1 Legal framework
1.1 Which general legislative provisions have relevance in the private equity context in your jurisdiction?
In Nigeria, provisions regulating private equity transactions are contained in different legislative instruments. The most important provisions can be found in:
- the recent Companies and Allied Matters Act 2020 (CAMA) and the Companies Regulations 2021 made pursuant to S. 87 of CAMA;
- the Finance Act 2019;
- the Guidelines on Simplified Process for Foreign-to-Foreign Mergers with Nigerian Component;
- the Nigerian Police Trust Fund (Establishment) Act 2019;
- the National Pension Commission Regulations;
- the Venture Capital (Incentives) Act;
- the Federal Competition and Consumer Protection Act 2019; and
- a number of regulations issued by the Securities and Exchange Commission (the body responsible for regulating the capital markets in Nigeria).
Considered the most progressive piece of legislation on corporate law in Nigeria in the past three decades, CAMA is a game changer. For instance, previously, there was no federal legislation regulating the registration of limited partnerships and limited liability partnerships, which are the preferred structures worldwide for setting up and managing private equity funds.
1.2 What specific factors in your jurisdiction have particular relevance for and appeal to the private equity market?
The environment for businesses looking to establish in Nigeria is increasingly favourable, largely thanks to the government's efforts to create a conducive regulatory framework and improve the ease of doing business. Other factors that continue to improve the investment climate in the country include:
- a large population;
- increased investor appetite;
- advancements in technology development and adoption;
- a cheap and relatively well-educated workforce;
- youth bulge demographics;
- competitive company valuations;
- sectoral restructuring; and
- evolving policies aimed at enabling business in Nigeria.
2 Regulatory framework
2.1 Which regulatory authorities have relevance in the private equity context in your jurisdiction? What powers do they have?
The Corporate Affairs Commission (CAC) is in charge of overseeing the registration, management and dissolution of companies. Thus, its powers over the affairs of corporate entities as provided under the Companies and Allied Matters Act (CAMA) naturally apply to the establishment and activities of private equity firms. CAMA regulates everything from the constitution of a company to share capital requirements, share issues and transfers, corporate conversion and restructuring, insolvency and dissolution. In December 2020, the CAC issued the Companies Regulations 2021 pursuant to Section 87 of CAMA.
The Securities and Exchange Commission (SEC) regulates private equity funds through the provisions of the Investment and Securities Act and the rules and regulations issued by the SEC. In particular, the SEC requires that:
- private equity funds established in Nigeria with a minimum commitment of NGN 1 billion in investor funds be registered with the SEC; and
- fund managers with a minimum share capital of NGN 150 million be registered with the SEC.
The National Pension Commission regulates private equity and investments through its regulations and guidelines, which prescribe the kinds of private equity funds in which Nigerian pension fund assets may be invested. Critical criteria for eligibility include that:
- the manager be registered as a fund manager with the Nigerian SEC;
- up to 75% of the fund be invested in Nigeria; and
- the fund manager retain a minimum investment in the fund.
The Federal Competition and Consumer Protection Commission (FCCPC) is another major regulatory agency, as it ensures the implementation of the Federal Competition and Consumer Protection Act, which is Nigeria's primary and most comprehensive competition law. In November 2019 the FCCPC issued the Foreign Merger Guidelines, which regulate the acquisition of shares or other assets outside Nigeria resulting in a change of control of a business, part of a business or any asset of a business in Nigeria.
Notably, the act applies to "all undertakings and all commercial activities within or having effect within Nigeria", as well as offshore transactions that result in a change of control of "a business, part of a business or any asset of a business in Nigeria"; and provides that the approval of the FCCPC is required for such transactions.
2.2 What regulatory conditions typically apply to private equity transactions in your jurisdiction?
Under the rules and regulations of the SEC, a private equity fund must not solicit funds from the general public and must instead privately source funds from qualified investors such as banks and pension funds.
The National Pension Commission's Regulation on the Investment of Pension Fund Assets 2019 prohibits pension fund administrators from investing pension fund assets in private equity funds that are not SEC registered or managed by SEC-licensed fund managers.
