Nigeria is brimming with young talents, many of whom have carved their pathway to success, but need that little financial push toward their goal.
This is where you take center stage–your venture capital firm–or rather a private equity firm where you gather funds from your limited partners and other sources to assist budding startups known as portfolios.
But there Is one problem; in venture capital, it isn’t like the startup is applying for a loan, you are just lending out a helping hand in return for equity, these startups become your portfolio that is an extension of your business.
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Now, this is where the problem becomes worrisome; like loans where the borrower pays interest and places collateral worth the value of what you loaned, capital investment has nothing of such, it’s a very risky and yet profitable investment if things don’t fall south.
Now how do you make sure things don’t fall south and how can you start a profitable venture capital firm in Nigeria? Not to worry, this article will guide you through everything you need to know before starting as a Venture capitalist, stay glued.
Understanding Venture Capital firms a Short Story.
Mr Ademola, a fresh graduate, had a brilliant idea for a new app that he believed could outshine Twitter. He had the idea and all that was needed to get the project to reality.
But there is one major problem, finance.
He needed capital and so he went in search of support. He found one, a capital venture firm. He presented a business plan and a pitch deck, marketing his bright ideas and growth potential. They were impressed by his vision and strategic plan.
They offered to invest 15 million naira(plus additional support) in his startup in exchange for a 20% equity stake.
This means the capital venture firm would own a fifth of the startup shares. Years later, the app was launched and was an instant success. And the capital venture firm shared parts of the fortune.
End of story!
This story illustrates how venture capital firms work. They provide funds, expertise, and support to startups in exchange for equity, to achieve significant returns on investment as the startup grows and succeeds.
10 Steps to Start a Venture Capital Firm in Nigeria
Starting a venture capital firm in Nigeria involves several key steps.
These 10 ten steps will guide you through the process:
1. Market research
Comprehensive market research and analysis help to brush up on your investment strategies and position your venture capital firm for success. There are a lot of terms that fall under market research however here are the few ones that move the needle:
- Identify sectors with profit potential: learn how to identify key startups with high demand and profit potential. You cannot just pick a random startup, as a Johnny in the business you might want to identify the key industries in Nigeria that have high growth potential. We have the tech–fintech, agritech, health tech, etc. Taking the Fintech sector as a case study, the substantial demand for financial-related apps software, and techs like digital payment apps like Opay serves as a good source to invest. Also, logistics is a good area, Uber and the like.
- Study your competitors: studying your competitors will give you the advantage of learning from their strategies. Before starting venture capital business in Nigeria you should take a look at the existing venture capital firm in the sector you have chosen. And gather as much information as you can about them, especially ones that are useful to you.
- Is the challenge worth it? : before starting a private equity firm you should first analyze the challenges in the business, the Risks, and downsides. If you think the risk and challenges are worth the investment then you can create a buffer.
- Study your angel investors: you can start by identifying the type of Investors with the same investment goals as yours. Where to find them and how to engage with them and gain their trust.
- A compelling pitch deck and presentation: research how to develop a convincing pitch deck that highlights the bigger picture of the startups you are willing to invest in. Their unique value proposition, investment strategy, track records, and bootstrapping (If applicable).
You should also explain how much you intend to invest, the expected returns, turnaround year/period, and exit strategies. All in all, your presentation should resonate with the angel investors’ or Limited partners’ interests.
2. Create a Business Plan
A business plan contains all the steps you are likely to take to get your business sailing in the right direction. This includes:
- Outline the types of startups you plan to Invest in, the stage in which you want the startup to be before investing(seed, early stage, growth), and geographical location.
- You can also outline the industries that align with your investment thesis. For example, if you believe fintech has a strong growth potential in Nigeria, you can indicate in your business plan how you plan to go about it.
- Outline how you want to source funds, how to approach investors, and how much you intend to raise.
- Draft all the risks associated with venture capital investment; the challenges you might face and how to mitigate them.
- Provide projections for expected returns. This may include target internal rate of return(IRR), multiple on invested capital(MOIC), and as well expected timeline for the return.
- Determine your possible exit strategies for investments. Outline your plan on how to realize returns through an initial public offering(ipo), mergers and acquisitions(M&A), or secondary sales.
