Lack of adequate and sustainable financing has always maintained a top spot in the list of challenges facing SMEs in most jurisdictions, Nigeria inclusive. Traditional methods of entrepreneurial financing, like venture capital and angel investing have proven unattractive to entrepreneurs as they often come at a high cost to the entrepreneurs – loss of control, amongst other prohibitive conditions. High interest rates, demand for collateral and assets charging have also made access to loan facilities from commercial banks non-viable to entrepreneurs and SMEs, and despite governmental efforts at providing customized financing, the problem persists.
Within the last decade, the concept of crowdfunding, an offshoot of the model of collaborative economy, emerged as a one-size-fits-all financial solution. Its basic appeal is in gathering small sums of money from a large, dispersed audience, dubbed as ‘the crowd’, to fund a project (which could be infrastructural, commercial or simply philanthropic). From peer-to-peer lending to social lending; crowdfunding as it is, has developed beyond a ‘lending’ culture to accommodate models and variations and is now being adopted to finance nearly every kind of project; ranging from business ideas, to purely personal projects like education and medical expenses. One of its variations is equity crowdfunding.
Equity crowdfunding is a form of equity investing, its distinguishing factor being that rather than being restricted to private placements, private companies (or in general, companies not listed on the stock exchange) can solicit funds from a large, often dispersed audience through leverage on the borderless world of the internet. In today’s increasing hyper-digitized corporate environment, crowdfunding has interestingly enlarged the scope of private companies accessibility to investors.
While the excitement (accompanied by skepticism) and benefits surrounding this ‘finance wonder baby’ are mounting in most jurisdictions, Nigeria closed the door to this opportunity (hopefully temporarily) when the Securities and Exchange Commission (SEC) in August 2016 announced the ban of all equity crowdfunding activities until further notice.
Flowing from this background, this report aims to evaluate the legal and regulatory restrictions to equity crowdfunding in Nigeria and propose workable solutions, borrowing from a couple of jurisdictions where the concept is thriving.
1. CREATING A REGULATORY FRAMEWORK FOR EQUITY CROWDFUNDIG IN NIGERIA: MUCH ADO OR MUCH TO DO
Nearly 3 years after the ban on equity crowdfunding until regulatory intervention, the SEC has not issued any regulation on equity crowdfunding, despite reports to the effect that it is collaborating with experts and understudying other jurisdictions with relevant regulations. Perhaps, one of the reasons for this hesitation is the extent of the disruption that accommodating equity crowdfunding within the Nigerian corporate space would occasion. Let us examine some of them:
- Crowdfunding operates by allowing a multitude of stakeholders participate in the raising of funds for a particular purpose. However, section 22 of the Company and Allied Matters Act, 2004 (CAMA) interdicts private companies from having more than fifty members and restricts the transferability of shares.
- A private company is, at the point of incorporation, required to fill form CAC 2 detailing the particulars of its subscribers and providing their signatures. Any change in this information is also required to be registered at the CAC by post-incorporation filings. Complying with this incorporation and post-incorporation requirement will be impossible for a crowdfunded company, whose investors are widely dispersed.
- The Investment and Securities Act, 2007 (ISA) by virtue of section 67 disallows persons from offering an invitation to the public to acquire or dispose of securities without being duly registered with the SEC. Therefore, only a duly registered public company can offer equity and solicit for funds from the public, upon obtaining approval from the SEC. This appears absolutely prohibitive for the Small and Medium-Scale Enterprises (SME) to which crowdfunding mostly appeal, as they are usually unable to meet the requirements to be incorporated as a public company.
In 2018, a Bill to amend the Companies and Allied Matters Act was introduced to the National Assembly and was received with high optimism by the general public. Curiously though, especially for a country professing to be on the drawing board for how best to regulate equity crowdfunding, the Bill has no provisions addressing or alluding to the imminent changes that equity crowdfunding would occasion, and the limitations discussed above would persist, should the Bill be passed into law in its current form. In other words, before equity crowdfunding will see the light of day in Nigeria, the CAMA Bill will either have to be reviewed to accommodate equity crowdfunding; before the Bill is passed into law, or we would, in the very near future need to entertain another Bill to amend the CAMA.
Aside regulatory constraints, another necessary pre-condition for equity crowdfunding to thrive is a fool-proof system of citizens’ record and identification, as well as proper cyber security and cyber identification mechanisms which Nigeria as a country is still grappling with in terms of the appropriate legal and regulatory structures and processes.
