Why won't more companies access the stock market for funding?

Nigeria’s most valuable unicorn, Flutterwave, recently reiterated its plans to take the company public via an Initial Public Offering (IPO) on the Nasdaq stock exchange in the US.

Also, earlier in the year, another Nigerian company—BUA Foods, was listed on the Nigerian Exchange (NGX).

The capital market can be extremely attractive for most companies (be it a startup or a more traditional companies).
 

According to the Central Bank of Nigeria (CBN), the capital market is the long-term (meaning the instruments traded mature between three years to infinity)* end of the financial market. It is where long-term funding instruments such as stocks (shares of companies), debt instruments (like bonds and debentures), currencies, etc., trade between investors, business institutions, governments, and individuals.

The most important feature of the capital market is that it is a public market. This means that companies utilising this market have access to a wider array of investors and, by extension, more capital.

Usually, companies visit the capital market when they need to fund long-term or capital-intensive projects.

Also, going public (listing on an exchange) helps spread ownership risk (person or people responsible for managing risks or threats) and could present opportunities for the business owner or early investors to cash in on returns on the equity they invested in the business's early days.

For Flutterwave, following a series of funding rounds via venture capital, the company has now decided to raise some more funds through the IPO, to access even more capital due to the increased reach to investors as it becomes a publicly listed company in the US.

According to Kabiru Rabiu, Group Executive Director of BUA Foods, the listing of the leading consumer food company was to “build capacity for food sufficiency,” i.e. expand.

This really got me thinking. Why don’t more Nigerian companies go through this route of raising funds? After all, the capital market is the perfect “place” to access a wider array of investors (meaning more financial capital) and improve your credibility, which is always good for business.

Since 2019, only nine Nigerian companies (i.e. Skyway Aviation Handling Company (SAHCOL) Plc, Airtel Africa Plc, MTN Nigeria, BUA Cement, Nigerian Exchange Group, Briclinks Africa, Ronchess Global and BUA Foods) have listed in Nigeria and one (Jumia on the NewYork Stock Exchange) wasn’t even in Nigeria. 

This compares favourably with a peer country South Africa (ten listings since 2019) but contrasts with listings in an advanced market like the Nasdaq in the US, with 70 listings in Q1 2022 alone.

Given the benefits above, what’s stopping Nigerian companies from accessing the capital market? To answer this question, we need to understand what it means to “access the capital market”, the requirements, the benefits and some limitations that serve as a disadvantage and then draw our conclusions. 

What does it mean to access the capital market?

Here’s an example. Meet Donda. Donda has built a successful artisan hailing app using personal funds and some bank loans.

So much activity is now happening on her app, making the platform crash. So she needs to hire more developers and expand her database to take on more customers and even the artisans to do the work. She has also conducted her market study and seen that the next place to launch this product is in Abuja before someone else replicates her business model. 

The problem here is Donda doesn’t have all this cash at hand, and taking on more bank loans might prove destructive to her growth model due to the costly interest payments attached to the loans that could hamper profitability. And according to her business plan and test market results, she will make millions in the first year. Enter: capital markets.

As I described earlier, the capital market offers Donda reach to a wider array of investors and more capital (cheaper too).

So Donda has two primary sources of funding to pick from, i.e. equity financing or debt financing (both from the capital market). Companies use a combination of both, but there are distinct advantages to utilising either one.

For equity financing, there is no obligation on Donda’s part to repay the funds received, while debt financing does not require her to give up any ownership of her business.

The decision as to which source of financing to go for often depends upon which source of funding is most easily accessible for the company, its cash flow, and how important maintaining control of the company is to its principal owners.

So what exactly do equity and debt financing mean? Understanding these two funding sources would help us see why more companies don’t look to the capital markets.

Equity versus debt financing

Equity financing involves the selling part of an owner’s stake in their business.

If Donda decides to sell 10% of her business, now valued at ₦1 billion, Donda can raise ₦100 million to fund her business expansion. However, the investor(s) has a say in the business's decision-making.

Some types of equity financing include venture capital, angel investing, listing on a stock exchange etc.

The main advantage of this source of financing is that there is no contractual obligation to repay the investors who supplied the funds. Of course, the investors would demand returns on their investments, but that’s in the form of profit sharing or dividend payments and stock price appreciation (as in the case of listing on an exchange).

Equity financing does not place a further financial burden on business owners. As such, Donda is not worried about making monthly interest payments or is not worried that interest rates are rising. She would be able to focus on growing the business with the newly available capital. 

However, a downside to this is that now more people have a say in Donda’s business. Remember, the definition of equity financing involves the sale of a portion of the owner’s equity.

