HIGHLIGHTS OF THE NEW SECURITY AND EXCHANGE COMMISSIONS’S REGULATION ON CROWDFUNDING
INTRODUCTION
One major issue confronting startups and SMEs seeking to either commence business or expand their operations is funding. Accessing loans from commercial banks in Nigeria can be extremely difficult given the stringent requirements and prohibitive lending rates. A viable alternative means of funding startups and SMEs is crowdfunding.
Crowdfunding is the practice of raising funds from a segment of the public to fund a project. The funds are raised from the public are often negligible amounts of money raised through an internet platform, in return for equity in the business venture or an ascertainable profit. The issuers disclose the purpose for which the funds will be utilized, the rate of return accruable to the investor and set the timeframes within which the investor will get his returns.
FORMS OF CROWDFUNDING
Crowdfunding can take any one of the following forms:
Donation based Crowdfunding: This is typically reserved for non-profit and humanitarian efforts and
Reward Based Crowdfunding: The entrepreneur solicits funds from individuals in return for non-monetary rewards.
Investment Crowdfunding: Funds in return for equity or shares in the sponsor investment vehicle.
Debt Crowdfunding: Funds for a fixed income until the loan sum is due.[1]
In addition to the above models, that have been in some crowdfunded ventures, the utilization of hybrid crowd funding models with the merger of the debt-based crowdfunding and cooperative society structure. This model is believed in some quarters, to be best suited for the African market. In 2019 alone, Nigerian startups raised more than USD377million through crowdfunding more than twice the value raised in 2018 showing the growing acceptance of this mode of financing for startups.[1]Despite its attraction, crowdfunding had hitherto the recent intervention by the Securities and Exchange Commission (SEC)[2]been unregulated in Nigeria which meant that investors were susceptible to a number of investment risks.
The SEC; the apex regulatory agency for the Nigerian capital market and responsible for the regulation of all offers of security as well as the protection of investors amongst other things, recently released its Rules on Crowdfundingthat will govern crowdfunding activities in Nigeria.
Crowdfunding Regulation in Nigeria
The provisions of the Investment and Securities Act (ISA) and the Companies and Allied Matters Act (CAMA) do not permit private companies in Nigeria to invite the public to subscribe to any of their shares. The SEC’s regulation on crowdfunding will apply to investment-based crowdfunding alone and will govern the process of raising funds from the public through an online portal in exchange for shares, debt securities or other investment instruments approved by the Commission. Some of the provisions of the regulation are discussed below.
How will funds be raised?
Under the new regulation, Crowdfunding can only be raised through crowdfunding portals. These portals must be operated by crowdfunding intermediaries who are required to be registered by the SEC and have a minimum paid-up capital of N100 million or approximately $258,000[3]and a current Fidelity insurance Bond valued at 20% of the paid-up capital amongst the other registration requirements. This capital requirement will prove difficult for existing and intending Crowdfunding portals to achieve but can be surmounted through raising additional equity capital and or consolidation.
Crowdfunding Portals and Intermediaries
The proposed regulation further provides that a person is considered to be facilitating, operating, providing, or maintaining a Crowdfunding Portal in Nigeria if:
(i) the platform is operated, provided or maintained in Nigeria;
(ii) the platform is located outside Nigeria but actively targets Nigerian investors; or
(iii) the component parts of the platform, when taken together, are physically located in Nigeria even if any of its component parts, in isolation, is located outside Nigeria.
A Crowdfunding Portal that is located outside Nigeria will be considered as actively targeting Nigerian investors if the operator, or the operator’s representative promotes the platform directly or indirectly in Nigeria. This regulation seeks to put an end to Crowdfunding portals incorporating their companies outside Nigeria to avoid registering with the SEC but actively operating and raising funds in Nigeria.
In addition to the foregoing, the regulation places a number of obligations on Crowdfunding portals that must fulfilled for the purposes of registration with the SEC and these include:
- The Chief Executive of the Crowdfunding portal has an obligation to confirm the suitability and efficiency of its personnel to operate the portal and that adequate security measures have been implemented;
- The Crowdfunding portal must display conspicuously information on the fundraisers, a general risk warning on participating on the portal; information about complaints and a grievance redress mechanism
- The Crowdfunding portal will also have to show Business Continuity Plans, risk management, data integrity and confidentiality, proper record keeping and audit trails as part of its application for registration with SEC;
- Crowdfunding portals will further be mandated to take adequate measures to reduce risk of fraud such as obtaining background and securities enforcement regulatory history checks on the issuer;
- Crowdfunding portals must carry out due diligence, conduct background checks, and verify the accuracy and viability of the business proposition of the fundraisers intending to use its platform;
- Comply with all KYC and AML/CFT regulations;
- Crowdfunding Intermediaries must file monthly reports at the SEC stipulating the total number of investors, fundraisers and securities issued during the reporting period; and
- Portals must ensure the installation and operation of suitable back-up facilities and must also be adequately insured against portal failure or closure amongst other obligations.
Existing Crowdfunding Portals have been given a 90-day timeline effective from the 21stday of January 2021 to restructure their operations and conform with the provisions of this regulation.
The Fundraiser
In contrast to what presently obtains, the regulation provides that only Medium, Small and Micro enterprise (MSMEs) incorporated in Nigeria and in operation for a minimum of two (2) years; and MSMEs with less than a two-year operating period but having a strong technical partner who possess the 2-year operating record minimum will be eligible to raise funds through a Crowdfunding Portal. The imposition of a two-year track record for MSMEs to be eligible to raise funds appears to negate the advantage of crowdfunding being an avenue for startups to raise funds. However, the regulation does not require the MSMEs to register with the SEC before becoming eligible to undertake crowdfunding activities unlike in the United States (US) where business issuers must first register with the US Securities and Exchange Commission before pursuing a crowdfunding round.
