Creating and running a “Legally Saleable” business or company

Provided by Fluxmans Attorneys

By Jack Phalane

Topics Commercial & Corporate Law | Mergers & Acquisitions

30 Aug 2021

The prudent business person is one who, prior to establishing or acquiring a business or company, gives thorough consideration to the vehicle which is most suited from a financial and legal perspective, in which to house that business. Considerations involved include funding, tax efficiency, structural flexibility and the like, for which expert advice should be obtained prior to effecting the proposed acquisition or establishment, as the case may be.

Every business owner aims to make a return and eventually a capital profit from owning a business undertaking. Thus, it is important to appreciate and prepare for what will be required when a person sells a business or shares in the company which owns it, regardless of whether or not there are immediate intentions of selling the business or shares.

From a contractual point of view, a saleable business or company assumes the seller’s ability and preparedness to furnish appropriate representations and warranties regarding the business and where appropriate, the company in which it is housed. These representations and warranties include those relating to the corporate/legal structure, financial performance/profitability of the business and compliance with various laws and regulations. Warranties and representations contained in a sale agreement are the subject of a give and take process of negotiation. The seller invariably wants to furnish as few warranties as possible, whilst the purchaser wants to receive as many warranties as possible. No purchaser will be prepared to pay the seller’s asking price unless appropriate representations and warranties are furnished and the seller is more likely to achieve a better price if these are provided.

Long before the thought of selling the business crosses the owner’s mind, due consideration must be given to the structure of the business or company, contractual relationships with key stakeholders, tax structure and legal and regulatory compliance and these considerations should enjoy ongoing attention and review.

Structure of the business or company

A business can be structured as a sole proprietorship, trust, partnership or private company, depending on the applicable estate planning and related financial considerations. Each ownership structure has its own legal and tax consequences and these must be adapted to the requirements of the individual concerned.

As part of the operating structure, a business owner should avoid basing the success of the business on the expertise or personality of an individual. A risk invariably considered by business suitors is the sustainability of a business dependant on the founder or one person. It is advisable to build a business around a team so as to ensure that its success is perceived to be independent of one or more individuals.

Tax consequences and compliance

Every business structure and activity has tax consequences. Understanding these consequences prior to the acquisition or establishment of the business can be critical. By way of example, a sale of business may attract VAT depending on among others, whether or not the seller is registered as a VAT vendor. Where a business is structured as a going concern, and both the seller and the purchaser are registered as VAT vendors, the sale is zero rated for VAT purposes thereby creating a further attractive incentive for a potential purchaser. Equally important to having an appropriate structure is ensuring that one renders unto Caesar what belongs to Caesar. The last thing that a purchaser would want is to acquire a business or shares in a company whose tax affairs are not in order or up to date or subject to query or investigation.

Contractual relationships

The value of a business or company can also materially depend on contractual relationships which exist between the business and its customers, suppliers and key employees. These contractual relationships need to be structured in a way that does not negatively affect the sale of the business. Ideally, contracts should not contain provisions that require the counterparties’ consent in the event of a proposed sale of business or change of control in the event of a sale of shares. Furthermore, an owner will do well to ensure that key contracts do not restrict cession and/or assignment to successors in title. As for employees, employment contracts should contain appropriate restraint of trade provisions, restrictions on the use and disclosure of the company’s confidential information, and ownership by the proprietor of the business of any intellectual property developed by the employee during the course of his/her employment.

Legal and regulatory compliance

A business owner needs to be fully acquainted with and understand the laws and regulations that apply to the business and ensure compliance with same. A warranty that the company or business has complied with laws and regulations applicable to it is found in most, if not all sale transactions. These cover compliance with among others, labour, tax, competition, anti-bribery and corruption laws. To the extent that a business has business activities outside South Africa, compliance with export and import laws and foreign exchange regulations is important.