Moral Rights In The Context Of Copyright Law In South Africa

INTRODUCTION

In simple terms, a “copyright” is a form of intellectual property right that grants the creator of an original work (“the author“), the legal and exclusive right to the use and distribution of the work (in return for compensation for the author’s intellectual efforts). In this sense, a copyright can be said to be an economic right.

A “moral right” in the context of copyright law, on the other hand, is rather a personal right which attaches to the author, allowing the author to receive the appropriate credit when his/her work is used and it also dictates, to an extent, the way in which an author’s work is treated by others.

In South Africa, copyright law is regulated in terms of the Copyright Act, No. 98 of 1978 (as amended) (“the Act“), and is administered by the Companies and Intellectual Property Commission, as a branch of the Department of Trade and Industry. In terms of the Act, nine classes of works are eligible for copyright protection and they include literary works, musical works, artistic works, cinematograph films, sound recordings, programme-carrying signals, broadcasts, published editions and computer programs.

 

THE CONCEPT OF MORAL RIGHTS

Section 20 of the Act creates a legal obligation to give credit to works of an author and not to treat it in a derogatory way, and further defines a moral right as a protected right that applies to literary, musical and artistic works, cinematograph films and computer programmes (but excludes sound recordings, broadcasts and published editions) (“work/s”). At its heart, a moral right consists of the right to paternity and the right to integrity of the author’s work. The right to paternity allows the author to claim authorship of the work, whereas the right to integrity allows the author to object to any distortion, mutilation or modification of the author’s work to the extent that any such distortion, mutilation or modification would be prejudicial to the author’s honour or reputation. In other words, if the author reasonably feels that making certain changes in or to his/her works would undermine his/her creative intent or “vision” embodied in those works, he/she can prevent that change from being made, regardless of any economic rights that another person may own in that same work by virtue of a license or copyright.

An author’s moral rights to his/her works are, however, qualified by the economic interests which a copyright seeks to protect, and section 20 of the Act further provides that an author may not object to modifications to his/her works which are absolutely necessary for the commercial exploitation of those works.

It is important to bear in mind that a moral right can only subsist in the above works if such works enjoy copyright in South Africa in the first place.

 

WAIVER AND TRANSFERABILITY OF MORAL RIGHTS

Just like many personal rights, moral rights can be waived by the author and the author can choose not to enforce them. No formalities are prescribed in the Act for the waiver of moral rights, although good practice dictates that any waivers of moral rights be reduced to writing.

Whereas copyrights are freely transferrable, a moral right attaches to the author throughout the author’s lifetime and terminates upon his/her death (or in the case of an author which is a corporate entity, the dissolution of that entity) and cannot be transferred. What is interesting in this regard is that an assignment of copyright leaves the author’s moral rights unaffected and in many instances, the holder of the copyright will still be required to obtain the necessary waivers from the author. In other words, no matter who gets to exploit the economic rights being the subject matter of the copyright, the author will still have the right to be named and given recognition for his/her work (unless he/she waives such right).

 

INFRINGEMENT, ENFORCEMENT AND REMEDIES

A moral right could be infringed by, for example, not properly attributing the work of the author, or treating it in such a manner so as to lower the reputation or dignity of the author. Given the closely related nature of copyright and the moral rights that subsist in the copyright, the statutory remedies which apply to an infringement of copyright would also apply to an infringement of an author’s moral rights. The Act provides for a claim for damages or the imposition of an interdict. These statutory remedies are complemented by common law remedies to the extent that any conduct that violates the dignity and reputation of the author can give rise to a similar claim for damages or an interdict to curtail the infringement.

 

CONCLUSION

Authors in South Africa enjoy a reasonable measure of protection regarding the intellectual products of their labours. South Africans have, however, been slow to enforce these rights and to date, there have been very few reported cases dealing with this area of law. Perhaps the reason why moral rights are so rarely asserted are, firstly, it is a fairly unknown concept in South Africa, and secondly, many commercial agreements governing the use of intellectual property will often include a waiver of the moral rights of the author.

