The dos and don’ts of recording conversations

The dos and don’ts of recording conversations

There are several reasons why a business may want to record its interactions / conversations with customers: improving customer service; ensuring that employees always treat customers in the best possible way; ensuring easy customer follow-up and resolution of disputes; demonstrating accountability to customers; and aiding reliable note-taking.

Several businesses may not, however, realise these benefits as they are unsure of the legality and legal parameters of recording conversations. To clear up grey areas and enable you to grow and improve your business using all tools available, we have set out the basics of recording conversations in South Africa.

Am I (or is my business) allowed to record conversations with customers?

While, in terms of the Regulation of Interception of Communications and Provision of Communication-Related Information Act 70 of 2002 (“RICA“), the general rule is that no person may record a conversation without consent, the Act does set out certain exceptions to this rule. The exceptions include (and you can therefore record a conversation) where:

  • you are a party to the conversation (“single-party consent”);
  • you have the prior written consent of at least one of the parties to the conversation; or
  • the conversation relates to, or occurs in the course of, the carrying on of your business (“the business exception”).

It is important to note that the business exception is subject to further requirements in terms of RICA.

As a side note, certain businesses (specifically those in the financial services and intermediary industry) are legally required to record certain conversations with customers and to maintain such recordings for a statutory minimum period. This is however beyond the scope of this article.

Consent to record

As stated above, consent of at least one party to the communication is required when recording a conversation. This rule does not apply where the recorder is also a party to the conversation.

However, where a third party is recording the conversation, the third party must obtain informed consent from one of the parties to the conversation in order to legally record the conversation.

Guidelines for recording conversations

  • When recording conversations under the business exception, it is required that you make all reasonable efforts, in advance, to inform all parties that you will be recording conversations. It is good business practice to ensure and be certain that all customers are aware when conversations are recorded.
  • Use reliable technology to record and store recordings of conversations – you want to make sure that your customers’ (and your business’s) information is protected! In this regard, ensure that any recordings and storage thereof comply with all relevant laws (including, for example, the Protection of Personal Information Act 4 of 2013)
  • Maintain an effective storage system so that you can make the most use of your recorded conversations in developing your business

The article is serves only as a basic introduction to the topic of recording conversations and legal advice should be sought in relation to specific circumstances.

Are directors also employees?

Are directors also employees?

INTRODUCTION:

If you have a business of your own, then you will know that the role of a business owner is multi-faceted and often requires the wearing of many different hats. These relate to the roles of a shareholder, a director and an employee. Many business owners wear all three of these hats at once which can be quite challenging if they are not kept distinct and separate. As a shareholder, your attention should be focused on the return you are receiving from your business. As a director, your responsibility is to govern the business in a way that substantially delivers the return that shareholders expect. As an employee, your main obligation will be the tendering of personal services and to further the business interests of the employer. However, outside of the owner-managed scenario, the question arises as to whether a director can generally also be an employee? Let us examine this question in more detail below.

EMPLOYEE VS DIRECTOR AND REMUNERATION:

Generally speaking, there are usually two sources of a director’s remuneration: the one source flows from the fees that he receives for his services as director (example, fees for attending board meetings) and the other source flows from such director’s employment contract (if any) which would provide for the payment of a salary.

A director in his capacity as director is not necessarily an employee of the company and will not always be entitled to the standard rights flowing from an employment contract. It therefore follows that a director is not entitled to be remunerated for his services as a director simply because he has been appointed as a director. Granted, if such director enters into a contract of employment with the company, then he or she will be entitled to those rights that flow from an employment relationship and he would then stand in a position of both an employee and a director.

As a director only, he is not automatically entitled to be remunerated for his services as director. Under the Companies Act, 71 of 2008 (“the Companies Act“), a company may pay remuneration to a director for his services as director, unless it is prohibited by the company’s memorandum of incorporation (“MOI“). Should the MOI prohibit the payment of remuneration to a director, he will not be entitled to remuneration for his services, which is thought to stem from the rule that people in a fiduciary position are not entitled to use their office to profit themselves, unless they have the consent of the majority of the shareholders.

In terms of section 66(9) of the Companies Act, remuneration paid to directors for their service as director may only be paid in accordance with a special resolution approved by the shareholders within the previous two years. However, the words “service as directors” are ambiguous because it is not clear if approval is required only for directors’ services as directors or whether the words are broad enough to include remuneration paid to executive directors in terms of their employment contract.

CORPORATE GOVERNANCE:

The King IV offers some guidance. It embraces the underlying philosophy of ethical leadership, sustainability and corporate citizenship. On the issue of leadership, the board should ensure that all decisions and actions are based on the four values underpinning good corporate governance: responsibility, accountability, fairness and transparency.

As such, King IV differentiates between executive and non-executive directors. An executive director is involved in the day-to-day management of the company. He or she is normally in the full time salaried employ of the company and is generally under a contract of service with the company. A non-executive director, on the other hand, is a part time director who is not considered an employee of the company. Such non-executive director does not manage the company, but rather plays an important role in providing objective, independent judgement on various issues relating to the company. An executive director can therefore be an employee and a director at the same time.

