Crowdfunding 101 — A Legal Guide To Crowdfunding In Nigeria
Table of Content:
- What is Crowdfunding?
2. Types of Crowdfunding
3. Legal Framework for Crowdfunding In Nigeria
4. Which Entities Are Eligible for Raising Funds Through Crowdfunding?
5. Which Entities Are Prohibited From Fundraising?
6. Are Crowdfunding Entities Required To Register In Nigeria?
7. What Are The Modalities For The Protection of Investors’ Interests?
8. What Are The Restrictions On Investment-Based Crowdfunding Activities In Your Jurisdiction?
9. Conclusion
In this article, we are going to examine the crowdfunding landscape in Nigeria and answer some of the most pertinent legal questions surrounding crowdfunding in Nigeria.
What is Crowdfunding?
Crowdfunding is simply defined as the process of acquiring funding for a business or project by collecting small donations from many individuals. The Securities and Exchange Commission (SEC) Rules 2021 further defines crowdfunding as “the use of small amounts of money, obtained from many individuals or organizations, to fund a project or, a business through an online web-based platform”.
It is a non-traditional approach to financing that could be beneficial to private enterprises or charitable causes of all kinds. Crowdfunding could be used to raise interest-free loan capital to run a developing business. Thus, the benefits of crowdfunding cannot be overstated.
Types of Crowdfunding
At its very core, crowdfunding can broadly be categorized into two types-
A. Donation-based Crowdfunding
B. Investment-based Crowdfunding
Let us briefly consider these two types of crowdfunding activities.
Donation Crowdfunding
Donation-based crowdfunding often entails raising funds for a cause from many persons with little or no rewards given in return. Funding could be raised for purely charitable causes with no benefits accruing to the donors or for businesses with some form of reward (for instance, a discounted pricing on goods and services to individuals based on their contributions to the business) or incentive given to the donors in exchange for their donations.
In reward-based crowdfunding, the rewards obtained by the donor typically have a lower value than the sum donated. The rewards obtained in this type of crowdfunding very often have only symbolic values attached to them.
Investment-based Crowdfunding
As opposed to donation-based crowdfunding, investment-based crowdfunding is different in the sense that it is employed towards funding a business for profit. Investment-based crowdfunding could be either debt-based or equity-based. An example of debt-based crowdfunding is peer-to-peer lending where loose bands of individuals pool resources to lend to a business with an agreement for profit-sharing in the venture.
Debt-based crowdfunding is often resorted to by small to medium-sized businesses that cannot afford traditional debt financing from banks. It is also deplored by businesses that may be unable to access loans due to factors such as the absence of proper banking facilities. There is often little to no interest rate associated with the credit given to the business.
Supposed the money lent out in this context is given for a specific social project with no interest or profit accruing to the lenders, then this can be termed, “social lending”. Social lending is also a type of debt-based crowdfunding activity.
Equity-based crowdfunding entails businesses raising funds from the public in exchange for part ownership in the business. The benefit of this type of crowdfunding is that it offers the public opportunity to own part of a thriving business and provides liquidity for the business. This type of crowdfunding is long-term, and donors/investors are only entitled to a return on their investment if the business venture succeeds.
Equity-based crowdfunding models are typically high-risk-high-rewards crowdfunding as some are solely based on profit-sharing only. in this case, the investors invest an upfront sum of money in a business, with an agreement for predetermined rates of profits.
Legal Framework for Crowdfunding In Nigeria.
Although by Section 67 of the Investment & Securities Act 2007, only public companies can offer their securities to the public for purchase and subscription, Crowdfunding is a relatively new legal development in the Nigerian capital markets jurisdiction. To bring some form of regulation to this area, the Securities and Exchange Commission issued new rules on the regulation of investment-based crowdfunding activities in 2021.
Conversely, there are no similar regulations for donation-based crowdfunding activities.
