2023 wasn’t a great year for tech startups in Africa. This was very much pronounced in Nigeria where a series of mishaps led to a significant downturn in the startup ecosystem. Prominent among them is the funding winter which saw funding into the continent decline by 43 per cent.
There were also incidents of shutdowns and layoffs in the startup ecosystem, especially in the financial technology sector. The crypto segment also took a hit, with major crypto companies and exchanges suffering major hacks with users losing significant sums of money. All of these contributed to dampening the outlook of the ecosystem in 2023.
That isn’t to say there were no impressive stories too, far from it. But taking a look at these mishaps and general trends from the legal point of view, Akpor Ikogho, a legal practitioner at Mark Renee Legal Practitioners takes us through the mishaps and legal ways to avoid them.
Question: Let us look at 2023, startup performance from a legal point of view. It wasn’t a very good year with many startups closing shop. From a legal standpoint, what are Nigerian startups getting wrong?
Firstly, In 2023, African startups faced a funding challenge, securing approximately $3 billion, encompassing equity and grants. This was a 32% decline from the $5 billion. With that in mind research shows that around 90% of startups fail over a period of years: 21.5% of startups fail in the first year with the amount rising to 70% in the tenth year.
In Nigeria, more than five prominent startups, which had collectively raised over $50 million between 2020 and 2022, ceased operations in 2023. The causes of their closure varied across different factors.
Having given a cursory look and analysis of what led to the death of these startups indicates that the following were the reasons for their closure:
Changing market conditions: Sometimes those involved in a startup have an accurate view of the market, but then market conditions change before they are established enough to weather those changes. The CBN prohibition of crypto trading was a perfect example of changing market conditions that caused CryptoStartups to pivot, struggle or fail. For some startups in their early days without much profit to fall back on and without an established customer base, the huge market change was too substantial to keep afloat.
Poor management structure: It is essential for every business to adopt a robust corporate governance structure and system that avoids concentration of power. Many startup founders, driven by a passion for their products or services, lack experience in business administration. Neglecting the administrative aspect can lead to issues. An example is seen in the shutting down of PayDay. There was a case of alleged internal fraud by the CEO who overpaid himself at the expense of the health of the company. a viable corporate governance structure would have prevented this by creating a system of checks and balances.
Management infighting: Pivo, a promising fintech in Nigeria, failed and closed shop in 2023 due, in part to infighting and conflicting interests among founders. This highlights the importance of well-drafted Shareholders’ Agreements that should clearly outline the rights, obligations, and duties of shareholders to avoid misunderstandings.
Cashflow issues: Another reason for startup failure is simply running out of money. Most startups rely on investors and venture capitalists to fund them until their product or service starts making money, and if that doesn’t happen fast enough, investors often baulk at continuing to fork over cash for an extended period of time.
Flawed business plan: Having a business plan is Startup 101, and just about everyone knows you’re supposed to have one in the early stages of any small business. But just because you have a business plan doesn’t mean it’s a good one.
Fintech startups, especially crypto startups have folded with lots of customers losing their funds. It seems to be the case that there are no legal means of getting back these lost funds. Please share a perspective on that. Are there legal means of redress for customers who lost funds to such companies?
In 2023, the Central Bank of Nigeria (CBN) announced its decision to lift the two-year restriction on Cryptocurrency transactions in Nigeria’s banking system. Jurisdictional issues aside, the Securities and Exchange Commission subsequently came up with the Rules on the Issuance, Offering Platforms, and Custody of Digital Assets.
The ban wasn’t lifted after carefully considering the impact of cryptocurrency globally and its effect on the economy of any given State. It was lifted because of a change in CBN Management.
Up until this declaration was made, cryptocurrency trading in Nigeria was in effect illegal. Generally, the position of the law is that where parties contract to carry out an illegal, unenforceable or unlawful act, such contract is void ab initio. However, the DOCTRINE of SEVERABILITY also known as the Blue Pencil Rule holds that where parties contract to carry out an unlawful act, an aggrieved party can in fact sue for damages. This is because the rule helps the court to strike out the illegal part of the contract/Agreement and enforce the legal part, so long as the Agreement shows the intentions of the parties.
What this means is that if A contracts B to perform an illegal act (such as trading cryptocurrency at the time it was still illegal to so do in Nigeria), and B defaults in trading the same, and further absconds with the money. A can still maintain an action in Court for the recovery of his money even though the reason for parting with money at the time was for an illegal act.
