Nigeria: Analysing Business Structures For Promoting The Expansion Of Nigerian Information Technology (IT) Firms Into Other Countries

Last Updated: 25 June 2019
Article by Adebola Adeyemi

Introduction

This document highlights corporate structures and legal risk issues that should be considered by a Nigerian IT firm seeking to expand into foreign target countries. Considering the complexity and divergence in business and legal provisions this brief considers crucial legal risk issues that might impact on expansion plans including; regulatory requirements; corporate structures; governmental barriers; local content requirements; data privacy, protection and security; tax; intellectual property (IP) rights; employment law; quality control; dispute resolution; profit repatriation; and technology transfer regulations. In addition, the suitability of the possible option to a particular project will have to be considered in light of the characteristics of the product to be deployed either as a front-end solution or back-end solution.

Please bear in mind that this document is meant as a guide as countries have different political, regulatory and commercial arrangements. Based on the options suggested in this document, specific models can be designed and adopted for specific target countries.

1. MODES OF ENTRY

A Nigerian IT firm can rely on three modes of entry to access target countries. These are direct entry, joint venture, and local partnership. These modes can be combined where the target country has the legal and commercial framework to support it.

1.1 Direct Entry:

An IT firm can access a target country by opening a branch in the target country or through a subsidiary company.

1.1.1 Branch Option

An IT firm can open a branch/representative office. In some countries, this need not be a separate legal entity. It is merely an office of the IT firm in the target country. Advantages

(a) It is cheap and easy to establish with minimum registration requirements.

(b) The IT firm will have complete control and ownership and can take decisions through the head office.

Disadvantages

(a) Local businesses and banks may be hesitant to do business with the branch as they are unlikely to understand the company's structure and there may be little assets held in the target country to provide confidence and security.

(b) With the absence of separate legal personality, the IT firm is responsible for the debts and obligations of the branch

(c) Some opportunities may be lost as major decisions may be reserved for the Board of the IT firm.

(d) Generally, the branch will be registered as an establishment in the target country. Therefore, it must meet disclosure requirements where this is required.

(e) In addition, the law of the target country will apply to the operations of the branch as it relates to real estate ownership, employment, tax, health and safety regulations, and consumer protection.

1.1.2 Subsidiary Company

Generally, a company can create a group structure with subsidiaries operating under the guidance of a Parent company. A subsidiary company is one that over 50% of its shares is held by another company or where another company has major control over its Board composition.

The risk profile of a subsidiary with its own assets and employees is different to that set up as a shell company. Where a subsidiary acts on the instructions of the parent company, there is a high probability that the parent company will be held liable for the acts of the subsidiary. In addition, the group structure can be used as a risk management device. Liability can be managed by devising appropriate ring fencing/insulation strategies. Subsidiaries could be set up to carry out specific tasks such as management, advertising, ownership of IP rights, and operational functions. Relying on the structure of a group company, value can be held in specific sections of the group for the purposes of preventing accrual of legal risk to the parent company. For instance, a member of the group can hold all the rights to the company's IP. Then, another entity within the group can deal with operational issues. Further, another entity within the group can deal with marketing and advertising. With this compartmentalisation, the IT firm is able to ring fence and insulate its activities to the extent that risk in a specific sector will not harm the value held in other parts of the business.

Advantages

(a) Ownership and control of the subsidiary is vested in the parent company

(b) The parent company will not be liable for the debts and obligations of the subsidiary unless it agrees to be liable

(c) Existing businesses (clients, suppliers, and lenders) in the target country are familiar with the structure of the subsidiary and will be willing to contract with it. (d) Possibility of ring fencing operations and risks.

Disadvantages

(a) It may be expensive to acquire an existing company.

(b) Decision making process might be slow, if the Board of the subsidiary is required to seek authorisation from the Parent company.