TERMINATION OF SERVICES:

Flowing from the above, there are obvious complications that present itself when a company wants to terminate an executive director’s services. Where the company wishes to remove a director from his office as director and as an employee of the company, the procedure is twofold and reference must be given to both the Companies Act as well as the Labour Relations Act, 66 of 1995 (“the LRA“)

In some instances, the employment contract with the director as employee contains an automatic termination clause which provides that if the director is removed from his office as director, his employment with the company will be automatically terminated or vice versa. In other instances, the MOI of the company will have an automatic termination clause.

However, in the case of Chilliebush v Commissioner Johnson & Others the court held that the insertion of an automatic termination clause into a company’s MOI is in direct contravention with the LRA. The reasoning provided for the court’s decision is that an employer is not at liberty to contractually negotiate the terms of an employee’s dismissal, despite that employee also being a director. Should a company rely on an automatic termination clause as its reasoning for the automatic termination of the director/employee’s contract of employment, such termination does not constitute a fair dismissal for purposes of the LRA. The director/employee will then be well within his rights to proceed to the CCMA on the grounds of unfair dismissal.

The decision is significant because in situations where a director holds two positions (one as a director and one as an employee) his rights as an employee will not be affected by the fact that he is also a director.

Software-as-a-Service (SaaS) – understanding some of the aspects of this technology model

Software-as-a-Service (SaaS) – understanding some of the aspects of this technology model

As commercial law attorneys, much of our work is helping tech start-ups negotiate and draft software agreements. There is no doubt that the emergence of Software-as-a-Service (SaaS) – often referred to as “cloud computing” – has been one of the most profound technological developments in the commercial software industry.  It is shaking up traditional software vendors and it is expected to continue disrupting traditional businesses. Think “Slack”, “Trello”, “Salesforce”, “Stripe” and “Dropbox” – these are all SaaS enterprise applications delivered over the internet.

This article will provide a basic overview of SaaS and some of the legal aspects tech start-up founders need to understand when negotiating and preparing their SaaS agreements.

What is “SaaS” and SaaS Agreements?

Software-as-Service is a software distribution model with which a business hosts software applications and makes them available to customers over the internet.  The agreement or contract that governs the access and use of the software service and describes the rights and obligations of the parties is referred to as a SaaS agreement. The SaaS agreement differs from your typical software license agreement because SaaS is not a license to use the software, but rather is a subscription to software services and allows remote software access.

Benefits of SaaS

Low set-up cost: SaaS removes the need for organizations to install and run expensive software applications on their computers and data servers. It eliminates the expenses associated with hardware acquisition and maintenance, as well as software licensing, installation and support costs.

Payment flexibility: rather than purchasing software to install, or additional hardware to support it, customers subscribe to a SaaS offering. Typically, customers pay for this service on a monthly subscription or utility basis i.e. the number of users who has access or the number of online transactions.

Highly scalable: cloud services like SaaS offer high scalability. Upgrades, additional storage or services can be accessed on demand without needing to install new software and hardware.

Automatic updates:  customers can rely on a SaaS provider to automatically perform updates and software improvements and modifications, which are generally free of charge.

Accessibility:  customers aren’t restricted to one location and can access the service from any internet-enabled device and location.

Software Licencing Model vs SaaS Model

Software license agreements are used when a proprietary software is being licensed by the licensor to a licensee.  The licensee purchases the software and receives a right to install, download and use the software. The licensor owns all the intellectual property rights in the software and related documentation.  A license is a limited grant of use those rights.

With SaaS agreements, the customer does not download or install copies of the software, but remotely accesses and uses the software by logging into the software provider’s system.  The software provider hosts the software either on its server or in the cloud and provides a service to the customer which consists of hosting its software, performing services to support the hosted software and granting access to the hosted software.

Important legal aspects to consider in your SaaS Agreement

SaaS agreements can touch upon nearly every area of the law, but broadly, a SaaS agreement should include clauses regarding: the services provided; the parties who will have access to the service; user obligations and prohibited use; payment terms; data collection and personal information; termination; service levels; maintenance and support services; disclaimers and liability; and intellectual property rights.

We discuss a few of these below:

Limitation of liability

The most important provision of any SaaS agreement is the liability clause as liability presents itself in many forms. What if the SaaS service is hacked or the subject of a cyber-attack and the customer’s sensitive confidential data (including banking details) is stolen? Are you going to indemnify and hold the customer harmless for all the damages suffered as a result of the data breach? Limitation of liability explains the extent of damages your customer can seek against you and how much they can sue you for. A well-drafted limitation of liability cannot be overstated!

Service levels

An important consideration is whether the SaaS service is going to be up and running and functioning for a guaranteed minimum amount of time. Service level agreement or commitments are very common in any SaaS agreement. Generally, the SaaS provider guarantees that the service will be up and running for 365 days a year 99% of the time, for example. Your company will need to consider what type of service guarantees and commitments it will be making in terms of its service “uptime” and “downtime”.

Maintenance and support

What types of maintenance and support services will your company be providing? Will you be guaranteeing bug fixes in a timely manner, providing customer support via email and telephone or periodic software upgrades and maintenance? These are issues that need to be considered and which will affect your agreements with your customers. To this end, the contact details, extent of support and troubleshooting methods offered by the provider should be recorded in your agreement.

