Investors are once again writing big cheques for Nigerian tech companies as normalcy begins to return. While the balance sheet of the company, the customer acquisition numbers, and what stage of development the company is currently at, are significant factors that help investors decide which start-up will be getting their money, there is a big catch to land big-ticket funding.
Where is the company incorporated?
Nearly 90 percent of the companies that have closed big-ticket funding in 2021 so far were incorporated either in the US or UK.
In the month of March alone, tech companies have raised more money than they did in the whole of 2020. However, the about $204 million raised so far have mostly come from companies with publicly known incorporation records outside the continent. In fact, four out of the six companies accounted for about $195 million raised so far.
It is the same for companies that have raised funding since January.
uLesson which raised the first big-money – $7.5 million – in 2021 was founded in 2019 and incorporated in the state of Delaware in the United States. Flutterwave, which has closed the most funding so far in 2021 was also incorporated in Delaware and identifies its head office as 1323 Columbus Avenue, San Francisco CA 94133 USA with company number 6031713. Cowrywise which raised $3 million from Quona is another company incorporated in Delaware. Afriex which raised $1.2 million was incorporated in California, US.
Others are Kwik Delivery, which raised $1.7 million, incorporated in Paris, France, and Kuda Bank, which raised $25 million was incorporated in London.
A local investor may not think too much of this, but a tech company incorporated in Nigeria stands little chance of convincing foreign investors they are worth their big cheques.
So why do Nigerian founders prefer to go outside the country and even continent to incorporate the entity that gives birth to their ideas? The least motivation is the difficulty involved in incorporating companies in Nigeria.
Although the federal government of Nigeria has in recent times thrown weight behind efforts to ease company registration in Nigeria, it still takes two to four weeks to register a business name and a minimum of a month to incorporate a limited liability company in the country. After completing incorporation it takes even more weeks to get a license especially if it is a company going into payments or any fintech segment.
This doesn’t apply to tech companies, not in that section’s category at least. In that sense, Flutterwave and the rest have double incorporation documents.
Experts say registering a company has improved from what it used to be in the past. At least the push for reforms has been working pre-COVID-19 but got bad again during the lockdowns.
“In fairness, the CAC is quite effective and post-Covid were very reliable. Completed over 40 transactions within 2019-2020 alone with ease. Have a few pending and due to COVID,” Rikimaru Tenchu, a legal professional said.
Regulations in Nigeria, however, don’t permit any business registered abroad to conduct business in Nigeria without registering with the Corporate Affairs Commission (CAC).
The Companies and Allied Matters Act (CAMA) however provides situations in which a foreign company can operate in Nigeria without a CAC registration. Section 56(1) of CAMA provides that a foreign company may apply to the National Council of Ministers (Federal Executive Council) for exemption from registration. The exemptions are mostly to foreign companies invited by the Nigerian government to execute a national project within a specific period of time.
Nevertheless, if the Nigerian process is such a big hurdle, you will think surely other African countries will be better. Wiza Jalakasi, vice president, Developer Relations, Chipper Cash, says not at all.
Incorporating a company in South Africa – after Ethiopia – is very complicated for a foreign entity, he says. You require a resident director to even begin the journey.
“The company incorporation process itself is not as complicated but opening a bank account in South Africa is the hardest thing I have ever had to do in terms of banking,” Jalakasi said on a podcast.
However, a company doesn’t need a license to set up an office in South Africa if it is incorporated in the US.
“If we don’t have things like Clerky, Carta, etc in Africa, and jurisdictions like Estonia or Delaware, we are only joking. To register a new entity yesterday, all I did was click a few things and type a few words. All done in minutes,” said Victor Asemota, Africa Partner, Alta Global Ventures.
Difficulty in regulation aside, there are more urgent needs tech start-ups feel compelled to be incorporated in the US or UK or any other country outside Africa.
Incorporating for funding
Funding is arguably the most important reason Nigerian tech entrepreneurs go abroad to incorporate their companies. This is down to the operating environment in most African countries like Nigeria being more difficult for taking out or receiving foreign exchange, perpetual currency devaluation, inflation, and ease of doing business when compared to other countries.
“We have preached against this, but Nigeria does not help matters,” Collins Onuegbu, executive vice chairman of Signal Alliance and a director at Lagos Angels Network said. “Registering the companies abroad helps in fundraising. And since the fundraising is driven by foreign investors, you really cannot blame the start-up.”