Also, the SEC extensively regulates promotional materials used by registered private equity funds. Comprehensive information memoranda must be distributed to investors, whose content is also strictly prescribed. The SEC rules apply only to private equity funds established in Nigeria with a minimum commitment of NGN 1 billion.
3 Structuring considerations
3.1 How are private equity transactions typically structured in your jurisdiction?
Transactions are typically structured around share acquisitions, which may be via subscription or purchase from existing shareholders, quasi-equity instruments and debt. For majority share acquisitions, control and direct influence are the main drivers; while acquirers of minority stakes seek contractual and similar protections such as key executive appointments to provide insight into financials, operations and so on.
Transactions are often implemented by investor-controlled, offshore-registered special purpose vehicles. Mauritius is the base of choice due to its low tax rate, network of tax treaties and private equity-specific legislation, which allows for significant flexibility and certainty.
3.2 What are the potential advantages and disadvantages of the available transaction structures?
The advantages of equity investments (shares acquisition) include:
- right shares;
- claims over assets and income;
- dividend entitlements;
- limited liability; and
- perhaps most importantly, control.
The disadvantage is that it is a lot riskier than other investment structure types (especially debt):
- There are no guarantees on investment (so where there is a loss, there is no question of dividend;
- Where there is a profit, unless the board of directors proposes a dividend, investors will receive nothing; and
- Equity investors usually have residual claim (eg, compared to debenture holders).
At the extreme end of the investment spectrum is debt financing, which basically involves the lending of money to businesses in the expectation of a repayment with interest. Debt instruments are sometimes preferable because they are less risky, as principal and interest payments must be made on specified dates without fail. The major disadvantage of debt is that it does not give private equity firms any real control over the target's activities.
To mitigate some of the pros and cons outlined above, some private equity firms adopt a hybrid combination of debt and equity, also known as mezzanine financing, which is subordinate to pure debt but senior to pure equity. This gives the lender the right to convert to an equity interest in the company in case of default.
3.3 What funding structures are typically used for private equity transactions in your jurisdiction? What restrictions and requirements apply in this regard?
Investments in private equity funds are usually sourced from qualified institutional investors – that is, purchasers of securities that are financially sophisticated and legally recognised by the Securities and Exchange Commission (SEC), including:
- fund managers;
- registered and/or verifiable private equity funds;
- registered and/or verifiable hedge funds; and
- other operators as determined by the SEC from time to time.
Private equity funds registered outside the country can raise funds from investors in Nigeria only with the prior approval of the SEC.
3.4 What are the potential advantages and disadvantages of the available funding structures?
The defined scope of funding sources makes it easier for private equity firms to know what category of investor to target. However, the fact that funds cannot be raised from the public constitutes a limitation to the pool of investors that can be reached and leveraged.
3.5 What specific issues should be borne in mind when structuring cross-border private equity transactions?
A few concerns are unique to cross-border private equity transactions, including tax considerations and importation of capital. Where capital is to be imported in a private equity transaction, the investors require a certificate of capital importation that is issued by the bank within 24 hours of the capital entering the country. There are no foreign investment restrictions on cross-border private equity transactions in Nigeria, except in certain industries in which private investment – both local and foreign – is prohibited without a licence from the federal government (eg, defence).
Also, as indicated in question 3.2, where a private equity fund registered outside the country seeks to raise funds from investors in Nigeria, it must obtain the prior approval of the SEC.
That said, there are a number of incentives for foreign investors, including:
- a reduction in withholding tax for investors from countries that have a double tax treaty with Nigeria; and
- a reduction in the tax liability of private equity funds that provide debt capital with a repayment period (including moratorium and grace period) of at least two years, which enjoy significant tax exemptions (from 10% to 70%).