Upselling and upgrading

You should consider including language in your agreement that allows for future orders or “up-sales” from the customer. By specifying that “up-sales” or upgraded orders from the customer will be governed by the agreement, you avoid having the customer sign or click through another agreement if they purchase additional services, upgrades or expand their usage.

Conclusion

A SaaS agreement is designed to be a comprehensive document and as such, companies should pay careful attention to the multiple aspects of the agreement that set out their liability, responsibilities and obligations. Failing to include or properly define a crucial clause can have serious legal implications on a business’ risk, reputation and commercial relationships.

If you require any assistance in preparing any SaaS, software development or any other software related agreements don’t hesitate to contact us.

 

Due diligence: an inevitable destination on any start-up’s yellow brick road to investment success

Due diligence: an inevitable destination on any start-up’s yellow brick road to investment success

In the age old classic, The Wizard of Oz, Dorothy is advised to follow the yellow brick road through the surreal and unfamiliar world of Oz until she reaches the Emerald City. Red boots and all, she, together with her travel companions, set out on this journey, facing some unnerving scenarios along the way. Sound familiar?

Although not written with start-ups in mind, this story can easily serve as a metaphor to illustrate the fascinating world start-up entrepreneurs must navigate on the “yellow brick road” to their next “Emerald City” destination – be it funding rounds, impossible deadlines, incubator pitches or that big exit – this journey has it all. One of the most important, however, not-so-often-discussed, destinations on this “yellow brick road” are due diligence investigations. This article explains why start-ups (or investors) should always keep this often-forgotten destination, and its potential impact on future investment success in mind.

What is a due diligence investigation (commonly referred to as a “DD”)?

Startuplawyer.com defines a due diligence as “an investigatory process performed by potential investors or acquirers to assess the viability of an investment or acquisition and the accuracy of the information provided by the target corporation (or start-up)”.

As such, although a due diligence is usually done by the investors, any start-up would be well-advised to consider the due diligence implications of all their actions leading up to that point. Simply put, this starts by ensuring that internal processes are in place to accurately and continuously record, save and timeously update documentation from the get go. More specifically, documentation and official company records, items relating to internal governance procedures, stakeholders’ communications and company information (i.e. organisation information, market size, team structure), key and material agreements, financial management and annual statements, asset valuation, regulatory approvals, product development and proof of intellectual property (IP) protection are all important for the start-up to keep on record. Furthermore, saving these documents in an orderly and easily accessible folder system eases the process of any due diligence investigation, which in turn, speeds up negotiations and valuations, potentially staving off weeks on an investment timeframe.

Why is it important?

Any sensible investor likes to determine beforehand exactly what it is that they are investing into and in doing so, considers various factors, including: compliance with the potential investor’s investment model, the financial position and investment viability of the start-up, material risks related to its business model, management structure, founders’ commitment, company valuation, legal standing and regulatory compliance. In short, investors are eager to get an all-inclusive and well-rounded snapshot of the start-up to encourage them to provide the necessary funding and to see if the two parties fit. Therefore, if a start-up can provide this information accurately and timeously, it may well contribute to investment negotiations being concluded far more easily than anticipated. Both parties are advised to note that due diligences generally take longer than anticipated, but by being adequately prepared and organised many a pitfall can be avoided.

Does a due diligence benefit the start-up at all?

Yes, regardless of whether the investment proceeds, the preceding due diligence is a good trial by fire for any start-up. Usually, by way of the investor providing a due diligence report, concerns or queries are highlighted in detail, providing an objective and holistic view of all the facets contributing to the start-up’s business. This can greatly assist the start-up in determining further strengths, weaknesses, opportunities or threats. Start-ups are, however, advised to not be duped into a due diligence too easily. Especially during early stage negotiations, a commitment from investors (usually in the form of a term sheet) is important to ensure mutual benefits are derived from the due diligence investigation.

Concluding remarks

Although a due diligence is a high level and intense review of the start-up’s business, it need not be a daunting experience. It is important to remember that both the investor and the start-up should benefit from this process – the start-up showing off its true colours, and the investor justifying its investment. As such, communicating honestly to avoid any confusion, disappointment or time wastage is well advised before any due diligence and subsequent negotiations commence. Considering the above, if a start-up is aware and is pro-actively engaging this inevitable destination from the get-go, the due diligence need only be a brief stopover on your “yellow brick road” to the next Emerald City destination.

2017 Budget Speech implications for the externalisation of intellectual property (IP)

2017 Budget Speech implications for the externalisation of intellectual property (IP)

Relaxing the South African (SA) Exchange Control Regulations, in relation to IP in particular, is crucial for many of our start up clients (especially those operating in the software development and technology space). Up to now, SA resident companies could not export their IP to a non-resident, unless the approval of the Financial Surveillance Department (FSD) of the South African Reserve Bank (SARB) was obtained. This proved to be an insurmountable hurdle for many companies trying to externalise their businesses by moving them “offshore” for any reason, including that of attracting foreign capital investments.

The Exchange Control Regulations provide that when a SA resident (natural or juristic person) enters any transaction in terms of which capital, or any right to capital, is directly or indirectly exported (i.e. transferred by way of cession, assignment, sale transfer or any other means) from South Africa to a non-resident (natural or juristic person) such transaction falls in the ambit of the Exchange Control Regulations.

