The Law on Venture Capital in Kenya
Venture capital may be defined as long-term risk capital typically provided by professional investors to new and expanding businesses which are usually high risk, but offer the potential for above-average returns. Venture capitalists pool their resources including managerial abilities to assist new entrepreneur in the early years of the project. Once the project reaches the stage of profitability, they sell their equity holdings at high premium. The concept has its roots in the US. The common projects in which such capital is invested are usually in Information Technology (IT), Biotechnology or Clean Technology.
In Kenya, this type of investment is governed by the Capital Markets Act (“the Act”) and Regulations made under it. The Act contemplates registration of venture capital companies (VCCs) and defines a registered venture capital company as a company approved by the Capital Markets Authority (CMA) and incorporated for purposes of providing risk capital to small and medium sized businesses in Kenya with high growth potential, whereby not less than 75% of the funds so invested consist of equity or quasi-equity investment in eligible enterprises.
The Act empowers the CMA to grant approval to entities to operate as registered VCCs. In addition, it bestows upon the CMA the power to issue guidelines and rules governing VCCs. Pursuant to this power, the CMA issued the Capital Markets (Registered Venture Capital Companies) Regulations in 2007.
Approval of Venture Capital Companies
In order to operate as a registered VCC, one has to obtain approval to the CMA. When one applies to be registered, they are required to provide details in respect of such matters as the capital structure, shareholding, subsidiaries and affiliated companies, the nature of venture capital financing to be undertaken, particulars of directors, shareholders, auditors and company secretary, amongst others.
Additionally, so as to be considered for approval, the applicant must meet the eligibility criteria set out in the Regulations. For instance, the applicant must be duly incorporated under the Companies Act as a company limited by shares, have as its principal object the provision of risk capital to SMEs, have a minimum paid up share capital of Kshs. 100M, have a minimum fund of Kshs. 100M and have a demonstrable track record as a VCC.
To enable CMA make a decision on the application, the law requires one to furnish the CMA with certain information and documents, which include details of the investment policy in respect of each fund to be operated, prescribed evidence of appointment of a licensed fund manager and details of the corporate governance structures of the applicant.
It is imperative to note that under the Act, without the approval of the CMA, it is unlawful to carry on business as a registered VCC or to hold oneself out as a registered VCC and carry on business as such.
Benefits of Registration
Once registered, VCCs enjoy certain tax incentives under the Income Tax Act. For instance, there are exemptions in respect of dividends received by registered VCCs. In addition, there are exemptions on gains arising from trade in shares of a venture company enterprise earned by a registered venture capital company within the first ten years of the date of first investment in that venture capital enterprise. This is subject to meeting the criteria that the venture company enterprise in which the investment is made has not been listed for a period of more than two years at the date of the trade.
Limitations imposed on Registered VCCs
The flipside is that the Regulations limit investment that can be made by registered venture capital companies. They require that investment may only include investment in a company or person associated with a venture capital enterprise.
The enterprises that they may invest in (venture capital enterprises) are limited to companies that do not trade in real property, banking and financial services, and retail and wholesale trading services.
In addition, registered VCCs are only allowed to raise money through private placements and are prohibited from making offers to the public.
Statistics indicate that the in 2018, annual venture capital invested surpassed $100 billion. Approximately $130.9 billion was invested across 8,948 deals recorded in 2018. These statistics suggest that venture capitalists will have capital to fund innovation for years to come. Venture capital has great potential to spur growth of SMEs in Kenya. With an enabling legal framework, we hope that the relevant players can tap into the potential which we believe will have a lasting social and economic impact in the country.
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