Should you have any queries concerning your business and its use of its own intellectual property and that of others, please feel free to contact us – we would be glad to assist you.

Insights Into Restraints Of Trade

It is a well-known commercial practice for employers to include restraint of trade provisions in their employment agreements despite prevailing uncertainty as to when and how (as well as to what extent) these restraint of trade provisions would be enforceable.

A restraint of trade is essentially an agreement in terms of which one party agrees to some form of limitation to their freedom to carry on their trade, profession or business. Restraint of trade provisions are most frequently encountered in employment contracts, where the employee undertakes not to compete with his or her employer during and/or after termination of his or her services to the employer. There are also other forms of agreements in which these provisions can be encountered, for example, in a sale of business, where the seller agrees with the purchaser not to carry on a similar business in competition with the purchaser within a reasonable proximity of the business premises and for a prescribed period of time. Partnership agreements may also include similar provisions in terms whereof each of the partners undertakes not to compete with the business of the partnership during and/or after leaving the partnership.

In terms of the well-known and oft-cited Appellate Division judgment in Magna Alloys and Research (SA) (PTY) Ltd v Ellis [1984] 2 All SA 583 (A),it was held that restraint of trade provisions are valid and lawful unless the party wishing to escape the provisions of the agreement in question can prove that they are contrary to public policy and therefore unenforceable.

The Magna Alloys precedent necessitates an enquiry as to when restraints of trade will be deemed contrary to public policy (which is by nature a vague concept). Fortunately in the later judgment in Basson v Chilwan and Others [1993] 2 All SA 373 (A) the court laid out several guidelines with which to determine whether or not a restraint of trade agreement is contrary to public policy, as follows:

  • Does the restraining party have an interest deserving of protection, during or after termination of the relevant contract (a “Protectable Interest”)?
  • If so, would that Protectable Interest be prejudiced by the restrained party’s freedom not being limited by the restraint?
  • If the above can be answered in the affirmative, then it furthermore needs to be decided whether the Protectable Interest of the restraining party (seeking to uphold the restraint agreement) qualitatively and quantitatively outweigh the interest of the restrained party to be economically active and productive?
  • Are there any other aspects to be considered to determine whether or not to uphold or reject the restraint?
  • Does the restraint go further than reasonably necessary to protect the interests of the restraining party seeking to enforce the restraint in question?

Generally speaking, according to the Basson judgment, if the answers to the first three questions above are in the affirmative, and the answer to the last question is in the negative, then the restraint of trade is reasonable and consequently not contrary to public policy, therefore making it enforceable against the restrained party. However, if the answers to the first three questions are in the negative and the answer to the last question is in the affirmative, then such restraint of trade would be contrary to public policy and therefore unenforceable. In some instances the court may find that a restraint of trade provision has gone further than is necessary to protect the interest of the restraining party but doesn’t go so far as to render it contrary to public policy. The court may then order that the restraint be partially enforced. By partially enforcing a restraint, the court would restrict its limitation to either a narrower proximity than the one that was initially included in the restraint of trade, or for a lesser period of time than the period that was initially agreed.

In order to determine whether a restraint would be reasonable, the concept of a Protectable Interest must be considered further, as either parties’ assertion or defence would primarily be dependent on whether there is any Protectable Interest that the restraining party could argue he is entitled to protect. A court would normally only entertain a restraint of trade dispute if it is satisfied that there is indeed a Protectable Interest. There’s no exhaustive list of what constitutes a Protectable Interest, although the judgment in Advtech Resourcing (Pty) Ltd t/a The Communicate Personnel Group v Kuhn and another [2007] 4 All SA 1368 (C), provides the following insights:

  • A Protectable Interest includes the restraining party’s ‘trade secrets’ (meaning any information that is capable of application in trade or industry provided that such information is only known to a certain number of people but not to the public and is of economic value). By way of example, technical processes, chemical formulae, computer software, price lists, credit records and business conversation, constitute trade secrets.
  • However, the mere fact that an employer had provided an employee with training and skill development does not mean that he or she owns the skill provided to an employee. This is illustrated by the following excerpt: “An employee who, in the main, uses his own expertise, knowledge, skill and experience [after leaving employment] cannot be restrained [from doing so]”.
  • Confidential information constitutes a protectable interest.
  • Customer goodwill or trade connections constitute a protectable interest.