The export of “capital” specifically includes any IP right (whether registered or unregistered), which means the Exchange Control Regulations must be considered when dealing with an externalisation of IP.

The reasoning behind this regulation is that the offshoring of assets / capital belonging to SA residents amounts to an exportation of assets / capital and therefore erodes the asset base of the SA resident by way of a transfer of ownership from a SA resident to a non-resident. While this reasoning may have seemed sound, the application of the Exchange Control Regulations to the export of IP has led to many negative and unintended consequences for SA companies, and start ups in particular.

In the 2017 National Budget review the Government proposed that SA residents would no longer need the SARB’s approval for “standard IP transactions”. It was also proposed that the “loop structure” restriction for all IP transactions be lifted, provided they are at arms-length and at a fair market price. “Loop structure” restrictions prevent SA residents from holding any SA asset indirectly through a non-resident entity.

The SARB has started the process of relaxing the Exchange Control Regulations by issuing two circulars relating to IP. These latest amendments to the Currency and Exchanges Manual for Authorised Dealers mean that, under certain circumstances, approval for the exportation of IP can now be sought from Authorised Dealers (banks appointed by the Minister of Finance for exchange control purposes), as opposed to the FSD. This is good news for clients looking to restructure and offshore their IP, as the approval process should now be less administratively intense, less expensive and with faster turnaround times.

Approval can now be sought through an Authorised Dealer for:

  • a sale, transfer and assignment of IP;
  • by a SA resident;
  • to unrelated non-resident parties;
  • at an arm’s length and fair and market related price.

The Authorised Dealer will need to be presented with: (i) the sale / transfer / assignment agreement; and (ii) an auditor’s letter or intellectual property valuation certificate confirming the basis for calculating the sale price ((iii) together with any additional internal requirements).

For the approval of the licensing of IP by a SA resident to non-resident parties at an arm’s length and fair and market related price, the Authorised Dealer will need to be presented with: (i) the licensing agreement in question; and (ii) an auditor’s letter confirming the basis for calculating the royalty or licence fee ((iii) together with any additional internal requirements).

The second set of amendments provide that private (unlisted) technology (among others) companies in South Africa may now establish companies offshore without the requirement to primary list offshore in order to raise foreign funding for their operations. This effectively means that “loop structures” can now be created to raise loans and capital offshore, and these companies may hold investments in South Africa. Note that there are still certain requirements that must be met, for example, registration with the FSD.

Our commercial team has experience in making the necessary applications for exchange control approval. Feel free to get in touch if this is something on the horizon for your business.

Website terms – purpose, importance and consequences

Website terms – purpose, importance and consequences

Nowadays, websites almost always contain policies and terms that govern your use of the site. Sometimes these policies will appear as banners on the site (which you have to “agree” to in order to make them disappear), links in the page footer (like we have on our website) or as a statement along with a tick box saying that you have “read and agree with” the terms (usually when transacting online).

The questions on peoples’ minds are firstly, why do I need all these different sets of terms and, secondly, are these policies binding.

Why do we need all of these terms?

The website terms which we feel are important are browser terms, privacy policies and commercial/transactional terms. Each one of these deals with specific aspects of the website’s use, including, for example, the collection of personal information, social media integration, payment methods and your rights as a user of the website. Below we discuss each policy and its importance. These policies also protect your rights and interests in your website and can allow for you to have a claim in law against people who infringe your rights.

Browser terms

Although browser terms are not a legal requirement, they are useful to ensure that the “web surfer” understands and agrees to certain key points. Browser terms should be used to inform the surfer that:

  1. you, as the website owner, owe them no responsibilities;
  2. they get no rights to any services or IP merely by browsing;
  3. they are required to respect your website and the content thereof; and
  4. you comply with all necessary legal disclosure requirements.

Browser terms are “agreed” to through the surfer continuing to browse the website. These types of agreements are called “web-wrap” agreements. More on this below.

Privacy policies

Privacy policies are essential whenever the website collects or makes use of personal information. Personal information is often collected through cookies as well as when browsers become users of a website by creating an account or by integrating their social media accounts with the website.

The Protection of Personal Information Act 4 of 2013 (“POPI”) sets conditions for the lawful processing of personal information. Included in POPI’s ambit will be the mere storage of personal information when it is collected by cookies. POPI also requires that companies make certain information available to users when they collect their personal information. This can be achieved through a privacy policy. Privacy policies therefore also assist the website owner to comply with legal requirements

Privacy policies usually include the following important aspects:

  1. the use of cookies to collect certain information;
  2. the purposes for the processing of the personal information;
  3. the sharing of personal information by the website owner with certain select third parties;
  4. the storage of personal information, including the security measures taken and whether cross-border storage will occur; and
  5. the user’s rights in relation to his/her personal information and the recourse that he/she has.

Privacy policies are, like browser terms, usually agreed to by browsing, however, a recent trend has been to display the fact that cookies are used as a banner on a website requiring a “click-wrap” agreement to be entered into in order to remove the banner.