A threshold has also been set for the amount that can be raised by MSMEs through crowdfunding to not more than N50million (approximately $129,000USD) for a micro enterprise; N70million ($180,000USD) for a small enterprise; and N100million ($258,000USD) for a medium enterprise in a 12-month period[4]. In other jurisdictions such as New Zealand, issuers have a maximum limit of $1.5 million in a 12-month period; in comparison to the USA, where issuers cannot sell more than $1million of their offered security in a 12-month period and Malaysia which has no limit on the amount an issuer can crowdfund. These limits are however not applicable to digital commodities investment platforms that connect investors to specific agricultural or commodities projects for the purpose of sponsoring such projects in exchange for a return.
All crowdfunding offers are valid for 60 days, but can be extended for another 30 days during which a minimum of 50% must have been realized. Where this threshold is not met, the offer must be withdrawn, and the issuer may commence a new crowdfunding offering not earlier than 30 days after the said withdrawal and after showing to the Crowdfunding Intermediary that the relevant financial and other information has been updated.
Non-permitted Fundraisers
Certain entities are prohibited from raising funds through a Crowdfunding Portal and they include:
- complex structures[5];
- publicly listed companies and their subsidiaries;
- companies with no specific business plan or a blindpool[6];
- companies that propose to use the funds raised to provide loans or invest in other entities; and
- such other entity as may be specified by the Commission.
Investors
The Rule further seeks to restrict the amount that can be invested through Crowdfunding. With the exception of sophisticated and qualified institutional investors[7], retail investors will not be permitted to invest more than 10% of their annual income in a calendar year. This provision of the regulation aligns with international best practice. Retail investors in Malaysia are not permitted to invest more than RM50,000 ($12,368) within a 12-month period[8]; while Investors in the USA are not permitted to invest more than $2,000 or 5% of their annual income or net worth if their net worth is less than $100,000; and 1% of their annual income or net worth is equal to or greater than $100,000[9].
The rules of the Crowdfunding Portal make satisfactory provisions for the protection of investors and public interest. It offers investors the rights of action and withdrawal in the case of a misrepresentation; the option to withdraw their investment or an offer to purchase securities within 48 hours of the close of the issuer’s offer where there is any material adverse change which affects either the project or the issuer. Investors also have the right to rescind their investment within 7 days from the date the change became public knowledge. Where an investor cancels an offer or decides to withdraw his investment, all funds which may have been debited from or blocked in the account of such investor is required to be refunded or released within 48 hours of their request to cancel. Investors are however prohibited from transferring their securities or investment instrument for a period of 1 year unless the transfer is to the issuer of the securities or investment instrument; to an institutional investor; or part of an offer for sale registered with the Commission.
The regulation further provides for a time limit within which an investor can cancel or withdraw his investment but does not require the investor to provide reasons for which an investor can request to cancel or withdraw its investment. If this is not provided, the utilization of the funds raised will be subject to uncertainty due to the fear of cancellation by investors.
Data Protection and Privacy
In compliance with the provisions of the Nigerian Data Protection Regulations, the Crowdfunding Intermediary and the data controller must ensure the security and confidentiality of all personal data of investors. They are to install and operate suitable back-up facilities and ensure the development and implementation of a written identity theft prevention program.
General Disclosure
The offering document must disclose the target offering amount, details of the fundraisers; Board resolutions of the fundraiser; use of the proceeds; exit options for investors; particular and peculiar risks facing the fundraisers business; a narrative of the financial condition of the fundraiser; warnings to the investors; and state all the risks associated with the investment without mitigants.
Compliance and Penalties
The Crowdfunding Intermediary must implement written policies and procedures relating to the operations of its portal and shall permit inspection and examination of its business and business operations by representatives of the SEC. Any Crowdfunding Intermediary who does not comply with one or more of the rules shall be liable to a fine of not less than N100,000 ($258) and the sum of N5,000 ($13) for every day the violation persists. The Intermediary will also be liable for the loss of any investor’s funds arising from its failure to comply with the regulations.
Conclusion
Regulating the Nigerian Crowdfunding industry is a very welcome development and it brings a lot of hope and excitement for the future of innovation in Nigeria. Although the Rules understandably seek to protect investors and it appears to have addressed that , the SEC still needs to balance the expectation of all stakeholders in the Crowdfunding space. It also still remains to be seen how effective and efficient the implementation of the rules will be.
[1]https://techpoint.africa/2020/02/26/nigerian-startups-funding-report-2019/
[2]Section 13, Investments and Securities Act, 2007
[3]The conversion rate used is 1naira to 0.00258USD. However, this rate is subject to change depending on foreign exchange fluctuations
[4]The conversion rate used is 1naira to 0.0027USD. However, this rate is subject to change depending on currency market fluctuations
[5]A complex structure is an entity without immediate transparency of ownership and/or control thereby making it difficult to immediately ascertain the beneficial owners of the entity.
[6]A blind pool is a business plan which is solely for the purpose of merging with or acquiring an unidentified entity.
[7]. A sophisticated or qualified institutional investor is any investor who has a net worth, in excess of N250million in securities, cash or real estate assets or earns annually the sum of N25million.
[8]Regulation 13.24, Chapter 13, Guidelines on Recognized Markets in Malaysia
[9]https://www.sec.gov/oiea/investor-alerts-bulletins/ib_crowdfunding-.html
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