Another question that needs to be considered is that of who bears the onus of poof in restraint cases. Most past judgments follow the approach that was laid down in Magna Alloys, in which it was held that the party alleging that the restraint is contrary to public policy, bears the onus of proving the unreasonableness of such restraint. In the new Constitutional dispensation, however, every person has a constitutionally enshrined right to choose and carry on his/her chosen trade, profession or business. With that background, some more recent commentaries have held that the restraint enforcer should bear the onus of proof. Some commentators remark that it does not matter who bears the onus of proof because the guidelines that were laid down in the Basson judgment are decisive.

In conclusion, restraint of trade provisions in agreements are lawful, valid and enforceable provided they are reasonable and not contrary to public policy, and the enquiry into public policy will often centre on a consideration of the Protectable Interest that a restraining party would wish to protect. Beyond this, although restraints of trade are very common in practice, it is notoriously difficult to predict whether a court would determine a particular restraint to be fair and reasonable in the circumstances. We recommend that any party to a restraint carefully consider its terms and limitations, and attempt to negotiate on these limitations if you foresee a time when this restraint may be detrimental to your ability to carry on your chosen trade or business.

The effect of Section 12J of the Income Tax Act on the South African venture capital regime

Section 12J of the Income Tax Act has been the talk of the town in many South African venture capital circles in the last few years, but ironically there has been a lot less action in the market than the government expected when implementing this tax incentive in 2009. This incentive seems very promising on face value, but at the moment there are still less than 10 approved Section 12J venture capital companies in the country. This is an exceptionally low number if we consider how popular a similar venture capital incentive in the United Kingdom has been over the years, which beckons us to take a closer look at the incentive to determine the reason for the market’s reluctance to explore this.

The rationale behind the incentive is quite simply to address the fact that one of the main challenges to the economic growth of small and medium-sized businesses in South Africa, is the inability of these businesses to secure equity finance to fund their growth.

In terms of Section 12J, any South African tax resident that invests in a venture capital company (VCC), approved and registered in terms of Section 12J, can claim income tax deductions in respect of the expenditure actually incurred to acquire shares in such VCCs, subject to certain conditions.

Section 12J VCCs are therefore intended to be a marketing vehicle that will attract retail investors to invest in VCC’s, whereas the VCC makes money by investing in smaller trading companies. These are entities which the VCC’s fund managers deem as having prospects of producing a favourable return on investment. These companies are generally referred to in this context as qualifying investee companies.

However, before a venture capital company can start trading as a Section 12J VCC, it has to apply to SARS to be registered as such, for the purpose of which the company must meet certain preliminary requirements. To meet these requirements, the company must:

  • be a South African tax resident and its tax affairs must be in order;
  • have as its sole object, the management of investments in qualifying investee companies;
  • not control (whether directly or through a related entity) any qualifying investee company in which it holds shares; and
  • be licensed as a financial services provider in terms of section 7 of the Financial Advisory and Intermediary Services Act, 2002.

The major risk for a Section 12J VCC and its investors alike, is that SARS can withdraw the approved VCC status if, during any year of assessment, the company fails to comply with the preliminary approval requirements as listed above. SARS may also withdraw the company’s VCC status, if the preliminary requirements are met but the company fails to satisfy the following additional requirements after the expiry of 36 months from the date of SARS approving the company’s Section 12J VCC status:

  • a minimum of 80% of the expenditure incurred by the VCC to acquire assets must be for shares in qualifying investee companies, and each investee company must, immediately after the issuing of the qualifying shares to the VCC, hold assets with a book value not exceeding R300 million in the case of a junior mining company or R20 million in the case of any other qualifying company; and
  • the expenditure incurred by the VCC to acquire qualifying shares in any one qualifying investee company may not exceed 20% of its total expenditure to acquire qualifying shares, which basically means that the VCC must have at least 5 investee companies in its portfolio.

