February 26, 2017
There is a growing wave of entrepreneurs and first-time GPs in Nigeria who have recently launched or currently promoting a first-time venture capital or private equity fund. We think that global trends in the venture capital and private equity industry justifies this development. Whilst there is still some noticeable reluctance amongst the traditional institutional investor class, who generally prefer to seek out established managers with a proven track record, the more established private equity and venture capital firms – an emerging LP class in the Sub-Saharan Africa play- seem to find it strategic to give first-time GPs, the opportunity to close a fund and to prospect for deals locally, using a number of innovative fund-of-fund and feeder structures that offer varied downside protections.
As part of Balogun Harold’s commitment to bridging the information gap in Nigeria’s evolving venture capital and private equity industry, we share below some key legal considerations that first-time GPs should pay attention to when setting up a fund in Nigeria. This Market Update particularly focuses on certain legal & regulatory considerations and is intended to be a resource for both local and foreign sponsors or would-be LPs, looking to set up or invest in a private equity or venture capital fund in Nigeria. Although often overlooked, legal and corporate governance considerations do have a bearing on the success and or attractiveness of a fund.
For context, we draw parallels from the regulatory approach to fund formation in the Cayman Islands.
Fund Manager Registration
All private equity and venture capital fund managers operating in Nigeria are required to register with Nigeria’s Securities and Exchange Commission (SEC). In accordance with the rules made pursuant to the Investment and Securities Act, a fund manager is an entity that provides investment advisory services, selects securities for a fund under management, publishes financial market periodicals, manages funds on behalf of investors and performs any role ancillary to the above. It is important to note that venture capital and private equity fund managers are required to register with the SEC regardless of whether there funds will be domiciled in Nigeria or in an offshore jurisdiction.
Fund Registration
Although it is possible to structure around fund registration with the SEC, private equity and venture capital fund managers are generally required to register their funds with the SEC where the fund(s) are to be domiciled in Nigeria. Depending on the structure and marketing objectives of a fund, there may be a need for parallel registration of funds with the SEC in Nigeria. It is important to note that the funds registered with the SEC are subject to a number of rules relating to marketing restrictions, investment limits, valuation standards and capital requirements. For instance, private equity funds domiciled in Nigeria may only be marketed to the institutional investors delineated by the SEC. It is useful to note that there exist safe harbour provisions for private equity funds with the effect that private equity funds with investor commitments of up to N1 billion need not register with the SEC. Although, the same provisions do not exist for venture capital funds, certain other benefits come with SEC registration. For instance, certain local institutional investors like pension funds are statutorily permitted to invest in funds that are registered with the SEC. In addition to these general considerations, fund promoters may have to contend with additional laws and regulations depending on the location and/or preferences of the fund’s targeted investors. In any event, it is extremely important for fund formation/marketing activities to be carried out with the benefit of professional counsel as the evolving nature of fund regulation requires early and careful planning.
(AML/CFT) Compliance
Private equity and venture capital fund managers are required to comply to the fullest extent possible with Anti-Money Laundering/Combating Financing of Terrorism (AML/CFT) standards prescribed by the SEC. Amongst others, private equity and venture capital fund managers are required to develop internal policies for complying with AML/CFT standards, undertake customer due diligence and KYC exercises based on the prescribed statutory risk categorisation of investors.
Entity Structuring
Private equity or venture capital funds are investment vehicles formed by fund managers looking to raise capital to make multiple investments in a specified industry sector or geographic region over a predetermined period of time. The investors in the funds are usually passive investors who make a commitment to invest a set amount of capital over time, with the expectation that sponsors will source, acquire, manage and divest the fund’s investments. More often than not, private equity or venture capital funds are legal entities structured as close-ended investment entities. In Nigeria, private equity and venture capital funds can be structured as limited liability companies, trusts or as limited liability partnerships (LLP) with different legal implications. For instance, funds structured as LLP, only possible in Lagos State as of date are treated as ‘pass-through” entities for corporate income tax purposes and therefore not subject to corporate income tax at the entity level. In practice, the entity’s income, gains, losses, and deductions are passed through to the partners and taxed only once at the investor level. Funds structured as LLPs also have the benefit of management flexibility and limited liability. Personal liability and income tax liabilities are huge considerations for investors. First-time GPs must put these requirements in focus in determining which entity best suits not only investor requirements but also, the need to, as far as is possible, shield the carry, the GP’s fees and co-investments returns from avoidable tax liabilities.
