THE IMPORTANCE OF COSEC – SHARES AND THE SECURITIES REGISTER

THE IMPORTANCE OF COSEC – SHARES AND THE SECURITIES REGISTER

Company secretarial matters (or more commonly referred to as “CoSec“) are not overly exciting but do play a very important role when looking at any commercial transaction. Various matters can fall under the CoSec stable, but this article will focus exclusively on share issuances and updating the securities register (or more commonly referred to as the share register) following such issuances.

Background

In the haste of getting started or in the excitement of closing that first deal, many investors and entrepreneurs do not consider CoSec matters as a priority and often end up not properly implementing the investment. Most often, this leads to investors ending up without any share certificates evidencing their investment. Furthermore, their investments are not reflected in the securities register, which may prove detrimental to both the investor and the company as described below. First things first, however…

What is a share issuance?

In terms of section 38(1) of the Companies Act 71 of 2008, as amended (“the Act“), the board of directors of the company (“the Board“) may resolve to issue shares of the company at any time, subject to the conditions of such section being met. In addition to this, further conditions may regulate the issue of shares in certain instances, most notably when there is a subscription of shares (section 39), where consideration requirements must be considered (section 40) and where shareholder approval is required (section 41).

If the investment is successfully concluded and the relevant sections of the Act (as mentioned above) are complied with, the investment can be implemented. This means that the company can proceed to issue the shares that the Board has resolved to issue. This share issuance can then be evidenced by way of a certificate (some securities may also be uncertificated in certain instances). A share certificate is a commonly found example of a certificated security, and as such, must adhere to the provisions of section 51 of the Act, which include the fact that the certificate must state the name of the issuing company, the name of the person to whom the shares are being issued, the number and class of shares being issued, and any restriction on the transfer of such shares. The share certificate must furthermore be signed by two persons authorised by the Board, and serves as proof of ownership of the shares (in the absence of evidence to the contrary).

If the Board issues a share certificate which complies with the above, only one leg of the share issuance is complete. A very important secondary leg is the act of entering the investor’s details into the securities register as required in terms of section 50 of the Act (each company is obliged to have a securities register – even for uncertificated securities).

The importance of the securities register

Why is this second leg so important? Well, in terms of section 37(9) of the Act, only once the subscriber’s name is entered into the securities register, does he actually acquire the rights associated with the particular securities issued to him. As such, although there are contractual rights and obligations between the parties (in terms of the subscription and/or sale of shares agreement), for all intents and purposes, the investor does not acquire, and therefore cannot exercise, the rights awarded to him as proprietary holder in the company until the securities register has been updated.

Regrettably, in our experience, various investors are comfortable when they receive their issued share certificate (sometimes not even validly issued) and therefore do not request a copy of the updated securities register evidencing their investment. Especially where larger transactions are contemplated, parties require an accurate reflection of the shareholding position of the company to determine how the investment should proceed. Where the securities register has not been kept up to date and accurate, and when this is discovered during the due diligence investigations, such CoSec matters may cause unnecessary and costly delays for the company. Other matters may also be more difficult to administer post-transaction (especially where shareholder disputes are present).

Conclusion

Considering the above, it is advised that all CoSec matters are done accurately, diligently and kept in good order at all times to ensure that all parties’ rights are adequately protected, and that good corporate governance is maintained by the company. If you feel you might require any assistance with this, please do not hesitate to contact us.

POPIA: RESPONSIBLE PARTIES AND OPERATORS

POPIA: RESPONSIBLE PARTIES AND OPERATORS

Our previous POPIA articles have examined various aspects of the Protection of Personal Information Act 4 of 2013 (“POPIA“) at length, most notably, the various conditions for processing personal information.  In this post, we will examine the roles of “responsible party” and “operator” in terms of POPIA and what each of these roles entails, along with the rights and responsibilities of the roles.

The main purpose of POPIA is to regulate the use of personal information (as defined by POPIA and summarised below) and to provide for adequate security measures to protect personal information, and the different parties in a relationship will have to comply with these measures in certain ways. Therefore, these roles are important to consider as they have a profound impact on the relationships between responsible parties and operators and also affect the way in which information is processed and used.

What do these terms mean?

  • responsible party” means the party who determines the purpose of and means for processing personal information. This decision may be made alone or in conjunction with another party.
  • operator” means a person who processes personal information for a responsible party in terms of a contract or mandate, but does not come under the direct authority or control of the responsible party.
  • processing” means any activity (including automatic means) concerning personal information, and includes the collection, receipt, recording, organisation, collation, storage, updating or modification, retrieval, alteration, consultation or use, distribution by means of transmission, distribution or making available in any other form or merging, linking, and restriction, degradation, erasure or destruction of information.
  • personal information” is information relating to an identifiable, living person and is not limited to information relating to race, gender, marital status, pregnancy, ethnicity, age, health, disability, religion, language, culture, education and employment, criminal history, identity number, contact details, biometric information, personal opinion, etc.