2. ESTABLISHING A PROGRESSIVE ENVIRONMENT FOR CROWDFUNDING IN NIGERIA: LESSONS FROM OTHER JURISDICTIONS.
A study conducted by the International Finance Corporation (IFC) reveals that approximately 96% of Nigerian businesses are SME’s, whereas 53% of businesses are SME’s in the US and 65% in Europe. Most capital market financing options such as private equity financing, loans from banks and venture capitalism tend to abstain from investment in SME’s because of the high risk involved, however crowdfunding will grant entrepreneurs the opportunity to raise funds and grow their business, thereby contributing towards the building of a sustainable Nigerian economy. In addition, if adequately regulated it will be a less cumbersome and cheaper mode of raising capital than other securities trading options.
Interestingly, in devising a workable system for equity crowdfunding in Nigeria, the SEC need not build a framework from scratch. It can borrow models from jurisdictions that are ahead in this regard and adjust the adopted models to suit local circumstances. Two exemplary jurisdictions are highlighted below
i. UNITED STATES OF AMERICA
President Barack Obama’s administration enacted the Jumpstart Our Business Startups Act in 2012. It authorised startups, SME’s and private companies to raise capital via crowdfunding. However, the US Securities and Exchange Commission further created codified rules known as Regulation Crowdfunding (the Regulation). The major implications of the Regulations on participants include:
- requiring all transactions under Regulation Crowdfunding to take place online through a SEC-registered intermediary, either a broker-dealer or a funding portal
- provides crowdfunding exemption and requirements: it permits a company to raise a maximum aggregate amount of $1,070,000 through crowdfunding offerings in a 12-month period
- limitation on the amount individual investors can invest across all crowdfunding offerings in a 12-month period and
- requiring disclosure of information in filings with the Commission and to investors and the intermediary facilitating the offering.
A leaf that Nigeria can borrow from this is to separate regulatory disclosure requirements from the nascent companies by making the companies seek funds only through registered intermediaries who bear the burden of disclosure. Also, it can start with a low cap on how much companies can raise through crowdfunding and subsequently raise the bar as the market grows and the stakeholders’ understanding deepens.
ii. NEW ZEALAND
New Zealand established a regulatory framework guiding equity crowdfunding in 2013. Several platforms have launched since, allowing New Zealand companies to raise up to $2 million in a 12-month period without the typical offer documents required under securities law. On the 1st of April 2014, the Financial Markets Conduct Act 2013 (the FMC Act) introduced a new regime for equity crowdfunding through the licensing of Crowdfunding Service Providers (CSP). A 2016 paper published by the University of Oxford on Equity Crowdfunding in New Zealand, found that over NZ$25 million has been raised through the licenses procured by CSP’s.
A pertinent advantage of crowdfunding through a duly licensed CSP is the waiver granted to companies to raise up to $2 Million in a 12-month period without complying with the mandatory requirement to offer documents under securities law.
If Nigeria intends to duplicate a similar model and make it possible for issuers to offer securities once they are licensed CSP, it is necessary that the Nigerian SEC is thorough in providing the requirements for a crowdfunding license to avoid incidents of fraud.
3. RECOMMENDATION(S)/ CONCLUSION
The growth prospects for crowdfunding is huge in Nigeria considering her large population, large number of SME’s and entrepreneurs; and the increasing number of citizens with internet connectivity. Furthermore, the power of social media and the large number of citizens in diaspora will be an enabling factor to the profitability of crowdfunding to the economy. According to World Bank’s report on Crowdfunding Potential for the Developing World, it estimates a $93 billion equivalent crowdfund investing market by 2025, of which African market would generate $2.5 billion of the overall figure. With an adequate regulatory framework in place, Nigeria could be a major contributor to the overall output.
One of the major concerns regarding crowdfunding (as it is right now in Nigeria) is the notion that it is a medium to defraud the crowd. In order to prevent this from occurring, it is imperative that the Nigerian government create adequate legislation to regulate the stakeholders involved in equity crowdfunding operations. Where there are stringent checks and measures in place to protect, prohibit and sanction fraudulent entrepreneurs and intermediaries, financial extortion through this mode of financing will be mitigated.
An amendment of the relevant corporate laws and capital market regulations is necessary in order to elevate Nigeria to the league of crowdfunding-friendly countries. Fortunately, Mrs Mary Uduk, the Acting Director General of SEC has stated that the Commission is eager to become a sector participant and the next reform of the ISA shall regulate crowdfunding activities in Nigeria.
Nevertheless, a determined and financially innovative entrepreneur will find out that despite the express ban on equity crowdfunding in Nigeria, he can put corporate structures in place and take advantage of special purpose vehicles to access funding from the crowd. Also, it is doubtful that the ban of equity crowdfunding in Nigeria can prevent fund seeking ventures/companies in other jurisdictions from accessing the Nigerian crowd through the internet and with the help of internet-based payment systems and virtual currencies.