- Outline the governance structure of your venture capital firm including the roles and responsibilities of key personnel (managing partners, investment committees).
3. Determine the Legal Structure of Your Firm
The legal structure of a venture capital firm plays a crucial role in defining your operational methods.
Here are some common legal structures you can use to operate your firm :
1. Limited Liability Company(LLC):
In this type of business structure, you and your partners are offered limited liability protection.
This means that the personal assets of you and your members are protected from debts and liabilities and the legal obligations of LLC are instead deducted against the company’s funds.
Perks:
- limited liability protection: it provides limited liability protection to you and your members against debts and tax by making sure they are charged against your percentage of shares.
- No double taxation: your venture capital firm is taxed as a pass-through entity, meaning that profit and losses incurred pass through only to the individual investment returns, not the firm.
- Operational flexibility: LLC offers flexibility in operations regarding management structure, decision-making processes, profit distribution, and other internal operations.
- Easy formation and management: LLC venture capital firms are very easy to create and manage. It requires less paperwork, hence saving time and resources
Downsides:
- Taxation: while tax and losses are charged against the investor’s returns it may also have a setback for some, especially high-income investors most of whom may face high tax rates due to their level of profits.
- Exit strategies: LLC venture capital firms can hardly exit through the initial public offering(IPO) due to their structure and limited access to capital markets. However, there are still other doable options, mergers, and acquisitions(M&A) and secondary sales.
2. Limited Partnership(LP):
A limited partnership is a mashup of general partners (managers) who manage the firm and limited partners (investors) who contribute capital but have limited involvement in management. Unlike in the LLC where tax losses and debt are only charged against the investor’s percentage of return, in LC, it’s quite the opposite and a little complicated. There are two parties to a Limited partnership–the general partners and limited partners.
- General Partners: The general partners are the ones in charge of running the venture capital firm. They are personally responsible for all tax and debt obligations. This means that if the firm incurs any debt or legal claims, creditors can go after their assets regardless of the amount invested.
- Limited Partners: limited partners barely have a say in the daily activities of the business and hence have little to lose. Tax and debts are charged against the amount of return obtained from their investment, and not a dime is touched from their pocket.
Perks:
- Investment opportunities: LP can attract ghost investors(limited partners) who contribute capital behind the scenes but have limited involvement in the day-to-day activities of the firm.
- Control: you as the general partner of the venture capital firm, have full control over the management of your firm.
Downsides:
- Unlimited liability: as a General Partner, all taxes and debts are deducted from your income(your pocket), hence exposing you to financial risks.
- Complexity: LP can be difficult to manage especially when dealing with multiple classes of ghost partners.
In summary, while there are other business structures such as private equity and C-corporation, choosing the right legal structure for your venture capital business depends on factors like liability protection, tax implications, fundraising strategy and management structure, and investors’ preferences. You should consult legal advisors to determine the most suitable one that aligns with your objectives.
4. Registrations
Before operating a Venture capital firm in Nigeria you should register with the relevant government authorities. In Nigeria, businesses are registered With the Corporate Affairs Commission(CAC). The registration process is quite easy if you can follow the guidelines on their website. Once registered the CAC provides you with either a Certificate of Incorporation (for companies); or a business name Registration Certificate(for sole proprietorships or partnerships). After that, you will need to register with the Federal Inland Revenue Service(FIRS) to get a Tax Identification Number(TIN) for tax purposes
5. Licenses
Licenses are legal permissions or authorizations granted by regulatory bodies or government agencies that allow venture capital firms to operate legally without any hindrances. A perfect example is Nigeria’s SEC–Securities and Exchange Commission. Venture capital firms must get licensed and become answerable to this body before they can be able to operate. For guidelines on how to secure licenses from these bodies, you can visit their respective websites for the information. If approved, the regulatory bodies may impose conditions and requirements that your venture capital firm must adhere to. If these conditions are violated, it may attract severe penalties, fines, or sanctions and may harm your firm’s image.
Caveat –registration and licenses: licenses are typically valid for a specific period and require period renewal. And ensure to update your information if there are any changes to your business structure, ownership, or operation.
