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Start-up Advice

Buying a Business? Buy Right!

Understanding what it means to buy a business vs buying a company.

Sarah Lawrence

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In the commercial world, the terms ‘company’ and ‘business’ are often used interchangeably. Statements such as “my business employs 20 people” or “my company manufactures handbags” are commonplace, but what exactly do they mean?

In law, a company and a business are distinct concepts, and the purchase of a company has different legal consequences to the purchase of a business.

A clear understanding of the two is useful to businesspeople looking to obtain control of a particular business. This article provides an overview of how a company differs from a business, with reference to some of the key consequences of buying a business versus buying a company.

The tax and employee-related aspects of the two transactions are not dealt with, although they are important aspects of each transaction. For this and other reasons, the following should not be understood as legal advice.

What is a company?

A company is a legal concept, intended to promote commerce by allowing people to conduct business without personal liability. A company, once validly registered in terms of the Companies Act, No. 71 of 2008, has legal personality – in other words, it is able to transact in the same way as a natural person.

Just as a natural person owns assets, and is directly liable for his debts, so a company may also own assets and is directly liable for the debts that it incurs, generally to the exclusion of its shareholders.

What is a business?

A business is simply a collection of assets, both physical and non-physical, which generate income, as well as liabilities (debts)  that have arisen in the course of trying to generate that income.

A shoe manufacturing business, for example, would consist of:

  • physical assets, such as machinery and equipment;
  • contractual relationships with trusted suppliers and important customers;
  • intellectual property, such as shoe designs and trade marks (its brand name, perhaps);
  • accounts receivable and cash in the bank.

In addition, a number of debts might have arisen in the running of the business, such as amounts owed to suppliers for raw material, rental amounts owed to the landlord of the premises from which the business is conducted, and amounts owed by way of salary to people who work in the business.

A business is not a legal person and has no legal personality. It cannot enter into commercial transactions in the way that a natural person or a company can. In other words, a business cannot sign a contract. Rather, a business will be owned and operated either by a natural person (in other words, a sole proprietorship) or by a legal person such as a company.

A useful way to avoid confusing a company with its business is to remember that a company could own and operate a number of different businesses.

Acquiring control of a business

Let’s assume that Mr Smith has his eye on a successful shoe manufacturing business. The shoe business is owned and run by a company, Shoe Co Proprietary Limited. Shoe Co has two shareholders, Mrs and Mrs Sole.

Mr Smith decides he’d like to own the shoe business and run it for his own benefit. He has two options. He could buy all of the shares in Shoe Co from Mr and Mrs Sole, thereby acquiring the company which owns and operates the shoe business. Alternatively he could buy the shoe business from Shoe Co itself.

Buying the shares

Should Mr Smith choose to buy all of the shares in Shoe Co from Mr and Mrs Sole, he will become the only shareholder of Shoe Co. Mr Smith will therefore be in control of Shoe Co and all of its operations (including the shoe business). In this scenario, Mr and Mrs Sole will be the sellers, and Mr Smith will pay the purchase price for the shares to Mr and Mrs Sole.

The key disadvantage of this approach for Mr Smith is that Shoe Co, as a legal person, will continue to be liable for all the debts incurred by it before Mr Smith took over. Shoe Co may, for example, owe significant amounts to suppliers, to the Receiver of Revenue, or to other third parties, which Shoe Co remains liable to pay.

The existing debts will affect Mr Smith’s back pocket because, no matter how successfully the shoe business is run after he takes over, the amount available as profit for dividends to Mr Smith will necessarily be less after Shoe Co has paid its various debts.

It is for this reason that prudent purchasers insist on a due diligence investigation being conducted into the affairs of a company, prior to acquiring the shares. The purchase price for shares in a company burdened by significant debt should be correspondingly reduced.

As mentioned earlier, a company can own a number of businesses. If Shoe Co owns more than one business, buying the shares in Shoe Co is not the best way for Mr Smith to obtain control over the shoe business, because he will obtain control over all the other businesses operated by Shoe Co, at the same time.

Buying the business

The other option is for Mr Smith to buy the shoe business from Shoe Co itself. In this scenario, Shoe Co is the seller, and Shoe Co will therefore receive the purchase price. The shareholding in Shoe Co remains unchanged, and Mr and Mrs Sole continue to be its shareholders.

In this scenario, Mr Smith is buying the collection of assets which make up the shoe business from Shoe Co. He might be taking on some of the shoe business debts as well. The key advantage of this option for Mr Smith is that he will be able to negotiate which of the shoe business debts he will take over, and which debts will remain behind with Shoe Co.

