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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

Put On Your Wellies: It’s Time To Wade Into Risk

Entrepreneurs aren’t all leaping into the unknown like lemmings off a cliff, but they do need to consider it…

Chris Ogden

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You’ve had a great idea. You’ve looked into its development. You’ve recognised that it has potential beyond just what Auntie Mabel and Mike From The Grocer think. And you’ve clearly nailed a pain point that can make money. Now it is time to take the risk of running with it.

Every big idea comes with risk. You can’t step out into the world of entrepreneurial thinking and business development without it. Your idea may fail. It will also be time consuming, demanding, hungry for money, and hard work. It is unrealistic to expect that your project will leap out into the world and be an unmitigated success.

It is also unrealistic to assume that it isn’t worth taking this risk.

There are steps that you can follow to ensure that your risk is managed so you aren’t blindly leaping off that cliff…

Step 01: Do your research

No, canvassing your neighbours, friends and family is not doing research. You need to know that your idea will appeal to a broad market and that it will have significant legs. This may sound like daft advice, but you would be surprised how many people think an idea will take off just because Susan in Accounting said so.

Step 02: Understand the costs

Projects are hungry for money and investment. Realistically work out your budgets and how much it will cost to take your project off the ground and then stick to it.

A calculated risk is a far better bet than one that shoots from the hip and hopes for the best. You can also use this as an opportunity to draw a clear line under where you will stop investing and end the project. If it keeps eating money and isn’t getting anywhere with results you need to be able to walk away.

Step 03: Know when to walk away

As mentioned before, this can be defined by a line you’ve drawn in the proverbial sand (and budget) but no matter where you draw this line, you have to stick to it. Often, when time, money and energy have been poured into a project it can be incredibly hard to walk away.

You think ‘but I have put so much into this, just one more’ and then it gets to a point where the ‘just one more’ has taken you so far down the line that walking away feels impossible. Leave. Learn the lessons. Apply them to your next project.

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Start-up Advice

Mind The Gap

The entrepreneur’s guide to finding the gaps and building the right solutions.

Chris Ogden

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Innovation may very well be the key to business success but finding the gap into which your innovative thinking can fit is often a lot harder than people realise. Some may be struck by inspiration in the shower, others by that moment of blinding insight in a meeting, however, for most people finding that big idea isn’t that simple. They want to be an entrepreneur and start their own high-growth business, but they need some ideas on how to find that big idea.

Here are five…

1. Network

It sounds trite but networking is actually an excellent way of picking up on patterns and trends in conversation and business problems. The trick is to note them down and pay attention. Soon, you will find patterns emerging and ideas forming.

2. Look for pain

Just as networking can reveal trends in the market, so can spending time reading. The latter will also help you find common business pain points. These are the touchpoints that frustrate people, annoy business owners, affect productivity, or impact employee engagement.

Be the Panado that fixes these pains.

3. Luck

luck

This is probably the most annoying of the ideas, but it is unfortunately (or fortunately) very true. Luck does play a role in helping you capture that big idea. However, luck isn’t just standing around and random people offering you opportunities. Luck is found at networking events, it is found in research and it is found in conversations with other entrepreneurs.

4. Luck needs courage

You may have found the big idea through your network, a pain point or pure blind luck, but if you don’t have the courage to take it and run with it, you will lose it to someone else.

Being bold in business is highly underrated because most people assume that everyone is bold and prepared to take big leaps into the unknown. However, not all brilliant entrepreneurs were ready to throw their family funds to the wind and leap into an idea – they were courageous enough to figure out a way of harnessing their ideas realistically.

5. Pay attention

This is probably one of the most vital ways of finding a gap in the market. Often, people are so busy that they don’t really pay attention to that niggling issue that always bothers them on a commute, or in a mall, or at a meeting. This niggling issue could very well be the next big business opportunity. Pay attention to it and find out if that issue can be solved with your innovative thinking.

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Start-up Advice

5 Things To Know About Your “Toddler” Business

As you navigate this new toddler phase of your business, here are five things to bear in mind.

Catherine Black

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Ah, toddlers. Those irresistible bundles of joy bring a huge amount of energy, curiosity and fun to any family – but there’s also frustration and worry that comes with their unpredictability, as they grow and start to become more independent. If you own a business and it’s successfully past its “infancy” of the first year or so, it’s likely it will also go through a toddler stage of its lifecycle.

Pete Hammond, founder of luxury safari company SafariScapes, agrees with this. “Our business is now three and a half years old, and we’ve found that we’re not yet big enough to justify employing a large team of people to handle the day-to-day admin tasks, yet we still need to grow the business as well,” he says. “As a result, our main challenge is finding the time to step back and see the bigger picture. Kind of like when you are raising a busy toddler and you spend most of your time running after them!”

As you navigate this new toddler phase of your business, here are five things to bear in mind:

1. This too shall pass

Everything in life is temporary – and that goes for both the good and the bad. It’s as helpful to remember this when you’re facing the might of a toddler temper tantrum, as it is when you’re facing throws of uncertainty in your business. If your new(ish) venture is going through a rough patch in its first few years, it can be easy to think about giving up – but don’t. As long as you have an overall big idea that you believe can add value to your customers, keep pushing through the rough parts until you come out the other side.

2. Appreciate what this phase brings

The toddler years mean that the initial newborn joy is officially behind you. But these small humans also bring their own kinds of joy, as you watch them learn new skills, say funny things, and give affection back to you. While your two-year-old business may not hold the same exhilaration for you as it did during those first few months, there are now different things to appreciate about it: Maybe you’re expanding your product range, or employing new people who can take the workload off you.

3. Establish boundaries

Toddlers thrive on boundary and routine – and your toddler business will too. As it grows into a new phase, try and establish limits in terms of the type of clients you want to work with and the type of work you’ll do. It’s also a good idea to make a decision about the hours you’ll work and when you’ll switch off, which will help you establish a good work-life balance.

4. Take a break

Every parent with a toddler needs a break every now and then, even if that means a walk around the block (on your own!), a dinner out with friends, or even a few days away. The same is true for a demanding small business: every so often, remember to take time out to rest properly, where you switch off your laptop and completely unplug. You’ll return much more inspired and resilient to deal with the everyday uncertainty that it brings.

5. Give it space to make mistakes

While the unpredictability of a young business can be stressful and tiring, it’s also a time for trying new things without the risk of huge consequences if they don’t quite work. After all, it’s much simpler to change your USP if you’re a small business employing a few people, rather than a big company where 50 people are relying on you for their salary, or where you’ve received a huge amount of investment capital. While you may fail in some of the things you try with your business (in fact, this is almost guaranteed), see it as a toddler that’s resilient enough to pick itself up, dust its knees and keep moving forward.

During this phase of business growth it’s also essential to have the right type of medical aid cover. There are medical schemes such as Fedhealth which has a number of medical aid options and value-added benefits to ensure that your health and wellness is taken care of too. After all, the healthier you and your staff are, the more productive your business will be – during the toddler (business) stage and beyond.

While this phase can be frustrating, it’s a sign that your business is growing and adapting, rather than remaining in its infancy, and that can only be a good thing! So embrace the difficulties, learn from them, and watch as your business strides forward confidently into the next exciting phase.

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