Should VC Funds be Regulated like Mutual Funds?

If you are going to set up a venture capital fund in Nigeria, you will need to have ₦20 million in paid-up share capital. You will also need to register the fund with the Securities and Exchange Commission (SEC) and register your entity as a fund/portfolio manager. You will need to provide elaborate details on the structure of the fund, submit documentation relating to investment policies, governance, risk management, and file periodic reports with the SEC. You will need a fidelity insurance bond covering at least 20% of the minimum paid-up capital (i.e., N4,000,000). You will need a police clearance report and need to write exams to qualify as a sponsored individual, alongside two other sponsored individuals.

This approach to venture funds regulation, in our view, is counterproductive if the goal is to encourage the formation of capital, and this partly explains why local venture capital fund managers will continue to domicile their venture capital funds elsewhere.  Venture capital is essentially risk capital, and risk capital is essential to the growth of innovation, technology, entrepreneurship, and our GDP. Venture capital investors (LPs and downstream investors) in the asset class are aware of the risk. This is why they are in play and why venture capital is an alternative asset class.

Globally, Delaware remains the leading jurisdiction for venture capital fund formation, even for funds managed by Nigerian general partners (GPs). Its success lies in a contract-based regime, judicial predictability, and light-touch regulation tailored to private funds. In our view, Delaware should be the benchmark, and part of the goal should be to position Nigeria as a magnet for risk capital, attracting tech founders and fund managers from across the continent.

To achieve this goal, it might be appropriate to reconsider the current regulatory model. It may be useful to scrap the venture capital rules completely and to allow limited partners and general partners to collaborate on the basis of contracts, particularly since the capital is raised privately. To date, the global venture capital industry has run on primarily standard contracts, which are globally acceptable.

Currently, the SEC classifies venture capital funds a subset of collective investment schemes. While there are specific rules governing the formation of venture capital funds, this framing ignores the fundamental risk-return and liquidity profile of venture investing. Also, viewing venture capital from the standpoint of collective investment schemes poses a real risk that venture capital funds are treated similarly to mutual funds, with regulatory requirements that emphasise investor protection, liquidity, elaborate disclosures, and frequent valuation, which are hardly suitable for the long-term, illiquid, and high-risk nature of venture investing.

This misclassification is evident in the current venture capital rules in many respects. For instance, the entire rule 555 treats venture capital funds as though they are a public offering vehicle by requiring a venture capital fund manager to submit prospectuses, schemes of arrangement, letters of consent, disclosures, and valuation statements even where the fund is pre-operational. Worse, the rules demand five-year profit and loss statements, multi-year profitability forecasts, and cash flow forecasts from venture capital firms that are often investing in zero-revenue start-ups.  The SEC also imposes a registration fee of 1% of fund size and requires a venture capital fund manager to commit to monthly reporting, mirroring public fund registration and reporting. Very clearly, the registration and approval process is identical to that of a collective investment scheme.

If Nigeria is truly committed to fostering innovation, digital industrialisation, and start-up growth, part of the goal should be to make it “very” “very” easy to raise capital to start new ventures. Amongst others, that would mean:

(a) scrapping the current venture capital rules completely and/or replacing the rules with a principles-based regulatory approach.

(b) scrapping the current venture capital rules and replacing the rules with a registration-only regulatory framework that allows the SEC to simply maintain a database of fund managers and their activity without imposing mutual fund-style compliance obligations.

(c) developing a bespoke regulatory framework for venture capital to reflect the risk-return and liquidity profile of venture investing, as well as the realities of modern venture capital investing.

Final Thoughts :

It is not that more sophisticated regulation is unwelcome. Rather, it is that the local venture capital market is still in its formative stages and has not yet reached the level of maturity that justifies complex regulatory oversight. A more appropriate benchmark for determining regulatory intensity should be the number and diversity of local venture funds actively operating in the market. As the ecosystem evolves and deepens, the regulator will be better positioned to introduce targeted and proportionate rules that reflect the market’s maturity. Premature regulation, however well-intentioned, risks stifling the very growth it seeks to safeguard.  

What do you think?  

You may speak with our Venture Capital Fund Formation Lawyers here: 08060817371 or via bhlegalsupport@balogunharold.com.