What is the difference between a responsible party and an operator?

As set out above, responsible parties determine the purpose for processing information, what information is processed, for how long and how it is processed. Where an operator is involved, the responsible party will still determine the purpose for processing etc, but will outsource the processing of the information to the operator. The responsible party therefore still makes all decisions in relation to the information and the operator acts in accordance with these decisions and on the instructions from the responsible party.

The responsible party remains ultimately accountable for ensuring that POPIA is complied with by both itself and all operators providing services to the responsible party. The outsourcing or sub-contracting of any processing activities to operators does not absolve the responsible party from liability. If the operator contravenes POPIA, the responsible party will still be held liable by the Information Regulator.

The importance of contracts when appointing an operator

As with many other relationships, a contractual agreement between a responsible party and operator will prove very useful and high highly recommended in order to definitively address and govern the roles of each party and the boundaries of the relationship.

An agreement between the responsible party and operator should address, at the least, the following points:

  • That the operator only acts within the ambit of the agreement/mandate with the responsible party;
  • The purpose for processing of the information;
  • What information may be processed by the operator;
  • What the operator may or may not do with the information outside of the processing mandate;
  • A duty to protect the information received, not share it with third parties without consent, to keep the information received confidential and to otherwise act within the ambit of POPIA;
  • Limit the operator from appointing further operators without the responsible party’s knowledge or consent; and
  • Liability for the operator*.

Liability for the operator

As mentioned above, the responsible party will be held ultimately liable by the Information Regulator for a breach of POPIA by the operator. The Information Regulator will impose this liability on the responsible party where the breach occurred within the scope of the mandate agreement between the responsible party and the operator and will not be diverted to the operator where the breach is as a result of the operator’s failure to uphold the principles of POPIA.

Therefore, the agreement between the responsible party and the operator is extremely important for the responsible party as this agreement can result in the responsible party holding the operator liable for any claims that the Information Regulator and/or data subjects (the people whose personal information is being processed) bring against the responsible party as a result of a breach of POPIA by the operator. A liability clause will allow the responsible party to bring a claim for any loss suffered by the responsible party as a result of the operator’s negligence or breach of POPIA.

Some relief for a responsible party in this regard is where an operator breaches POPIA where the operator has exceeded its mandate. In these circumstances, the operator is seen to be acting as a responsible party in regard to the personal information as the operator is determining the purposes and means of processing.

Conclusion

We cannot emphasise the importance of an agreement between a responsible party and operator enough as such an agreement sets out the important details of the relationship between the operator and responsible party and aims to protect not only the responsible party, but also the operator by detailing the extent of the processing and other responsibilities that the operator undertakes.

Make sure that you know when you act as a responsible party and when you are acting as an operator as your responsibilities will differ along with your liability.

EQUITY CROWDFUNDING VS OTHER TYPES OF CROWDFUNDING

EQUITY CROWDFUNDING VS OTHER TYPES OF CROWDFUNDING

A little while ago we wrote an article on the regulatory vacuum relating to equity crowdfunding. Whilst there has been little movement from a regulatory perspective as to how South Africa is going to regulate crowdfunding – meaning that it is still unregulated – there have been some positive steps taken by the Financial Services Board (“the FSB“). Crowdfunding has been at the forefront of the FSB’s recent discussions – hopefully an indication of their support.

If you are unfamiliar with the term “crowdfunding” and you have looked to “professor” Google to gain a bit of an understanding of what it is, here is a small overview on what crowdfunding is and the types that are available.

The term “crowdfunding” is essentially a description of a funding raise of multiple (typically small) sums of money from the general public to fund some form of venture, whether that be a charitable venture or a profit-making venture.

  • Donations based crowdfunding is fairly straightforward – a group of people donate money to an organisation or person that they believe in, generally for a charitable cause. Backabuddy is a good example of this in motion in South Africa.
  • Rewards based crowdfunding is widely used to incentivise people to fund the venture of a small business. This is similar to donations based crowdfunding, but with a key difference, as the person seeking funding offers a reward to the person / people donating. Thundafund is an example of a South African rewards based crowdfunding platform.
  • Loan based crowdfunding occurs where the person / company borrows money from the crowd and the crowd receives interest as their return. Entrepreneurs typically use this to get a better interest rate than they would have gotten if they went to the more established money lenders.
  • ICO’s (Initial Coin Offerings) have become the most recent of the crowdfunding fads. Unfortunately, there have been a few notorious fraudulent schemes using ICO’s. In fact, the Useless Ethereum Token famously launched a satirical ICO that clearly stated that its coins were worth nothing and it raised USD$93,949 (+/- R1 million)! ICO’s are fairly complex, so we are not going to go into them in this article, but if you would like to see a previous article written on the subject, you can read about it here.
  • Equity based crowdfunding occurs where shares in a company are offered to the public in exchange for funding. This is really significant as the crowd become business owners of the company and have certain rights attached to their investment.