The Rules primarily provide for the regulation of four main players in the investment-based crowdfunding sector: Crowdfunding Intermediary, Crowdfunding Portal, Fundraiser, and Investor.
Crowdfunding Intermediary: The SEC Rules define a crowdfunding intermediary to be an entity organized and registered as a corporation to facilitate transactions involving the offer or sale of securities or investment instruments through a Crowdfunding Portal.
Crowdfunding Portal: A website, platform, portal, intermediary portal, application, or that facilitates interaction between Fundraisers and the investing public.
Fundraiser: refers to the originator, maker or obligor of the investment instrument to be issued according to the SEC Rules.
Investor: An investor is any person or other entity who commits capital with the expectation of receiving financial returns.
Which Entities Are Eligible For Raising Funds Through Crowdfunding Platforms?
Under the SEC Rules, only Micro Small, and Medium Enterprises (MSME) with a minimum of 2 years operating track record or MSMEs with less than 2 years track record but operating with a technical partner with more than 2 years track record, are allowed to raise funds from a registered crowdfunding platform run by a registered crowdfunding intermediary in Nigeria. In addition, such MSMEs are mandated to be incorporated in Nigeria.
Which Entities Are Prohibited From Fundraising Activities?
The following entities under Rule 39 of the SEC Rules are prohibited from raising funds through crowdfunding activities:
- Complex structures: these are entities without immediate transparency of ownership or control or entities whose beneficial owners cannot be ascertained.
- Public listed companies and their subsidiaries.
- Companies with no specific purpose or undefined objectives.
- Companies that intend to use raised funds to provide loans or invest in other companies.
- Every other company prohibited by the Commission from.
Are Crowdfunding Entities Required to Register In Nigeria?
The Crowdfunding Rules provide that entities involved in investment-based crowdfunding activities register at the SEC. Specifically, Crowdfunding Intermediaries are required to register first as a corporation incorporated in Nigeria with the Corporate Affairs Commission (CAC) and then register with the SEC as an institution dealing with funds invested by the public.
The Rules also provide that Crowdfunding Portals must be operated by Crowdfunding Intermediaries registered in Nigeria. In addition, under Rule 5, any foreign Crowdfunding Portal targeting Nigerian investors or promoting its offers to Nigerian investors must have the operating Crowdfunding Intermediary registered in Nigeria.
Crowdfunding Intermediaries are required to operate an orderly, fair, and transparent system concerning the investment instruments that are offered through their electronic platforms.
In addition to the foregoing, the board members, chief executive officer or any officer in charge of the financial management of a Crowdfunding Intermediary Platform are expected to be fit and proper persons who have not been found wanting, convicted, disciplined by any court or professional body in connection with financial offences.
A Fundraiser, by the requirements of Rule 21, is also expected to be an incorporated entity with a verifiable identity of its place of incorporation, management, and public offering document.
What are the modalities for the protection of investors’ interests?
The Rules have provided various mechanisms for protecting investors’ interests, which are briefly analysed below.
Due Diligence
Crowdfunding intermediary organisations are mandated by Rule 12 of the SEC Rules On Crowdfunding 2021 to conduct due diligence on all prospective Fundraisers seeking to employ their platform in raising funds from the public. The Crowdfunding Intermediary should ensure that a Fundraiser seeking to offer and sell investment instruments through the portal complies with the requirements of the Rules, verify the accuracy and viability of the business proposition of the Fundraiser, the solvency of the Fundraiser and if the business forecast is based on sound assumptions, as well as proper compliance with various Know Your Customer (KYC), Anti-Money Laundering (AML) and Combating Financing of Terrorism (CFT) regulations as may be issued by the SEC.
To avoid incidences of self-dealing and insider trading, Crowdfunding Intermediaries shall not allow a Fundraiser to use its platform if its directors or any officer or shareholder with significant shares of the Crowdfunding Intermediary own more than 5% or more of the securities of the Fundraiser. The only exception to this rule is where the consent and approval of the Commission are first sought and obtained before the acceptance of the Fundraiser on the platform.