Commercial/transactional terms

As the name suggests, the commercial terms become applicable where the website enables users to transact with the website owner through the website. These terms serve as the terms of the contract which you conclude with the user when the user becomes a customer. The important aspects that this policy should govern includes:

  1. a general explanation of the service or product being offered by the website;
  2. the fees that are payable, which may be a once off purchase price or a subscription fee, as well as the fees relating to delivery costs, insurance and VAT;
  3. the terms applicable to returns;
  4. limitation of liability, which will be subject to the Consumer Protection Act 68 of 2008 (if it applies);
  5. the applicability of promotional codes and vouchers; and
  6. acceptable use policies, however, this is more applicable where the website offers a service and not a product.

The Electronic Communications and Transactions Act 25 of 2002 (“ECTA“) requires certain disclosures in terms of section 43 by the website owner when goods or services are offered for sale or hire through an electronic transaction. Some of the disclosures required include:

  1. company name, registration number and contact number;
  2. addresses, including physical, website and e-mail;
  3. a description of the main characteristics of the goods/services offered (which fulfils the requirement of informed consent;
  4. the full price of the goods, including transport costs, taxes and any other and all costs;
  5. the manners of payment accepted, such as EFT, cash on delivery or credit card, as well as alternative manners of payment such as loyalty points;
  6. the time within which delivery will take place;
  7. any terms of agreement, including guarantees, that will apply to the transaction and how those terms may be accessed, stored and reproduced electronically by consumers;
  8. all security procedures and privacy policy in respect of payment, payment information and personal information; and
  9. the rights of the consumer in terms of section 44 of ECTA.

ECTA also requires that the customer must have an opportunity to review the transaction, correct any mistakes and withdraw from the transaction without penalty before finally concluding the transaction. ECTA non-compliance gives the consumer the opportunity to cancel the order and demand a full refund.

Additional requirements are placed on suppliers transacting online regarding payment systems. The payment system used must be sufficiently secure in terms of current accepted technological standards. Failure to comply with these security standards can render the website owner liable for any damages suffered due to the payment system not being adequately secure.

Are these policies binding?

Essentially, yes, website terms will be binding based on the principles of contract law. Website users must be made aware of the terms that apply to their use of the website and you should always ensure that you include wording to the effect that by anyone continuing to use the website they agree to the terms.

To this effect, web-wrap and click-wrap agreements come into play.

Web-wrap agreements

Web-wrap agreements (also referred to as browse-wrap agreements) are used to acknowledge the terms of use of a website by continuing to use the website. The user indicates acceptance of the terms by using the website and does not expressly indicate acceptance of the terms. Such agreements are usually used in browser terms and privacy policies.

Click-wrap agreements

Click-wrap agreements require the user of a website to indicate their agreement with the terms through positive action – usually by clicking “I accept” before proceeding with their activity on the website. These agreements are usually used for more important agreements, such as when installing new software on your computer or when entering into online transactions.

Conclusion

Even though all of these policies may seem excessive, they are worth having. Yes, copying and pasting clauses from other policies will get the job done, but you may leave yourself vulnerable to certain consequences that you haven’t thought about. These consequences may be even worse when it comes to commercial terms. Contact us for a free quote and ensure that your online business is fully protected!

Potential oversights of entrepreneurs – protection of intellectual property

Potential oversights of entrepreneurs – protection of intellectual property

Running a business is a tough ask of anyone – between maintaining cash flows, keeping customers happy, managing your employees and looking for potential investors (or dealing with current investors), there is a lot that can fall through the cracks. One of the things that is very easy to forget about, especially with the more modern, technology-heavy businesses, is the protection of your intellectual property (IP).

In the technology sphere, copyright law governs the development of computer software, which is much of what the entrepreneur of today is dealing with. As an entrepreneur, you may come up with a great idea that is going to be the next “Google”. So you call your business partner up and spend countless hours in the office and cups of coffee developing this new idea, whilst running your business at the same time. You come to the end of this, completely overworked, and you have produced the holy grail of products that is going to revolutionise the industry, and you own it, right…? Well, when considering this a little further, that may not be the case.

If your business is a company, you may be in for a surprise – it is probably the company that owns the product that you have just developed and not you personally. If that previous comment made you break out into a cold sweat, not to worry. Below are some factors that you should consider when developing a new idea as a director of or shareholder in a company:

• Did you use the company’s property or time to develop the product? As an example, did you use a company laptop and normal working hours to develop your new product?

• Is the product that you developed substantially similar to other products developed by the company or did you use the company’s software code to make your new product? As an example, if your company develops an app that is involved in data collection in agriculture and you develop an app that collects data in retail, it is likely that because of the common data collection thread, the products are substantially similar. It may also be likely that you “borrowed” some of the code from the previous app to make your new app.

If your answer to both or one of the above is “yes”, then your company probably owns the product that you just developed. This also should not be too much of a problem though. If you and your business partner (if you have one) are the only shareholders in the company, then both of you can just agree to transfer the product out of the company. The only difficulty comes in where you have investors looking for an opportunity to get a return on their investment.

It is not uncommon for investors to factor in protection against the company disposing of any property (including IP) without their consent, as they will almost always want a good return on their investment. You could be stuck in a situation where you have to share the fruits of your labour with the other shareholders in your company, which is not ideal.

A good way of avoiding this is, as soon as you are in the process of obtaining your first round of funding from your first investor(s), introduce a “pay-to-play” option into your company’s shareholders’ agreement. This will essentially provide that any new intellectual property that you are thinking about developing will be offered first to the company and then to any investor, provided that if they want a share in it, they must put some capital into the project, which project can, and should, be placed into a new company.

