Crowdfunding is a means of raising funds through the public in exchange for equity in a startup. According to a report, the global crowdfunding market was valued at 13.64 billion U.S. dollars in 2021. However, whether this option is available for Nigerian startups is something you are anxious to find out. Perhaps you also desire to have your startup funded through crowdfunding. Hence, you are asking what the legal implications might be.
Potentially, Nigeria should be the hub of crowdfunding in Africa. However, various challenges threaten the growth of this platform as a means of financing. These include regulatory issues, lack of adequate awareness, as well as fraud, and corruption.
What is crowdfunding?
Typically, according to (Ordanini, Miceli, Pizzetti, & Parasuraman (2011), crowdfunding is an unconventional alternative method of soliciting funds from a vast number of people through the use of the Internet. Historically, the 2008 global financial crisis caused challenges for businesses to acquire loans from banks because of strict requirements, limited amounts offered, and high-interest rates (Hendratmi, Sukmaningrum, Ryandono, & Ratnasari, 2019). Therefore, the evolution of crowdfunding has made it easier to use for financing.
Many countries have been utilizing this funding alternative with North America being the largest region with a crowdfunding market. Furthermore, this growth has also been recorded in Europe and some Asian regions. In contrast, there is a slow growth of crowdfunding in African regions.
Startup in Nigeria.” class=”wp-image-1496″/>Growth Rate of crowdfunding in Nigeria
A report shared by Afrikstart (2015) showed that at the end of 2015, there were 57 crowdfunding platforms across Africa, with South Africa leading with 21 platforms. This was followed by Nigeria and Egypt with 9 and 5 platforms respectively.
However, the overall crowdfunding market for Africa-based platforms as of then was estimated to be $32.3m, and this was less than 0.1% of the total activity around the globe. Out of this estimated fund, Nigeria raised $314,445.
Recently, different kinds of crowdfunding platforms have come into existence in Nigeria to serve businesses’ financial needs. These platforms provide a far-reaching service for various activities, including charity, farming, and raising funds for new startups.
The Concept of Crowdfunding
For the last ten years, crowdfunding has been thriving as an opportunity provider for businesses, charitable organizations, and individuals. It raises money from a large crowd of investors or contributors to provide for various projects, such as education, startups, and the arts.
It is an internet mode of funding to raise capital for entrepreneurs seeking investment. The motive of this investment goes beyond making a profit. The basic elements of crowdfunding are centred around the intensity of the crowd, the technology, and capital financing, which permits numerous small endeavours to accumulate into a huge financial result.
The crowdfunding procedure depends heavily on technology, both in terms of the sites for the presentation and the social media that facilitate its spread. Also, crowdfunding can be used for advertising or promoting one’s market and generating interest for new startups.
Legal Problems Associated with Crowdfunding Your Startup in Nigeria.” class=”wp-image-1497″/>What Are the Types of Models for Crowdfunding in Nigeria?
Generally, there are four models of crowdfunding available for startups;
- Donation-based crowdfunding
Donation-based crowdfunding is a mechanism in which the collection of funds occurs through the Internet for philanthropic, social, or other motives without expecting any compensation in return (monetary or not)
- Reward-based crowdfunding
Reward-based crowdfunding is a model where investors receive a gift or are provided with the products as an appreciation for financing an initiative.
- Loan-based crowdfunding
Lending-based or loan-based crowdfunding has a similar concept to borrowing money in a traditional way. Here, borrowing is done in an internet-enabled platform where lenders solicit funds and investors choose to lend money to the borrowers or founders in exchange for a lower interest rate, which is set by the platform.
- Equity-based crowdfunding
Equity-based crowdfunding is an online platform in which funders obtain benefits (financial return) in the form of fundraisers’ equity-based revenue or profit-share arrangements.
Startup in Nigeria.” class=”wp-image-1498″/>Prospects of Crowdfunding in Nigeria
Nigeria has prospective features which make it potentially viable for the crowdfunding market in West Africa. These features include a large population, widespread mobile users and internet connectivity, and strong social media usage. Furthermore, it has a great network of family and friends and thriving entrepreneurial prospects. Additionally, the country had 126.08 million internet users in 2019, equivalent to 61.2% of the population, up from 92.7 million in 2015, which was 51.1%. Therefore, many individuals can be reached through crowdfunding by potential entrepreneurs.
Nigeria is one of the fastest-growing emerging markets in the world, and its financial infrastructure is ahead of others. The biggest advantages are its strong social media usage and a great network of family and friends.
Secondly, the entrepreneurial scene is expanding rapidly just as the banking system is moving ahead of its counterparts in other emerging markets. Hence, it provides a promising infrastructure for crowdfunding in Nigeria with innovative mobile banking apps.