Apart from incorporating their companies abroad to raise funding, there are other things start-ups look out for in a country before making their decision. For example, the majority of the companies that have raised significant funding in 2021 were incorporated in Delaware for a reason.
A start-up registered in Delaware, a small mid-Atlantic US state that sits on a peninsula, is taxed as a C-Corp. A c corporation (or C-corp) is a legal structure for a corporation in which the owners, or shareholders, are taxed separately from the entity. Often these Delaware corporations come with 10 million shares of common stock authorised with $0.0001 par value. Most of these corporations issue half of the shares to founders.
These corporations are seen as well-adapted to venture capital (VC) and angel investing over other forms of business entities.
Importantly, US VC investors typically set standardised procedures for their investment activities and often require Delaware corporations for their investment targets. For example, Y Combinator, a US seed money accelerator founded in 2005, requires that international start-ups they invest in are registered in the US as well as in their local countries. Y Combinator has invested in Nigerian companies such as Paystack, Flutterwave, Cowrywise, Termii, and many other Nigerian companies.
A US VC investor often prefers Delaware start-ups because of the several classes of stock that Delaware law allows. The law gives preferred stock investors of a corporation certain voting rights and control over the corporation. Many VCs insist on the Delaware corporate form, and will even require a start-up to convert the current entity to a Delaware C Corporation before they are willing to invest.
“Investing in start-ups is risky, a lot of things can go wrong,” Onuegbu says. “Statistics of the rate of failure of early-stage companies is known. Investors will hedge their risk in any way possible. One of these risks is legal. When a start-up pitches for investment, it is usually for a purpose. Investors will like to sign an agreement that ensures all sides keep to their side of the agreement under a jurisdiction that is comfortable to the investor. So it is easy to see why registering in the jurisdiction as Delaware or any of such places offers comfort to investors.”
Expansion dreams
Nigerian tech start-ups with expansion ambitions or are looking to secure a big tech partnership or endorsement have a better chance at achieving these with international incorporation, according to Jalakasi.
Many tech companies are incorporated abroad as holding companies – a company created to buy and own the shares of other companies, which it then controls. Jalakasi says running such a structure is helpful for centralising investments.
“If you are raising funds, all the funds can be directed in the parent holding company which owns all the operating companies that are set up across the different countries,” he says.
Another reason he identifies is for tax efficiency purposes. With the holding structure, a tech company can then set up a corporation in a country like Mauritius that signed a double-tax avoidance agreement with 46 states worldwide, about 18 from Africa. In the case of Flutterwave, the Delaware entity is the owner of the companies in Africa including Nigeria. This is also the case with Kuda Bank, where the London entity owns the companies in Nigeria.
Sydney Aigbogun, founder and CEO of CashBox makes the point that founders can be moved to incorporate their companies abroad because they grew up there or attended schools there, and have built a large network of people who could be potential investors. For example, Tayo Oviosu who completed his higher education in the US built most of his tech network there, which eventually led to the founding of PagaTech.
Where Nigeria stands
Some experts say getting to the trend towards double incorporation is not necessarily a net gain for Nigeria. A start-up incorporated solely in Nigeria means the taxes and other revenue streams accruing to the home country are not shared. When the company earns foreign revenue in the course of transacting business with foreign partners, the economy gains.
However, the trend means that the country the start-up takes as its primary state of origin gets the giant revenue while Nigeria gets less. Flutterwave’s $170 million raise for example is assumed to be conducted by the holding company in Delaware on behalf of the subsidiaries in Nigeria and the ten other countries in Africa where it has a presence. Hence, the tax transactions are within the jurisdiction of Delaware and by extension the US economy.
“If these companies were Nigerian companies and still achieve the kind of success that access to foreign funding gets them, Nigeria will benefit more in taxes and all,” Gbenga Sesan, executive director at Paradigm Initiative said.
Nevertheless, given that Flutterwave also has some Nigerians who have invested in the past, should these investors decide to exit the company following the $170 million Series C round, they would have to pay local taxes.
Onuegbu also makes the point that if there are local companies involved in the deal, lawyers, for example, will also report and pay taxes on fees.
“In summary, the government could have earned more. But it also means that policymakers should see this as a growing trend and create the necessary policies and incentives to encourage those deals being done locally,” Onuegbu said. If Lagos will be the start-up capital for Africa in the true sense, he explains the state would need to consider policies that incentivize investors and all those involved in the ecosystem.