3.6 What specific issues should be borne in mind when a private equity transaction involves multiple investors?
Depending on the investment vehicle, multiple investors may want to consider the extent of the liabilities of general partners and limited partners as defined under the Companies and Allied Matters Act. In a limited partnership, a general partner is liable for the obligations of the partnership, while a limited partner is liable only to the extent that it agrees to contribute at the time of joining the partnership. In a limited liability partnership (LLP), the partners are generally not personally liable for the obligations of the LLP.
4 Investment process
4.1 How does the investment process typically unfold? What are the key milestones?
Private equity investment is an interactive process, as some of the activities take place simultaneously, rather than sequentially. It usually involves the following:
- an evaluation of the target, which typically involves an assessment of the company in terms of growth potential, skillset of management and return on equity for fund investors, among other things;
- initial negotiations;
- due diligence (usually a necessary, albeit time-consuming and expensive effort carried out to minimise risks);
- final negotiations based on the outcome of the due diligence;
- valuation of the target and consideration of the financing structure; and
- drafting of completion and post-completion documents
4.2 What level of due diligence does the private equity firm typically conduct into the target?
Due diligence is usually extensive and thorough, as it seeks to uncover every aspect of the target's business, from commercial to operational, compliance and human resources. This is the process through which the private equity firm gains access to information shared by the target. Where due diligence reveals specific issues, indemnities are often sought from the target against any fines or losses that may be incurred as a result of such lapses.
Depending on the investor, typical due diligence usually encompasses the following:
- anti-bribery and corruption;
- IT; and
- environmental, social and governance.
4.3 What disclosure requirements and restrictions may apply throughout the investment process, for both the private equity firm and the target?
The recent Companies and Allied Matters Act (CAMA) contains stringent disclosure requirements that may affect the compliance processes of private equity firms – in their capacity as directors or shareholders of targets – and targets themselves. Notably, CAMA requires disclosure in the following circumstances:
- 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 this interest;
- A person who acquires significant control over a company must disclose the particulars of such control to the company within seven days;
- A 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; and
- A person with significant control over a limited liability partnership must, within seven days of gaining such control, indicate to the limited liability partnership in writing the particulars of such control.
4.4 What advisers and other stakeholders are involved in the investment process?
- Investment team – private equity firm (internal);
- Investment committee/board – private equity firm (internal);
- Diligence advisers – financial; tax; legal; compliance; environmental, social and governance; anti-bribery and corruption; IT etc;
- Legal advisers – local and/or international;
- Tax advisers;
- Regulators; and
- Insurers (early acceptance is increasingly common).
5 Investment terms
5.1 What closing mechanisms are typically used for private equity transactions in your jurisdiction (eg, locked box; closing accounts) and what factors influence the choice of mechanism?
The locked box mechanism is preferred, as it removes uncertainty for all parties: the equity price of the portfolio company is calculated based on a historical balance sheet – where cash, debt and working capital are known amounts – and is fixed in the sale and purchase agreement at the date of signing. Factors that influence the use of the locked box mechanism – especially in private equity transactions – include the fact that it simplifies the legal documentation for a transaction and provides economic certainty, as both parties negotiate a fixed price.
Due to the possibility of leakage – that is, circumstances in which the box is 'not appropriately locked' and value is extracted from the portfolio company before the completion date – buyer's confidence is key in a locked box approach.
5.2 Are break fees permitted in your jurisdiction? If so, under what conditions will they generally be payable? What restrictions or other considerations should be addressed in formulating break fees?
Break fees – a penalty paid by a party which breaks a deal or agreement to the counterparty – are agreed and stipulated by the parties. Common situations in which break fees apply include where a 'no-shop' clause is breached or where the target accepts a bid from another party.
As break fees are, by their nature, paid when a transaction fails, liable parties may attempt to dispute their enforceability. To mitigate this risk, the break fees provisions must be carefully drafted; a break fee may be unenforceable if it is found to be a penalty payable on breach of contract (rather than arising from a defined event as part of a contractual payment mechanism), and if the fee is disproportionate to the legitimate interest of the receiving party.
5.3 How is risk typically allocated between the parties?
This is subject to the negotiations of the parties and will typically depend on the investment structure adopted.