What Are the Legal Challenges Facing Crowdfunding in Nigeria?
Crowdfunding has the potential to become one of the most prevalent markets in the world. However, the adoption as a means of financing suggests the need to analyze the prominent challenges facing the newly embraced means of financing. Some of the identified challenges and their possible solutions are as follows:
Regulatory Issues
Different crowdfunding platforms are emerging in Nigeria to raise funds, but unfortunately, the country does not have a comprehensive legal framework to accommodate its growth. Consequently, this poses a threat to the progress of crowdfunding as a means of fundraising. Although SEC enacted a crowdfunding rule in 2021 to address these challenges, the rule creates certain requirements to regulate crowdfunding, especially equity-based types. For example, a crowdfunding platform is expected to be registered with the SEC, and a registered intermediary body will operate such a platform.
Under the rule, the right to cancel the registration of any platform is reserved for the SEC due to failure to meet the requirements of the rules, such as a sum of 100 million to operate a crowdfunding platform or losing out to control or keeping up for six months successively.
Furthermore, the rule specifies the types of businesses that are permitted to solicit funds through the crowdfunding platform. Precisely, it was stated in rule 2 that micro, small and medium enterprises (MSMEs) are to be the only ones permitted to seek crowdfunding.
All startups must be registered as a company and should possess a minimum of two years of operating track record before they can solicit funds through a crowdfunding platform. Also, companies lacking two years’ operating track record may also solicit funds. Also, as a condition, these companies must have an essential investor or a robust, practical partner with a minimum of two years of operating track record.
Additionally, the rule limits the amount that micro, small, and medium enterprises (MSMEs) can raise within a year. It was stated in Rule 3(1) (b) that the maximum amount to be raised by a Medium enterprise shall not go beyond ₦100 Million.
This approximately equals US$263,157, and the amount to be raised by a small enterprise shall not exceed 70 million, which is approximately US$148,210.00. Meanwhile, microenterprises are not allowed to raise more than 50 million, which is approximately equal to $131,575.00.
It also limits the maximum amount to be invested within a year. Investors are disallowed from investing more than 10% of their yearly income in a calendar year (SEC Nigeria, 2020).
It can be concluded that these rules are designed to protect investors from unwanted stories. These new regulations permit shutting down some of those platforms that have been doing well over the years when they fail to raise the required amount of 100 million to operate a crowdfunding platform.
However, they can choose to partner with another company since a partnership is the easiest route to avoid being shut down. SEC regulations will not affect them when they choose to operate only as technology providers to other registered bodies.
Subsequently, the government should provide regulations that safeguard investors from fraud, duplicity, and dishonesty, and most importantly, a stringent regulatory framework that will work for this means of financing.
It is worth mentioning that donations and rewards-based crowdfunding are not affected by the regulation draft since the backers neither have any return to share nor the financial profits from the business.
Startup in Nigeria.” class=”wp-image-1499″/>Lack of Adequate Awareness and Understanding
Crowdfunding facilitates stress-free access to capital for businesses due to the use of the Internet to promote and nurture it. Unfortunately, the mechanism is yet to be known by many people in Nigeria.
In a study conducted by Soreh (2017) on the awareness of crowdfunding, it was stated that the awareness is very low and most of the respondents could not identify or at least mention crowdfunding platforms in the country, and campaigns for entrepreneur activities are at their lowest flow.
Practically, most of the successful crowdfunding campaigns are mostly for charity, like raising funds for the sick or children, and instead of utilizing one of the established local crowdfunding platforms or portals, campaigners mostly go for the electronic media, specifically television stations.
Some respondents still believe that crowdfunding is how the government gives SMEs money, and this misconception was influenced by occupation and education level.
Fraud and Corruption
Generally, fraud is one of the prominent issues posing a challenge to the growth of crowdfunding across the globe. Additionally, it may manifest in various ways, from the funders or fundraisers to outsiders.
However, Renwick and Mossialos (2017) asserted that even though fraud and money laundering constitutes a major threat, the act is rare and does not significantly discourage people from participating in crowdfunding.
The issue of Nigeria regarding fraud is even more worrisome due to the large number of internet users. The expansion of the Internet in the country has undoubtedly come with unexpected fallout as a refuge for criminals. Therefore, the rate of internet fraud is very high.
The NDIC (Nigeria Deposit Insurance Corporation) reported that the figure for Internet (web-based) banking fraud increased from 316 in 2013 to 1,271 and 1,471 in 2014 and 2015, respectively (The Guardian, 2017).
