This article is intended to explore the concept of private equity, venture capitalism and angel investments and the guiding principles, structures and regulation of these concepts.
What is Private Equity?
The Security and Exchange Commission (SEC) defines a private equity fund as a type of collective investment scheme that invests primarily in private equity/unlisted companies, whether to gain control of the company. It is essentially direct investment into a company's growth by way of capital provided by investors to non-quoted companies with high profit potential. A private equity firm/fund provides financial backing and makes investments in the private equity of start-ups or established businesses through a variety of loosely affiliated investment strategies including equity investment, management buyout, venture capital etc.
Investments in Africa
Investing in businesses that generate non‐financial impact is not a new concept in Africa; loans and investments to family and friends are as common on the continent as they are around the world, if not more so. West Africans at home and around the world have a long and proud history of supporting each other financially through community and family channels. These investments have both social and financial impact, building communities at the same time as building businesses. Beyond these informal investment networks, DFIs and other international investors have been pursuing a similar combination of philanthropy and investment for years. Recently, as more foundations, private investors, and institutional investors expand their investment strategies, many investors have developed investment strategies that would fall under the definition of “impact investing”. Despite this development, many “impact investors” in West Africa are still unfamiliar with the term. The International Monetary Fund has predicted that the growth of private equity investment in Sub-Saharan Africa (SSA) will probably surpass the global average by a good margin in the nearest future. Furthermore, SSA will experience an increase in Gross Domestic Product of over 5.1% in 2018. Nigeria is a major contributor to the private equity sector in SSA, with investment to the tune of billions of dollars.
The Nigerian private equity market, despite the current economic situation, continues to thrive. According to data obtained from Africa Private Equity and Venture Capital Association (AVCA), it was deduced that foreign equity investors have found Nigeria as the most attractive investment destination in Africa with $7.8 billion investments in the last five years. This amount is more than the total equity investments in South Africa and Kenya. In addition, 32 percent of all private equity investment deals that took place between 2012 and 2017 in Africa are situated in companies operating in Nigeria. It is noteworthy that the private equity industry in Nigeria is still in its growth phase. The country's evolution as a preferred destination for private equity investment in SSA is largely due to its constantly growing population and the ongoing privatization, deregulation and restructuring of strategic sectors.
In Nigeria, Private Equity Firms/ Funds (PEFs) often obtain their funding through contributions from institutional and retail investors, including high net worth individuals, pension funds, insurance funds, banks, and other financial institutions. As earlier mentioned, investments by private equity firms are usually made via management buyouts, equity investment, company restructuring and leveraged buyouts. However, equity investment is the most preferred option, as it entitles the investor to partake in the management of the investment.
PEF's often target the following sectors: consumer goods, telecommunications, health, information and communications technology, mining, real estate and construction, oil and gas, financial services, media and entertainment, shipping, food and ago-allied products among others. The approach essentially adopted by PEFs in Nigeria is to identify competent entrepreneurs and management teams with a proven track record of performance. This is usually because entrepreneurs and management teams tend to be the majority owners of the business and would possess an understanding of the relevant market as well as required local network for their respective businesses. The investments are based on the potential of the business to grow and expand, and the capacity of management to deliver the projected return on investments.
Regulatory Implications
The New Companies and Allied Matters Act enactment (CAMA), CAMA has introduced certain restrictions with respect to the transfer of shares and assets. With respect to the transfer of assets, on the combined reading of sections 342(2) and 22(2)(a) CAMA ‘major asset transactions’ (i.e. transactions outside the ordinary course of business) involving assets, or rights representing 50% or more of the book value of the company’s assets require shareholder approval. Prior to this, the law was silent as to the requirement of shareholder approval for the disposal of significant assets. One area of note is the apparent contradiction between the approval thresholds stated in sections 342(2) (which provides for 75% threshold) and 22(2)(a) (which provides for unanimous consent) for asset transactions. It will be interesting to see how this conflict is addressed in practice.
With respect to the transfer of shares, the extant CAMA imposed a requirement on private companies to restrict the transfer of its shares in their articles of association, though the form of the restrictions was not outlined. CAMA has gone further. Section 22(2) (b)-(c) provides for rights of first offer for all shareholders before shares are sold to third parties and for the sale of a majority equity stake to be subject to the remaining shareholders’ tag-along rights. There are, however, differences of opinion as to whether the provisions at section 22(2)(a)-(c) are default, mandatory or optional. Should they be mandatory, these provisions could significantly extend transaction timelines and investors will need mechanisms to mitigate their impact. It may also impact funding and existing shareholder rights. Existing agreements may need to be reviewed to ensure alignment with these provisions. Companies may also need to amend their articles of association to specifically exclude these restrictions where necessary.
Pre-emption Rights
CAMA gives existing shareholders of any company statutory protection from dilution by giving them pre-emptive rights to any newly issued shares. However, there is no specified timeframe for the exercise or relinquishment of rights. In addition, there is no clarity on whether relinquished rights to new shares can be redistributed and timeframe for the entire process.
Financial Aid
CAMA permits a private company to provide financial assistance (in most cases, collateral/security for acquisition financing) for an acquisition of its own shares or the shares of its holding company upon meeting certain conditions. These conditions include the passing of a special resolution (i.e. a 75% majority decision) of the shareholders approving the financial assistance, the making of a declaration by the directors in a form to be prescribed by the Corporate Affairs Commission and the non-reduction of net assets, or where reduced, that such assistance be financed out of distributable profits.
Share Buyback
Prior restrictions on the purposes for executing a share buyback have been removed in the CAMA. Prior to this, buybacks were permitted for a limited number of purposes and there was no provision allowing buybacks as a means of returning capital to investors.
Offers to buy back shares must be made to all shareholders in proportion to their existing holdings. A public company may now buy back its shares in the open market (i.e. at market price). The overturn of these previous restrictions provides investors with an additional exit option.
Investor Rights
CAMA now clearly allows companies to impose qualified and super-majority voting thresholds for board decisions and to disable the chairman’s casting vote in board meetings. However, at shareholder level, there is still no express provision for bespoke voting thresholds or option to disable the chairman’s casting vote.
CAMA does not clarify the relationship between articles of association and shareholders agreements. CAMA also makes no amendments to the restrictions on non-voting and weighted shares.
Conclusion
Conclusively, With the establishment of Small and Medium-Scale Industries Equity Investment Scheme (SMEIS) in 2001 and the liberalization of telecommunication in Nigeria, venture capital activities have expanded leading to a corresponding increase in the presence of VC firms in Nigeria or outside with focus on Nigeria (Sub-Saharan Team often based in London, South Africa or Ghana). The use of ICT in Nigeria is growing in the financial services sector outside the Oil and Gas Industry, a major consumer of technology. The agriculture business sector (renewable energy, seed production) has equally enjoyed interest from the VCs. The interest to invest in Nigeria over the last ten years by both local and international venture capital funds is attributable to the stable macroeconomic indicators fueled by a continual democratic governance and entrenchment of rule of law and economic policies (our interviews, Unmanned, 2011, Yusuf, 2011). We have seen an upsurge in the number of funds created (in Nigeria or Sub-Saharan-dedicated) by fund managers, though the proportion invested directly on technology-based firms (TBFs) in Nigeria could not be asker- tainted with great certainty, yet we acknowledge the presence of Venture Capital supporting creation of Technology-Based Firms.