6. Sourcing for Capital
The capital required to establish a Venture capital firm in Nigeria varies. It relies solely on factors such as your firm investment strategies, target sectors, operational expenses, staff salaries, infrastructures, marketing and networking, registration and licensing, and the list goes on and on. As a word of advice, you should complete your due process by conducting a thorough financial analysis to determine the appropriate amount of startup capital needed to launch that business. A good financial analysis will let you know if there is a need to apply for loans or seek financial support.
7. Fundraising
Fundraising is a mere amalgamation of two words “fund” and “raising”, simply, raising funds. This refers to the process of acquiring funds from various sources to finance investments in emerging startups (portfolios) or innovative projects. What follows is the process of actually raising funds for investments:
- Limited Partners(LPs): you can raise funds from institutional investors, rich individuals, pension funds, and other entities who choose to invest in your business as ghost or angel investors behind the scenes, with the expectation of receiving a return on investment
- Corporate partnerships(CPs): you might as well form a strategic Alliance with corporations, financial institutions, or top 1% players in the industry that you intend to invest in.
- Government funds: in Nigeria, venture capital firms can access government-backed funds, grants, and loans aimed at promoting entrepreneurship and economic development.
- Banks: some venture capital firms sometimes utilize debt financing, such as bank loans to supplement their capital.
Requirements
You can’t go about expecting a random entity to give you funds without actually giving them a purpose to. You can’t raise funds with just a bunch of words or promises. Here are the best manners to present your requests
- Investment Thesis: you will need to present an investment thesis containing your focus industry, investment criteria, expected returns, and value proposition for potential investors.
- Pitch deck/presentation: you need to pitch(present) your investment strategy, track record, team expertise, and potential profits for the investors through your pitch decks or presentations
- Due Diligence and Compliance Checks: on your end, Conduct thorough due diligence on potential investors to ensure they meet suitability criteria, legal requirements, and compliance standards
Related: 10 Business Risks in Nigeria
8. Networking and Partnership
This might sound unimportant but it is very crucial if you want your venture capital firm to grow. Actively engage with stakeholders and key players within the entrepreneurial society in Nigeria.
This includes entrepreneurs, startup founders, industry experts, other venture capital firms, ghost investors, accelerators and incubators, and most importantly, industry associations.
You can do this by attending Industry events, conferences, and forums to build solid relationships and stay connected with the latest trends and opportunities
9. Tracking performance
Tracking performance in a Venture capital firm involves monitoring and evaluating key metrics and indicators to ascertain your success and profitability. This includes keeping track of all portfolio startups you have invested in.
Monitor their financial performance and growth metrics. You can also track the operation of your portfolios by monitoring their growth rate, sales pipelines, customer retention, cash flow, operating expenses, and expansion strategies.
In summary, by effectively tracking your portfolio performance, your venture capital business can make educated investment decisions, mitigate risks, and create long-term value creation for investors/stakeholders.
10. Exit Strategy Planning
Exit strategy planning in Venture capital is the strategic selling or exiting investment to generate profits and optimize the performance of your investment portfolios.
Here is why you need an exit strategy:
1. To maximize returns for the firm by selling off at the right time and price
2. To identify underperforming assets/portfolios and sell and reallocate capital to more promising opportunities
3. To mitigate the risk of losing investments
Exit Strategies
- Acquisition: this involves selling to industry players, competitors, or larger corporations seeking to expand their presence and portfolio base.
- Initial public offering: you sell portfolios through IPO on stock exchanges thereby allowing your investors to sell shares to the public and realize liquidity.
- Secondary sales: this involves selling equity stakes In your portfolios to other investors, private equity firms, or secondary markets to generate liquidity.
- Mergers and Consolidation (M&C): mergers bring portfolios together to operate as one, while consolidation involves your portfolio absorbing others to become bigger or more efficient.
- Liquidation: liquidating assets means selling off portions of the business to generate cash flow. This is a viable option where other exit options aren’t available.
Conclusion
This is where the curtain draws. We believe you have gotten a basic grasp of the 10 steps to start a Venture capital firm in Nigeria.
Dealing with the basics, we still tried to elaborate on every point just as we did with the “legal structures of a venture capital firm” down to our most recent “performance tracking.” You will need to research further regarding what’s being discussed to be well acquainted with every corner of a venture capital firm in Nigeria.
I have a simple question for you. Which of steps is more appealing to you in personal?
Good luck.