WHAT IS A BUSINESS?
There are various entities participating in the every day business activities of commerce and industry. These entities include:
- Close Corporations
- Sole Proprietors
A common feature of these entities is the fact that they all conduct business for the purpose of generating income.
A business encompasses:
- Income generating activities.
- The goods or tools used in generating the income.
- The assets obtained and liabilities incurred in generating the income.
WHY SELL A BUSINESS
One usually has a choice between:
- Selling the entity which conducts the business (i.e. the shares of the company), or
- Selling the business itself whilst the seller retains ownership of the entity.
The option that you will choose will depend on factors such as:
- The type of entity currently being used by you for your business.
- The existing financial structure of your business.
- The tax implications of a sale.
- The result, financial or otherwise, that you wish to achieve by selling your business.
A sale of a business is usually more appropriate where:
- Transfer duty of 1% payable on the transfer of shares is prohibitively expensive.
- There is doubt about the history of the entity and its potential liabilities.
- Only a part and not the whole of the business conducted by the entity is to be sold.
- The entity disposing of the business is a partnership or sole proprietor. These entities cannot be sold.
- The seller wishes to retain the entity for the purpose of utilising an assessed tax loss for the benefit of the seller.
ISSUES TO BE CONSIDERED BY THE SELLER
The seller must try to obtain the highest possible price for capital assets as the profit on these assets are tax free although, under certain circumstances, a recoupment tax may be payable.
The seller of a business shall retain, in the entity, any tax loss which he may be able to utilise.
Should values of certain assets realised through the sale be in excess of its depreciated value for tax purposes, recoupment tax will be payable by the entity selling the business.
The responsibility of the seller to its existing employees, the type of warranties to be given, and the effect of existing agreements on the transaction.
It is highly recommended that the seller consults his attorney as early as possible whilst negotiating the sale of a business to ensure that the seller's objectives are properly set and the seller's rights are protected.
IMPORTANT CONCEPTS OF A SALE OF BUSINESS
In structuring the sale of business it is important to define the following concepts clearly:
- The parties involved.
- The effective date of the sale - the date on which the risk and ownership of the business as well as the rights to profits from the business will pass from the seller to the purchaser.
- Exactly what is being sold - land and buildings, movable assets, stock in trade, work in progress, shares, loan accounts etc.
SOME ELEMENTS TO CONSIDER
It is useful to calculate the purchase price with reference to the value, at the date of sale, of the following:
- Stock on hand, as determined by a physical stock take.
- The book value of debtors, as determined by an audit.
- The depreciated book value of fixed assets.
- The value of any other assets such as shares, loans, cash etc.
- The balance for goodwill or other intangibles.
- Payment of the purchase price should be guaranteed in the form acceptable to the seller.
- Interest should be requested at the most competitive rate.
- Should guarantees not be furnished, ownership of the business should remain with the seller until full payment of the purchase price.
- The seller should specify by whom, when and where payment should take place.
In order to determine the value and extent of the stock, it is important for a physical stock-take to be conducted jointly between the buyer and the seller at close of business on the day preceding the effective date. The following factors should be considered by the seller:
- Stock should be valued at the higher of cost price or market value.
- No allowance should be made for damaged, unsaleable or obsolete stock.
- The buyer should warrant that he was not induced to enter into the agreement by any representation with regard to the condition of the stock.
It is important that the following dates are agreed to and clearly defined:
- Signature date - being the date upon which the last signatory signs the agreement.
- Effective date - being the date upon which ownership of, risk in and the right to profit from the business passes to the buyer.
- Delivery date - being the date upon which the formalities necessary to transfer the business to the buyer are complied with.
- Final date - being the date upon which the warranties given by the seller will lapse (where applicable).
In a sale of business it is often of vital importance that the seller is released from certain obligations or manages to conclude additional agreements. In such an event, the entire agreement is made subject to such conditions being met. Some of these conditions are:
- If the premises are leased the seller should obtain the consent of the Landlord to the cession or assignment of the lease to the purchaser.
- The seller being released from any sureties and guarantees given by the seller to third parties in respect of the business, its performance or the quality of its products.
- The seller obtaining the consent, where appropriate, of third parties to the sale of the business.
It is important to fix a date by which the conditions must be fulfilled. If not fulfilled, the sale should lapse and both parties released from the agreement.
- A sale of business is often associated with the sale of the debtors of the business.
- It is often important for the purchaser to acquire the debtors as it gives the purchaser an easy entry to the client base of the business.
Important aspects for the seller are:
(i) the buyer should take over all the debtors 'voetstoots',
(ii) the buyer should agree to take all necessary and reasonable steps to collect the book debts,
(iii) the seller should resist the giving of warranties in respect of the debtors.
- In terms of Section 34 of the Insolvency Act the seller must publish a notice advertising the sale of the business in accordance with certain specifications.