Domicile
It is typical for local private equity and venture capital funds to domicile their funds in an offshore jurisdiction. The reason for this is because of the perceived advantages that offshore jurisdictions offer in terms of tax, flexibility, repatriability and sometimes familiarity of investors with an offshore jurisdiction. The tax position of would be investors is a matter for careful consideration and perhaps one of the biggest factors influencing the choice of an offshore jurisdiction as the domicile for a fund. Overall, fund promoters must ensure that investors will not be in a financially worse position than they would have been if they had invested directly. Admittedly, it is practically impossible to foresee all the tax concerns that would-be investors may have. It is typical for GPs to use feeder fund structures to accommodate investment in a fund by one or more investors where such investors have special tax considerations or prefer for tax purposes to invest indirectly in a fund, through an upper-tier entity.
There are significant tax and operational advantages for funds domiciled in and structured as an Exempted Limited Partnership (ELP) in Cayman Islands. For instance, an ELP in the Cayman Islands is tax transparent with the effect that there is no entity-level taxation and the value distributed from investments will ordinarily flow through to investors. In addition to the benefit of tax transparency, there are no capital gains, income, withholding, estate or inheritance taxes in the Cayman Islands. An ELP can apply for an undertaking from the Cayman Islands Government that no form of taxation that may be introduced in the Cayman Islands will apply to the ELP for a period of 50 years from the undertaking being given. The GP of an ELP can also obtain an undertaking from the Cayman Islands government that no form of taxation that may be introduced in the Cayman Islands will apply to the GP for a period of 20 years from the undertaking being given. In some ways, the Cayman Islands ELP bears features similar to those found in the Delaware Revised Uniform Limited Partnership Act, hence the attraction from managers and investors in the United States. More importantly, private equity funds however structured are not regulated by the Cayman Islands Monetary Authority, because the equity interests issued by the ELP are not redeemable or repurchaseable at the option of investors and GPs do not require any form of approval or licensing.
Private Placement
The Investment and Securities Act makes provisions imposing restrictions on raising private capital. As a practical matter, interests in a private equity or venture capital fund are considered as securities and promoters of private equity and venture capital funds need to ensure that offerings are carried out as a private offering and that such activities do not constitute an invitation to the public. An invitation will be deemed an invitation to the public where such invitation is (a) published, advertised or disseminated by newspaper, broadcasting, cinematograph or any other means whatsoever (b) made to or circulated among any persons whether selected as members or as debenture holders of the company concerned or as clients of the persons making or circulating the invitation or in any other manner (c) made to anyone or more persons upon the terms that the person or persons to whom it is made may renounce or assign the benefit of the offer or invitation or any of the securities to be obtained under it in favour of any other person or persons; (d) made to any one or more persons to acquire any securities dealt in by a securities exchange or capital trade point or in respect of which the invitation states that an application has been or shall be made for permission to deal in those securities on a securities exchange or capital trade point.
On the whole, we find that the chance that first-time GPs will run foul of securities regulation or basic corporate governance standards during fund formation activities is very high, especially in markets where the regulatory landscape is still largely evolving. It is extremely useful for first-time GPs to obtain professional counsel at the very early stages of fund formation to avoid incurring the costs, in time and in money terms, that come with regulatory infraction and to increase their chances of securing the level of commitments required to close a first-fund.
The objective of this note is to provide individuals looking to set up a private equity or venture/impact capital fund with preliminary, high-level information on the legal and regulatory framework around venture capital and private equity fund formation in Nigeria. The Note is not intended to be a substitute for specific legal advice or a legal opinion. It deals in broad terms only and is intended to merely provide a brief overview and general guidance. For more specific advice on the setting up private equity or venture/impact capital funds in Nigeria or in an offshore jurisdiction, or conducting due diligence/ investing in a local venture capital or private equity fund, please refer to your Balogun Harold contact or write us via support@balogunharold.com
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