Legal And Regulatory Considerations For Fintech Startups In Nigeria

Joshua Akhator with Kikelomo Adeoye, Omoerere Erhuen and Faith Omole. ¹

INTRODUCTION:

Financial Technology (“Fintech”) is a fast- paced and effective industry which covers a large range of business activities including payment products, payment solution services, budget management services, digital assets, peer-to-peer lending and crowdfunding, banking, saving and deposit products, etc. Fintech startups have particularly revolutionized the way solutions are provided for financial services thereby disrupting traditional financial services model for faster and more expedient financial services. This article provides a comprehensive analysis of the business structure for fintech startups, the regulatory framework, licenses required by fintech startups, data privacy and cybersecurity considerations and recommendations on how fintech startups can navigate the challenges associated with the fintech industry.

BUSINESS STRUCTURE FOR FINTECH STARTUPS

A startup is a company incorporated under the Companies and Allied Matters Act, 2020 (“CAMA 2020”) and granted the startup label and organizations and establishments whose activities affect the creation, support and incubation of labelled startups in Nigeria in accordance with the Startup Act.²

For a fintech startup to operate in Nigeria, it has to choose a business structure for operation. In Nigeria, business structures include the following: Private or Public Limited Liability Company, Company Limited by Guarantee, Unlimited Liability Company, Partnership/Firm, Limited Liability Partnership, Sole Proprietorship and Incorporated Trustees. CAMA 2020 regulates the formation of these business structures except for partnership/Firm and Sole Proprietorship. The choice of any of these business structures determines the size of the business, the total number of owners, and the extent of the liability of the founders. They are explained as follows:

Sole Proprietorship

This is a business structure owned and controlled by a single person. The owner has no separate legal personality from the business. The owner bears the responsibilities and liabilities of running the business. A sole proprietorship shall be granted a pre-label status for a period of six (6) months to enable him to comply with the requirements of registering it as a limited liability company.³

Partnership

This is a business structure owned and controlled by two or more people who share the profits and the liabilities of the business. Essentially, there are three types of partnerships; general limited partnership, and Limited Liability Partnership.

A General Partnership is one where all partners share the financial and legal liabilities equally. A Limited Partnership is one in which at least one of the partners is a general partner who bears the liabilities of the partnership while at least one of the other partners' liabilities are limited to the amount that was invested in the business. Limited Liability Partnership is one which is a body corporate with a legal entity separate from the partners. A partnership is usually granted a pre-label status for a period of six (6) months to enable the sole proprietor to comply with the requirements of adopting a limited liability company structure⁴.

Limited Liability Company

This is a corporate entity that operates independently of its shareholders and directors. Shareholders are only liable for debts up to the value of their shares in the company. A startup qualifies for labeling where it is registered as a limited liability company under CAMA 2020 and has been in existence for no more than 10 years from the date of incorporation.⁵

REGULATORY BODIES FOR FINTECH STARTUPS IN NIGERIA

Regulatory compliance considerations of Fintech Startups depend largely on the nature of their business operations and the sector of the economy in which they operate. Key government agencies regulating fintech startups include the following:

1. Corporate Affairs Commission (CAC);
2. Central Bank of Nigeria (CBN);
3. Securities and Exchange Commission (SEC);
4. Nigeria Communication Commission (NCC);
5. Nigerian Deposit Insurance Corporation (NDIC);
6. National Insurance Commission (NAICOM);
7. National Office for Technology Acquisition and Promotion (NOTAP);
8. Federal Inland Revenue Services (FIRS);
9. Nigeria Data Protection Commission (NDPC);
10. National Information Technology Agency (NITDA);
11. Nigerian Investment Promotion Commission (NIPC);
12. Nigeria Social Insurance Trust Fund (NSITF); and
13. National Pension Commission (NPC).

Corporate Affairs Commission (CAC)

Fintech startups must be incorporated with the Corporate Affairs Commission, which oversees the incorporation and statutory regulation of all companies in Nigeria. The startup's records must be maintained accurately, including fulfilling post-incorporation requirements such as filing annual returns.

Central Bank of Nigeria (CBN)

Fintech startups engaged in financial services should obtain the necessary licenses as per the guidelines set forth by the CBN.