1.2 Joint Venture (JV)

The IT firm can pursue its expansion agenda by creating relationships through a JV arrangement. A JV arrangement can be used to interact with a local partner relying on the structure of a company, partnership or through a contract with no business vehicle. The JV arrangement can be promoted through a number of different forms as follows:

(i) The IT firm can register a foreign management company as an offshore entity. This management company will now interact with a company in the target country. By doing this, the IT firm can insulate or retain value in a separate company while the foreign management company contracts with the company in the target country. If the business goes bad for any reason, the main business of the IT firm will not be impacted. Also, the JV vehicle may be set up in an offshore centre either because the parties are not confident in the laws where the commercial operation is domiciled or as a compromise jurisdiction.

(ii) A JV arrangement can be structured so that the partners will hold shares in a company limited by shares. This means the rules relating to setting up a private company in the target country will apply. The parties will negotiate important terms including financing, management, profit sharing, termination and voting rights.

(iii) It is also possible to use a JV vehicle for the purposes of execution of a specific project. Here, the JV will be constituted purely on a contractual arrangement without the constitution of a JV vehicle.

Advantages

(a) Penetration of a new market is easier through local business partner(s). This is because the local partner is likely to have valuable local knowledge and links making entry into the target country easier.

(b) Other local businesses and financiers are familiar with this business vehicle and will be comfortable dealing with the business.

(c) This is an effective way of diversifying risk

(d) In some countries, direct foreign entry may be difficult or it may not be allowed. A joint venture arrangement provides a basis for collaboration to access such market. Where government through a State enterprise currently controls the sector, the joint venture will need to be made with the State.

This has advantages and disadvantages.

The advantages are follows:

(i) The IT firm can gain from the monopoly status of the State enterprise, as it will be able to share from monopoly profits from a tightly controlled market.

(ii) The IT firm will be able to build a relationship with the State so that issues such as export permits, expatriate quotas, customs and administrative matters connected with entry and operation of the joint venture may be easily negotiated.

The disadvantages are as follows:

(i) The state might promote its objectives through the State enterprise and reflect its agenda in the joint venture operation. This agenda may clash with the objectives of the IT firm. However, the nature of control that will be wielded is dependent on the type of project. For a technology based project, where access can only be possible through the owner of the technology, the IT firm may be able to manage the power of the State by exerting influence over the State enterprise because of its technology.

(ii) In countries where joint venture with a State enterprise is compelled by legislation because of the importance of the sector, it may be difficult for the IT firm to exert any influence.

Disadvantages

(a) It may be difficult to negotiate the degree of control that the IT firm will surrender to the firm in the target country.

(b) It might be costly to obtain legal, tax, and business advisory services to set up the joint venture.

(c) Discussion on managing, financing, profit sharing and terminating the joint venture arrangement, may be long drawn and complicated.

1.3 Partnership

Local partnerships represent a veritable tool for testing the market of a target country. Where the IT firm is not sure of what it wants to achieve in a particular target country, it can employ this model as a means to test the regulatory and commercial environment relying on revenue sharing based model or a commission-based model.

In employing this model it is important to consider the cost of entry, investment relating to building direct presence and whether this can be justified based on the market size. Partnerships can be promoted through a franchise arrangement or appointment of agents. The local agent will act on behalf of the IT firm (franchisor). Based on the relationship, the agent could have authority to bind the franchisor or such authority could be excluded. The franchisee acts like a distributor but depending on the arrangement may be able to use the name, logo, and branding materials of the franchisor. This arrangement is an effective model for taking benefits from global transactions without the need of having to set up locally.

Advantages

(a) Cheaper to set up compared to a joint venture

(b) No requirement to publish accounts or other corporate details

(c) The IT firm can rely on and exploit the local knowledge of the other party.

Disadvantages

(a) Heavy reliance is placed on the agent or franchisee without adequate or direct control over the activities of the agent or franchisee.

(b) This arrangement is based primarily on contract. The arrangement can only be restructured or influenced by enforcing or reviewing the agency or franchise agreement.