Equity based crowdfunding has previously been avoided in South Africa, as people are generally wary of entering a space like this due to the regulatory concerns. Uprise.Africa (which has already had its soft launch) has, however, started an equity based crowdfunding operation in South Africa and is about to become fully operational.

What’s the difference?

Equity based crowdfunding differs significantly from its more underpowered cousins, as shareholders in a company (even minority ones) have certain rights that they can exercise to ensure that startups aren’t off buying bean bags and half-price sushi with investor funds. This means that the crowd has some oversight and can share in the rewards or growth of the business. So, the crowd is rewarded in the long term for investing into the startup (although most startups are high-risk investments and returns are not very common).

What this means for the startup is that they can market test their product to see whether the general public would be interested in the investment. It also means that the startup can probably get a more favourable investment than your average venture capital (“VC“) firm would give as the crowd isn’t normally as interested in the bottom line of the startup as your average VC firm is.

Equity crowdfunding has such huge potential to boost the South African economy, in fact the World Bank recently predicted that the market potential in Africa for crowdfunding will be up to $2.5 billion by 2025. Equity crowdfunding in South Africa will hopefully tap into that and unleash significant potential in the startups that are based here.

OBSERVATIONS ON COMPANY NAMES

OBSERVATIONS ON COMPANY NAMES

Choosing a name for your new company may seem simple, but what may not be clear is that you cannot call your company whatever you want, as South African law regulates what a company name can and cannot be. Section 11 of the Companies Act, 71 of 2008 (“the Companies Act“) sets out the criteria for company names. In essence, the name of your company may comprise of words in any language together with any words or letters / numbers / symbols and / or punctuation marks. However, the name of your company may not be the same (or similar to) the name of another company or close corporation, someone else’s defensive name (a name registered up to two years which is aimed at preventing trade marks from being included in the new company name), business name or registered trademark or a mark on any merchandise. Your company name must not falsely imply that the company is part of any other person / entity, is an organ of state, is owned by a person having any particular educational designation, who is a regulated person or is owned by any government or international organisation. Importantly, your company name must not include anything that may constitute propaganda for war, incitement of imminent violence or advocacy of hatred against any right entrenched in the Bill of Rights.

Registered vs trading names:

The registered name of a company is the name which has been reserved, approved and then registered with the Companies and Intellectual Property Commission (“the CIPC“). In terms of the Companies Act, a company is required to display its registered name (and registration number) on all forms, notices and correspondence with others and failure to do so constitutes an offence.

Despite that, it is common practice for entrepreneurs to acquire shelf companies or to register a company with a non-distinctive name and to simply trade under a different name. Although a trade name does not need to be registered, the assumption is that a reasonable level of investigation would have been conducted to ensure that a trade name is not already in use. In reality, this often leads to the infringement of third party trademarks or causes confusingly similar names to exist.

For the above reason, the Consumer Protection Act 68 of 2008 (“the CPA“) has introduced changes to the way in which “trading as” names (which the CPA calls “business names“) may be used. The provisions relating to business names are contained in sections 79 to 80 of the CPA, and will only come into effect upon a date to be determined by the Minister of Trade and Industry (“the Minister“) and published in the Gazette. This has not happened yet, but it is likely that when it does, the Minister will allow a certain amount of time after the published date for companies to comply with these new provisions.

The intention of the legislature in this regard, is to seek to enforce the consumer’s right to information concerning suppliers. The aim is to prevent a situation where a business would trade under one name but fail to disclose the identity of the actual entity behind the transactions, thereby frustrating the attempts by the consumers to seek redress in pursuing the correct entity.

What you need to know and the CPA’S requirements

In terms of section 79 of the CPA:

A person must not carry on business, advertise, promote, offer to supply or supply any goods or services, or enter into a transaction or agreement with a consumer under any name except:

  • the person’s full name as:
  • recorded in an identity document or any other recognised identification document, in the case of an individual; or
  • registered in terms of a public regulation, in the case of a juristic person; or
  • a business name registered to, and for the use of, that person in terms ofsection 80, or any other public regulation.

What the above means is that an individual or company (as the case may be) may not operate / carry on business with a business name unless it is registered in terms of the CPA. This information will then be publicly available on the business names register as maintained by the CIPC. The implication is that, should any business operate with any other name other than those as set out in section 79, the National Consumer Commission (“the NCC“) can issue a compliance notice and failure to comply will result in a fine or prosecution as a criminal offence.

