There is a growing wave of entrepreneurs in Nigeria who have recently launched or are currently promoting the launch of a first-time venture capital or private equity fund.
Whilst there is still some noticeable reluctance amongst the traditional institutional investors, who prefer to seek out established managers with a proven track record, global and more established PE/VC firms, an emerging LP class in the sub-Saharan Africa play, seem to be much more eager to give first-time local funds opportunities to prospect for deals locally, using a number of innovative fund-of-fund and feeder structures that offer downside protection.
We share below some key legal considerations that first-time general partners should pay attention to when setting up a fund in Nigeria. Although often overlooked, legal and corporate governance considerations do have a bearing on the success and 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 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 their funds will be domiciled in Nigeria or in an offshore jurisdiction.
Private equity and venture capital fund managers are 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 the fund, there may be a need for parallel registration of funds 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 ₦1bn 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 institutional investors, like pension funds, are prohibited from investing in funds that are not 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 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.
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.
Private equity or venture capital funds are investment vehicles formed by fund/investment managers, known as sponsors, looking to raise capital to make multiple investments in a speciﬁed industry sector or geographic region. The investors in the funds are usually passive investors who make a commitment to invest a set amount of capital over time, entrusting the fund’s sponsor to 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 (LLPs) with different legal implications. For instance, funds structured as an 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, deductions and credits 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 and income tax liabilities are huge considerations for investors, and fund managers must put these requirements in focus in determining which entity best suits present requirements.
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 some offshore jurisdictions.
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. 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 investors may have. Feeder fund structures are typically used to accommodate investment in the fund by one or more investors where they prefer, for tax purposes, to invest in the fund indirectly 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 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 general partner of an ELP can also apply for 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. Also, the private equity fund’s general partner does not require any form of approval or licensing in the Cayman Islands.
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 should 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. It is useful for fund managers to discuss fund marketing strategies with counsel ahead with a view to complying with extant securities regulation in this regard.
Olubunmi Abayomi-Olukunle is a partner at Balogun Harold, a boutique M&A and finance law firm for private equity, venture capital and strategic buyers focused on Africa.