In Nigeria's economy, startups have emerged as a significant driving force, playing a role in fostering innovation,2 job generation,3 and overall economic expansion. Nonetheless, the transition from a mere concept to a thriving enterprise demands careful planning, with a pivotal element being the startup's operational legal framework.
2. CHOOSING THE RIGHT LEGAL STRUCTURE
The first step in the corporate structuring process is choosing the right legal structure for your startup. The Companies and Allied Matters Act 2020 ("CAMA 2020")4 offers several options, each with its advantages and disadvantages. The most common structures are:
2.1 Sole Proprietorship5
This is the simplest form of business, where an individual owns and operates the business. It requires minimal legal formalities, making it a quick option to get started. However, personal liability is a significant drawback, as the owner's assets are at risk in case of business liabilities. It is generally infrequent for venture capitalists or investors to allocate their resources to the business, as it is customarily owned and organized by a sole individual.
In a partnership, two or more individuals or entities come together to operate a business. While partnerships allow for shared responsibilities and resources, the business structure is prone to potential conflicts among partners.7 A limited Liability Partnership which is the most preferred partnership formation for a startup is a body corporate with a legal entity separate from the partners. A limited liability partnership combines the liability protection of a corporation with the flexibility of a partnership.
2.3 Limited Liability Company
A limited liability company is a business entity that that prevent shareholders, members, and directors from being personally liable for the company's financial losses and debt liabilities.8 The process of establishing a limited liability company involves more formalities compared to sole proprietorships or partnerships, but it provides a solid foundation for growth. This is because investors are willing to invest in this type of business structure because it provides leeway for equity sharing among founders and investors. Usually, there are two types; Private Limited Company and Public Limited Company ('PLC').
A private limited company is a separate legal entity from its owners. It offers limited liability protection to shareholders and is a popular choice for startups aiming to attract investment. However, the compliance requirements are more rigorous, including regular financial reporting and holding shareholder meetings. Public limited companies on the other hand can raise capital by selling shares to the public through an Initial Public Offering or other forms of stock purchase avenues. This structure is suitable for startups with ambitious growth plans, but it involves extensive regulatory requirements, making it more suitable for mature businesses. In practice, startups restructure their businesses into PLCs when they are done raising their series 'C' funding rounds9 or when they attain Unicorn10 status.
3. REGULATORY COMPLIANCE, CORPORATE GOVERNANCE, AND INTELLECTUAL PROPERTY
Once the appropriate legal structure is chosen, startups must navigate Nigeria's regulatory landscape and protect their intellectual property. Key aspects to consider include:
3.1 Business Registration
Registering the business with the Corporate Affairs Commission ("CAC") is mandatory. This process involves providing necessary documentation, such as the memorandum and articles of association, particulars of directors, and shareholders' details. Most times, CAC agents and corporate lawyers are the most knowledgeable in getting approvals from CAC.
Understanding Nigeria's tax laws is crucial to avoid legal complications. Startups must register for taxes such as Value Added Tax (VAT), Companies Income Tax, and Personal Income Tax for employees and some other taxes wherever applicable.
3.3 Intellectual Property Protection
Safeguarding your startup's innovations and creative works is essential. Registering trademarks, patents, designs, and copyrights with the Trade Marks, Patents, and Designs Registry or the Nigerian Copyright Commission (NCC) respectively, provides legal protection against infringement. Also, seeking necessary approvals from the National Information Technology Development Agency (NITDA) and Nigeria Data Protection Commission (NDPC) is crucial in operating a startup in Nigeria, especially where such a startup business model is operated on a mobile or Desktop App.
3.4 Corporate Governance
Corporate governance in any corporate entity, plays a vital role in ensuring transparency, accountability, and sustainable growth. It establishes clear guidelines and a structural framework by defining the roles and responsibilities for decision-making, financial reporting and performance evaluation while promoting accountability.
4. FUNDING AND AGREEMENTS
Securing funding is often a critical step for startup growth. While attracting investors can be exciting, it is important to have well-drafted agreements such as Simple Agreement for Future Equity (SAFE),11 shareholder agreements, founder(s) agreements etc. in place to outline ownership percentages, decision-making processes, and dispute resolution mechanisms and to further provide some level of structure in the startup. These agreements help prevent future conflicts (and reduce ambiguity when such conflicts inevitably occur) and ensure alignment among stakeholders.
Establishing the right corporate structure is important for startups in Nigeria. Each structure comes with its own benefits and challenges, so, it is essential to choose one that aligns with the startup's goals and growth strategy. Additionally, adhering to regulatory requirements and protecting intellectual property are vital for long-term success.
By taking these legal considerations seriously and seeking professional legal advice, startups can position themselves for sustainable growth and navigate the complex Nigerian business landscape with confidence.
1. Emmanuel C. Onele, Associate, S. P. A. Ajibade and Co., Lagos, Nigeria.
2. Blessing Earnest, 'Nigerian Tech Startups/startup incubators Fanning the Flames of Innovation' available at https://www.africanleadershipmagazine.co.uk/nigerian-tech-startups-startup-incubators-fanning-the-flames-of-innovation/ accessed 5th September 2023.
3. Tom Jackson, 'Jobs created by funded African tech startups almost doubled in 2022', available at https://disrupt-africa.com/2023/02/24/jobs-created-by-funded-african-tech-startups-almost-doubled-in-2022/ accessed 5th September 2023.
4. The Companies and Allied Matters Act 2020 is the law regulating corporate organisations in Nigeria.
5. S. 814 CAMA 2020.
6. S. 750 CAMA 2020.
7. However, this is not in all cases as Limited Liability Partnership limits their liability to the amount of equity owned and contributed by the said partners or, the terms adopted in the partnership agreement. It is worth noting that partners who share liability amongst themselves are called general partners. In such a partnership, the partners can be sued individually for business obligations.
8. Although, more often than not, directors or shareholders are prevented from being personally liable, there are exceptions where the veil of a company is lifted to hold such individual personally liable. Some of those exceptional circumstances include when the business is insolvent, when a director acts wrongfully, when the individual personally guarantees a loan, misapplication of company's property etc. See, section 42 Companies and Allied Matters Act 2020.
9. In Nigeria, most tech companies raise funds in 5 different fund-raising rounds, they include: pre-seed funding, seed funding, series A funding, series B funding and series C funding rounds. As such, the company will begin the process of an Initial Public Offering in any stock market of their choice after the series C funding round. Startups that have attained this height include Flutterwave, Opay, Andela, Interswitch, E-Tranzact, etc. Usually, when startups are done with the series C funding round, they begin the process of converting it shares structure and selling same in a public for the first time.
10. A unicorn is a privately held startup company with a current valuation of 1 billion U.S. dollars or more.
11. A Simple Agreement for Future Equity (also known as a SAFE) is a legal contract that startups use to raise seed financing capital like a convertible note. The SAFE agreements convert upon increased investment in the startup.
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.