What happens when a Section 12J VCC loses its status as such? Well, SARS can include in the VCC’s income in the year of assessment during which the status was withdrawn, an amount equal to 125% of expenses incurred to issue shares.

If you consider the fact that venture capital investments are generally regarded as high-risk, relatively illiquid investments, the picture seems even less rosy for investors if the drastic consequences of non-compliance looms as an additional risk to their investments.

However, in the 2014 National Budget Review, the government announced that it will propose one or more of the following amendments to the VCC regime:

  • making tax deductions permanent if investments in the VCC are held for a certain period of time;
  • allowing transferability of tax benefits when investors dispose of their VCC equity investments in VCC’s;
  • increasing the total asset limit for qualifying investee companies from R20 million to R50 million, and that of mining companies from R300 million to R500 million; and
  • waiving capital gains tax on the disposal of assets by the VCC.

These new changes are to be welcomed and have certainly sparked renewed interest in the market, which is still wide open for those that are willing to enter this relatively untapped opportunity. Whether the proposed reforms are substantial enough to give this incentive the required momentum to ignite the South African venture capital industry as intended by the government remains to be seen.

Buying a Distressed Company – Bargain or Burden?

Things you need to know before buying a distressed company

Every now and then an opportunity comes along that looks very hard to resist. If you’re a seasoned entrepreneur, this might come in the form of a company that, although in such distress that the shareholders want out, still has genuinely valuable assets or a viable business model.

Buying the company at a discount and then selling off its assets is one way to turn a profit from such a situation. Another option is to buy the company and turn it around. This can be especially tempting when the company has liabilities that may prevent it from showing a profit for some time, which can translate into a considerable tax advantage.

Deals like this are not for the inexperienced or fainthearted – or for those who tend to get carried away by their own enthusiasm. Unfortunately, this perfectly describes most entrepreneurs – seeing the upside and getting swept up in your own enthusiasm is practically part of the job description. This is why you need a team of lawyers, accountants and other advisers on your side to provide a reality check.

The first rule of buying a company in distress is: Never, ever go soft on due diligence. Hire the most paranoid team you can find and have them tear the place apart. There are bound to be skeletons in various closets, and you want to shine clear, cold daylight on all of them.

The primary objective of the due diligence is to make sure there are no liabilities in the business that you’re unaware of, and no unquantifiable risks. It’s always the stuff you don’t know about that will trip you up, so do whatever is possible to ensure you know everything.

We usually ensure that a Purchaser has recourse to the amount paid to the Sellers (such as by retaining all or a portion of the purchase price, or placing it on escrow).  The big thing to beware of is any material risk that could expose you to a liability greater than the price you’re paying for the company. You can always ask for warranties from the sellers that they haven’t withheld any relevant information – but the warranty indemnity probably won’t be more than the purchase price.

You also need to beware of any evidence that the previous management has not been running the company properly in the past. If there is any suggestion that they’ve been playing fast and loose, SARS can re-open tax assessments from previous years – and then the entire basis for your purchase could be undermined.

Which brings us to the second rule of buying a company in distress: Get the best tax advice you can afford. The really interesting structures often have tax advantages – and if your goal in buying the company is to enjoy the tax advantage, you had better be sure it really exists.

If the due diligence confirms there is no SARS debt or other debt you can’t compromise, and that you have identified all the risks –then there is a chance you have a real opportunity on your hands. If you are confident that you can turn the company around and make it work, the rest is up to you.