Mr Smith might agree, for example, that he will assume and be liable to pay debts due and owing by Shoe Co to its suppliers, as long as those debts are no more than three months old. All other debts will remain with Shoe Co, and it will continue to be liable to pay those debts.

By buying the shoe business out of Shoe Co, as opposed to buying the shares in Shoe Co, Mr Smith protects his commercial operations and his finances from Shoe Co’s debts and liabilities.

Of course, the extent to which Mr Smith is prepared to assume Shoe Co’s debts will likely affect the purchase price payable for the shoe business. In general, the more debts the purchaser agrees to assume, the lower the purchase price for the business.

Buying the shoe business out of Shoe Co will also work well for Mr Smith where Shoe Co owns a number of businesses which Mr Smith has no interest in acquiring. Only the shoe business will transfer to Mr Smith, while the rest of Shoe Co’s operations will remain behind.

Commercial circumstances

The decision as to whether control of a business which is housed in a company is best obtained by a share purchase or the purchase of the business itself is always dictated by the commercial circumstances of the particular transaction.

In very general terms, purchase of the business is more appropriate when:

  • the buyer does not wish to take over all of the company’s liabilities, or there is a danger of undisclosed liabilities in the company;
  • the buyer wishes to acquire only some of the company business assets and not all of them;
  • the company owns a number of businesses and the buyer is only buying one of them; or
  • there are difficulties with acquiring the majority shares in the company, perhaps due to pre-emptive rights, or where certain shareholders do not want to sell their shares.

The purchase of the shares in a company might be more appropriate when:

  • the success of the business depends on certain agreements which the company is not allowed to transfer, such as a licence agreement, a supply agreement or an important lease;
  • one of the business assets is a property, which the purchaser wishes to acquire without going through the actual transfer process;
  • the sellers insist on selling their shares in the company, rather than selling the business out of the company; or
  • tax considerations dictate that a sale of shares will be more tax efficient than a sale of business.

The agreements

Since the transactions are different, the agreements regulating each transaction are also different. A sale of a business agreement will typically cover aspects such as:

  • which assets are to be sold, and which liabilities (if any) are to be transferred;
  • whether any consents or approvals are required before important contracts may be transferred;
  • the purchase price for the assets, which frequently includes a portion for goodwill;
  • the date upon which the purchaser will become the owner of the business;
  • the manner in which delivery of the assets will take place;
  • whether the transaction will be zero-rated for VAT, provided both the seller and the purchaser are registered VAT vendors;
  • whether the transaction is to be advertised in terms of section 34 of the Insolvency Act, No. 24 of 1936; and
  • whether the seller makes any warranties regarding the business, and whether the seller has put a limit on its potential liability to the purchaser, should any warranty be breached.

A sale of shares transaction will typically cover aspects such as:

  • how many shares in the issued share capital of the company are to be sold;
  • whether the sellers have any shareholders loans against the company, and whether those will also transfer to the purchaser;
  • the price to be paid for the shares;
  • whether any approvals or consents are required before the shares may be sold (such as obtaining the consent of any other shareholders);
  • the manner in which delivery of the shares will take place (usually by the seller handing its share certificates and a signed share transfer form to the purchaser); and
  • whether the seller makes any warranties regarding the shares and the company, and whether the seller has put a limit on its potential liability to the purchaser, should any warranty be breached.

In practice, the decision as to whether the purchase of a business or the purchase of a company is more appropriate is determined not only by the factors discussed here, but by tax considerations and considerations relating to the employees in the business, if any.

For this reason, it is usually advisable to obtain legal advice on the best approach under the circumstances.

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.

Start-up Advice

Entrepreneurs! Do You Know What Your Customers Want?

Take off those rose-tinted spectacles and start looking at your business the way your customers do.

Chris Ogden

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Do you know what your customer’s need? Have you really looked at their problems and challenges and asked yourself how your product or solution helps solve them? Do you even know if your business addresses any one of the myriad pain points they face every day in their personal and professional lives? If your business talks to other businesses, are you speaking in the language they want to hear? If you don’t answer a definitive YES to every one of these questions, then you need to start paying attention…

Put in the effort

Research, research, research. Find out what people need through all the myriad of digital and physical research channels available to you. And when you engage with your customers in person, ask them questions and write those insights down. Listen.

Related: 5 Reasons Why Your Business Is Losing Customers

Bad feedback is great feedback

If clients are unhappy, they talk to you. This is good news. Use this feedback to build solutions that change these issues into advantages. This is when you should consider building an open feedback loop or mechanism into your business to ensure that you are getting the best possible insights from your customers. I

It’s also a good idea to check their criticism against reality before you spend thousands on fixing a problem that doesn’t really exist. For example, if they complain about poor customer care, assess your process and see how many complaints you have. It may be that one customer happened to deal with that one unhappy employee.