The National Information Technology Development Agency (NITDA)

The NITDA is the government agency responsible for the process of labelling a startup, establishing platforms to provide access to information on matters pertaining to the establishment and development of a startup, incubation, acceleration and venture building programmes, access to fiscal and non-fiscal support. The NITDA is statutorily mandated to collaborate with relevant MDAs and other stakeholders to promote innovation in digital technology, and enterprise development for a startup in Nigeria

Securities and Exchange Commission (SEC)

Fintech startups which are involved in raising capital must register their securities with SEC and must comply with the Investments and Securities Act 2007 and its Rules.

The Securities and Exchange Commission established the Rules on Digital Assets for the issuance, offering platforms and custody of digital assets. The SEC is empowered to regulate the issuance of digital assets as securities, registration of digital assets offering platforms, registration of digital asset custodians, virtual assets service providers and digital assets exchange⁶.

Nigeria Communication Commission (NCC)

Fintech startups that offer services that involve the use of mobile phones or mobile networks must obtain operating licenses from the NCC and are subject to the NCC's regulation.

National Insurance Commission (NAICOM) and Nigerian Deposit Insurance Corporation (NDIC)

These government agencies are responsible for the administration and regulation of the activities of insurance companies in Nigeria. A fintech startup that carries out insurance services will have to get licenses from NAICOM before carrying out its business.

National Office for Technology Acquisition and Promotion (NOTAP)

This agency has the responsibility of regulating and promoting the acquisition, transfer and domestication of foreign technology in Nigeria. Fintech startups that leverage the services, skill, and strategic assets of foreign technical partners in an arrangement that involves the transfer or acquisition of technology are required to comply with the NOTAP's regulation.

Federal Inland Revenue Services (FIRS)

This body has the responsibility of collecting value- added tax, company income tax, withholding tax and stamp duties paid to the federal government. These taxes are required to be paid by fintech companies operating in Nigeria.

Nigeria Data Protection Commission (NDPC)

The NDPC regulates how personal data are being processed by data processors and controllers in Nigeria. Fintech companies are required to adhere to the provisions of the Nigeria Data Protection Act (NDPA) and National Information Technology Development Agency (NITDA) Act because they process, store and transfer data of data subjects in their daily business activities.

Aside from those highlighted above, other relevant government agencies include the Nigerian Investment Promotion Commission (NIPC) and the Nigeria Social Insurance Trust Fund and National Pension Commission (NSITF & NPC).

LICENSES REQUIRED BY FINTECH STARTUPS

There are several licenses needed by a fintech startup to be able to operate in Nigeria. These licenses are dependent on the kind of services the fintech startups provide.

Fintech Startups that operate as Payment Service Banks has the key objectives of providing payment/remittance services to small businesses, low-income households and other financially excluded entities through high-volume low-value transactions in a secured technology-driven environment.⁷ The licenses granted to these fintech startups can either be Approval in Principle or a Final Banking License. These licenses are granted upon the promoters of a startup submitting a formal application for the grant of a license to the CBN Governor and make a formal proposal to the Director, Financial Policy and Regulation Department (FPRD), CBN. Similarly, Startups that are Payment Terminal Service Providers and Payment Solution Service Providers have licenses which include the Approval-in-Principle license, the Commercial license and other licenses advised from time to time. The Approval-in-Principle license of Payment Solution Service Providers is valid for six months while the commercial license is determined by the CBN renewable upon satisfactory performance of operations. The validity of other licenses is determined as advised from time to time. These licenses allow a fintech startup to offer payment processing and switching services for electronic transactions. Other licenses available for Fintech startups include mobile money operator license, super-agent license, switching and processing license.

 INCENTIVES AVAILABLE FOR FINTECH STARTUPS

The Startup Act provides for incentives for fintech startups.⁸ Companies that have been labelled as “startup” by the National Information Technology Development Agency are entitled to enjoy these incentives. Some of these incentives are highlighted below:

Pioneer Status Incentive (PSI)

The Act provides that a labelled startup which falls within industries captured under the legally specified Pioneer Status Incentives (PSI) may receive expeditious approval from the Nigerian Investment Promotion Commission for the grant of tax relief under the Pioneer Status Incentive Scheme.⁹

 Exemption from Companies Income Tax

A labelled startup may be entitled to exemption from the payment of income tax or any other tax chargeable on its income or revenue for a period of three years and an additional two years if still within the period of a labelled startup, provided that the commencement date of the tax relief will be the date of the issuance of the startup label. Labelled startups also enjoy full deduction of any expenses on research and development which are wholly incurred in Nigeria. Also, Non-resident companies that provide technical, consulting, professional or management services to a labelled startup are subjected to a five per cent withholding tax on income derived from the provision of such services, provided that the payment of the withholding tax, is the final tax to be paid by such non –resident companies.¹⁰

Other Tax Incentives

An angel investor, venture capitalist, private equity fund, accelerator or incubators that invests in a labelled startup is entitled to an investment tax credit equivalent to 30% of the investment in the labelled startup on the condition that such credit is applied on any gains on investment which are subject to tax.