This means that before Donda can make any decisions in the business, she has to consult more people and even share her profits with them. This, coupled with the fact that interest paid on debt raised in the capital market is tax deductible (it can be subtracted from taxable income to lower the amount of taxes owed), informs the famous saying in corporate finance—“debt is cheaper than equity”.

Most business owners are not so willing to part with a portion of their company or even have to consult others to make decisions in THEIR companies. 

This brings us to the second primary source of financing–debt financing. 

Debt financing from the capital market involves a company borrowing money from lenders/investors with an agreement to pay back on a specific date, with interest payments attached. The most common type of this is bonds.

Bonds are long-term fixed income instruments that corporations and governments issue to raise capital.

Say Donda needed ₦100 million to expand her business and doesn’t want to relinquish any equity. She decides to issue a corporate bond of 10% per annum for three years to raise the ₦100 million. 

This means that over the next three years, Donda would have to make interest payments totalling ₦30 million (10% of ₦100million for three years) and then still pay back the ₦100million at the end of the three years. So in total, she’s paying back ₦130 million.

The major advantages of this source of financing are: firstly, no investor or lender has a say over the decision-making of Donda’s business. Secondly, once she makes the final interest payment and pays back the capital, her relationship with the lenders has ended. Lastly, the interest payments are tax-deductible.

So now we understand the difference, advantages and disadvantages of both sources of financing available via the capital market.

But to completely put this into perspective, let's look at real-life examples of how accessing the capital market can benefit a company to understand why more Nigerian companies don’t access the capital market. 

Does the capital market help companies? 

One common theme among most top Nigerian banks is that most of them, between 2004 and 2005 listed on the NGX either for the first time (e.g. Zenith Bank, FCMB etc.) or the second time (e.g. UBA, GTCO etc.).

Following the mandate to recapitalise their capital buffers (from ₦2 billion to ₦25 billion between 2004 and 2005) by the then CBN Governor—Charles Soludo, banks were offered four possible solutions by the CBN to meet the 2005 deadline.

One was to approach the capital market to issue IPOs, rights issues etc. The second was to consolidate through mergers with like-minded and synergy-producing banks. The third was to acquire another bank or be ready for acquisition, and finally, close up shop and surrender the banking licence.

So 2004 - 2005 was a busy time for banks. In the end, of the 89 banks in operation before the announcement, only 25 survived.

Many banks approached the stock exchange to raise capital. According to the CBN’s 2004/2005 annual reports, the NGX “considered and approved 37 applications for new issues, valued at ₦235.5 billion in 2004, compared with the 26 applications valued at ₦185 billion in 2003”.

One of the most notable listings was Zenith Bank’s ₦23.5 billion IPO and $650 million raised from international capital markets.

In fact, in the first half of 2005, the exchange recorded 32 new issues valued at ₦264.9 billion (compared to the eight issues we have seen on the NGX since 2019).

According to Ayodeji Dawodu, a director at BancTrust & Co, a UK-based investment firm focused on emerging markets, “access to the capital markets enabled most of these banks to survive the Soludo reforms. The surviving banks were better positioned to fund large projects in development-enabling sectors, like the telecoms and oil & gas”.

As I mentioned earlier, there were 89 banks in Nigeria before the reforms, but the Nigerian banking system was fragile and inefficient. The major reason was due to the size of the banks. 

In Nigeria, the single borrower limit (how much you can lend to a single borrower) is 35% of shareholders’ funds (equity). Before the reforms, the minimum capital requirement for banks was ₦2 billion. And while most of these banks had up to ₦10 billion in capital, all it meant was that the maximum they could lend to any single borrower was ₦3.5 billion (35% of ₦10 billion).

This amount was too small to fund capital-intensive projects like those undertaken by operators within the telecoms and oil & gas industries.

As of December 2005, the aggregate capital base of the banking sector rose from $3 billion in 2004 to $5.9 billion. The reforms also attracted ₦350 billion (almost $3 billion then) in foreign portfolio investments through the capital market and about $500 million in foreign direct investments.

So not only did the capital market help these banks stay afloat, but it also helped facilitate growth and development in the country.

Capital markets bring borrowers and lenders together efficiently and help channel resources to create a healthy national and global economy. They provide essential funding that affects people's lives in many ways, from starting a business to expanding a current one or providing investment opportunities for people planning for their future.

So with all these opportunities within the capital markets for companies and the positive ripple effects on the economy, it begs the question, “why don’t more companies access the capital market?”

So why don’t they? 

According to Dawodu, “most companies started as either individual or family companies, and the idea of diluting their ownership just doesn’t appeal to them. This is one of the major reasons you don’t see more companies listing on the exchange”. 