5.4 What representations and warranties will typically be made and what are the consequences of breach? Is warranty and indemnity insurance commonly used?
These include representations and warranties concerning:
- the information disclosed by the target;
- the capacity of the vendors;
- the ownership of shares; and
- the legal and compliance status of the target.
In Nigeria, warranty and indemnity insurance is not common.
6 Management considerations
6.1 How are management incentive schemes typically structured in your jurisdiction? What are the potential advantages and disadvantages of these different structures?
In order to encourage stellar performance by the target's management, a combination of incentive structures is adopted, which may include:
- participation in profits;
- share option plans;
- performance-related incentives;
- employment/severance protections, depending on the length of service;
- salary at the time of retirement/resignation; and
- bonus payments.
6.2 What are the tax implications of these different structures? What strategies are available to mitigate tax exposure?
As individuals, management personnel are subject to personal income tax under the Personal Income Tax Act 2004 (as amended). The marginal personal income tax rate is 24%.
6.3 What rights are typically granted and what restrictions typically apply to manager shareholders?
Special privileges granted to manager shareholders are subject to negotiation and will typically include the grant of privileges such as preferential shares, right of first refusal and so on.
6.4 What leaver provisions typically apply to manager shareholders and how are 'good' and 'bad' leavers typically defined?
Manager shareholders are usually bound by the terms of the shareholders' agreement and/or the articles of association. Usually, manager shareholders who are leaving the company for one reason or another automatically forfeit all their shares which are unvested at the time of their departure; or automatically forfeit that percentage of their shares which remains unvested at the time of leaving. Where a manager shareholder decides to sell his or her shares, he or she is usually required to offer the shares to the company first. Finally, the company may require that a leaving managing shareholder pay up on his or her shares if the shares in question are not paid up at the time of departure.
Good leaver provisions may apply where the employee or director ceases to be employed because of ill health, redundancy or resignation after a certain number of years' service. On the other hand, bad leavers are those who breach the terms of their service or shareholders' agreement, or who resign after a short period of employment.
7 Governance and oversight
7.1 What are the typical governance arrangements of private equity portfolio companies?
Typically, governance arrangements in private equity companies usually aim to protect the investors, which will seek to establish and maintain control over the affairs of the portfolio company. To this end, certain corporate measures – such as voting rights, quorum prescriptions, board management, reserved matters and other operational structures – are put in place in the portfolio company's constitution, shareholders' agreement or other vital corporate and contractual documents.
7.2 What considerations should a private equity firm take into account when putting forward nominees to the board of the portfolio company?
A nominee director is a non-executive director who is appointed to the board of the portfolio company to represent the interests of the private equity firm. As a non-executive director, a nominee director's role is part time and he or she is not involved in the day-to-day management of the portfolio company. He or she is also not entitled to remuneration, but only reimbursement.
7.3 Can the private equity firm and/or its nominated directors typically veto significant corporate decisions of the portfolio company?
Yes, if the private equity firm has acquired a controlling interest in the portfolio company and/or negotiated super-majority voting and veto rights, in order to be able to maintain and exercise some degree of control over the affairs of the portfolio company. The veto right is usually negotiated for reserved rights such as corporate, strategic and commercial matters at the shareholder and board level.
7.4 What other tools and strategies are available to the private equity firm to monitor and influence the performance of the portfolio company?
The private equity firm may also adopt strategies such as:
- stipulating the formula for board constitution;
- ensuring representation at critical board meetings; and
- reserving the right to identify/recommend candidates for top management positions.
These are usually contained in the shareholders' agreement or any similar contractual document, and/or the company's articles of association.
8.1 What exit strategies are typically negotiated by private equity firms in your jurisdiction?
Initial public offering: An initial public offering (IPO) appears to be the most popular exit strategy. This allows a private company to go public by selling its shares to the general public, such that, once the IPO is done, the company's shares are traded on the open market.
