Thursday, September 09, 2021 / 6:50 PM / By Balogun Harold
/ Header Image Credit: RevTek Caiptal
Nigeria's venture capital rules do not appear to have been designed to attract modern venture capital. That's 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 and fund innovation. Its 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.
According to a report by Partech, venture capital firms invested up to US$ 2.02 Billion in 2019 and to US$ 1.429 Billion. In a 2021 report, by AfricArena, venture capital firms are projected to invest up to US$2.8 Billion in Africa's tech companies. These numbers mean a lot. In part, the numbers are evidence of increasing entrepreneurial activity in Africa especially in tech sector. The numbers also speak to an increasing confidence and willingness by global venture capital firms to invest in Africa-focused funds and in companies solving problems for Africa.
It is against this background that the Securities & Exchange Commission (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 formal incubation and 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").
How Does the SEC Define Venture Capital?
The Rules do not define "venture capital fund". 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?
What are the Marketing Rules?
There is no clarity on what marketing restrictions apply to venture capital funds. 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.
Should the SEC register all without any Safe Harbors 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. 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.
What Requirements are Necessary for Authorization?
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.
Where We need to Be
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 and Central Bank (CBN) 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 regulatory arbitrage.
This update does not constitute and should not be taken or relied upon as legal advice.
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