The Companies Act: Friend or Foe of Small Business?

The Companies Act: Friend or Foe of Small Business?

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On 1 May the “new” Companies Act will have been in place for exactly three years. Many entrepreneurs are likely to remember the initial confusion when the Act first took effect, mainly because it did away with the concept of a close corporation.

Small business owners are often caught between the need to house their business operations in a legal entity that affords limited liability and a desire to avoid the legal and administrative difficulties that come with registering and maintaining a legal entity.

Close corporations were perceived as easier to run and administer. Also, they were certainly cheaper to maintain than a company since financial statements did not have to be audited. For this reason most small businesses opted for a close corporation rather than a company before 1 May 2011.

After 1 May 2011, however, it was no longer possible to register a close corporation or convert a company to a close corporation.

While compliance with the Act has been intimidating for small businesses, the provisions of the Act do provide for greater administrative and operational efficiency in the long term. The Act also allows for the increasing complexity of small businesses as they grow.

Three years on the Companies Act has proven to be a friend of small business rather than a foe as initially feared by many entrepreneurs. Business owners still harbouring resentment towards the Act should consider taking advantage of the following five benefits offered by the Act:

 

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1. Less onerous admin and operational requirements

The Act has simplified certain of the administrative rules previously associated with companies. Under the Act, companies may store documents in electronic format, give notice of meetings electronically, and electronic signature of documents is permitted.

These changes suit smaller businesses and start-ups, which tend to be digitally based and seldom deal with documents in hardcopy format.

2. Structured shareholding

The introduction of the Act has made it possible for small businesses to house their operations in a private company structure with all the flexibility around share capital that a company offers, but without the prohibitive expense of auditors’ fees.

This is because, in terms of the Act, a private company is no longer required to have its annual financial statements audited unless it chooses to do so or unless it meets certain criteria relating largely to business size.

The Act therefore offers investors a chance to own equity in a small company, whilst reserving control, at both a shareholder and a board level, for the founding shareholders.

3. Shareholders and directors

The scope afforded by the Act for directors’ powers to be almost as extensive as those of shareholders, whilst shareholders retain final control of the company, align well with how small businesses like to work.

A characteristic of many smaller businesses is that their shareholder numbers are small and there is often a 100% overlap between shareholders and directors. Even where the shareholders are themselves legal entities, the board nominees of those shareholders are generally the principals behind the entities.

The result is that the founders of small businesses find the distinction between shareholders and directors puzzling. Often they do not understand why the directors alone cannot run the company since in their view the directors and the shareholders are the same people.

Depending on the content of the Memorandum of Incorporation (MOI), which is determined by shareholders, the powers of the board of a small company may be extensive, including the power to affect the share structure of the company.

This means the board may have a wide discretion to run the company without constantly reverting to shareholders, which makes particular sense where the board and the shareholders are for all intents and purposes the same people.

4. Protecting shareholder interest

Once a small business reaches a certain level of maturity, or takes on additional shareholders who do not have board representation, it makes sense for the distinction between the board and the shareholders to be more strongly drawn. Shareholders can achieve this by resolving to amend the MOI, thereby circumscribing the board’s powers.

While the board has wide powers in terms of the MOI, the Act reserves certain key powers for the shareholders alone, including the requirement that at least 50% of the board must be elected by the shareholders, and the power to remove directors from the board.

The flexibility that the Act affords around the percentages required for an ordinary and a special resolution means that even where there is only one class of shares in a company, shareholders can arrange the percentages in a manner that they consider appropriate, provided of course that there is always a 10% difference between the percentage of votes required to pass an ordinary resolution and that required to pass a special resolution.

5. Simpler decision making processes

The Act contains more extensive and detailed provisions than the old Act in relation to the manner in which shareholder and directors’ meetings are to be held, and the process by which shareholders and directors make decisions.

Whilst the old Act contained some guidance in this regard, the detail was generally to be found in a company’s articles of association. The Act is much more comprehensive, which means there is no need to replicate those provisions in the company’s MOI. The MOI can therefore be a simpler document.

Sarah Lawrence
Sarah Lawrence is a commercial legal consultant at Caveat Legal. She holds a BA in English, Sociology and Industrial Psychology from the University of Stellenbosch, an Honours degree in English Literature from the University of Cape Town, and a BA LLB from the University of Cape Town. Sarah completed her articles at Edward Nathan Sonnenbergs and was admitted as an attorney of the High Court of South Africa in 2010. She specialises in Corporate Commercial Law, with a focus on transaction work.