There are many more layers to this issue, but the long and the short of it is that you should always be wary of losing all your hard work due to a simple legal slip up.

Registering your company for VAT

Registering your company for VAT

WHY DO I NEED TO REGISTER MY BUSINESS FOR VAT?

Businesses, whether large or small, have a vital role to play as taxpayers in our economy. Any business (whether a CC, a company, a partnership or a sole proprietor) has various tax obligations it must meet. If certain conditions are met, it is required to register and pay value added tax (VAT) to SARS, which is the amount that is levied on the value of most goods and services, whether supplied by sale, rental agreement, instalment credit agreement or any other form of supply. The standard VAT rate is currently 14%.

Your business must register as a VAT vendor if its income earned in any consecutive 12-month period exceeds the prescribed threshold. If your income earned is less than the threshold, it may still be beneficial for your business to register on a voluntary basis – although this will add to your administration, you can then claim VAT back on your expenses (which is then deducted from the VAT you owe SARS).

WHEN DO I REGISTER MY BUSINESS FOR VAT?

Compulsory registration: It is mandatory for a business to register for VAT if the total value of the taxable supplies made in any consecutive 12-month period exceeded or is likely to exceed R1 000 000.

Voluntary registration: A business may also choose to register voluntarily for VAT if the value of the taxable supplies made or to be made is less than R1 000 000, but exceeded R50 000 in the past 12-month period.

VAT registration when the value of your taxable supplies is less than R50 000: Per the new VAT Registration Regulations, an enterprise which has not made R50 000 in taxable supplies in the past 12 months may still register for VAT if it can satisfy SARS that, as at the date of the application, the following circumstances exist:

  • where you have made taxable supplies for more than two months (but not exceeding 11 months), you must prove that the average value of taxable supplies in the preceding months prior to the date of application for registration exceeded R4 200 per month;
  • where you have made taxable supplies for only one month preceding the date of application for registration, you must prove that the value of the taxable supplies made for that month exceeded R4 200;
  • where you have not made taxable supplies yet, you must have a written contract, in terms of which you are required to make taxable supplies exceeding R50 000 in the 12 months following the date of registration;
  • in any other case, you have entered into a finance agreement with a bank, specified credit provider, designated entity, public authority, non-SA resident or any other person who continuously or regularly provides finance, wherein finance has been provided to fund the expenditure incurred or to be incurred in furtherance of the enterprise, and the total repayments in the 12 months following the date of registration will exceed R50 000; or
  • in any other case, you have proof of expenditure incurred or to be incurred in connection with the furtherance of the enterprise as set out in a written agreement or proof of capital goods acquired in connection with the commencement of the enterprise and proof of payment or an extended payment agreement evidencing payment has either exceeded R50 000 at the date of application for registration; or that it will in any consecutive period of 12 months beginning before and ending after the date of application, exceed R50 000; or will in the 12 months following the date of application for registration exceed R50 000.

HOW DO I REGISTER MY BUSINESS FOR VAT?

You can either elect to register your business for VAT yourself or you can make use of the services of a registered tax practitioner to handle the whole process for you. In both instances, the VAT 101 application form must be submitted to the SARS branch nearest to the place where your business is situated, together with the following supporting documentation:

  • if your business is operated through a company, certified copies of your company registration documents (i.e. CoR 14.1 Notice of Incorporation, CoR 14.1A Notice of Incorporation – Initial Directors, CoR 14.3 Registration Certificate, CoR 15.1A Standard Short Form MOI or custom-drafted MOI (as the case may be);
  • certified copies of the identity documents of all the directors / members / partners;
  • originally signed and stamped letter from the bank confirming the business account’s banking details;
  • latest original copy of the business municipal account;
  • if the business’ property is leased, a certified copy of the signed lease agreement;
  • latest three months’ bank statements; and
  • latest three months’ invoices to confirm income.

THINGS TO NOTE WHEN REGISTERING / PAYING VAT

  • For any sale of more than R50, you must issue a tax invoice (with the words “tax invoice” printed on it). This is the most important document in the VAT system so make sure you get it right.
  • The frequency with which you have to pay VAT to SARS depends on your “taxable period”. For businesses who file their returns and make payments electronically, VAT is due by the 25th day of the first month commencing after the end of the taxable period, while for businesses that file via eFiling, the due date is the last business day of the month after the end of the taxable period.
  • Failure to submit a VAT return at the end of each VAT cycle can lead to a business facing heavy penalties and interest on late submission.
  • You must keep your records for a period of five years from the date of the last entry in any book, as SARS can ask to see these records at any time within this timeframe.
The Art of the Exit: drags, tags and everything in between

The Art of the Exit: drags, tags and everything in between

In the world of venture capital funding, it’s easy for the role players involved (lawyers included) to make the mistake of losing sight of the other party’s objective in an intended funding transaction. There are a myriad of fears and expectations that need to be balanced and measured in order to formulate a funding and capital structure that speaks to the parties’ bespoke needs. It is therefore fundamentally important for investors and investee companies alike to appreciate the main objectives of the party on the other side of the term sheet. In this article we look at investors’ main aims. Hint: it’s not to get a free T-shirt with your company’s logo on it.