As discussed earlier, equity financing involves relinquishing part ownership of your company in exchange for capital. While the owner can retain the company's controlling interest (highest shareholder), consulting others (who may not necessarily share in the vision that brought the company to its current status) is appalling to business owners. 

In fact, as more investors take up higher percentage holdings of a company’s share, their influence (ability to make decisions) also grows. This could lead to the shareholders overruling the business owner's decisions or even sacking him/her.

Remember how Steve Jobs (the co-founder and CEO of Apple Inc) was forced out of his own company in 1985, following a long power struggle with the company’s board? Yeah, that could happen. 

Therefore, staying private leaves business owners with greater control over their businesses, and they don’t have to share profits with anyone.

Douye Mac-Yoroki, an equity analyst with Renaissance Capital, a global investment bank with operations in Nigeria, explained that “most business owners don’t want to deal with the increasing regulations listed companies are required to adhere to”.

Recall those stringent SEC rules I mentioned that give listed companies a form of credibility. It turns out they also deter accessing the capital market.

Chief among the rules is that the company must have proven track records backed up with profitability. According to the SEC, “the company must also have a minimum of three years operating track record with a pre-tax profit from continuing operation of not less than ₦300 million cumulatively for the last three fiscal years and a minimum of ₦100 million in two of these years”.

The SEC requires annual reporting and third-party auditing of financial statements of all publicly listed companies. This helps investors understand the businesses better, as they can perform financial analysis and carry out forecasts that aid investment decisions. It also fosters trust and transparency in the capital market.

However, Dawodu brings another perspective to this point. According to him, “private companies only have to apply accurate and current accounting when making their financial statements, but they do not require any third-party auditing and are not mandated to publish the statements. Therefore, they can hide shady dealings and transactions while appearing to be law-abiding companies”.

This could explain why Seplat energy is the only upstream oil and gas company listed on the NGX. The level of corruption and subsidy fraud emanating from the national oil company and former oil and gas sector regulator—NNPC is enough reason for most of the other operators in the sector to hide their books and shy away from public scrutiny.

A third reason is the level of risk attached to going public or issuing an IPO. Although an IPO can be an effective way for companies to access large sums of capital, it can be an expensive endeavour that can easily spell doom for a business if unsuccessful. A classic example was WeWork’s IPO in 2019.

WeWork was a real estate company in the US that was valued at $47 billion before its IPO and was one of the most eagerly anticipated IPOs in the summer of 2019.

However, following its submission of required documents for its IPO, financial documents also showed that WeWork was losing tons of money and its market projections were wildly optimistic.

Within 33 days, the IPO was scuttled, and WeWork’s valuation dropped by 70% to $14 billion. After the failed IPO, WeWork was taken over by SoftBank, its largest investor. The company’s CEO, Adam Neumann, also stepped down and gave up majority control of WeWork’s stock.

Moreover, Mac-Yoroki links reduced interest in the capital market to “structural issues associated with the Nigerian economy”. He adds, “the health of the capital market is linked to the health of the economy”. 

In my article, I explained how the equity market is seen as an indicator of how the economy will perform. Similarly, the economy's state can affect the capital market's attractiveness. Foreign investors have been exiting the Nigeria equity market since 2020 due to the volatile exchange rate and fx illiquidity, leading to issues around fx repatriation (taking profit back to their home countries). 

The selloffs of stocks and persistently high inflation have fueled capital market apathy among business owners or founders. 

Persistently high inflation translates into higher interest rates (cost of borrowing) as the CBN tries to tame it. However, since investors buy a company's stock in anticipation of more future profit, higher borrowing costs dim these expectations. Hence high inflation could lead to lower company valuations, affecting how much they can raise. 

This makes business owners think twice about going through all the stress of listing on an exchange, only to have economic headwinds (that are beyond their control) eat into their valuations. 

Finally, Nigeria’s capital market is shallow, and there aren’t that many options in terms of the securities traded. As such, there isn’t that much liquidity in the market. Since accessing the capital market is to access a wider array of investors, what good is a capital market that doesn’t offer such? 

In conclusion, while there are many reasons to access the capital market, the access might come at a high price in terms of ownership dilution and scrutiny from the SEC and shareholders. 

So, is the juice worth the squeeze?

There are no right or wrong answers to whichever decision a business owner makes—it ultimately boils down to what they think is best to stimulate growth.

While remaining private suits a family company like S.C. Johnson well, United Parcel Service (UPS) chose to go public in 1999 after 92 years in business to raise the capital necessary to compete in the global delivery marketplace.

Both companies perceive their choices as the right ones.