As some assurance, however, the CPA provides a certain degree of relief for businesses which have been in trade before the business name provisions come into force – the NCC may not enforce the business name requirements against a business if it has been trading under the business name for a period of at least one year.

Procedure

Section 80 of the CPA provides for the procedure in registering the business name of a company. As mentioned before, these provisions are not yet in force since the business names registry and the registration process have not yet been established.

When the provisions come into force, a person may file a notice with the CIPC to register any number of business names currently used by your entities. If the business, under which the business name has been registered does not carry on business for a period exceeding 6 (six) months, the CIPC reserves the right to cancel such business name.

Possible difficulties

These provisions may cause difficulties for franchises because there are normally multiple franchisees trading under the same name as the franchisor. However, the registered name for each franchisee, may be completely different. The new requirements therefore force each separate franchisee to register the same business name leading to multiple entries of the same name being reflected on the records of the CIPC. This could be somewhat counter-intuitive since the confusion that it creates may defeat the purpose of the consumers’ right to information in the first place. Furthermore, franchisors may not be happy allowing each and every franchisee incorporating what is effectively their “trade mark” as the franchisees business names.

Going forward

Although these provisions have not come into effect yet, in the interests of avoiding the rush of changing branding and registering new names at the CIPC, the provisions above should be duly considered when choosing a business name as the criteria will most likely need to be adhered to in the near future.

THE RESPONSIBILITY OF A SUPPLIER TO CONDUCT A CONSUMER PRODUCT SAFETY RECALL

THE RESPONSIBILITY OF A SUPPLIER TO CONDUCT A CONSUMER PRODUCT SAFETY RECALL

Introduction

The Consumer Protection Act 68 of 2008 (“CPA” or “the Act“) establishes certain rights applicable to all consumers when purchasing goods (and services) for their personal use. The Act sets out, amongst others, that consumers have the right to fair value, good quality and safety as well as an implied warranty of quality.

The implied warranty of quality warrants that the goods comply with the requirements of being of good quality, durable, and safe for the use as advertised or designed. Where goods are of inferior quality, unsafe or defective, the consumer may return the product and the supplier is obliged to repair, refund or replace the failed, defective or unsafe product.

Consumers have a further right to have goods monitored for safety and recalled when such goods or components of such goods are hazardous, unsafe or defective. The Consumer Product Safety Recall Guidelines (“Recall Guidelines“) have been drafted in terms of the CPA to provide further detail for such instances and set out the procedure to be followed where products are to be recalled.

Hazardous products

Whilst suppliers would take necessary steps to ensure that their product is manufactured or produced in line with the required design and/or material specification, the reality is that there may be some unforeseen occurrences where manufacturing/production lines may deviate from such design or material specifications. In such cases, a product may be identified as unsafe where it presents health or safety hazards to the public. However, in some instances, a consumer product may also be identified as unsafe to consumers irrespective of whether there was a manufacturing or production error. The deciding factor is whether the product poses health or safety hazards to the public.

The CPA doesn’t clearly unpack the term “hazard”, but generally, a supplier’s product may be identified as presenting health or safety hazard where such product has the potential to cause the following:

  • injury;
  • illness;
  • death;
  • loss of, or physical damage to, any property; or
  • any economic loss as a result of any of the above.

Product safety recalls

In terms of the CPA and the Recall Guidelines, a supplier is required to, among other things, conduct a consumer product safety recall where a product poses a health or safety hazard. In essence, a consumer product safety recall is a process whereby a supplier is required to remove all affected product(s) from production, supply chain and any point of sale.  In terms of section 5(5) of the CPA, these Recall Guidelines apply to all goods supplied in South Africa, regardless of whether the transaction for the supply of such goods is subject to the CPA or not.

In 2012, the National Consumer Commission (“NCC“) published the Recall Guidelines detailing, among other things, procedural steps required to be followed by suppliers when conducting a product recall. In terms of the Recall Guidelines, a supplier may voluntarily initiate a safety recall. Where a supplier fails to voluntarily conduct a safety recall, the NCC may issue a written notice to the relevant supplier ordering it to conduct such safety recall.

Irrespective of whether a supplier voluntarily conducts the safety recall or is ordered to do so, a supplier is required to ensure that the procedural steps, as briefly set out below, are followed:

  • assess the risk;
  • cease distribution of the product;
  • notify the NCC;
  • notify consumers;
  • facilitate returns; and
  • facilitate returns.

In order to comply with the above mentioned procedural steps and to avoid any penal sanctions, a supplier may be required to prepare and put in place some form of a policy document(s) in anticipation of a product recall becoming necessary in the future.