Additionally, gains that accrue from the disposal of assets by an angel investor, venture capitalist, private equity fund, accelerators or incubators with respect to a labelled startup are exempted from capital gains tax provided the relevant assets have been held in Nigeria for a minimum of 24 months.¹¹

Exemption from Contribution to Industrial Training Fund (ITF)

The Act exempts labelled startups from contributions of 1% of annual payroll cost, to ITF where it provides in-house training to its employees for the duration where it is labelled as a ‘startup'.¹²

Export Incentive

As part of its statutory functions, NITDA is mandated to ensure that Labelled startups involved in the exportation of products and services, which are deemed eligible under the Export (Incentives and Miscellaneous Provisions) Act, are entitled to export incentives and financial assistance from the Export Development Fund, Export Expansion Grant and the Export Adjustment Scheme Fund.

Access to Government Grants, Loans and Facilities

As part of its statutory functions, NITDA is also mandated to ensure that labelled startups are able to benefit from grants and loan facilities administered by the CBN, the Bank of Industry or other bodies statutorily empowered to assist small and medium scale enterprises and entrepreneurs as well as the Credit Guarantee Scheme established by NITDA.¹³

Crowdfunding

Under the Act, startups have the option of raising capital through crowdfunding intermediaries and commodities investment platforms that are licensed by the Securities and Exchange Commission (SEC).

Establishment of the Credit Guarantee Scheme

This is to offer financial and credit assistance to labelled startups by providing this financial stimulus, framework for credit guarantee, financial information etc.¹⁴

Repatriation of Capital and Profits

Foreign investors are guaranteed repatriation of investment through the CBN's authorized dealer in freely convertible currency of dividends or profits, and proceeds, in the event of a sale or liquidation of the startup or any interest attributable to the foreign investor's investments provided the foreign investor can present a Certificate of Capital Importation (CCI) as evidence that the initial investment fund was injected through the proper channel.

Easing Compliance Process for Startups

Under the Act, the statutory responsibilities of the NITDA includes collaborating with key government MDAs to ease regulatory compliance process of startups in the manner highlighted in the table below:

MODES OF SECURING FUNDING FOR FINTECH STARTUPS

Fintech startups can secure funding through various means which include, but are not limited to the following:

Crowdfunding

As discussed above, Fintech Startups may raise funds through crowdfunding intermediaries and commodities investment platforms duly licensed by the Securities and Exchange Commission (SEC) that would have their platforms available for use by startups on the Startup Portal.¹⁵

Angel investors

These are high net worth individuals or companies which provide funding to an early-stage fintech startup typically in exchange for equity in the startup company.

Seed funding

This is the fund used to establish a fintech startup until the startup generates funds of its own or till it is due to further investments. This kind of fund is gotten as an exchange for equity stake in the startup.

Series funding

This is the stage for fintech startups after seed funding. It consists of Series A, B and C funding. Series A funding is the startup's first round of venture capital financing. Series B is a follow-up on the Series A funding which helps to bring in more investors for a Startup. Series C funding is focused on scaling the startup to make it grow quickly and successfully. In this funding, investors inject more capital into the startup and they receive more than double the amount invested.

Venture Capital

Venture capital is the fund invested in fintech startups or other businesses with flourishing potentials. Also, it is usually provided in exchange for equity in fintech startups. The investors are the driving force behind venture capital funds, they include institutions such as insurance firms, high-net worth individuals or pension funds that provide capitals to venture capital firms to invest in fintech startups or small businesses.

A Venture capitalist is a person or company that provides capital to a startup that is exhibiting high growth potential in exchange for equity.

Other sources of fundings for fintech startups include loans, mezzanine, etc.

DATA PRIVACY AND CYBERSECURITY CONSIDERATIONS FOR FINTECH STARTUPS

Fintech startups need to consider the issues of data privacy as they will be collecting sensitive financial data. They are required to comply with the provisions of the Nigeria Data Protection Act, 2023 and other applicable data protection laws and regulations.