Some investors are genuinely driven to expose their cash and commit their expertise (at least in early-stage funding) by an interest in the business they are investing in and a desire to see the economy flourish as investee companies grow and generate economic welfare. This might be true in most cases, but even the most start-up friendly investor has one primary objective: to realise returns from their investment that matches the relative risk associated with the investment. Your uncle who waived his morning coffee to crowd-fund your potato salad (https://www.kickstarter.com/projects/zackdangerbrown/potato-salad) wants to know when he is getting his bite of the salad. That’s just how life works.

While this may be obvious to some, parties often fail to think “exit” when they start a journey together. It is important for both the entrepreneurs and investors as they seek to get a return on their investment (whether time, money or other resources) to understand and manage their exit strategies in order to strike a balance between their own aspirations and motivations on the one side and the stark commercial realities on the other.  It is therefore crucial to determine and negotiate the best exit strategies well in advance. In light of the above, this article will aim to provide an overview of the exit strategies commonly found in later stage Seed Round investments or Series A investments.

Difference between Seed and Series A investments

Seed Round (Series Seed)

A Seed Round is an early round of investment into a start-up entity which is meant to support the business until it generates its own cash or until it is ready to receive further investments as soon as it is cash-generative. Terms associated with Seed Rounds are usually still fairly simple and exit strategies are still relatively low priority in most of these transactions, although investors typically aim to be protected from negative events and benefit from positive events.

However, investors would typically subscribe for a different class of shares, which gives them certain preferential rights (senior to that of ordinary shareholders) when a liquidation event occurs in the company.

 

Series A

Series A investments are mostly made by astute and experienced venture capital firms. They are less flexible on their funding terms – for good reason. Venture capital firms are mostly structured as funds managed by persons or a separate entity (called a managing partner) on behalf of various investors in the fund (called limited partners). Limited partners can include high net worth individuals or institutional investors. The managing partners have a very clear and limited investment mandate and have an investment committee that are obliged to ensure that the firm invests on specific terms and has a clear exit strategy as to how the investment may be realised. For this reason, Series A funding is provided on more strenuous terms and includes various provisions aimed at securing and advancing the return on investment for the firm and eventually, the limited partners. All of these usually activate on an exit event occurring.

Like Seed shareholders, Series A shareholders subscribe for preference shares, but their shares will rank senior to ordinary shares and Seed shareholders when a liquidation event occurs. So if a liquidation event occurs, the liquidation preferences are paid first to Series A shareholders, then to Seed shareholders and then only will all the other shareholders participate in the balance on an as-converted basis.

Basic liquidation events

An exit on equity investments (such as Seed and Series A investments) will see the parties cashing in on the equity they own and receiving monetary reward (and hopefully some upside) for taking the initial commercial risk. The following methods are referred to as “liquidation events” in funding documents:

  1. transferring ownership of the investee company, business or other assets owned by the investee company to a third party (by way of sale of business, mergers, acquisitions or management/employee buyouts);
  2. listings or other offers of shares to the public by way of an Initial Public Offering (IPO); or
  3. by liquidating the company.

There are various ways in which each of the methods above can be applied to realise a return for shareholders. Liquidation is very rarely a feasible option, as there is simply too much value lost on liquidation costs. It therefore falls beyond the scope of this article.

Exit strategies: the good, the bad and the ugly

When considering liquidation events, it is important to consider who controls the occurrence of a liquidation event. In other words, who needs to approve an event before it can occur? This is often referred to as a “drag along” right. If the preference shareholders have the drag along right and can force an event without the ordinary shareholders’ approval, this might, on face value, seem like an effective exit strategy for the investors. However, in reality, this means that founders will not be motivated to grow the value of the company as investors can simply force a liquidation event that merely repays their liquidation preference. If the founders of the company (who usually hold ordinary shares) have the drag along right, this means that the Seed shareholders and Series A shareholders will be forced to accept a liquidation event if the ordinary shareholders approve it. This is not an ideal scenario either, as the preference shareholders are unlikely to receive any returns until the company has grown in value to such an extent that the ordinary shareholders receive a favourable return after payment of the liquidation preference to preference shareholders.

A good balance to strike is to require a high percentage of ordinary shareholders to approve a liquidation event (i.e. considerably more than majority), but then to give the preference shareholders the right to convert their preference shares to ordinary shares and vote accordingly. This means that there is no possibility of a sale at low value if the company is doing well as the drag along right is not held by the shareholders who have the liquidation preference rights. If the company is not doing well and raises funding at a lower valuation at some point (also called a down-round), the anti-dilution rights will enable the preference shareholders to convert to more ordinary shares in any event. This means that if a sale is done after a down-round, the preference shareholders will enjoy a higher participation in the liquidation event if they convert to ordinary shares.

If investors insist that provision is made for the approval of a majority of preference shareholders before a drag along is triggered, then you may want to provide for the liquidation preference to fall away once the company reaches a certain valuation. This still forces the liquidation event and allows Series A and Seed investors to get a return on their investment, but removes the hurdle of the liquidation preference. This ensures that founders are adequately incentivised to grow the value of the company and get the company to a favourable liquidation event that promises returns for all shareholders.

