Last week there was a talk at the iHub about founder stock agreements i.e. the agreements that people enter with each other as they set up companies. John Freeman, an attorney who has advised on tech startups in the US & Asia, as a venture capitalist and now as an angel investor, said that most founders allocate their shares 50/50 when starting our or in other equitable ratios.
But he said that this was a wrong allocation and that company founders should instead take some time to run a “founders pie calculation” (designed by Frank Demmler) to assess the founders commitment and responsibilities at the companies to determine exactly how much each founder is entitled to get.
He also said’ it’s important not to have too many cofounders (never more than 5) as when they get new investment, their stakes may be diluted to become negligible. As more key people are, added, they should remain employees, but who can earn bonuses and options that vest over several years.
Founders also need to come up with term sheets, employment agreements (e.g. which note that the company owns all intellectual property developed) and shareholders agreements that have clauses such as right of first refusal. (He said if a company does not have this clause, it is not worth investing). The clause determines who can invest in the company even if a cofounder leaves, dies or gets divorced etc. Founders who leave companies should also sign termination notices.
He said that there is an increasing trend or more convertible debt in lieu of equity investments. The documentation for theses is much faster (he does this in two weeks) and cheaper compared to equity investment, but that many Kenyan lawyers do not understand the convertible debt agreements. He mentioned that investor templates could be found at sites such as founders workbench, startup percolator, cooleygo, ycombinator and orrick.
The iHub event was in partnership with m:lab East Africa and uWakili.
CBA has been in the news as it was reported to have facilitated bail in an ongoing criminal case. It’s not common to see a bank linked to a case.
The bank issued a statement to clarify that it was not a party to the case. It only issued a guarantee of Kshs 140 million to its customer which is a law firm, and it is presumed that the law firm used that to arrange to release the accused person in the case.
Most of the time a court demands bail or bond in Kenya, it is usually presented as cash or vehicle logbooks or land title-deeds. It’s rare to have a bank guarantee. But the amount called for in this case is quite large, and it is doubtful that any of these regular items offered as bail would be arranged at short notice. The Kshs 140 million guarantee is equal to about $1.39 million or £1.05 million.
News coverage of the case
Bank’s do offer several forms of guarantees mainly as trade finance or insurance products. The guarantee in this case ensures that the defendant will show up in court during the case. If not, then the bank will have to pay the court the amount on behalf of the law firm.
The case is being covered extensively in Kenya and UK media because of the defendant, a commodities trader whose firm was found to be moving a consignment that apparently contained illegal drugs.
$1 = Kshs 101 and .39 million or £1 = Kshs 133
The Central Bank of Kenya, Financial Sector Deepening Trust Kenya and the World Bank, have published a study on bank financing of Small and Medium Enterprises (SMEs) in Kenya ($1=Kshs 100). Excerpts
- The total SME lending portfolio in December 2013 was estimated at Kshs. 332 billion, representing 23.4% of all banks’ total loan portfolio
- Donor Support: Nearly all of the banks interviewed received some form of donor support or were in discussions with donors for support directly related to financing of SMEs. In several cases there were banks with support from as many as four donors at a time.
- Limited Government Intervention: In 2010 The Government (though the Treasury) established a special SME scheme, called the MSE Fund, but since 2012 no new loans have been approved by the fund. According to Treasury, the scheme was discontinued because “the intention was not for the Government to lend, but to create an incentive for banks to engage with SMEs”. After only a year of the fund’s operation, banks started to lend more to SMEs from their own books, especially Equity Bank, and therefore Treasury did not see any reason for the continued operation of the fund. In addition to the MSE fund, the Government set up a Youth Fund and a Women Entrepreneur Fund, in which a number of banks are participating. The Government is also contemplating a partial credit guarantee for agricultural loans.
- Courts Not Good at Dispute Resolution: Enforcement of secured claims appears to be slow and costly, affecting the cost of credit. It takes 4.5 years, costs 22% of the value of the debtor’s estate, and only yields 30% of what is owed
- PE & VC’s: The majority of around 15–20 active private equity funds focused primarily on SMEs with a perceived financing gap of typically between US$50,000 and $5 million. The funds target deal sizes of around $1–3 million, which is still at the high-end of the SME segment and is therefore out of reach for most SMEs in Kenya. The venture capital industry is still nascent with about 10 venture capital type funds, but interest from international firms, as well as local ones, especially in the emerging ICT industry, has recently been on the increase. There are several incubators which have been set up to help build the pipeline for such deals, but the sector is still at an early stage of development
- 3 Kinds of Banks: Banks target the market segments they are most effectively able to service. There are 1. Corporate oriented (Barclays, CfC Stanbic, Standard Chartered) 2. Supply-chain oriented (BoA, Chase, DTB, Ecobank, FINA, I&M, NIC) 3. Micro-oriented (Co-op, Equity, Family, KCB, KREP, Jamii Bora)
- Overdrafts are Bad: The most interesting finding from this analysis is arguably the central role played by overdrafts in SME lending in Kenya. While overdrafts can be useful to meet immediate liquidity needs and to avoid firms having to turn to informal lenders or shadow banking, a problem arises when firms use overdrafts to fund specific working capital or investment financing needs. Overdrafts tend to be very expensive and inefficient in addressing specific business funding needs. Banks, on the other hand, may have limited incentives to reduce firms’ reliance on overdrafts, as the overdrafts usually provide high profit margins. Nonetheless, during the interviews some bank managers confirmed that over-reliance on overdrafts can be a major hindrance to the development of SME finance in Kenya: overdrafts are a financial ‘black box’ because they do not reveal why firms are borrowing nor how the loans are used.
- Interest Rates: The average annual interest rate is 20.6% for microenterprises, 18.5% for small enterprises, 17.4% for medium enterprises and 15.3% for large enterprises.
- Potential 20 Million Credit Reports: As of 31 December 2014, a total of 5.2 million credit reports were requested by banks, compared with 2.3 million as of December 2012. Adding the information from the over 20 million registered mobile money/mobile financial services users would lead to a significant expansion of the underlying information base.
A few weeks ago there was an odd debate by thousands of people in many countries over what color a certain dress was – “White and Gold?” , or “Black and Blue?”.
While the dress debate rages on, there are similar debates are going on in the Kenyan judicial system. If you attend a Kenyan court, and hear lawyers for two sides argue, they will say polar opposites of each other. E.g a bank lawyer will say that Person A has defaulted on a Kshs 10 million loan and they want to sell his/her house. In reply, the lawyer for Person A will deny that he knows the bank, or took a loan from the bank, and that there is a fraudulent attempt to sell his house.
Or in the case of the Tatu City, you have two groups of directors saying totally different things. One side calls the others fraudsters who have never put a cent in what is a billion shilling project, while the other side says that foreigners want to deprive them of a rightful stake.
The truth is usually somewhere in between in these cases, but why do antagonists, through their lawyers and affidavits retreat to polar opposite sides ahead of court? This forces a judge to wade through months or years of volumes of evidence and documents in order to arrive at at a Solomonic decision that may reflect the reality, or a sense of fairness. Not the truth. In these drawn out cases sides are given injunctions and orders that prolong, and make the ultimate decision, needlessly more expensive.
Could a lot of cases be settled faster, and less time lost in the courts? There’s no need for Solomon in every case.