Trade sale/strategic acquisition: Private equity investors may sell all of their 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 sometimes preferred, as they return the cash investment to the fund almost immediately. They are also less dependent on capital market conditions and can provide a more predictable sale price
Secondary buyout or sponsor-to-sponsor buyout: Another popular exit strategy is a secondary sale, either to financial investors such as larger private equity firms or to international or regional businesses looking to expand into the Nigerian market.
Management buyouts and owner buy-backs: These are other exit strategies that are sometimes used.
8.2 What specific legal and regulatory considerations (if any) must be borne in mind when pursuing each of these different strategies in your jurisdiction?
Generally, given the limited life of funds, the exit process may need to start early due to the timeline from start to finish – especially where regulatory approvals are required.
Specifically in relation to an IPO, the downside is that there is no guarantee that the exit will be at a preferred price, as market conditions could affect the listing price. Also, the private equity firm/seller should be aware of:
- the cost of effecting the IPO;
- the value of the seller's shares following changes in share capital; and
- the underwriting of shares not taken up by/issued to third parties.
Furthermore, material agreements with a potential impact on share price may have to be disclosed to regulatory authorities. Finally, attention should be paid to contractual provisions such as drag-along and tag-along provisions, pre-emption rights and similar.
9 Tax considerations
9.1 What are the key tax considerations for private equity transactions in your jurisdiction?
The tax issues involved in a private transaction will depend on the structure of the transaction. Typically, tax consultants are appointed to carry out a tax assessment of the proposed transaction – especially where the acquisition vehicle is not domiciled locally – to ensure that on exit, tax incidences are not immoderate.
Where a private equity vehicle is registered as a partnership, the individual partners will be liable to pay tax on their income. Limited liability companies, on the other hand, bear the tax as an entity; while the individual investors (which may be corporate or individual) are liable to tax on their investment income. Income such as dividends, interest and management fees is subject to withholding tax. For non-resident investors, such taxes withheld are treated as their final tax obligation. Other tax liabilities attaching to investors will depend on the exit model that the private equity transaction adopts.
Targets that are incorporated as companies are taxed under the Companies Income Tax Act. For companies that record losses and companies operating in specified sectors (with the exception of small companies), company profits will usually be taxed at the rate of 30%. In Nigeria, interest payments on sums borrowed and employed as capital in acquiring profits are tax deductible. Consequently, some businesses prefer debt financing to equity financing, to enable them to benefit first from the loan and subsequently from the tax deductibility of interest payments. Equity financing – whether in the form of preferred or ordinary stocks – will entitle the shareholders to dividends that will be subject to a 10% withholding tax. Upon deduction of the withholding tax, such dividend will be treated as franked investment income (ie, dividend income which has been subjected to withholding tax as final tax and therefore not subject to further tax).
Finally, capital gains made by private equity firms through a disposal of chargeable assets are taxed at the rate of 10%. If those gains are made on the disposal of shares in portfolio companies, the gains will be exempt from capital gains tax. In the case of a disposal of assets through a takeover or a business reorganisation within a group of companies or among companies under common control, the capital gains tax exemption applies only where these companies have been so related for a period of at least 365 days before the transfer or sale of the assets.
9.2 What indirect tax risks and opportunities can arise from private equity transactions in your jurisdiction?
A number of investment incentive schemes are available, ranging from tax-free holidays to tax reductions and total exemptions (eg, those granted on foreign loans and those granted on interest accruing on the deposit account of a non-resident company).
Tax risks may occur where private equity funds are not well structured – for instance, partnerships are considered to be relatively tax inefficient for Nigerian private equity funds that invest solely in equity. This is because the absence of franked investment income provisions in the Personal Income Tax Act means that a limited liability company that is a partner in a private equity fund structured as a partnership must withhold tax (at the rate of 10%) when redistributing the profits it has received from the partnership to its own shareholders in the form of dividends.
9.3 What preferred tax strategies are typically adopted in private equity transactions in your jurisdiction?
Depending on the negotiating power and leverage of the parties, an agreement is usually reached for the parties to bear their own tax obligations.