Conclusion

Like with non-compliance with the provisions of the CPA in general, non-compliance with sections 60 and 61 of the CPA and the Recall Guidelines may have dire consequences. Suppliers may be declared to have engaged in prohibited conduct and an administrative fine of up to R1 million or 10% of its annual turn-over for the preceding financial year may be imposed.

Closely linked to the topic of safety recall, our next article on the CPA will be dealing with a discussion around the concept of “product liability”. For any further details on this topic, please do not hesitate to contact us.

NATIONAL WILLS WEEK – DOMMISSE ATTORNEYS

NATIONAL WILLS WEEK – DOMMISSE ATTORNEYS

This year we’ll be participating in National Wills Week from 11 – 15 September 2017.

For anyone who wishes to have a basic will drafted at no charge, all they’ll need to do is contact leanne@dommisseattorneys.co.za to schedule an appointment.

The attending practitioner will send a short questionnaire that each person is required to complete and return prior to any consultation.

Please note that this is a free service and is offered on a first come first serve basis.

http://www.lssa.org.za/our-initiatives/advocacy/national-wills-week

What is the deal with preference shares? Part 1: liquidation and dividend preference

What is the deal with preference shares? Part 1: liquidation and dividend preference

(This post is the first in a series, giving practical information to start-up founders to gain a better understanding of the mechanics of preference shares. This post will focus on liquidation and dividend preferences.)

Venture capital investors are almost always aiming to invest in start-ups through “preferred” equity, typically referred to as preference shares. Preference shares trump ordinary shares, as the holders of preference shares normally receive preferential treatment in the event of a liquidation of the business. (For these purposes, a liquidation event can be the insolvency, a dissolution or a sale of the company.)

When start-ups enter funding stages, the good and/or lucky ones may end up with a few term sheets from an array of interested investors. These term sheets often come with an abundance of terms regarding the structure of the preference shares. As an inexperienced founder, this can be an overwhelming experience and it can be a daunting task to understand which terms are “standard” and which are particularly important. Venture capital investors have the upper hand due to their experience in this area – this is where professional advisors, such as start-up lawyers, come in handy in assisting the start-up and its founders.

The purpose of this series of articles is not to cover all aspects of term sheets, but to give you, a start-up founder, a better understanding of what preference shares really are, what to look out for and how they are typically structured during a series seed or series A investment.

What are preference shares?

When early-stage start-ups issue shares, there are generally two classes of people receiving shares: founders and investors. Founders typically receive ordinary shares and investors generally receive preference shares in return for their investment and risk taken.

The main characteristic of preference shares is that they provide for the preferential treatment of their holders and rank above ordinary shares in the event of a liquidation event. This means that if a company is unable to pay its debts or its business is sold, the investor will have a first claim on the company’s assets or sale proceeds over ordinary shareholders i.e. the founders. This is a protection mechanism given to the investor in return for the risk incurred when investing in the company.

Preference shares may further entitle the holder to preferential dividends, based on the profits of the company. Preference dividends are normally fixed at a certain annual percentage. As a preference shareholder, the investor will receive dividends ahead of ordinary shareholders when dividends are declared by the board of the company.

Liquidation preference

The liquidation preference determines how the pie is shared on a liquidation event. Preference shares almost always come with a liquidation preference, but the amount of the liquidation preference can differ. For example, the investor’s preference shares may come with a multiple of 1x purchase price. This means that upon a liquidation event, the investor will be paid 1x the issue price of his shares before the ordinary shareholders get anything. (For example, if the investor invested R1 million into the company, the investor wants R1 million paid back to him before the founders receive anything.) Similarly, if the investor’s liquidation preference is 2x purchase price, the investor will receive a multiple of 2x the issue price of his shares before the ordinary shareholders get anything.

As a start-up founder, you need to know what you are promising the investor. You might realise a few months down the line, when it’s too late, that you have given the investor a preference of 10x return on liquidation, leaving you and your co-founders with nothing. How a liquidation preference is structured can make a significant difference when the proceeds from a sale are split between the shareholders. Start-up founders should pay particular attention to this term.

Participating and non-participating

Generally, as seen above, the preference shareholders receive preferential returns. This means that they are paid back their initial investment plus some preferential payment (the liquidation preference multiple) before any other proceeds are disbursed. The extent to which additional funds, beyond this preference, are disbursed to investors depends on whether the equity is participating or non-participating preference shares. Participating preference shares take a share of the additional proceeds, along with ordinary shareholders, after receiving their preferential returns. For example, the preference shareholder participates in the equity apportionment in addition to receiving his liquidation preference. Holders of non-participating preference shares, however, only receive the preference plus any accrued dividends.