Director’s Duties – 5 things you need to know

There has been a lot of media coverage in the past couple of years devoted to directors’ duties under the new Companies Act of 2008, and the fact that directors can be held personally liable if they breach those duties. The effect can be fear and uncertainty – but the basic principles are easy to understand and live by.  There are five things every director should know:

1.     What exactly is a “fiduciary duty” anyway?

Fiduciary” comes from the same Latin word for faith and trust that’s given us “fidelity” and “confidence” (it’s also why there’s a tradition of calling dogs Fido). Basically, if someone places their faith and trust in you – for example by giving you their money to invest or their company to manage – you have a duty not to betray that trust. You have to be loyal and act in their best interests, not your own. It’s really that simple. The moment you find yourself thinking in terms of what’s best for you personally, take a deep breath and a long cold drink of water and think again.

2.     What is a “duty of skill and care”?

As a director, you don’t only have to act in good faith – you have to know what you’re doing. The expectation is not that you should be an expert, or never make a mistake – but you should have the skills that can reasonably be expected of someone in your position, and apply those skills. You can’t, for example, approve a deal because it feels right in your gut or the other person is in your church and you’re sure you can trust them. You need to do all the due diligence required to make sure it will benefit the company.

3.     It doesn’t matter how big or small the company is

 These duties apply equally to directors of small companies, large listed companies and non-profits. It gets more scary and complicated the more of other people’s money is at stake, but your basic duties and responsibilities to your shareholders remain the same.

4.     It doesn’t matter what it says on your business card

 You don’t have to carry the name of Director to bear these responsibilities. The law puts it in more complicated terms, but basically: If it looks like a duck, and walks like a duck, and quacks like a duck, it’s a duck. So if you attend board meetings, make important decisions, sign off on deals and do other things that directors do, the law will regard you as a director. You can’t avoid the responsibility by steering clear of the name.

5.     When in doubt, always opt for more transparency

The law is absolutely clear that you may not use your position to make any kind of secret profit, whether the company loses out or not. If you set up your own new company to take advantage of a major opportunity offered by a client, that’s a clear breach of your duties. But things that seem more innocuous can also be breaches: What if a major supplier offers you a discount when you renovate your house? Even if there’s no expectation of reward, this could still breach your duties. Honesty, as always, is the best policy: Tell the board and let them decide.

In many ways, the Companies Act just codifies in law what most people regard as basic ethics and common sense. If your habit is to act in good faith and care, you’re unlikely to have any problems. But anytime you’re in doubt, seek advice – – it’s always better to know what you’re getting into.

How to Kick Off Investor Negotiations

Dommisse Attorneys
July 2013

It can take months of pitching before you find the right investor for your business, but finalising the deal can be tricky. Corporate Finance attorney Adrian Dommisse of Dommisse Attorneys shares his tips to avoiding the pitfalls you may encounter during the negotiation.

Finding an investor can be a difficult and time-consuming process and once you’ve found one with the right strategy and values, you may be tempted to rush through negotiations to access the promised cash injection. However, there can be serious ramifications if the details of the deal are not negotiated on level playing fields.

Here are some issues for you to consider:

• Ask for a term sheet early

A term sheet is simply a summary of the deal in a few pages. It exposes the bare bones of the fundamental commercial terms of the investment and because it is so concise, you are less likely to miss some essential detail, as you tend to do when faced with pages and pages of legal documents. The term sheet can be an invaluable document because each board member or founder can get to grips with it quickly, and give input from their unique perspectives.

• Compare deals

Always compare the terms on which different investors would invest. Don’t be tempted (or persuaded) to commit to one investor unless they offer a genuinely better deal. Often an entrepreneur is focused on the valuation of the company, hoping for a higher valuation and therefore a higher investment. But don’t forget other important points – there may be a significant “negative” value such as founder restrictions, share claw backs, rights of investors to sell (their shares and yours!) and other terms that come along with a higher valuation.

• Determine which terms are binding

Before you put pen to paper on the term sheet, be sure to understand which parts are binding. Although the terms of a cash injection will not be binding until set out in comprehensive documentation, the investor may require you to commit to an exclusivity period, in terms of which you undertake not to negotiate with anyone else for a set period.

