Nigeria has recently witnessed an increase in private equity (PE) investments. Based on the report made by the African Private Equity and Venture Capital Association (AVCA), PE investments in Nigeria constituted 68% (sixty-eight percent) of PE deal value and 55% (fifty-five percent) of deal volume in West Africa between 2014 and 2019. As a result, the country is rated as Africa’s most attractive destination for PE investments.
Investment activities have resumed across several sectors despite the Covid-19 pandemic and Nigerian start-ups have secured significant PE investments. New rules are being enacted with aggressive enforcement of the old laws, thus, making it vital to stay abreast of the various legal requirements across several stages of PE investing in Nigeria.
Regulatory framework
The laws regulating PE transactions in Nigeria are fragmented and contained in different legislative instruments. Generally, the Corporate Affairs Commission (CAC) oversees the registration, management, and dissolution of companies in Nigeria. The Companies and Allied Matters Act (CAMA) 2020 contains the powers of the CAC over corporate entities. The CAC also recently released the Company Regulations 2021 as subsidiary legislation to CAMA. Consequently, CAMA and the Company Regulations regulate all corporate matters in Nigeria. These regulations, in effect, apply to the establishment and activities of PE firms.
The regulatory powers of the Nigerian Securities and Exchange Commission (SEC) over PE transactions are obtained from the Investment and Securities Act 2007 (ISA), and it classifies a PE fund as a Collective Investment Scheme (CIS). The SEC has also enacted several subsidiary rules which apply to PE transactions. One of the most significant of these regulations is the SEC Rules on Private Equity Funds 2013. It defines a PE fund as one that invests primarily in private equity/unlisted companies, whether or not in an attempt to gain control of the company. The Rules expressly state that it applies to private equity funds established in Nigeria with a minimum of 1 billion Naira in investor funds. With a minimum share capital of 150 million Naira, funds and fund managers must register with the SEC. In addition, the rule prohibits a private equity fund from soliciting funds from the general public. They must instead privately source funds from qualified investors. These are pension funds, insurance companies, banks, development finance institutions, sovereign wealth funds, endowments, and high net worth individuals (HNIs).
Additionally, the SEC extensively regulates promotional materials used by registered private equity funds. The Rules require the distribution of comprehensive information memoranda to investors. During the subsistence of every PE fund, there is a continuous obligation to file quarterly and annual returns with the SEC and semi-annual returns with the investors.
Another effective regulation is the National Pension Commission’s Regulation on the Investment of Pension Fund Assets 2019. It prohibits pension fund administrators from investing pension fund assets in private equity funds unless SEC-registered or managed by SEC-licensed fund managers.
Other vital laws regulating PE are the Finance Act, the Venture Capital (Incentives) Act, the Federal Competition and Consumer Protection Act, the Nigerian Police Trust Fund (Establishment) Act 2019, and the Guidelines on Simplified Process for Foreign-to-Foreign Mergers with Nigerian Component (Foreign Merger Guidelines).
Structuring Considerations
Funds
Generally, PE funds are structured in several ways with different legal implications. They could be limited liability companies (LLCs), trusts, limited partnerships (LPs), or limited liability partnerships (LLPs).
Before CAMA 2020, there was no federal legislation regulating the registration of LPs and LLPs. One could only register a limited partnership in Lagos state under the Partnership Law of Lagos State. Under the new CAMA, these structures are now available to investors across the federation. Their nationwide availability now removes the prior uncertainty on whether LPs would be under the jurisdiction of the federal courts or the courts of other states.
In a limited partnership, a General Partner (GP), usually the Fund Manager, is liable for the partnership’s obligations. In contrast, a Limited Partner (LP) is liable to the extent of its contribution upon agreeing to join the partnership. The Fund Manager manages the fund’s business. The fund’s investors are Limited Partners (LPs) and do not participate in the company’s day-to-day management but may receive certain investment-approved rights under their constituting documents.
Partners are not personally liable for the obligations of the LLP in a Limited Liability Partnership (LLP) because the LLP is a separate legal entity. The LLP combines the tax benefits of a partnership structure and the corporate protection of an incorporated company. CAMA limits the number of partners in an LP to a maximum of twenty (20), while an LLP does not have a cap. Accordingly, most PE funds register as LLPs following the enactment of CAMA 2020 because of the tax benefits and corporate protection they provide.
Transactions
Like other forms of investments, a private equity fund invests in companies (target) and looks to get substantial profit sometime later. These investments can take many forms. Usually, PE is structured around share acquisitions through subscription or purchase from existing shareholders, quasi-equity instruments, or debt financing.
Share acquisitions can be majority or minority acquisitions. Majority share acquisition means acquiring shares in a target to exercise a majority (more than 50%) of the voting power. A majority shareholder owns a group of shares that are more than any other shareholder has. The significant advantage of this is that it gives the PE firm control and direct influence over the target company.
Minority acquisitions, on the other hand, imply that a shareholder holds less than 50% (fifty percent) of the voting rights or equity rights in a target firm. In some instances, a minority shareholder can exercise control over the target, either solely or jointly with other shareholders. Acquirers of minority stakes usually seek contractual and similar protections such as key executive appointments to provide insight into financials, operations, etc. Share acquisitions are advantageous because they allow the investors to have direct and indirect control over the target’s activities.
Debt financing involves lending money to businesses with the expectation of repayment with interest. Investors prefer debt instruments because they are less risky. The target must pay the principal and interest on specified dates without fail. Under this transaction, private equity firms cannot control the target’s activities.
To mitigate some of the pros and cons outlined above, some PE firms adopt a hybrid combination of debt and equity, also known as mezzanine financing. Mezzanine financing enables lenders to convert their debt to an equity interest in the target company in case of default.