Tag-along Rights
By Rule 28 of the Crowdfunding Rules, Fundraisers are mandated to include in their articles of association the right of retail investors to sell their stakes in a Fundraiser company to a third party within three (3) years of the conclusion of the offer if the controlling shareholders in the Fundraising company transfer ownership of their stake to a third party.
By the same token, for debt offerings, no admission of such shall be allowed to a Crowdfunding Platform if there are no conditions for the existence of the right of early redemption in the said offering. As with equity offerings, the debt offering document/agreement must provide for the right of investors to exercise their right to early redemption if the controlling shareholders transfer control of the fundraising company to a third party within three (3) years from the conclusion of the debt offering.
Data Protection & Privacy
Rule 14 of the Crowdfunding Rules provides that Crowdfunding Intermediaries create proper safeguards ensuring the integrity of information received and published on its platform, ensuring security and confidentiality of information collected from investors, identify the sources of operational risks and adopt adequate procedures and control to avoid operational disruptions; develop and implement a written identity theft prevention as well as observe general compliance with the Nigerian Data Protection Regulation 2019.
Prohibition of Deceptive & Manipulative Inducement
Rule 19 prohibits intermediaries and persons associated with an intermediary from effecting or inducing any transaction using manipulative, fraudulent or deceptive business practices.
Disclosures
The Crowdfunding Rules provide for two distinct types of disclosure requirements for Fundraisers:
General Disclosures: — mandates that the offering document provided by the Fundraiser provides detailed warnings to investors, the particulars of the directors and shareholders of the Fundraising company with more than 5% equity interest, along with warnings given to the investors. In addition, offering documents must disclose such details as the use of proceeds, and capital structure of the fundraiser’s business to mention but a few requirements.
Risk Disclosures: — shall include the liquidity of the securities, the investment lock-in period, performance expectation risks, and dilution risks amongst many other risks associated with the offer.
Fundraisers are additionally required to continuously disclose detailed use of the proceeds from fundraising activities cum annual reports and financial statements to the Crowdfunding Intermediary.
What Are The Restrictions On Investment-Based Crowdfunding Activities In Your Jurisdiction?
Both the Intermediary entity and Fundraising company have distinct limits on their mode of operation within the scope of the Crowdfunding Rules 2021.
Crowdfunding Intermediary Restrictions.
An Intermediary is strictly prohibited from providing investors with financial assistance to invest in its platform as well as compensating anyone who introduces an Intermediary to information concerning investor prospects.
Furthermore, officers and managing executives of Crowdfunding Intermediaries are prohibited from canvasing for investments or making recommendations.
Lastly, a Crowdfunding Intermediary is prohibited from utilizing any, website, social media portals, or third-party portals other than the registered website of the Crowdfunding Portal to facilitate a crowdfunding offering.
Fundraiser Restrictions
Fundraisers are prohibited from hosting a single offer concurrently on multiple crowdfunding platforms. Also, Fundraisers are prohibited from offering referral rewards to anyone other than a crowdfunding intermediary in connection with their offering. However, this restriction does not apply to the compensation of persons offering professional legal / accounting services to the Fundraiser.
Furthermore, Fundraisers are prohibited from lending, making arrangements for financing or financing an investor to enable the purchase of its investment instruments by the investor.
Conclusion
The 2021 Crowdfunding Rules are indeed laudable as they have provided quite a robust means by which unlisted private companies could solicit the public for capital within the bounds of a registered crowdfunding platform. Nevertheless, there is always room for improvement as the Japanese “Kaizen” philosophy upholds. It is not clear from the regulation, the modalities by which these rules could be enforced. Special provisions also need to be drafted into the Companies and Allied Matters Act 2020 (CAMA) to provide definitions covering the unique identity of crowdfunding operators.