Understand their business

Your client has their own clients who have their own clients, and so on, and so forth. Take the time to get to know their business and their market. Often entrepreneurs don’t get to know how their client’s businesses work and they miss a crucial trick. By spending time with them and listening to them you get to understand their pain points and their needs. This way you can be the one who helps to fix their problems properly.

Related: How Well Do You Really Know Your Customers?

Don’t stop innovating

Don’t fear the ability to change something to suit a client’s needs. Your products and services have to evolve constantly as your market and consumers are changing constantly. You need to add value, change features or adjust your services dependent on the business you are in. Pay attention and innovate.

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Start-up Advice

Why Failing Is A Necessity Proven To Guarantee Success

We should always have this at the back of our minds whenever we have that nudge to give up on our dreams.

Matthew Mordi

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There comes a time, especially after a terrible defeat, when we feel like giving up or even quitting. The defeat clouds our minds and make us forget completely what victory feels like. We forget the successes and judge ourselves solely on the defeats. This feeling isn’t unique to a single individual as even the most successful businessmen, inventors, politicians, world leaders have experienced failures at different points in their lives.

We all love success stories. It’s a matter of fact that behind every success story is a large amount of failed attempts. The notion of overnight success is a myth. It took the Wright brothers between four and seven years of scientific experimentation and several failed attempts before their maiden flight covering a distance of 852 feet which lasted a mere 59 seconds was achieved.

History is replete with instances of individuals who were written off after a terrible fall from grace. These individuals, against all odds, didn’t give up.

Related: Having The Perfect Product Isn’t Enough To Keep You In Business

Tiger Woods, for example, has for the most part of his adult life being in the public eyes. That’s why when he went to his very public divorce, tales of womanising, dabbling with prescription drugs. Also plagued by injuries, his golf was seriously failing and in danger of being a “has been,” analysts advised he should just retire. It was obvious Tiger had a different plan up his claws by winning his first PGA tournament in five years.

His recent resurgence in form is testament to the fact that no one has the stop button to our life or life’s dreams and ambition. No one but you. It’s only when we stop innovating and trying that we’ve failed. Having lost a business deal that had the chance to change our lives positively forever isn’t the end of the world. Hence we need to reinvent and innovate.

If achieving success was easy, the vast majority of people would be successful. We have to put in the work and our skill to be able to achieve success because the most worthwhile things don’t come easy.

Defeats, if seen from a positive perspective, bring out the best in us. Victories don’t. Victories swell our egos, fill us with the air of invisibility, and this is dangerous. Hence we need a large dose of failures and defeats to bring us down to earth, to make us learn and better appreciate success the moment we’re able to achieve it.

What then do we do when we experience a poor run of defeats that make us doubt our abilities. Being fixated on the defeats for one, isn’t the solution. It has the tendency of making us forget what it felt like to win and totally derail us from our set goals. This, in itself, is a problem as it may lead to a state of unhappiness.

Related: Why Small Businesses Are Unable To Pay Staff Salaries

The bad results we might have experienced isn’t an indication of our inabilities, it’s an opportunity for us to look at the venture from a different perspective and take necessary action to improve or try a different approach towards achieving our aim.

Defeats can be depressing when we have dependents who rely on us for guidance and in some cases sustenance. Dependents could be in the form of a spouse, children, wards, parents, even staff. The pressure can be enough reason for some to give up and settle for the safer option.

With the decision to settle comes the likelihood of regret which may be more depressing than the expectations of dependents. Fortune they say favours the brave and nothing worthwhile was ever achieved without the possibility of failure.

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Start-up Advice

Why You Need Smart Legal Foundations For Your Start-up

The legal background to a start-up might not be the most exciting area for an entrepreneur, but it’s your foundation for growth. Are you aware of everything you need to have in place?

Kyle Torrington

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One of the best parts of what we do is helping start-ups — the right legal foundations can mean the difference between a start-up that’s geared for scale, and one that needs to retroactively put agreements, checks and balances in place. If you’re aiming for growth, you want to get these foundations right from the get-go.

When Benji Coetzee launched EmptyTrips, a hot up-and-coming start-up 16 months ago, Legal Legends was on the ground floor with her. Although your start-up trajectory may not be identical to that of EmptyTrips, many of the foundational principles canvassed in this article will apply at some point in the lifecycle of your business. They highlight what you should be thinking of from the word go.

Laying the right legal foundation

By the time we were introduced to EmptyTrips, they had already registered their entity as a company and had started to prepare for their first beta public launch in April 2017. When our dealings with the start-up began, the business had already enjoyed a quick and accelerated cycle.

