It is common knowledge that all businesses need finance or capital to start up, run or expand their businesses. Many Nigerian entrepreneurs, small businesses and companies do not have sufficient funds to finance their businesses or projects and may have to seek financing outside of themselves. Companies depending on their size and purpose of seeking financing may explore debt capital financing, equity financing or loan financing.
Equity financing involves raising capital for your business through selling parts of your business by issue of shares to investors or shareholders. This may be through issue of shares by public offerings for public quoted companies or by private equity financing for private limited companies.
Private equity financing in Nigeria may come from registered Private Equity Funds which are regulated by the Securities and Exchange Commission (SEC) or from private companies or individuals (not SEC regulated) that choose to engage in private equity investments. Note that in both private equity financing provided by Private Equity Funds and private companies, the same documentation and due diligence in respect of the transactions are to be followed.
Structure of Private Equity Funds
Private Equity Funds is a type of collective investment scheme that invests primarily in private equity/unlisted companies whether or not in an attempt to gain control of the company. See Section 557 of the SEC Consolidated Rules of 2013.
The structure of private equity investment as well as the terms and conditions of the investment will vary in nature and complexity depending on the type and size of investment. Private equity investment are often characterized by: (i)allowing management of the company to run the business but with the investor retaining full access to management, the business records and other information; (ii) the ability to take control of the management of the business if necessary, and (iii) exiting the investment for a profit usually after 3 to 5 years through initial public offerings, offers for sale, secondary-buyouts, trade sales, acquisition by initial sponsors or majority shareholders.
The most common types of Private Equity funding transactions in Nigeria are venture capital, development finance, growth capital, leveraged buyout. For the purpose of this article, we will deal with venture capital as one of the structures of private equity funding.
Venture Capital Investment
Venture capital Fund is regulated by the SEC which provides for the creation of venture capital funds in Section 555 of the SEC Consolidated Rules. Venture capital is a type of private equity investment provided to early stage, start-up businesses with little or no operating history. Startups that are more likely to have venture capital investors are those that explore new technology, new marketing concepts and new products that do not have a proven track record or stable revenue streams. Venture capitalist investors interested in these types of small businesses will usually bring technical, as well as managerial expertise to the management team. However, they will look to make high rates of return on their investments because of their high-risk nature.
Preparing for Venture Capital Investment
A business seeking venture capital investment must have:
- prepared its business plan
- collated all relevant information about the company and its business so the investor can conduct a satisfactory due diligence exercise to determine whether or not to proceed with the investment.
- Obtained relevant shareholder approvals for approving sale of shares
- Amended its articles of association to allow for issue of shares to investors where there are restrictions on transfer of shares. Section 22(2) Companies and Allied Matters Act 2019 (CAMA)
- increased share capital to allow for venture capital investment where the company has no unissued shares available.
Key Documentation in Venture Capital Investment
The key documents for venture capital investment are the articles of association and the subscription and shareholders’ agreement. The venture capital investor will want to ensure that there is proper documentation of its rights and liabilities in the company.
- Articles of Association: The articles of association of the company are public documents that contain the governing powers of a company which are signed by the shareholders at the date of incorporation and are binding on the company and its shareholders. Investors will generally require the adoption of new articles or amendment of existing articles which will provide for share capital, share classes, which may include preference shares and different classes of ordinary shares, share rights, including as to: dividends voting, and redemption and sale rights, rights and restrictions on share transfers, pre-emption on share transfer provisions, share allotments/issues, including pre-emption provisions on share allotments/issues, and the board of directors, including appointment and removal and board proceedings.
- Subscription and Shareholders’ Agreement: This agreement is between the investor, the company, management and any other shareholders of the company which sets out the basic terms of the investor’s subscription for new shares. It also contains how the company is to be operated. It will include provisions dealing with the constitution of the board including appointment of the investor on the board; regular provision of specified financial and other information to the investor; management’s conduct of the business; investor consents and directions, and exit mechanisms of the investor after the growth of the business for profit.
- Other documents
The managers may be required to enter into new employment agreements if existing arrangements are unsuitable to the investor. There will also be various ancillary documents necessary for completion such as: (i) board resolutions for the appointment of a new director or directors representing the investor, and; the issue of share certificates; (ii) the acceptance of the terms of investment including the issue of new securities; (iii) execution of the subscription
and shareholders’ agreement; (iv) company resolutions for an increase in the company’s authorised share capital (if appropriate), any issue of new securities in the company, any waiver of existing pre-emption rights and termination of any existing shareholders’ agreement.; (v) the adoption of new or amending existing articles of association.
Completion of the investment
This will usually be conditional on adoption of new articles (or amendment of existing articles); execution of new employment agreements (if existing arrangements are unsuitable) and other specific documentation, and specific prior consents and approvals such as shareholders consents and resolutions.
It is necessary to note that upon completion of documentation, the company will be required to file all shareholders and board resolutions, as well as file new (or amended) articles of association and all relevant forms at the Corporate Affairs Commission in compliance with the CAMA.
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