GUEST POST: Of the Economy, Venture Capital Funds and Start-Up Companies.

Despite the fact that the Nigerian economy is far from where it ought to be, there are still lots of opportunities within it that are begging to be taken advantage of. The Nigerian government in its bid to spur private sector investment and particularly in certain sectors has put in place laws that offer investors immense advantages in the hope of whetting their appetites. My elder brother, Ishaya Amaza writes on one such law here, the Venture Capital (Incentives) Act and how you can benefit from it as an investor.

Enjoy.

One of the most progressive legislation we have in Nigeria in terms of seeking to achieve economic empowerment is the VENTURE CAPITAL (INCENTIVES) ACT CAP. V2 L.F.N. 2004.

The Act provides generous incentives for both Private Equity and Venture Capital companies that provide early financing to start up companies, and the start-up companies themselves.

Some of the incentives include:

  1. 50% reduction on Withholding Tax for 5 years: A typical PE/VC company invests in a company by providing funding and taking up equity in the start-up company with the ultimate hope of selling its stake when the value of the company has appreciated. However, before such sale is achieved, the PE/VC will be entitled to dividends paid on its stake in the start-up. The tax laws require that when paying dividends, 10% of the dividends will be withheld as tax and then applied towards the future tax liabilities of the PE/VC. The Act provides that only 50% of this withholding tax (i.e. 5%) will be deducted for a period of 5 years. Now, Section 80(3) of the Companies Income Tax Act (CITA) regards dividend payments to companies as ‘franked investments’, which will not be subjected to further tax as part of the profits of the PE/VC company. Let me break this down: the tax rate charged on the profits of companies is 30%, but a PE/VC being paid up dividends for its shares in a start-up will only pay 5% for 5 years on those dividends and the dividends will not be counted as part of its profits which will be charged at 30%. If you consider the fact that most PE/VCs expect to sell their equity in start-ups in 3-5 years after making the investment, they might end up paying no more than 5% on dividends for the duration of the investments.

Now this extends even to the persons who have shares in the PE/VC in the first place. Their dividends are limited to 5% for the 1st 5 years.

  1. Capital Allowance: Section 4(a) of the Venture Capital Incentives Act provide capital allowance incentives on the equity investments of a PE/VC in a start-up company as follows:

(i) The first year deduct 30 per cent,

(ii) For the second year deduct 30 per cent,

(iii) For the third year deduct 20 per cent,

(iv) For the fourth year deduct 10 per cent,

(v) For the fifth year deduct 10 per cent

To simplify this, if a PE/VC invests in a start-up with the sum of N10, 000,000 naira, it will be allowed to deduct N3 million from its assessable profits in the following tax year. Remember that because the equity is the property of the company and could become income if sold, it is not considered a pre-tax expense. The company is further allowed to deduct 30%, 20%, 10% and another 10% for years 2, 3, 4 & 5 respectively. This means that at the end of the 5th year, the company would have gotten back 100% of the N10 million it has invested from its head income tax. Considering how risky PE/VC financing is, this provision removes any financing risk the company would have by enabling it to deduct its equity investment from its tax liabilities.

  1. Capital gains incentive. As I stated above, the most desirable aim of a PE/VC is to invest in a company’s shares or equity, increase the value of the company and then sell its shares at huge profit. The profit made on the shares sold is referred to as capital gains.
    E.g. a PE/VC invests $2 million dollars in a start-up juice factory in exchange for 49% of the shares of the company. After 4 years, the juice company becomes very profitable and its value explodes. The PE/VC then sells its 49% stake for $20 million; the capital gains on that sale would be $18 million. In Nigeria, the capital gains tax rate is 10% which means that in this instance, $1.8 million will have to be paid by the PE/VC as CG tax.

Now Section 4(c) of the Private Venture Incentives Act (PVIA) provides for incentives for the exemption of CG Tax on disposal of its shares as follows:

  • for disposal within 5 years of investment – 100% is exempted
  • for disposal between 6 – 10 years of investment – 75%
  • for disposal between 11 & 15 years of investment – 25%
  • for disposal after 15 years of investment – 0%

Following from the above scenario, if the PE/VC sold its 49% in the juice factory within 5 years, it pays absolutely nothing on the $18 million it has made. Remember, I said that most PE/VCs aim to sell of their stake within 3-5 years of making the initial investment.

  1. Pioneer status – This incentive is dead easy. This simply exempts the start-up company from paying any tax on its income for the first 3 years, which could be extended for another 2 years. In total, a 5 year income tax holiday. This is because the PVIA has made the Industrial Development (Income Tax Relief) Act applicable to start up companies, without it necessarily having to meet the requirement set out for pioneer companies.
  2. Export Incentives – If the startup company is to be engaged in exporting products from Nigeria, it will qualify for export incentives such as financial assistance, export expansion grants, etc.

Now to qualify for these incentives, the National Risk Fund needs only to qualify a PE/VC as ‘Venture Capital Company’, and a start-up as a ‘Venture Project Company’. The criteria for a VPC is that it must accelerate industrialization by nurturing innovative ideas, projects and techniques to fruition; commercialize research findings with high potential for far reaching forward or backward linkages; promotion of self-reliance through the establishment of resource-based and strategic industries through the provision of risk guarantee and insurance, encourage indigenous processes and technologies, or promote the growth of small and medium scale enterprises with emphasis on local raw materials development and utilization.

Forget all the big words – in essence it refers to companies that are innovative, encourage industrial growth, utilize raw materials, or encourage indigenous technologies.

Now, this entire write up might seem a bit boring for its importance to be fully grasped so I will try to simplify it with a practical example.

It was reported in December 2015 (The Nation & Leadership newspapers) that Nigeria imports US$4.6 billion of fruit concentrates every year for making fruit juices in-country. This is quite ironic given that the country produces fruits in abundance but most of them simply rot away (e.g. mangoes and oranges in Taraba & Benue states).

Now, a start-up company that comes up with an innovative way of making concentrates from these fruits for export should meet one or more of the criteria for being accredited as a Venture Project Company. The Middle East and North Africa have been identified as huge consumers of mango concentrates so a Venture Capital Company decides to invest in the production of mango concentrates in Benue State for export to these countries. These are the benefits both companies stand to gain.
Venture Capital Company

  1. 50% reduction on withholding tax for the first 5 years.
  2. No payment of capital gains tax if shares are sold within 5 years; 75% CGT reduction for years 6-10, and 25% for years 11 – 15.
  3. 100% capital incentive allowance on equity investments within 5 years.

Venture Product Company

  1. Pioneer status;
  2. Export incentives such as financial assistance and export expansion grants.

In the light of our fallen crude prices and poor economy, this piece of legislation provides some comfort to both PE/VC companies and a unique opportunity to would-be entrepreneurs with innovative business ideas.

I hope this post gives you the motivation to fully explore and utilize this Act.

Ishaya Amaza is an attorney-at-law with Aelex, a full-service commercial and litigation law firm with offices in Lagos, Abuja and Port-Harcourt. You can tweet at him at @ipamaza.

 


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