The Nigeria Data Protection Act defines a data controller as an individual, private entity, public commission, agency or any other body who alone or jointly with others determines the purposes and means of processing of personal data.¹⁶ Fintech Startups could be regarded as data controllers or data processors under applicable laws depending on the nature of their processing activities.

Fintech Startups are required to establish technical and organizational measures to ensure the safety and integrity of personal information obtained from data subjects and also to prevent data breaches that could be caused by external attackers through phishing, ransomware attacks and blackmail failsafe measures.

Fintech Startups should also have flexible policies that adapt regulatory changes by consulting with experts in data protection and its compliance so as to prevent financial penalties and loss of reputation for non-compliance.

Also, cybersecurity threats need to be addressed by fintech startups so that they can implement strong security measures. The Central Bank of Nigeria's Risk-Based Cybersecurity Framework and Guidelines for Deposit Money Banks and Payment Service Providers provides a risk-based perspective to managing cybersecurity risks.¹⁷ The guidelines provides that every company which fall under the payment service providers category should adopt cryptographic controls such as public key infrastructure, hashing and encryption to guard confidential and sensitive information against unauthorized access, develop a data loss/leakage prevention strategy to discover, monitor and protect sensitive and confidential business and customer data or information at endpoints, storage, network and other digital stores, whether online or offline and identify vulnerabilities in their assets by engaging professionals in this field to conduct penetration tests annually.¹⁸

CHALLENGES FACED BY FINTECH COMPANIES IN NIGERIA

Data security

Safeguarding data is a priority and Fintech companies stand the risk of breaches and hacks. Hackers have become increasingly sophisticated in devising means to access the data of fintech companies which usually entails sensitive data of their customers.

Onerous Regulatory compliance requirements

Irrespective of the incentives discussed above, Fintech Startups have diverse regulations to comply with, it may therefore become a hassle to navigate compliance with the diverse financial regulations. 

Insufficient technical expertise

Aside from lack of sufficient technical know-how, staying abreast with technological innovations can be a challenge for fintech startups. Also, some of the fintech apps are not user friendly thereby making it challenging for users to navigate easily.

Fund

Access to funds is a hurdle that fintech startups experience as it may not be easy to get or attract investors and they usually require high startup or operating costs.

Scalability

Fintech startups experience challenges in expanding their business into new markets.

CONCLUSION:

In this piece, an analysis of the business structure for fintech startups was provided, the regulatory framework governing the operation of fintech startups was examined, and the incentives that could be leveraged by Fintech Startups were discussed. Recommendations on strategies for navigating the challenges associated with the fintech industry were also preferred.

Regulatory compliance could be a “bitter” but “necessary” pill to swallow, especially for businesses that are still at their nascent stages. Conversely, there are incentives provided under applicable law to promote growth and development of startups in the country. Therefore, to maximize returns on investment it is essential to have a good understanding of the regulatory compliance requirements of your business and at the same time, the available incentives that could be leveraged to enhance profitability.

Footnotes

1. Joshua Akhator is a Partner at Alliance Law Firm, Lagos, while Kikelomo Adeoye, Omoerere Erhuen and Faith Omole are Associates at the same law firm.

2. Section 2 of the Nigeria Startup Act, 2022.

3. Section 13(4) of the Nigeria Startup Act, 2022.

4. Section 13(4) of the Nigeria Startup Act, 2022.

5. Section 13(2) of the Nigeria Startup Act, 2022.

6. New Rules on Issuance, Offering Platforms and Custody of Digital Assets, 2022.

7. Paragraph 2 of the Guidelines for Licensing and Regulation of Payment Service Banks in Nigeria 2020.

8. Part VII of the Nigerian Startup Act, 2022.

9. Section 24 Nigerian Startup Act, 2022.

10. Section 25(2)(3) and (4) of the Nigerian Startup Act, 2022.

11. Section 29 of the Nigerian Startup Act, 2022.

12. Section 25(5) of the Nigerian Startup Act, 2022.

13. Section 27 of the Nigerian Startup Act, 2022.

14. Section 28 of the Nigerian Startup Act, 2022.

15. Section 32 of the Nigeria Startup Act, 2022.

16. Section 65 of the Nigeria Data Protection Act, 2023.

17. Appendix III of the Risk-Based Cybersecurity Framework and Guidelines for Deposit Money Banks and Payment Service Providers, 2018.

18. Ibid

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.