 5% of the total funds raised in each campaign. The startups are totally forbidden from paying directly or indirectly a commission, finders’ fee, referral fees or similar payment to any person in connection with an offering other than to the crowdfunding portal.
What Are The Likely Difficulties A Startup May Face Should It Explore The Crowdfunding Option?
Under the new rules, some of the greatest barriers a startup may face should it explore the crowdfunding options include that:
- The extent a startup may go with the publicity of the fundraising is largely limited. The crowdfunding portal and the startup are limited to their websites at all times, and are therefore restricted from posting about any crowdfunding campaign on other platforms, such as the social media. The crowdfunding portal is empowered to vet each marketing material that goes out through the startup. This will limit the capacity of the startup to raise funds quickly.
- Compared to other jurisdictions, the largest amount available to a startup, apart from a commodity investment platform, from each crowdfunding campaign in a year is only limited to N100m. In South Africa, startups can raise as much as $2m or more. In the US, companies raising money through regulation crowdfunding can now raise up to $5 million. N100m is only about $260k, depending on the most current exchange rate of the Naira.
- Again, the definition of an MSME under SMEDAN only largely worsens the case as most startups substantially lack the capital to meet the requirements of the definition. This situation does not augur well for a society interested in allowing technological innovations to flourish. Nothing stops Nigeria from going ahead to enact a “Startup Act” like Tunisia or Senegal, in this regard.
- Furthermore, the process of obtaining a signed acknowledgement on disclosures on investment risks from the investor by the startup is quite unclear and, will to a large extent, deter investors from such investments. A better clarity would have sufficed.
- There is no certainty as to the recommended 2-day approval period given by SEC for startups who have submitted their applications for crowfunding. Thus, this gives room for an application to last for ages before it is approved.
- Again, SEC requesting to see and approve every crowdfunding application before being listed on crowdfunding platforms amounts to double (or over) regulation, and a huge disincentive to the intermediary portals who apparently look like messengers, and who are required not to charge more than 5% of the total amount of the funds raised, legal or accounting fees included. Why not ask the fundraising startups to submit their applications directly to SEC?
- Finally, like always, the regulations around foreign crowdfunding portals remain largely nebulous and open-ended.
NB:
- Micro Enterprises in Nigeria are those enterprises whose total assets (excluding land and buildings) are less than Ten Million Naira with a workforce not exceeding ten employees.
- Small Enterprises are those enterprises whose total assets (excluding land and building) are above Ten Million Naira but not exceeding One Hundred Million Naira with a total workforce of above ten, but not exceeding forty-nine employees.
- Medium Enterprises are those enterprises with total assets excluding land and building) are above Fifty Million Naira, but not exceeding One Billion Naira with a total workforce of between 50 and 199
employees — Source: SMEDAN Nigeria
Charles Rapulu Udoh
Charles Rapulu Udoh is a Lagos-based lawyer who has advised startups across Africa on issues such as startup funding (Venture Capital, Debt financing, private equity, angel investing etc), taxation, strategies, etc. He also has special focus on the protection of business or brands’ intellectual property rights ( such as trademark, patent or design) across Africa and other foreign jurisdictions.
He is well versed on issues of ESG (sustainability), media and entertainment law, corporate finance and governance.
He is also an award-winning writer
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