In April 2023, Lazerpay a cryptocurrency fintech startup set up in October 2021 in Nigeria announced that it was closing its business and shutting down operations, after being unable to raise funds to expand its business operations. Following this announcement, Customers were advised to withdraw their funds before the end of April 2023. If Lazerpay is unwilling to pay all its customers, aggrieved customers can institute an action at the Securities & Exchange Tribunal or resort to arbitration if it’s so stated in their terms of agreement. Alternatively
So many Nigerian startups appear to be registered in foreign countries like Canada, the USA, Lithuania etc. Yet their main business area of focus is here in Nigeria. What are the dangers posed by these startups, especially since they appear to be governed by one law and their customers by another?
While the startup industry is experiencing growth, it has its own inherent challenges. Despite the presumption that successful Nigerian startups like Flutterwave, Paystack, and Andela contribute to the local economy by having registered offices in Nigeria, the reality is different. Many well-funded Nigerian Fintech & startups channel a significant portion of their profits abroad, depositing them in various offshore accounts. This is primarily due to a strategic choice in favour of foreign jurisdictions like Delaware, Mauritius, San Francisco, Seychelles, and other business-friendly locations for their headquarters. The implications of this decision are briefly outlined below.
Loss of taxation income to the country: The impact of establishing a business outside its operational country results in a narrowing of the tax net. There is a Capital Flight contributed to by capital exportation. Nigeria loses taxes which would have been attributable if the big Fintechs and Neobanks its citizens rely on were registered locally.
Understandably the primary motive for the founders is to alleviate their company’s tax burden. Ultimately this leads to substantial revenue losses for the government.
Jurisdictional issues: The issue of choosing a jurisdiction for Litigation and other dispute resolution matters becomes crucial when organizations face contentious issues. The Nigerian Courts are notorious for unpredictability and slowness. Some startups exploit this to avoid legal actions in the country where they conduct business operations.
In instances of closure, like the example of Lazerpay, aggrieved customers face challenges in seeking redress to recover lost funds. Also, it was recently reported that a reputable Fintech Startup Patricia had relocated its headquarters abroad and shutting its business operations in Nigeria.
Having said these, investors and founders are therefore enjoined to ensure that appropriate steps are taken and all such pre-investment issues and checks are appropriately done.
At Mark Renee LP, founders are enjoined to harness the perks of incorporating their businesses in Nigeria (such as numerous tax incentives and large markets) after carefully analyzing current business and market trends to ensure the desired demands of customers are legally met and catered to.
So let’s talk about corporate governance vis-à-vis the law. An investment expert once told us that a lack of corporate governance is a major reason why startups especially fintechs fail. What are the legal structures around corporate governance in the Nigerian startup ecosystem and how could it be entrenched as a prerequisite for startups?
Everybody in the Fintech and Crypto space is aware of the recent FTX collapse. I will start my answer by quoting something the court-appointed administrator said of FTX “Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here.”
Prior to its collapse two years ago, FTX was the world’s second-largest cryptocurrency exchange with more than seven million registered users around the world. FTX raised almost $2 billion. The initial announcement of the company’s failure resulted in a market panic and a nearly 25% drop in the price of Bitcoin.
Management and governance of the FTX group were done by recent college graduates who had no experience in risk management or running a business. There was also no board oversight and FTX lacked independent or experienced finance, accounting, and human resources.
Understandably, many Nigerian startups don’t have an effective corporate governance system because founders are focused on gaining market traction and meeting their targets and timelines. Sometimes the line between ownership and management is blurred with many founders being wary of losing control with the appointment of new board members together with the fear that board involvement could lead to decisions not aligned with their vision for the company.
Let’s talk about the Startup Act. Do you think it is a very solid legal document that could be actionable if contravened?
While the Nigerian Startup Act does not directly make specific provisions for corporate governance it contains several elements that indirectly encourage and support good governance practices in startups. The CAMA 2020 on the other hand promotes good governance with provisions mandating transparent financial reporting, annual audits, accounting records and directors’ duties.
The CAMA provides that every company shall keep accounting records. It also provides that all companies in Nigeria are to file audited accounts with the CAC for the relevant financial year within the time frame prescribed by law. The main aim of these is to prevent unethical practices.
At Mark Renee LP we advise founders on the need to work together with management to establish strong systems and actively monitor their effectiveness. We also advise that startups set up a board comprising the required individuals and size to fulfil their business needs. Board meetings should also be carried out regularly. For financial transactions, the business should require the approval of two directors for high-value transactions. Also, businesses should conduct regular accounting audits to prevent fraudulent transactions and approval powers should be separated.