• Always check the fees

Once the investors instruct their attorneys to draft the investment documents, they will expect those fees to be for your account – usually deductable from the investment amount when it is advanced to you. However, what if there is a genuine disagreement on a fundamental term of the investment? Who pays those fees if the investment never closes? Make sure that you hash out all the details prior to signing and make sure that the legal fees are capped so that they won’t drain your investment funds.

• Determine if there are “arranging costs” involved

“Arranging” costs can be significant. If you are negotiating directly with the investor, this fee may not apply. You could argue that the investor’s profit will be from their investment (exit profit or distribution of profit), not from the company’s balance sheet at the commencement of the relationship. Having said that, it is not uncommon for investors to take a fee from the proceeds of the investment. There can be valid reasons for this, such as where a complex deal requires unique, expert skills to arrange. But you should investigate any such term in discussion with the investor to understand why they would rather do that than invest those funds with you. Check to see if this is common practice – again, by comparing deals.

Following the above process will help avoid disappointment, or even avert a failed deal later down the line, at your cost.

Director’s duties – five things you need to know

There has been a lot of media coverage in the past couple of years devoted to directors’ duties under the new Companies Act of 2008, and the fact that directors can be held personally liable if they breach those duties. The effect can be fear and uncertainty – but the basic principles are easy to understand and live by. There are five things every director should know:

1. What exactly is a “fiduciary duty” anyway?

“Fiduciary” comes from the same Latin word for faith and trust that’s given us “fidelity” and “confidence” (it’s also why there’s a tradition of calling dogs Fido). Basically, if someone places their faith and trust in you – for example by giving you their money to invest or their company to manage – you have a duty not to betray that trust. You have to be loyal and act in their best interests, not your own. It’s really that simple. The moment you find yourself thinking in terms of what’s best for you personally, take a deep breath and a long cold drink of water and think again.

2. What is a “duty of skill and care”?

As a director, you don’t only have to act in good faith – you have to know what you’re doing. The expection is not that you should be an expert, or never make a mistake – but you should have the skills that can reasonably be expected of someone in your position, and apply those skills. You can’t, for example, approve a deal because it feels right in your gut or the other person is in your church and you’re sure you can trust them. You need to do all the due diligence required to make sure it will benefit the company.

3. It doesn’t matter how big or small the company is

These duties apply equally to directors of small companies, large listed companies and non-profits. It gets more scary and complicated the more of other people’s money is at stake, but your basic duties and responsibilities to your shareholders remain the same.

4. It doesn’t matter what it says on your business card

You don’t have to carry the name of Director to bear these responsibilties. The law puts it in more complicated terms, but basically: If it looks like a duck, and walks like a duck, and quacks like a duck, it’s a duck. So if you attend board meetings, make important decisions, sign off on deals and do other things that directors do, the law will regard you as a director. You can’t avoid the responsibility by steering clear of the name.

5. When in doubt, always opt for more transparency

The law is absolutely clear that you may not use your position to make any kind of secret profit, whether the company loses out or not. If you set up your own new company to take advantage of a major opportunity offered by a client, that’s a clear breach of your duties. But things that seem more innocuous can also be breaches: What if a major supplier offers you a discount when you renovate your house? Even if there’s no expectation of reward, this could still breach your duties. Honesty, as always, is the best policy: Tell the board and let them decide.

In many ways, the Companies Act just codifies in law what most people regard as basic ethics and common sense. If your habit is to act in good faith and care, you’re unlikely to have any problems. But anytime you’re in doubt, seek advice – – it’s always better to know what you’re getting into.

Post-investment: Be prepared for growing pains

If your business has survived the first two to three years, and you want to continue growing it, there’s a strong chance you’ll be looking for an investor. But be careful what you wish for: The dream investment and the glow of success will bring growing pains, which will be more painful than you imagined.