Other ways in which exits are achieved (especially in Series A funding) are as follows:

Co-sale rights: if a founder intends to sell his/her shares to a third party on favourable terms, he/she has to provide the opportunity for the Series A shareholders to convert a proportionate number of its Series A shares to ordinary shares and then tag along on the founder’s sale. The Series A shareholder has a put option to sell any portion of its converted tag along shares to the founder before the founder can proceed with the sale to the third party. This enables the Series A shareholders to exit when a key founder exits the company and forces the company to negotiate exit terms for the Series A shareholder. Depending on the circumstances this can be very restrictive to founders and founders should aim to negotiate a right for them to sell their shares to third parties by means of a gradual earn-out without triggering the co-sale right.

Registration rights: this is a right provided to Series A shareholders in Series A funding documents and is essentially a right (based on the registration of securities in terms of Rule 144 of the Securities Act of 1933 – USA) to either force the company to register the Series A shareholders’ preference shares (convertible to ordinary shares) if the company undergoes an IPO (called demand registration rights). An alternative to demand registration rights are “piggyback” registration rights, in terms of which a Series A shareholders have the right to register their shares with other shares if the company or another shareholder registers its securities. Both options have the effect that Series A shareholders will be entitled to sell their shares when the IPO is done. In the absence of that, they will have to wait at least a year before shares may be sold. Registration rights are usually quite standard and Series A investors are not upon for material negotiation. However, the cost of registering securities can be fairly significant, so from the company’s perspective the less severe “piggyback” registration rights are favourable.

Put option/redemption right: this is when the preference shareholders have a put option to sell their shares back to the company or force the company to redeem the shares and get their invested funds back if certain negative events occur. This is a good example of a provision that should be avoided at all cost. There are various reasons for that, one being that redemption rights for preference shares should always be handled carefully, as they may cause the preference shares to be classified as debt rather than equity, which may render the company insolvent in certain scenarios. It will also cause any dividends or other returns on the capital invested to be taxed as interest in the hands of the investor.

Exit rights are found in various shapes and sizes, especially in Series A transactions. It is very important to formulate an exit regime that strikes a healthy balance between the interests of all stakeholders in the company. This ensures that all the role players are incentivized to drive the company to a healthy exit with favourable returns for all involved.

Deciding on joining an incubator: the ins and outs

Deciding on joining an incubator: the ins and outs

WHAT IS IT?

A business incubator is a programme that helps new and start-up companies to grow, by providing an assortment of business support services, ranging from the potential provision of start-up capital (which may or may not involve the acquisition of equity in the start-up company), structured training and guidance on how to commercialise an idea and to develop a business out of it, operational support (data, phones, admin etc), networking activities, links to strategic partners and investors, marketing assistance and office space, amongst other things.

Unlike many business assistance programmes, business incubators do not serve any and all companies. Entrepreneurs who wish to enter a business incubation programme, must first apply for admission. Acceptance criteria vary from programme to programme, but in general, only those with feasible ideas and a workable business plan are admitted.

WHY SHOULD YOU JOIN AN INCUBATOR?

Focus: Joining a good incubator gives you incredible focus. You can make great leaps in realising and achieving your business goals.

Credibility: As a start-up business, it’s always a good idea to be affiliated with a well-known / prestigious institution, since investors will know that you have undergone a stringent selection process, giving investors more confidence in your ability to commit and deliver.

Administrative Support: The administrative side of the business, including basic bookkeeping and secretarial work, is taken away from you so that you can focus on developing your business.

Professional services: Incubators often have a wide range of support structures and professional networks which will be able to offer assistance that is suited to your business needs, ranging from legal to tax and even immigration.

Facilities: Joining an incubator offers advantages of being able to work (together with other entrepreneurs) in a professional atmosphere (rather than in your basement or garage for instance), which includes a shared office space, board rooms and access to computer and internet facilities.

Access to capital: All types of investors work with incubators, ranging from angels, seed funds, and venture capital.

Building your network: Connecting with fellow incubatee companies and the opportunity to interact with like-minded people presents an excellent shared space to work in. You get real life business people to review, critique and / or validate your business idea, allowing you to start off on a better footing than if you had no input or support.

Learning Opportunities: The more structured incubators will involve you in formal lectures and workshops, dealing with the most important elements of starting, funding, growing, and presenting a business to investors, customers and / or buyers.

WHAT SHOULD YOU WATCH OUT FOR?

The success of any business depends ultimately on the company being able to deliver on its goals, to develop the products and services people care about and the ability of the founders to adapt and innovate. An incubator will only take you so far. Although incubators are a good place to consider when starting out, different incubators have different requirements and goals of their own. An incubator is run just like any other business, and has specific goals which they want to achieve. Understand what that goal is and what they want from you, so that you are well-informed and know what is expected of you and what to expect of them.

Some incubators may really just be investment vehicles which use the incubator as an opportunity to find early stage businesses and create the opportunity to invest in them. The incubator will most likely want preferential terms, so be very careful to make sure you understand what these terms are and how they could affect the way another investor views your company. Good incubators add enough value to justify their equity stake in your company (rather than tagging along for a free ride). So, as with any investor, remember that their money is the least valuable contribution to your business and that they should add value strategically first!