Have you decided to sell your business? Or are you looking at buying a business? If so, what’s involved in doing this?
Here we provide a lawyer’s perspective on matters related to the sale or purchase of an owner-managed business.
Always start at the beginning
What it is that you’re actually selling or buying? This may seem like an unnecessarily obvious question, but it must be answered thoroughly. The answer will define much of what’s contained in an agreement for the sale of a business.
Buying and selling “shares” in a business
Selling shares in a business, whether it’s is a close corporation or a company, is really quite straightforward. It simply involves transferring a group of assets, in the form of shares.
A buyer who purchases all the shares in a business will indirectly hold and control the business, including all its assets and liabilities.
Buying a business from a company
Acquiring a business from a company is more complex. It may involve acquiring only certain assets and certain liabilities. These may be of different types and have to be dealt with differently.
Accordingly, buying a business from a company (rather than buying shares in the company) requires a more carefully prepared contract.
This approach may be appropriate where:
- a purchaser wants to acquire only certain assets and certain or no liabilities; or
- the purchaser feels there is some risk in taking control of a company; for example, there could be a pending legal action or outstanding tax claim, or the company may just be poorly managed.
Due diligence evaluation
Whether acquiring shares or a business, a purchaser should undertake a due diligence evaluation. This is to ascertain the worth of the shares and/or business, as well as any risk in the business and the transaction.
A due diligence evaluation can vary in breadth and scope, but will likely include the following:
- a financial analysis of the business and its value
- an evaluation of assets, including any intellectual property
- assessment of any immediate or future risk to the value of the business
- a check for any legal impediment to the transaction, such as a shareholder agreement prohibiting the sale or use of shares as security under another transaction
- an evaluation of the formal requirements and procedures necessary to implement the agreement
- an assessment of whether the business operates in a sound and lawful manner, complying with all relevant legislation.
When shares are offered, it has to be clear that the seller has the right to sell the shares. This right could be limited if there are other shareholders with rights of pre-emption, or if shares have been offered as security for debt or some other reason.
Buying and selling shares: payment options
If the seller has a loan account against the business – that is, the business owes the seller money – it must be understood whether the purchaser is taking cession of that loan account and shares (the seller’s equity). This is what would normally occur.
It’s simplest if the purchaser pays for the shares in full upfront.
The transaction is more complicated if the purchaser is to receive the shares upfront but makes payment of the purchase consideration in instalments. In that case, the purchaser will likely have the benefit of the shares (for example dividends and voting rights), before having paid for those shares in full.
Buying and selling shares: implications for company directors
Be alert that if a business somehow assists the purchaser in acquiring shares, either through loans or as guarantor, it could fall foul of the provisions of the Companies Act.
It’s common for the seller to be a director of the company. Once the sale is concluded, there’s likely be a change of directors. However, the purchaser may wish to retain the seller as a consultant during a transitional period.
If the seller is involved in managing the business, it’s likely the purchaser will want to restrain the seller from establishing a competing business. This applies particularly if much of the value of the business lies in good will.
Often a company director is also an employee. Thought must therefore be given to the impact of the Basic Conditions of Employment Act on the agreement.
Pre-existing surety agreements
In an owner-managed company, the owner may have signed surety agreements for the debts of the company and would understandably wish to be released from those sureties after the sale.
Note that sureties granted in favour of a creditor can be waived only by that creditor, and this will be at the creditor’s discretion.
The best way to handle a surety is to ensure that the principal debt owed to the creditor is discharged and that the principal contract creating that debt is terminated.
For example, if the business has a bank overdraft for which you as seller stand surety, settle the overdraft and cancel the overdraft facility. It’s important to make sure the facility or contract is properly terminated, or you could be held liable for any future debt under that contact.
The agreement may be subject to a suspensive condition. This means that although the parties have concluded the agreement, it’s suspended until a certain event occurs.
This happens most often when the purchaser needs an opportunity to obtain finance.
It can also happen due to an existing agreement between the seller and a third party. For example, the seller’s business may has concluded an agreement with a franchise, joint venture, supplier, distributor or lessee, stipulating that the third party must approve any material change to the business’s shareholders or members.
In that case, the sale of shares would have to be subject to the approval of the third party. If this suspensive condition is never met, the agreement will lapse.
Of course, some time limit should be placed on the fulfilment of any suspensive condition.
Buying or selling a business: assets and liabilities
If you’re selling “the business” rather than shares, a useful exercise is to compile a detailed list of all the assets and all the liabilities being sold.
Assets can be movable assets, contracts that need to be ceded, debtors book or part thereof, intellectual property (trademarks, licenses and the like), stock on hand or good will.
Liabilities could include trade debts, asset finance agreements, leave pay owed to employees and contingent liability.
By the time your attorney starts drafting the agreement of sale, the parties should clearly understand which assets are being sold and which liabilities will be transferred.
Transferring business assets
By law, ownerships of different types of assets are transferred differently.
Good will may be secured through confidentiality agreements, restraints of trade, co-operation from the seller in introducing the purchaser to existing clients, transfer of domain names, transfer of telephone numbers, and so on.
Immovable property is transferred via registration at the deeds office.
Movable property could be transferred simply by delivery or collection of those items.
Where the business has claims or rights as its assets, those must be transferred via a well drafted cession. An example of such a claim or right would be where the seller is appointed by clients under fixed-term contracts to manage the clients’ properties. Those contracts with clients are the business’s assets and can be transferred to a purchaser only by way of cession.
Depending on the constitution of a business and whether it’s a company or a close corporation, specific strict procedures must be followed to dispose of the majority of the assets in the business. Failure to comply with the relevant formalities could make the sale invalid.
Careful thought should be given to what will happen to the liabilities of the business. Once the parties have agreed which of them will be responsible for which debt, it may be necessary for the party assuming the debt to indemnify the other party.
For example, say the purchaser agrees to be liable under a business lease, but the landlord nonetheless decides to claim arrears from the seller. With an indemnity agreement in place, the seller can then claim a reimbursement from the purchaser for the landlord’s claim.
Selling a business as a going concern
Selling a business as a “going concern” simply means that some part of the business that’s capable of generating income as an independent business is included in the sale. For example, that could be part of a client base, part of the business stock or a collection of tools used to manufacture goods for sale.
When a business is sold as a going concern, the parties must comply with the provisions of section 34 of the Insolvency Act.
This entails properly advertising the sale of the business. If the parties fail to do this and a creditor liquidates the business within six months of the sale, the creditor can regard the sale as void and claim the business assets as though there had been no sale.
A scenario like this could leave a purchaser having paid the purchase price and not having any business or asset to show for it.
Timing is everything
For a business sale agreement to be clear and enforceable, it has to specify the timing of each aspect of the transaction. For example, ensure that the agreement provides clear answers to questions like these:
- When does the purchaser receive the assets or benefit of the business?
- When is the risk transferred to the purchaser?
- At what date is stock assessed?
- If there are indemnities for liabilities, for which period will the indemnified risk apply?
- Will debts arising before a certain date belong to the purchaser and debts after that date belong to the seller?
For example, risk might be transferred at the date of signature, fulfilment of a suspensive condition, receipt of the full purchase price, receipt of a first instalment or any date defined as the effective date for the agreement.
What about VAT?
The sale of a business is subject to VAT. One would expect that VAT should be charged on the transaction by the seller and then claimed back by the purchaser.
However, SARS has recognised that this is inconvenient to the parties (and of no real benefit to SARS).
So even where the seller is registered to pay VAT, it’s not necessary to levy VAT, provided the business is sold as a going concern.
For professional legal assistance when buying or selling a business, contact JM Attorneys on 087 802 9930.