Tax Implications
The tax position of would-be investors is a matter of careful consideration. Fund promoters must ensure that investors would not be financially worse off than if they had invested directly.
A target incorporated as a Limited Liability Company (LLC) would have to pay Companies’ Income Tax (CIT). The Finance Act introduced a progressive CIT system for Nigeria. Start-ups and small enterprises with less than N25 million (25,000,000) turnover are exempted from paying CIT. Medium-scale companies whose turnover exceeds N25 million (25,000,000) but is less than N100 million (100,000,000) will be subject to CIT at 20% (twenty percent). Every other company with an annual gross turnover of N100 million (100,000,000) and above, defined by the Finance Act as “large companies,” will pay tax at the standard CIT rate of 30% (thirty percent).
Interest payments on sums borrowed and employed as capital in acquiring profits are tax-deductible in Nigeria. As a result, some PE firms prefer debt financing to equity financing. Debt financing allows entities to enjoy the tax benefits from the loan and the tax-deductibility of interest payments. There are, however, limits to the tax deductibility as the new Finance Act has introduced new capitalization rules for Nigerian entities regarding how they repay foreign loans. Therefore, it is advisable to consult a legal practitioner well versed in tax law.
Income tax is another important consideration. Where a target is registered as a partnership, the individual partners – which may be corporate or personal – will be liable to pay tax on their investment income. In addition, income such as dividends, interest, and management fees is subject to withholding tax. For non-resident investors, such taxes withheld are their final tax obligation.
As regards Stamp Duties, transfer of shares is Stamp duty exempt. However, based on the Federal Inland Revenue Service (FIRS) practice, the share purchase agreement is liable to stamp duty at a percentage of the consideration. Also, documents relating to electronic transactions are now liable to stamp duties.
As far as transactional taxes are concerned, Value Added Tax (VAT) is not payable on the sale of securities, e.g., shares. However, other incorporeal rights (safe for securities and interest in land) are ‘VATable’ goods. The VAT rate is 7.5% (seven point five percent).
Other tax liabilities attached to investors will depend on the private equity transaction’s exit model. Several investment incentive schemes are also available, ranging from tax-free holidays to tax reductions and total exemptions. For example, the pioneer status scheme grants qualified companies operating in certain industries an income tax holiday for three years which may be extended for two additional years.
Investment Process
The private equity investment process usually starts with an evaluation of the target. The target is assessed based on growth potential, management skill set, and return on equity for fund investors. A fruitful initial negotiation process necessitates due diligence.
Due diligence is a necessary, albeit time-consuming, and expensive effort to minimize risks. The target must be vetted for any existing liabilities or encumbrances.
The outcome of the due diligence leads to the final negotiation stage involving a valuation of the target and consideration of the financing structure.
It ends with the execution of the completion and post-completion documents and any other regulatory steps required.
Corporate Governance Arrangement for PE Portfolio Companies
Generally, corporate governance arrangements in private equity companies aim to protect the investors. Hence, corporate measures like voting rights, quorum prescriptions, board management, reserved matters, and other operational structures are included in the portfolio company’s constitution, shareholders’ agreement, or other vital corporate and contractual documents.
The new CAMA contains strict disclosure requirements that may affect the compliance processes of private equity firms in their capacity as directors or shareholders of targets and targets themselves.
Firstly, a member of a company’s board, who is directly interested in any company or enterprise whose affairs are being deliberated upon by the board or who is interested in any contract made or proposed to be made by the board, must disclose such interest.
Secondly, a person who acquires significant control over a company or a Limited Liability Partnership (LLP) must disclose the particulars of such control to the company or partnership within seven days.
In addition, the shareholding or interest of a company’s directors must be disclosed in the company’s register, which must be kept at the company’s registered or head office and be open to inspection during business hours.
The law further allows companies to impose qualified and supermajority voting thresholds for board decisions and disable the chairman’s casting vote in board meetings.
Restrictions on Transfer of Shares and Assets
CAMA has introduced certain restrictions concerning the transfer of shares and assets. For transfer of shares, it provides rights of the 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.
The law further gives existing shareholders of any company statutory protection from dilution by giving them pre-emptive rights to any newly issued shares. Waivers of these rights will be obtainable where necessary. However, there is no specified timeframe for exercising or relinquishing rights.
For significant asset transactions, i.e., transactions outside the ordinary course of business involving assets or rights representing 50% (fifty percent) or more of the book value of the company’s assets, shareholder approval is now required.
Exits
Some of the exit options are;
- Initial Public Offering (IPO): An IPO allows a private company to go public by selling its shares to the general public. Following the IPO, the company’s shares are traded on the open market.
- A trade sale or strategic acquisition: A private equity investor may sell all of his shares in the portfolio company to a third party or an existing minority shareholder for cash consideration or equity in another company. Trade sales are mostly preferred as they immediately return the cash investment to the fund. They are also less dependent on capital market conditions and can provide a more predictable sale price.
- Secondary buyout or sponsor-to-sponsor buyout: There is a secondary sale to financial investors such as larger private equity firms or international or regional businesses looking to expand into the Nigerian market. Depending on the sector in which the company operates and the turnover of the portfolio company, sector-specific approvals and merger clearance from the Federal Competition and Consumer Protection Commission (FCCPC) may also be required to effect a secondary sale successfully.
- Management buyout (MBO): This is the sale of a portfolio company to its management team or senior employees. MBO typically requires the approval of the company’s management making the acquisition and that of the SEC when a public company is involved. There is also sector-specific regulatory approval needed in certain instances.