Evidence in 2016 showed that 43% of the overall monetary loss was accounted for by cybercrime only due to fraud (Ibrahim, 2019). This is also coupled with the fact that corruption is rampant in the country.
Without a shred of doubt, once a country is labelled as a haven for fraud, potential investors will be cautious about investing through the Internet due to the panic of being prey to cyber-attack. This will certainly undermine the development of crowdfunding as a means of financing in the country.
However, Internet fraud cannot be simply eradicated but can be reduced. In order to minimize this crime to an insignificant level, there should be a call for an active collective and cooperative resolution between individuals, corporate associations, and mostly the government.
Furthermore, regulations should be provided to safeguard investors from fraud, duplicity, and dishonesty and to impose rigorous constraints concerning cybercrime that threatens Nigeria’s business.
Crowdfunding platforms are also indebted to creating legitimate notices to their customers in conformity with government guidelines and measures.
The Issue of Trust and Transparency
On a global scale, trust is one of the most important factors influencing the success of crowdfunding. This is because the platform involves channelling uncollateralized capital to finance a particular business through the Internet with no intermediary like a bank.
The issue of trust and transparency in Nigeria is not a mere thing. In a study conducted by Okoyeuzu, et al. (2019), it was discovered that most of the respondents stressed the significance of trust because there is a very big and considerable issue among many Nigerians regarding trusting each other. Consequently, they prefer using social media like Facebook, Twitter, and Instagram to solicit funds.
Furthermore, It appears challenging for crowdfunding to break into the financial market, which has been dominated by the customary mainstream means of financing. This is mostly accurate in the case of a trust, whereby mainstream financial institutions already have deep-rooted influence in the market.
This shows that the users are acquainted with and confident in their product. However, trust between the investors and the fundraiser can be established from the perspective of calculus and relationships. Furthermore, the key players religiosity can also contribute to trust.
In that regard, crowdfunding platforms can correct this. To conduct this, each crowdfunding site should demonstrate its trustworthiness and reliability to investors by displaying security features on its site and certificates of funds given stipulated terms and conditions.
The Issue of Double Taxation
One of the most prominent challenges facing entrepreneurs in Nigeria is the high tax rate. For crowdfunding to develop in a developing country, the tax system should be flexible concerning new projects. The tax rules should also expect corrections to think about the investors and entrepreneurs.
In any case, there is a premonition peril of a two-fold tax assessment that can be charged on crowdfunding. This is because of stamp obligations, and capital addition charges deductible upon asset transfer.
The Federal Government of Nigeria may consider providing special tax waivers and incentives for securities issued through the platforms. This includes the exemption of such securities from the tax imposed under the Companies Income Tax Act.
Such policies may further encourage eligible issuers to undertake such crowdfunding transactions. Finally, to preserve the reliability and good principles of crowdfunding, it is necessary to build a framework of best practices through the three pillar method.
Regulation pillar;
While waiting for regulation to be legislated, crowdfunding mediators should provide criteria centering around the subsequent sorts of consumer safety. These include financial and operational transparency practices, security of data and payments, and financial control to protect and detect fraud.
Education pillar;
For the assurance enhancement of crowdfunding, it is presumed that there is a necessity for educational settings to educate funders, entrepreneurs, and stakeholders on the advantages of the institution and its various types. These settings will be responsible for a just and reasonable guide to safeguard the economic interests, diversification, and exposure of investors and investees over various crowdfunding models. Furthermore, it helps to offer management about fraud, risk clarification, and possibly test investors’ knowledge.
Research pillar;
It is presumed that the crowdfunding industry should inspire educational and intermediary studies. The workers should make data sets available to promote industry requests for discovering an open and transparent method. Furthermore, studies and public reports will bring about improvement and competition within the industry.
CONCLUSION
Crowdfunding is an alternative funding option that has been thriving across the globe for the last decade with the help of the Internet. It supports society’s contribution to growing businesses and provides remarkable flexibility for entrepreneurs to solicit funds.
Interestingly, Nigeria, as a country that has a huge population and developmental chances, has the potential to become the hub centre of crowdfunding in Africa. However, various challenges are facing the growth of the platform as a means of financing. These include issues of regulation, lack of adequate awareness, lack of sufficient understanding, as well as fraud and corruption, which are prevalent in the country.
Meanwhile, the efforts of the SEC are commended and highly praised for having initiated the procedure of regulating the crowdfunding industry. However, the industry should not be excessively regulated since people’s involvement may be discouraged.
Lastly, there is a need for greater public awareness about crowdfunding and the establishment of a supportive environment for the workings of the system. Also, there is a crucial need to educate people on crowdfunding and its role in facilitating business projects with substantial funding.
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