For example, an investor invests R2 million into a company at a 2x liquidation preference and at a post money valuation of R10 million (giving the investor a 20% stake in the company). The company is sold for a net sale price of R20 million. Therefore, the investor receives his 2x R2 million liquidation preference (receiving R4 million) and a R16 million surplus remains. If the preference shares are participating preference shares, the investor will receive an additional 20% of the surplus amount (a further R3.2 million). Alternatively, if the shares are non-participating preference shares, the other shareholders, i.e. the founders, will distribute the surplus among themselves according to their shareholding percentages.

An important point to note is that “participation” in venture capital deals generally refers to capital, however, it may also refer to a participation in pro rata dividends beyond the fixed preference dividend. As a founder, you must have clarity on this from the start.

Dividend preference: cumulative and non-cumulative

Preference shares often provide for a preferential dividend as well – investors with preference shares are entitled to receive dividends before ordinary shareholders.

Dividends increase the total return for the investors and decrease the total return for ordinary shareholders. Dividends are often stated as a percentage of the share issue price for the preference shares (for example, 8% of the total share issue price). There are at least three general ways dividends are structured in venture capital deals: (i) cumulative dividends; (ii) non-cumulative dividends; and (iii) dividends on preference shares only when paid on the ordinary shares.

Dividend structures (i) and (ii): If a company does not declare a dividend in respect of a particular year, then preference shareholders with a right to non-cumulative dividends would lose the right to receive a dividend for that year. However, preference shareholders with a right to cumulative dividends would be able to carry over their right to receive a dividend for that year, entitling them to receive that dividend in the future, together with the dividend declared in that next year (before any dividends are payable to ordinary shareholders). Clearly, cumulative dividends are the most beneficial to the investor and the most burdensome on the founders (being ordinary shareholders).

Dividend structure (iii): Where dividends are paid on the preference shares only if paid on the ordinary shares, the preference shares are treated as if they had been converted into ordinary shares at the time the dividend is declared. This is the least beneficial to the investor and the most beneficial to the founders.

If not clearly understood, agreeing to a cumulative dividend can lead to significant and unexpected monetary burdens on the available and distributable profits for you and your co-founders. As a start-up founder, you must understand the different ways in which dividends can be structured. You need to consider the company’s projected cashflow from now until the expected exit and the impact the dividend preference has on shareholders.

Concluding remarks

We trust that the issues highlighted above will give you some insight and guidance as to why it is so important to have a good understanding of the preference share terms you are likely to find in a term sheet. If you would like to discuss any of these topics in more detail, please feel free to contact our Start-up Law team and we’ll gladly assist.

COMPETITION COMISSION INVITES COMMENTS ON DRAFT GUIDELINES FOR INFORMATION EXCHANGE BETWEEN COMPETITORS

COMPETITION COMISSION INVITES COMMENTS ON DRAFT GUIDELINES FOR INFORMATION EXCHANGE BETWEEN COMPETITORS

The exchange of information between competitors treads a thin line between enhancing efficiencies and potentially causing harm to competition. While the potential benefits of an information exchange system include the improvement of investment decisions, improved product positioning, lower research costs, benchmarking best practices and a more precise knowledge of market demand, such systems could also facilitate collusive / co-ordinated behaviour among competitors, to the detriment of consumers.

Recognising the difficulty in determining which side of the line an exchange of information falls, the Competition Commission (the “Commission“) intends to set out, based on its experience and international best practice, the general approach that it will follow in determining whether an exchange of information contravenes the Competition Act 89 of 1998 (the “Competition Act“).

The Commission has published and called for written comment on its Draft Guidelines on the Exchange of Information between Competitors (the “Draft Guidelines“) from any interested person. We set out the basic principles as set out in the Draft Guidelines below.

Legal basis for assessing information exchanges

Section 4 of the Competition Act regulates practices amongst competitors, with competitors including all firms that are in the same line of business (whether these firms actually or may only potentially compete with one another).

The section prohibits any agreements (including contracts, arrangements or understandings, whether legally enforceable or not) between competitors:

  • that have the effect of substantially preventing, or lessening, competition in any market (without sufficient technological, efficiency or other pro-competitive justifications); or

 

  • that involve cartel practices, including price-fixing, market allocation or bid rigging (which automatically fall foul of the Competition Act and for which no justifications may be advanced).

Where an exchange of information has the effect of substantially preventing or lessening competition in any market (without sufficient pro-competitive justifications for such exchange), or where it facilitates price-fixing, market allocation or bid rigging, such an information exchange system will therefore contravene the Competition Act.