- The Notice should be published so that, by the effective date of the sale, a period of between 30 and 60 days will have lapsed since the publication.
- Should such a notice not be published, any creditors of the business having an unsatisfied claim CAN AVOID THE TRANSACTION.
It is therefore of crucial importance that the seller either publishes the Notice or guarantees to pay all creditors of the business by the effective date, in which case the publication will not be necessary.
- Warranties are invariably a crucial part of any sale of business and should be considered with great care.
- Warranties should be reviewed by an attorney to ensure that the seller is not unnecessarily exposed.
- Should warranties not be drafted properly, it could result in the seller being in breach of the agreement from the moment of signing the agreement.
Some aspects for consideration by the seller when giving warranties are:
- If possible, warranties should be given 'subject to the seller's best endeavours'. This should protect the seller against unforeseen circumstances,
- The seller should be cautious of decisions which leave him liable for consequential or other damages,
- Assets should be sold 'voetstoots',
- The agreement should state that no warranties or guarantees were given other than those contained in the agreement,]
- Profit or turnover should not be guaranteed,
- The agreement should state that (where appropriate) the purchaser has been given sufficient and unrestricted opportunity to investigate the affairs of the business and has satisfied himself regarding its scope, value and condition.
It is customary for a purchaser of a business to call for the seller to agree to a restraint of trade.
Should this be agreed upon, the seller should endeavour to:
- limit the restraint to a specific area, period and commodity or activity,
- negotiate a consideration to be paid in respect of the restraint.
An important aspect of selling a business is the effect the transaction has on the employees of the business. The employees were employed by the seller and, will remain in the employ of the seller unless agreed with the employees to the contrary. It is recommended that the seller consult his labour attorney prior to entering into the transaction.
In proceeding with the sale, the seller should endeavour to obtain the purchaser's consent to taking over all employees on existing service terms,
The seller should make provision for leave pay, bonus and retrenchment payments which will remain the obligation of the seller up to the effective date.
Careful consideration should be given to the effect of the sale on any existing pension fund.
Names, Post Office Boxes and Telephone Numbers
The name and trade marks of the business sold should be specified to form part of the business being sold, if appropriate.
For the purpose of ensuring continued client contact by the purchaser, it is useful to offer to the purchaser:
- the existing telephone numbers,
- the existing post office box numbers,
subject to the purchaser taking over the obligations associated therewith.
If agent's commission is payable, it is important to specify:
- by whom the agent's commission will be payable,
- the amount of the agent's commission payable,
- that the agent's commission should only become payable upon fulfilment of all suspensive conditions and payment of the full (or at least x%) of the purchase price.
If possible, acceptance of the commission clause should be obtained from the agent.
Should the seller be in breach the buyer may not cancel over a minor breach, and the seller be afforded a reasonable opportunity to remedy the breach.
It has become customary for agreements to make provision for any dispute to be referred to arbitration due to the cost of litigation and time taken in resolving a dispute.
If the parties wish to resolve the matter out of court, the agreement should state:
- that any dispute arising from the agreement shall be referred to arbitration,
- the method of determining the arbitrator,
- the procedure to be adopted by the arbitrator in determining the dispute,
- how the costs of the arbitrator should be paid.
The following clauses of general application are useful to avoid any uncertainty arising after the agreement has been entered into:
- No changes or cancellation of the agreement will be binding unless in writing and signed by the parties to the agreement.
- No indulgence granted by one party to the other would constitute a waiver by such party of his rights.
CONSULTING YOUR ATTORNEY
It is strongly recommended that, in all sales of business, you consult with your attorney.
Your attorney should preferably be a person who has commercial experience and is able to record the details of the sale of the business accurately and correctly.
It is preferable that your attorney is involved throughout the process of selling your business. This should assure you of maximum legal protection.
Your attorney will:
- Advise you on the structuring of your agreement.
- Explain the procedure to be adopted in the disposal of your business.
- Jointly with you, set the target dates required for the successful implementation of the sale.
- Arrange for and co-ordinate the placement of the necessary advertisements.
- Liaise with your auditors and the attorneys acting for the purchaser (where necessary) in order to facilitate the sale.
- Scrutinise guarantees and arrange for payment of the purchase price.
- Settle the contents of the agreements, especially warranties, to be signed.
- Assist in attending to any conditions imposed to the sale.
- Collect and pay the purchase price to the seller at the end of the transaction.
- The seller's attorney should protect the interest of the seller and to ensure that the sale is effected and implemented in the manner envisaged and agreed to by the seller.
This brochure is aimed at addressing some of the more important issues to be encountered in a sale of business.
This brochure is not intended to be a comprehensive discussion of all aspects relating to a sale of business.
It is strongly recommended that, should a sale of business be contemplated, the prospective seller consults his legal advisors well in advance of the sale to ensure that the seller's interest are fully protected.
For more information, please feel free to contact our offices on +27 41 396 9200