Nigeria’s venture capital rules do not appear to have been designed to attract modern venture capital. This is concerning because venture capital fund managers perform an all-important intermediary function of mobilising capital from local and foreign private sources of capital to enterprises and founders that require capital to create economic value. It is also concerning because local demand for venture capital has more than quadrupled in the last year as evidenced by an uptick on the supply side. Partech reports that African tech start-ups raised over $5 billion in venture capital investments in 2021. In part, these investment amounts speak to the increasing confidence of global venture capital firms to invest in Africa-focused funds and in tech companies solving problems for Africa.
It is against this background that the Securities & Exchange Commission (the “SEC”) should consider rethinking its regulatory approach to capital formation in the venture capital industry with a view to simplifying and modernising the process for formation of venture capital funds locally. Localized fund managers can be very useful in the acceleration of innovation, identifying and excluding “bad actors” on the demand side and also, generally de-risking venture capital investments. In this update, we identify a few of the concerns around the state of the SEC’s venture capital rules (the “Rules“).
1. How Does the SEC Define Venture Capital?
The Rules do not define “venture capital fund” [1]. The absence of a definition creates some level of doubt as to the scope of regulatory coverage. From a regulatory compliance standpoint, there are a number of practical questions here – Are angel funds or angel networks to be considered as venture capital funds? Are rolling funds to be considered venture capital funds? What are the limitations for corporate venture capital fund with third party money? Is a venture debt fund to be considered a type of venture capital fund?
2. What are the Marketing Rules for Venture Funds?
There is no clarity on what marketing restrictions apply to venture capital funds [2]. As currently drafted, there are no marketing restrictions for venture capital funds. The practical questions here are as follows: Can venture capital funds market to all types of investors regardless of their sophistication? What rules govern promotional activities for venture capital funds? Can venture capital funds market their funds publicly? Although there is a general prohibition on solicitation in the extant Investment and Securities Act, one cannot assume without more, that the rules against public solicitation for private companies and securities are the same for venture capital securities, especially given the global trend that allows for venture capital funds to solicit publicly in so far as the investors in such funds are accredited investors.
3. Should the SEC Register all Venture Funds without any Safe Harbours or Exemptions?
As currently drafted, the Rules adopts a catch-all approach to registration and authorization, suggesting that the SEC wants to regulate and authorise all types of venture capital fund and managers, regardless of the amount of investor commitments, the sophistication of investors , the number of investors or the assets of under management.[3] There is some doubt as to whether this approach is optimal, when one considers the administrative burden that a catch-all approach can create for the SEC. Safe harbours can be very useful in facilitating the growth of early-stage funds. A related point is the question as to whether or not venture capital fund managers require a paid-up capital at the point of registration or whether insolvency risks are better managed as a private matter between limited partners and a general partner or with the use of a custodian.
4. What Requirements are Necessary for Authorising a Venture Fund
There is a general need to elevate the language of regulation in the Rules and the requirements for authorisation. For instance, venture capital funds do not not have to be structured as trusts but can be structured using a limited partnership. Also, a venture capital fund manager need not be the “general partner” and does not always have to participate in the management of a portfolio company as suggested by the Rules. Additionally, requirements around “super fund companies” and “technical & management agreements” in the Rules, do not, in our view, exactly reflect “what’s market” in the global venture capital industry.
The Future of Venture Funds in Nigeria
This regulatory update is by no means exhaustive and only represents a highlight of some of the concerns with the Rules. However, we need to see the SEC take more deliberate steps around facilitating the formation on onshore dollar and Naira funds. The CBN also has a critical role to play as the ability to exchange currencies and move money is often critical for fund managers. There is no doubt that some level of regulation is key for investor confidence. However, vague regulation can also hamper investment activity and encourage a breach of regulations.
The foregoing does not constitute and should not be taken or relied upon as legal advice. For queries specific to a particular situation, kindly reach out to you usual Balogun Harold contact or via support@balogunharold.com
[1] The Private Equity Rules define “Private Equity Funds” means a type of collective investment scheme that invests primarily in private equity/unlisted companies, whether or not in an attempt to gain control of the company. In a previous opinion, we argued that this definition is inadequate as it does not capture the all the private equity strategies. For instance, private equity funds often conduct PIPE transactions
[2] The Private Equity Rules restrict prohibit “private equity funds” from soliciting funds from the general public. Also, private equity funds can only market to qualified investors
[3] The Rules require only private equity funds with a minimum commitment of N1billion investors’ funds to obtain SEC authorization.