As with all start-ups, the founders had a clear vision and objectives. Unlike too many start-ups however, Benji understood how important the right legal foundations would be, particularly as the business matured and required different support structures.

The following three actions are a good example of the legal foundations all businesses should consider, particularly if growth is a part of the founder’s vision:

1. Why you need trademark protection

Given that EmptyTrips is a digital solution, with limited physical assets, protecting intellectual property as ‘soft’ assets was critical to its differentiation and valuation given the recognition of brand value over time.

At first, we set out to ensure that EmptyTrips’ marketing materials and properties, such as company name, slogan, and product names were protected sufficiently from use by others. This was done by filing for various trademark registrations.

A trademark is a sign or symbol that is unique to your business, and which distinguishes it from other businesses. The most common forms of trademarks are business names, product names, logos and slogans.

By registering a trademark you are granted exclusivity over the use of the name, slogan or logo, and may prevent others from using similar names, slogans or logos in their business in the future.

Related: [PODCAST] Benji Coetzee, Founder & CEO Of Empty Trips – How To Disrupt A $8 Trillion Logistics Industry

When it came to EmptyTrips, they had already filed a trademark for their business name, so we focused on protecting the names of the different service offerings on the business’s platform as the solution evolved and pivoted. These included Trip Exchange; Freight Open Exchange; SureFox and RailFox. As the business grows and product lines are added, we will continue to update this list.

2. The importance of website legal documents

EmptyTrips is predominately an online marketplace solution to enterprises. It is a digital transport brokering agency that has been developed to source, match and market available transport capacity (empty space on trucks, trains, vessels and so on) to commercial freight with on-demand supporting financial products (insurance etc).

Our next task was to prepare the documents that would govern the relationship between EmptyTrips, its users and service providers. These documents, as with most websites, consist of both a terms of service and privacy policy.

Each company’s Terms of Service will be unique to that business, market and customers, but privacy policies are universally required by law.

A privacy policy is a written document available for all users to inspect on your website and which they are required to agree to. It sets out the different kinds of personal information that you collect, coupled with how you store that information, and what you do with it. A privacy policy is required by the Protection of Personal Information (POPI) Act No 4 of 2013, and the General Data Protection Regulation (GDPR) (EU) 2016/679 if you are collecting personal information from European citizens.

In the case of EmptyTrips, their pick up and drop off address, business information to cater for the pick-up and drop-off of goods by carriers, personal information such as the name of the carrier, and payment details, need to be recorded in the privacy policy. In addition, certain elements of the information, such as pick up and drop off locations being shared with potential transporters, need to be mentioned.

If you do not have a privacy policy in place on your website, Legal Legends has a cheap automated version available at the following link if you would like to order one: www.legallegends.co.za

3. The legal frame work around outside investment

Like many high-growth starts-ups, Benji and her team reached a point where outside investment was needed. This is an area where your legal partner is key. Apart from attending to various due diligence meetings and ensuring proper governance controls, we were tasked with ensuring that the contracts for external investment were prepared in a manner that sufficiently protected the interests of EmptyTrips and its founding members.

It’s common during a seed or series A round of funding for an investor to present the start-up with a term sheet detailing the nature or basis of the intention and extent of their investment, as well as all the terms relating to the governance of the company that they would like to put in place.

In this case, the institutional investor presented EmptyTrips with a term sheet that detailed the monetary investment that the investor would provide over a number of years, the monthly draw-downs of the investment that EmptyTrips would be entitled to, the number of shares that the investor would be issued for their investment, as well as the manner in which the governance of the company would be changed in order to protect their investment.

Often, and this applied to EmptyTrips, the terms contained in the term sheet require a new shareholders’ agreement and/or memorandum of incorporation in order to protect the interests of the minority shareholder (the investor).

A shareholders’ agreement governs the relationship between the shareholders of the company and their ability to administer the company.

A memorandum of incorporation governs the relationship between directors, shareholders, prescribed officers and the company.  A standard memorandum of incorporation is issued when a company is registered, but it will often need to be amended at a later stage if, for example, measures to protect the minority shareholders are introduced.

A memorandum of incorporation can regulate the same aspects as a shareholders’ agreement, however, the main difference is that it is a public document available for inspection by anyone, whilst a shareholders’ agreement is a private document.

In addition, if there is any conflict between a shareholders’ agreement and a memorandum of incorporation, the shareholders’ agreement will not apply and will be voided to the extent of its inconsistency.  This often means, as was the case with EmptyTrips, that certain aspects of the shareholders’ agreement that provided for protection of the investor required a redraft of the memorandum of incorporation so that the two documents were aligned.

A shareholders’ agreement might not be enforceable until a memorandum of incorporation has been aligned with it.

Read next: 5 Lessons From The Legal Legends On Pivoting

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