In many companies I’ve worked with, there is a moment not long after that first big investment when the founders look at each other and think “Was R20mln/R30mln/R50mln worth putting up with this?” Suddenly they’re being faced with apparently unreasonable demands for new structures and processes that seem like a massive distraction from core business focus. This is the moment when it feels like you’re drowning in red tape, the interfering investor has no clue how the business really works, you’re losing your competitive edge and the whole thing has been a horrible mistake.

If that describes you, take a deep breath. If there’s any chance this could be you in a couple of years’ time, listen carefully: That pain is a normal part of the growth experience. Embrace it.

We South Africans have a fantastic ability to create new stuff out of nothing, sailing off into uncharted waters on “boer-maak-’n-plan” makeshift vessels that achieve great things. Our maverick tendencies make us really good at start-ups. But if you want to make it out of the world of plucky pioneers into the big leagues, you’re going to have to adapt.

Adapting means qualitative change, not quantitative: think of it as building the infrastructure that will maximise profitability when growth comes.  Proper systems and corporate governance structures, compliance, regular structured forecasting, budgeting and reporting, all the infrastructure that will be needed to support the business safely through the next wave of growth.

In fact, a fair chunk of a typical R20-R50m investment should be spent precisely on creating those structures. You can’t become a R200m or R2,000m company if you’re still acting like a R2m company. All that tedious bureaucracy – the board charters, the audit committees, the renegotiated employment contracts – is laying the groundwork for the future.  But bear in mind the important point: the actual cash should be the very least of what an  investor in your business should bring. Far more valuable in the long run is the active involvement of someone who has been there and done that: the strategic alliances, the operational know how, the connections and the experience and knowledge they bring.

Really tap into the investor’s experience in everything from product efficiency to bonus pool structures.  If they have requested a board seat, make them work!  Appoint them to the sub committees and involve them in weekly calls.  Appreciate their need for reporting and their need for transparency, how else can they give the guidance that will add a zero to your company valuation?

You’ll probably go through a phase of regretting the investor along the way, but that’s ok, if you have chosen the right investor.  If you’ve ever seen a martial arts movie the story arc should be familiar: There’s always method in the master’s madness.

There will be sacrifices, notably your complete independence of decision making. But the rewards of growth will far outweigh them.  If you can prove that you have the strength and discipline to run a business in which you are the custodian of other people’s money, not just your own, the world is your oyster.

Want a new investor for your business? Six housecleaning tips for success.

Many businesses, especially in the technology sector, are started with the idea of selling them one day. Even if that isn’t on the cards, it’s a rare company that won’t one day want outside investment to grow the business, whether you’re seeking venture capital from an international fund or a new partner to take up a shareholding. In either case, your task as a business owner will be immeasurably easier if you lay some basic legal groundwork early on.

The essential principle to keep in mind is this: complication and clutter can alarm Investors. The less complex your capital structure and financial statements, the more reassured they can be that they know exactly what they’re getting themselves into.

 So here’s a checklist of things to put in place before you ever need to open your doors, and your books, to a potential investor:

