The prohibition of financial assistance to private equity firms and other equity investors is probably the most important legal barrier to the growth of the local leveraged buyout market. With the passage of the Companies Act in 2020, private companies in Nigeria can now legally provide financial assistance to private equity firms and strategic investors in connection with an acquisition of their shares. This marks a crucial step forward for the leveraged buyout market in Nigeria, which has been constrained by a mix of legal challenges and limited sources of debt financing. This legal update examines some of the practical ramifications of the new financial assistance rules in Nigeria.
Background
Prior to 2020, the Companies Act applicable in Nigeria generally prohibited private companies from providing financial assistance to purchasers of their shares. Under this regime, companies could only provide financial assistance with respect to employee share schemes, employee loans, ordinary business lending and any other transactions authorized by law. Following the enactment of the new Companies Act, the rules prohibiting financial assistance have now been relaxed to encourage more private company acquisitions, public-to-private transactions and intra-group re-organisations.
Key Practical Considerations
- The Meaning of Financial Assistance
Understanding the legal scope of the new financial assistance rules can be useful in designing an optimal capital structure for a private equity portfolio company. Under the new Companies Act, “Financial Assistance” is defined to include the provision of a security, a gift, a guarantee, indemnity or a loan by a target company to another person, towards the acquisition of the target company’s shares. Some of the key transaction structuring considerations here are that, while certain types of transactions are included in the definition of “Financial Assistance,” the term is broadly interpreted and extends beyond the corporate transactions explicitly covered in its definition. Therefore, a transaction structure where a target company transfers any of the company’s assets for use in buying its shares or a situation where a target company buys an asset from the third party who then uses the proceeds of sale to acquire shares in the company, could reasonably fall within the statutory meaning of financial assistance. It may also be prudent for private equity firms to review a proposed transaction structure to ensure that the structure is not caught by the financial assistance rules. In a recent matter which we advised on, the investor was unaware that the transaction structure proposed in its term sheet was caught by the financial assistance rules and omitted to comply with financial assistance rules. The legal issue that had arisen was whether or not, the investor and the representative director appointed post-closing (in a de facto capacity) could be made jointly and severally liable with the Company and the directors appointed and existing prior to the closing of the transaction, given that the obligation to comply with the financial assistance rules is that of the target company and its directors under the new Companies Act.
- Financial Engineering & Maximizing Value
Share redemptions and put options are some of the more common exit strategies used by private equity firms doing deals in Nigeria where there has not been a liquidity event within the holding period. With the relaxation of the rules enabling private companies to provide financial assistance, private equity firms can be more capital efficient and put less capital at risk by borrowing money from a bank or other financial institutions to fund a portion of the purchase price. Under this structure, private equity firms can arrange to use the stock or assets of the target company as collateral for the loan. When structured properly, private equity firms are able to achieve a higher rate of return than can be generated on an investment made entirely with equity.
- Pre-Conditions for Providing Financial Assistance
Private companies are required to comply with a number of procedural and substantive pre-conditions before providing financial assistance to a private equity firm. Firstly, the directors of a target company are required to procure a special resolution in a general meeting approving the proposed financial assistance transaction. Directors are also required to file a statutory declaration prior to the provision of financial assistance to a private equity investor. It is useful to note that a private company may only provide financial assistance out of its distributable profits or where such financial assistance will not reduce its net assets, which is defined in terms of the aggregate of the company’s assets less the aggregate amount of its liabilities. The controlling provision, i.e. Section 183(4)(a), does not include a materiality test thereby creating some uncertainty as to the threshold for determining materiality [1]. However, given that directors are required to file a statutory declaration, it would appear that the primary consideration is for a target company to be solvent at the time of providing financial assistance.
Final Comments
The new financial assistance rules represent a significant advancement for Nigeria’s leveraged buyout market. However, most private equity investments in Nigeria tend to be minority stakes rather than buyouts, meaning private equity firms might not need leverage and could fund investments solely with their capital. Despite this, leveraged buyout structures could prove to be the more capital-efficient approach for local public-to-private transactions.
This publication is not intended to provide legal advice and is not prepared with a specific client in mind. Kindly seek professional advice specific to your situation. You may also reach out to your usual Balogun Harold contact or contact us via support@balogunharold.com for support.
[1] For public companies, the materiality threshold is 50%.