(c) Where EU law applies, protective rights for commercial agents may override some contractual provisions in the agreement between the Franchisor and the agent or franchisee.

2. RISKS TO BE CONSIDERED WITH RESPECT TO MODE OF ENTRY

a) IP rights

It is important to state here that adoption of any of the structures discussed above will determine the extent to which the IT firm is able to settle ownership rights. The IT firm can adopt a model to separate control from ownership rights. The benefit of this is that where a particular entity within the group structure faces a problem, it will not negatively impact on related entities.

Concerning IP rights, these could be settled in a company specifically set up for this purpose. All existing and future IP rights will be transferred to this company for the purpose of insulating them from claims from third parties. In this sense, the structure can be used as an effective way to manage the risk of damage to IP rights.

In relation to the type of service to be rendered, it is crucial to consider whether the service will be implemented as a purely backend service or a frontend service. If the solution is deployed as a backend service, it is highly likely that the IT firm will only be concerned with interactions with regulators and other businesses. To this extent, the IT firm might not be subject to detailed consumer protection rules applying to transactions between businesses and consumers. This is because businesses are seen as experts who are able to negotiate the terms of their contractual relationship.

b) Tax

Tax liabilities can be managed by relying on the international group structure. Transactions within the group can be structured in a way to take advantage of the complexity in tax provisions around the world to pay the least amount of tax possible. Tax arbitrage is perfectly legal, as tax will be paid in the jurisdiction with the lowest tax requirement.

Another device to reduce the burden of tax is to rely on double taxation arrangements (DTAs) between two countries. Where a DTA is executed between two countries, individuals and businesses with a relationship in the two countries will not be subjected to double taxation on income, assets or profits. For instance, a Nigerian IT firm can benefit from executed DTAs between Nigeria and target countries where one exists.

Asides from tax considerations, where wealth is earned in a foreign territory, an offshore company will be useful for purposes of asset protection to avoid potential foreign exchange control restrictions that may be applicable in the country where the money is earned. This is where offshore business registration becomes apposite.

Also, there may be tax exemptions and incentives in certain target countries available to companies that are able to claim pioneer status where the product/solution to be deployed is recognised as novel or innovative.

c) Data

It is important to keep in view the importance of data protection and security as grave consequence attach to misuse of private data. Target countries will have data protection rules and this must be taken into account when planning to access such countries. In most jurisdictions, data collection and management must be done following strict legal rules. For instance, there could be rules on data collection, processing and storage. It is important to keep these in mind especially where the existing IT infrastructure in the target country acts as a limitation.

d) Political risks

In jurisdictions where the government plays a central role in regulatory and economic activity it is important to ensure continuity of obligations or obtain indemnities where contracts are broken. It is also important to consider the effectiveness of local laws and the alternative provided by international dispute resolution procedures.

e) Exchange rate risks

Currency hedging is a bit complicated but may be used as a tool to manage exchange rate risks. The firm should consider the value obtainable from currency that is earned in the target country to the currency of disbursement. It is also important to consider what can be set aside for reinvestment, research and development, technology transfer and profits. With global operations, currency hedging may be considered to manage exchange rate volatility.

3. CONCLUSION

While there are no physical limitations to what can be achieved relying on applications and platforms, the main limitations are legal and institutional. It is important for Nigerian firms to have this in mind while conceptualising the establishment of a global IT business ecosystem. This document suggests possible modes of entry for a Nigerian IT firm seeking access into foreign countries. It has considered business structures and options that may be employed to facilitate entry while also considering risk issues. It is important to reiterate that this document does not recommend any of the suggested models for adoption. The model to be adopted and the particular factors that will come into play will depend on the product to be deployed, political, financing, and regulatory factors at play. It has to be borne in mind that the commercial aspect and the local regulatory regime in the target country will impact on the design and application of the business model. However, the business model can be deconstructed and reconstructed based on the IT firm's strategic investment priorities.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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