General principles of assessment

Importantly, the guidelines only concern the exchange of information between competitors. Also, information in this context refers to “commercially sensitive information”, being trade, business or industrial information which has a particular economic value to a firm and its business strategy and is generally not available or known by others.

Information exchange systems between competitors are evaluated on the following general bases (among others).

  • The nature of the information sought to be exchanged: considerations will include whether the information is based on past, current or future conduct or outcomes, the level of aggregation of information, the frequency of sharing and the age of information;
  • The purpose for which the information is being exchanged; and
  • The market characteristics and dynamics: considerations include whether products are homogenous, the level of concentration in the market, the transparency of information in the market, the symmetry and stability of the market shares of competing firms and barriers to entry.

It is important to note that the Guidelines are just that – they are not binding on the competition authorities and will not be applied mechanically – there is no set formula / combination of the above factors that will ensure that an information exchange system is compliant with competition law and assessment will be multi-factorial and on a case-by-case basis.

Forums for information exchange

The Commission also set out an (open) list of platforms over which information exchange may occur and practical considerations and platform-specific guidelines to ensure competition law compliant exchanges over such platforms.

These platforms include, among others, trade / industry associations and regulators / policy makers, public announcements (which may constitute market signalling), joint ventures, cross-directorships / shareholdings, market studies and benchmarking and cartels.

Information exchange and your business

Whatever the final guidelines, given the inherent difficulties in determining whether an information exchange system between competitors will fall foul of the Competition Act, and the significant penalties and reputational harm that such conduct (even if unintentional) may incur, obtaining legal advice before embarking on any such practice may prove invaluable to your business.

The full draft guidelines can be found here.

Please note that the closing date for the submission of comments is 14 September 2017.

BITCOIN, BLOCKCHAIN, CRYPTOCURRENCIES AND ICO’S: LEGAL ENIGMAS FOR START-UP’S OPERATING ON THE FUTURE FRONTIER

BITCOIN, BLOCKCHAIN, CRYPTOCURRENCIES AND ICO’S: LEGAL ENIGMAS FOR START-UP’S OPERATING ON THE FUTURE FRONTIER

The latest buzz words shaking up the technology, business, financial and legal establishments are not to be treated lightly. These terms are uniting (hard as it might be) all the major role players in their quest to evaluate the potential far-reaching effects it might hold for the future of commerce globally. It is difficult to ignore the fast-paced development of the latest technological advances, as we find ourselves amid the fascinating transition phases nestled between the Third and Fourth Industrial Revolutions. More importantly, as the universal compatibilities envisioned for this technology have now progressed from hypothetical online discussions between “tech-developers” and futurists to functioning real-life applications, passionate debates have erupted across a variety of diverse forums. Ranging from the corridors of legislators and financial regulators to the living rooms of the Stokvel run by Joe Soap, as people are curious (and watchful) about the industries based on the Future Frontier – and rightly so.

As the terminology is complex, we will not aim to explain what the Blockchain, Cryptocurrencies (which include BitCoin) or Initial Coin Offerings (“ICO”) are. We will also not attempt to define or address the application possibilities of these initiatives in this post, as the possibilities are vast and beyond the scope of this post. (For more information on the technical aspects relating to these terms, please see the links below explaining this in more detail.[1]) We will only briefly aim to highlight some aspects start-ups and potential investors should bear in mind when investigating the opportunities created by the technology found on this Future Frontier.

For Start-Up’s

Start-ups looking to venture into the industries of the Future Frontier are advised to note that there is still a lot of uncertainty as to the regulations governing and enforcing the practical application thereof. As such, carefully considering the current legislative frameworks in existence (and more importantly, the purpose behind it) might provide a helpful understanding of the things entrepreneurs should consider when developing their business models for the market. In a South African context, start-ups should consider the following legislative and regulatory concerns which might be applicable to them:

  • FICA, Money-Laundering and Know-Your-Client (KYC) legislation: due to cryptocurrencies trading far more anonymously over various encrypted platforms entrepreneurs are encouraged to familiarise themselves with the relevant FICA, Money laundering and KYC processes. Especially in industries where payments are being made by potential payment or payment systems operators;
  • Business of a Bank and Collective Investment Schemes: Business models based around the collecting and pooling of fees and/or accepting deposits for investments into cryptocurrencies and ICO’s might be considered to be Collective Schemes or structures conducting the business of a bank, both of which are strictly regulated by the SARB and FSB, respectively;
  • Financial Advisory and Intermediary Services Act (Twin Peaks Financial Sector Regulation Bill): any current or potential services aimed at the financial advisory or intermediary industries are strictly regulated by the Financial Services Board (and will soon fall under the Twin Peak Provisions);
  • Exchange Control Regulations: Strict requirements regarding the outflow of capital and funds exist in South Africa. As a result, certain apps or services designed to facilitate transfers of this kind without prior SARB approval, tax clearance from SARS or adherence to existing policies may pose some concern to regulators;
  • Companies Act: A very popular means to raise funds for start-ups focusing on Future Frontier industries is by way of an ICO. During an ICO the start-ups issue their own crypto- tokens to participants at a discount and often raise vast amounts of capital. However, an ICO might, depending on the rights attached to these crypto-tokens, in some cases be regarded as a thinly veiled offer of securities to the public. If that is the case, the Companies Act and accordingly, the strict laws relating to the issue of securities by way of an offerings to the public will be applicable. Since the Securities Exchange Commission of the USA recently declared this position (not without criticism), other jurisdictions may follow suit; and
  • Consumer Protection Laws: The loss of virtual cryptocurrencies value, tokens issued to paying participants without any underlying value and other types of blockchain transaction issues such as erroneous payments and systems breaches, hacks or Ponzi schemes are things to consider. If not adequately managed, this may create serious liabilities, not to mention reputational damage, to any start-up involved in these types of commercial venture.

These are merely some of the myriad questions start-ups are urged to consider as a starting point into the regulatory and compliance frameworks regulating the industries on the Future Frontier.

Investors

Warren Buffet once said the following: “What counts for most people in investing is not how much they know, but rather how realistically they define what they don’t know”.

In keeping with this thought, we would therefore urge any investors considering investing into start-ups which focus on the Future Frontier industries to not stray too far from established investment principals. Especially in determining what the Investor does not know, conducting an adequate due diligence investigation (or “DD“) into the envisioned Start-up’s proof of concept, management of regulatory and compliance issues and the viability of their intended financial and business models should be considered a minimum requirement. Further to this, investors would do well to consider special escrow arrangements for any transfer of investment funds irrespective of whether these funds are done by way of crypto-funds/tokens and/or fiat currency. Also using respected and knowledgeable service providers may mitigate against any risks involved in these investments.

Conclusion

There are various levels of uncertainty regarding the practical and legal implications of these Future Frontier industries. This accordingly provides ample grey area for entrepreneurs and investors alike to either flower or flounder through. As such, we would recommend that any Start-Ups or investors contemplating to venture into these Future Frontier Industries to make sure that they have a clear view of the legal nature of the transaction at hand. If the legal nature of the transaction is clear, it enables the parties to take a measured approach to control the relative risk associated and build in the protective mechanisms that the law requires.

We hope to see legislators work with other industry experts to create a legislative framework that promotes certainty, without smothering the revolutionary initiatives and staggering opportunities presented by Future Frontier technology.

[1] For further detailed information regarding how Cryptocurrencies and the Blockchain function and operate please make use of the following recommend sources:

 

Service agreements: why they are necessary and what they should cover

Service agreements: why they are necessary and what they should cover

If you are a service provider of any kind, regulating your engagement with your customers is crucial to show potential investors how you have secured your revenue stream and managed your risk. Investors are going to be interested in how you protect your revenue stream. They will typically assess how “water-tight” your agreements are with your clients in order to determine business level risk.

A service agreement is an example of a revenue contract. This is the agreement that describes how your company generates revenue in return for delivering services and describes the fees which you charge.

Some key considerations for a service agreement are as follows:

  1. Description of your services:

It is important to accurately describe your services so there is clarity and certainty regarding what it is your customers are paying for. It can sometimes work well to describe the services by referring to your website which then provides for a full description of the services in greater detail. This has the advantage of allowing you to evolve your services over time, and change the specific terms and pricing on your website (on notice to the client).

  1. Duration of the agreement:

How long do you expect the service agreement to be in place? Depending on the nature of the services rendered, it may be for a specific period or ongoing. Whether the contract can be renewed and on what terms should also be carefully considered together with termination rights. You will want to ideally strike a balance between easily terminating the relationship when it no longer suits you while still attracting and maintaining a constant revenue stream without too much unexpected disruption.

  1. Risk provisions:

You should consider what warranties you are willing to make with respect to the quality or outcome of your services. This will be specific to your service offering but you should also consider the industry in which you operate and what your average client would expect. Your appetite for risk and the level of risk associated with your services should also determine what warranties will be offered. Another related consideration is what your liability to your clients should be, whether you will have any liability at all and how you manage this.

The other considerations which we discuss with our clients for the purposes of drafting their service agreements include service levels, payment terms, exclusivity, IP and license arrangements, data and privacy matters and whether there are any specific regulatory aspects applicable.

We provide a Service Agreement Package to start-ups and through this process we are able to prepare bespoke service agreements applicable and appropriate for each client. We can also assist with reviewing and updating existing service agreements, if you are not sure whether your existing contract is up to scratch.