10 Trends and predictions
10.1 How would you describe the current private equity landscape and prevailing trends in your jurisdiction? What are regarded as the key opportunities and main challenges for the coming 12 months?
Nigeria remains an important investment destination in Africa, as reflected by the total value of foreign direct investment ($934.34 million) which flowed into Nigeria in 2019. The general atmosphere is characterised by a high level of investor confidence, marked with a degree of caution. The COVID-19 pandemic currently ravaging the world and the unprecedented slump in oil prices continue to put a strain on the level of private equity investments and deals in Nigeria, across Africa and globally. Meanwhile, the issue of currency depreciation and devaluation continues to put a strain on the value of investments.
Depending on how they are managed, the unintended and unexpected consequences of the current economic climate may affect or lead to the renegotiation of deal terms, or even to the outright termination of contracts. To mitigate some of these challenges, the federal government has made a number of timely economic interventions, including the provision of relief packages to small and medium-sized enterprises.
Also, with the recent signing into law of the Companies and Allied Matters Act (CAMA) by the Nigerian president, significant changes are expected that will positively affect the structuring and operation of private equity firms. CAMA 2 provides for innovations such as single-member and single-director companies; company voluntary arrangements and administration; and limited partnerships and limited liability partnerships.
In terms of opportunities, Nigeria recently signed the African Continental Free Trade Agreement (AfCFTA), a continental agreement that aims to bring together more than 1.2 billion people with a combined gross domestic product of more than $3.4 trillion. The AfCFTA, which came into effect on 1 January 2021, will ease the movement of people, goods and services across Africa and is expected to boost the level of private equity investment in Nigeria and the wider continent. In enhancing intra-African trade, the AfCFTA is set to improve the standards of economies, create the market size necessary to stimulate growth and encourage private equity investment.
10.2 Are any developments anticipated in the next 12 months, including any proposed legislative reforms in the legal or tax framework?
The Nigeria Data Protection Bill is progressing through Parliament and is expected to be passed soon. Once passed, the law will replace the National Information Technology Development Agency's Data Protection Regulations to become the most comprehensive law on data protection in Nigeria. To avoid heavy penalties and sanctions stipulated under the law, parties to private equity transactions will have to be more cautious when conducting due diligence, and will have to put in place more stringent accountability measures to assess not only what personal data has been acquired during a transaction/due diligence, but also how it is protected.
Efforts are also being made in the area of corporate governance to reduce the multiplicity of corporate governance codes applicable to various industries and implement a National Code of Corporate Governance. Again, there have been several initiatives by the Securities and Exchange Commission and the Nigerian Stock Exchange (NSE) to facilitate the listing of companies as well as trading in unlisted securities of public companies. Finally, it is anticipated that the ongoing demutualisation of the NSE will improve investor participation in the ownership of the NSE, improve the NSE's corporate governance and increase accountability. Being in line with global best practices, the NSE's demutualisation is likely to have a positive effect on foreign direct investment in general, and private equity in particular.
11 Tips and traps
11.1 What are your tips to maximise the opportunities that private equity presents in your jurisdiction, for both investors and targets, and what potential issues or limitations would you highlight?
Despite the pressure stemming from the impact of the COVID-19 pandemic, Nigeria boasts an array of investment opportunities, unexploited assets/resources and a need for solid facilities and capital equipment requiring sizeable capital injections. Thus, the expectation is that private equity activities in Nigeria will continue to grow, even as investors adapt to the peculiarities of the country's ecosystem in order to unlock the opportunities within. In particular, we advise investors to focus on the energy, logistics and support services, agriculture and technology sectors in Nigeria – especially fintech and telemedicine (which is projected to be worth $1 billion per annum).
Potential issues or limitations include:
- political risks;
- evolving legal and regulatory regimes;
- exchange rate instability;
- limited data/public information; and
- high asking/purchase prices for investments, which potentially limits the range of private equity deals.
Co-Authored by Ms. Adenike Kuti, CEO OakHeirs Limited.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.