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Regulation of Venture Capital in the EU and East and West Africa: Impacts and Possibilities

Document Cited in Related
Vincent
Published date01 May 2019
Author
Date01 May 2019
DOI10.3366/ajicl.2019.0273
Pages292-307
INTRODUCTION

Interest in private equity financing in Africa has gained traction in recent years. Given the challenges in capital sourcing for entrepreneurs, it is hardly surprising that the role of financial intermediaries serving between sources of funds (typically institutional investors) and high-growth and high-tech entrepreneurial firms1 has become increasingly prominent. While private equity in general has been of immense interest in research and scholarly circles, venture capital has remained conspicuous by its absence. Such an anomaly persists despite the growing presence of venture capital firms such as the Africa Media Ventures Fund, the eVA Fund, Jacana Partners, the Angel Investment Network, Adlevo Capital, Invenfin Venture Capital, Fanisi Capital, the TBL Mirror Fund, the East Africa Capital Fund (East Africa) and West African Synergies (West Africa).2 While few studies have attended to venture capital in Africa, they have often followed the main destinations of such capital, namely and predominantly in South Africa,3 Kenya4 and Nigeria,5 among others. In the main, the studies often attend to the nature of the venture capital without affording detailed attention to the institutional factors which affect the flow of capital. This article is concerned with filling this lacuna in the venture capital space. It does so by discussing venture capital in relation to regulation over three geopolitical spaces which are Europe, East Africa and West Africa.

Regulation is important because it determines what is legally possible and what is not. In the West African Economic and Monetary Union, for example, the Insurance Regulatory Body (CIMA) does not allow its member insurance companies to invest in private equity funds. In Nigeria, pension funds are not permitted to make private equity investments.6

The article is premised on a textual and quantitative analysis of secondary data. It starts off by looking at the broad legislative and operational framework of venture capital in these three areas. Thereafter, it draws focus on three representative economies in the geopolitical blocs. In adopting an analytical approach on three specific cases, there is a possibility that nuances within and across regions may be lost. However, the available data reveals that, except for Germany, the two other African case countries – Kenya and Nigeria –dominate their respective regions such that many of the policy approaches towards venture capital mimic or imitate these country positions. It is therefore very likely that – for example, with regard to policy – one will find similar positions in Niger and Ghana as one would in Nigeria.

 THEORETICAL AND CONCEPTUAL FRAMEWORK

Before engaging in a discussion of the regulatory framework in all regions, it is worth laying out the conceptual platform on which we discuss issues on venture capital, its regulation as well as innovation. To start off, it is a form of finance wherein financial intermediaries enable investors/funders together with entrepreneurs to meet, each party accessing their desired conditions with an option of exit at some point. Venture capital is by its very nature involved at a key point in the new investment process, such that its role in determining discontinuities in regional growth and the emergence of ‘new’ industrial core locations may be proportionally greater than its absolute value would suggest.7 In other words, whatever the amount injected as funds towards a specific new venture, it is very conceivable that such amount understates the true economic significance of the activities to which such funds relate.

The discussion of capital will employ an institutional lens. Due to this theoretical framing, we observe that when discussing the institutions which relate to markets, we ought to be cautious on which form of institution we refer specifically to. This is because institutions have various typologies that include normative institutions, regulatory institutions and cognitive institutions. In this article it is regulatory institutions which we pay attention to. This focus is grounded in the theoretical body of new institutionalism. New institutionalism uses institutions to analyse processes of change and stagnation within institutions. An institution is a ‘web of interrelated norms – formal and informal – governing social relationships.8 To this, Ferris and Shui-Yan add that institutions are rules or humanly devised constraints that structure actions and interactions among individuals.9 It is through the existence of institutions that people recognise acceptable forms of engagement with other actors and organisations. To emphasise, North suggests that institutions are the humanly devised constraints that structure political, economic and social interaction.10 Through the study of institutions, researchers get a broader understanding of issues pertaining to the question ‘how do we explain the things people do?’11 In this article, they enable us to understand how states engage with venture capital funds. A detailed discussion of institutional theory is beyond the scope of our study here. Important to note is that of the three schools of thought in the new institutionalism – rational choice, sociological institutionalism and historical institutionalism – it is rational choice in which we situate our analysis and discussion. Rational choice has its roots in economics where it is presumed in micro theory that individuals act according to the information available, opportunities and constraints, to maximise on their self-interest. Citing Radnitzky,12 Ferris and Shui-Yan recognise that rational choice ‘assumes that individuals make decisions based on how they perceive and weigh the expected costs and benefits of alternative courses of action’.13

Lastly, when considering regulations in the venture capital space, it is important to recognise that these apply across various stages of the venture's life. The stages have been well depicted in models to explain what venturism is comprised of. Venture capital comprises five steps:

Deal origination

Deal screening

Deal evaluation

Deal structuring

Post-investment activities14

 METHODOLOGY

The study employed a mix of methods. The mixed methodologies are a combination of both qualitative and quantitative approaches either in data collection or data analysis or data interpretation or all of the stages.15 This project employed mixed methods in the analysis and interpretation stages. The scope of the study was regulation, which applies to foreign capital in general and venture capital in particular. As such, regulations on tax and investor protection were considered. Such an approach is consistent with Graham and Harvey who recognised that the main costs of equity as: tax costs, adverse selection, premium and floatation costs.16 A qualitative analysis comprises the specific laws which apply. However, due to resource constraints, three leading economies in the EU, West and East Africa were selected. These were Germany, Nigeria and Kenya respectively. From these three selected cases, indicators from the World Bank datasets in their annual ‘Doing Business’ reports were used to assess the change over time in both tax regulation and investor protection. This analysis is complemented by a portrayal of venture capital regulations and volumes over a similar period of time in each of the countries. These shifts are then tested for correlation in the case of Germany to establish whether there is any discernible relationship between regulations and volume. Nigeria and Kenya were not included due to inaccessible data.

 THE CONTEXT AND SCOPE OF THE STUDY

We focus on West Africa, East Africa and the European Union. West African states which constitute the private equity bloc attracting venture capital of note include Mauritania, Mali, Niger, Senegal, Sierra Leone, Liberia, Togo, Benin, Ghana, Nigeria, Côte d'Ivoire and Burkina Faso. Although these states form part of the Economic Community of West African states (ECOWAS) with the exception of Mauritania which has left ECOWAS in 2002 to join the Maghreb Union for northern countries. However, they do not have similarly universal membership of the West African...

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