  1. Keep things tidy. Start -ups and young companies typically have multiple loans and elaborate contracts designed to help fund growth in the early days, for example, loans which are convertible into shares or even by granting an option to a landlord in return for lower rent. If that’s you, take action now to consolidate your balance sheet, especially your loan funding, as much as possible.
  2. Maintain a clean shareholding structure. Where there are lots of “rats and mice” minority shareholders there is potential for      uncertainty and confusion for investors.  Beware of giving real shares to your employees (as opposed to phantom shares or other instruments that track the value of the company). However, fundamentally valuable members of the management team MUST have an equity incentive of some sort.
  3. Allocate shares to your founders and anchor investors early on. The later you leave it, the more value they have, and the greater the tax hit will be (gifted shares can be taxed as income, so tax may be payable now, on a share that can’t be sold for years).
  4. Give up any thoughts you may have of recouping all that sweat loan account in cold hard cash – here we are talking about salary’s sacrificed or other money foregone. It’s very unlikely you’ll find an investor who’ll be prepared to treat sweat loans by a founder as a true cash loan. If you actually dipped into your own pocket for cash to fund operations there’s a better chance, but in reality almost all the founders’ sweat loan funding may be written off when a new investor comes in. Rather pay yourself decently from the start – then loan that cash back to the business, and keep a written record of your loan arrangement!
  5. Take a good hard look at your board: Do the directors add real value to the business or are they largely family members, angel investors and other founders with experience as limited as your own? Look for board members who can provide useful advice and guidance, and whose CVs will make you look credible to potential investors – remember, they are buying into the executive team.
  6. Especially relevant for software and other IT companies: Check who actually owns your fundamental means of production! If you’ve built a product, be extremely careful that you own the “building blocks” and/or have a valid license to use those components. In the case of open source software, are you within the licence terms? Also make sure that your employees have all properly assigned to you the intellectual property rights to anything they develop in the course of their employment.
  7. Pay attention to all the standard due diligence issues: Make sure all existing contracts (employment, supply, lease, etc.) are in place and up to date and not overly skewed against you, that your incorporation documents are up to date, and so on.

While much of this looks like basic common sense to lawyers, in reality many entrepreneurs just don’t get around to these details – they’re too busy doing the work. If you’re one of those, it’s time to seriously consider interviewing some lawyers to find out what they can do for you. If nothing else, it could save you a fortune in a few years’ time.

 

What you need to know about offshoring your business

How to move one’s business offshore is a popular topic among entrepreneurs – but, says corporate law expert Adrian Dommisse of Dommisse Attorneys, the decision is not as easy as many seem to think.

“There is lots of excitement about Mauritius because their corporate tax rate much lower (potentially just 3% as opposed to 28% in South Africa), but offshoring needs to be a substantial and genuine exercise – just because you think you can avoid tax is the wrong way to go about it,” says Dommisse. “SARS is very aware of this issue. If you have a company registered in Mauritius but all your management and employees are in South Africa, you’re going to attract unwelcome attention.”

Dommisse says there are two good reasons companies should consider establishing an offshore office: If they’re genuinely expanding their activities beyond the borders of South Africa, or to meet the needs of major international investors.

In the first case, says Dommisse, entrepreneurs should be aware that there are major costs associated with setting up offshore.  “There must a real separation between your South African and international operations. You can’t just have a postal address in Mauritius but still run everything from Johannesburg: there needs to be real substance.”

“You will need to prove to anybody enquiring that key management decisions are made in the offshore jurisdiction,” he adds. “That means local offices, resident senior staff and all your board meetings will need to be held there, just for starters. That cost will need to be weighted against the benefits of actually running a business from that office. So if you’re genuinely looking for a good base from which to expand into South Asia, for example, go for it.”

Dommisse also cautions against “loop structures” in which South Africans have an interest in an offshore holding company that in turns owns assets in South Africa. “It’s a fairly obvious way to try and avoid paying tax, and it could make criminals of your entire board,” he says. “It’s a rookie mistake.”

The second reason to consider setting up offshore is to secure a major international investor who is wary of putting money into South Africa because of currency and political risk, the tax regime and exchange control regulations.

“The truth is that investors will only put their capital into a country like South Africa if they can take it out again easily,” says Dommisse. “We see investors who are willing to carry the cost of moving the whole operation offshore to avoid exchange control and political risks.  Obviously that assumes underlying operations that transcend national borders.”

They are also likely to insist that intellectual property be developed outside South Africa, he says. “IP that is developed locally will be classified as a South African asset, which is a  situation that international investors may not accept,” he says. For this reason, a significant part of key development resources will probably have to be located outside of South Africa.

In summary, says Dommisse, “establishing an international office only makes sense if you’re a genuinely international business. Choose your advisors very carefully, and accept that this is not a low-cost exercise. You will need a tax expert with specific experience in this area, as well as good legal advice. “